STARBUCKS Earningcall Transcript Of Q2 of 2024
Narasimhan, chief executive officer; and Rachel Ruggeri, executive vice president and chief financial officer. This conference call will include forward-looking statements which are subject to various risks and uncertainties that can cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factors discussed in our filings with the SEC, including our latest annual report on Form 10-K and quarterly report on Form 10-Q. Starbucks assumes no obligation to update any of these forward-looking statements or information. GAAP results in third quarter fiscal year 2024 as comparative period include several items related to strategic actions, including restructuring and impairment charges and other items. These items are excluded from our non-GAAP results. All numbers referenced on today's call are on a non-GAAP basis unless otherwise noted or there is no non-GAAP adjustment related to the metric. As part of our non-GAAP results, revenue, operating margin, and EPS growth metrics on today's call are measured in constant currency, whereby current period results are converted into United States dollars using the average monthly exchange rates from the comparative period rather than the actual exchange rates for the current period, excluding related hedging activities. For non-GAAP financial measures mentioned in today's call, please refer to the earnings release and our website at investor.starbucks.com to find reconciliations of those non-GAAP measures to their corresponding GAAP measures. This conference call is being webcast, and an archive of the webcast will be available on our website through Friday, September 13, 2024. And lastly, for your planning purposes, please note that our fourth quarter and full fiscal year 2024 earnings conference call has been tentatively scheduled for Wednesday, October 30, 2024. And with that, I'll now turn the call over to Laxman. Laxman Narasimhan -- Chief Executive Officer Thank you, Tiffany, and thank you for joining us this afternoon. Let me start by laying out our results for this quarter. Our Q3 total company revenue was $9.1 billion, up 1% year over year and 6% over Q2. We -- our global comparable store sales declined 3% year over year, driven by a negative 2% comp growth in North America and a negative 14% comp growth in China and partially offset by strong performance in Japan. Our global operating margins contracted by 70 basis points to 16.7% and overall earnings per share for the quarter was $0.93. Our total company results were in line with guidance, but international performance, particularly in China, was challenged. We are not satisfied with the results, but our actions are making an impact. Leading business and operational indicators are trending in the right direction ahead of our financial results, and our runway for improvement is long. We see green shoots in our U.S. business driven by the three-part action plan outlined last quarter. First, meet and unlock capacity for new demand through a relentless focus and improvements to our U.S. store operations and on elevating the experience we create for our partners and customers; second, attract new customers and drive transaction growth by launching and integrating more exciting new products with relevant marketing, while maintaining our focus on core coffee forward offerings; and third, reach new customers and demonstrate our value by making sure customers believe that Starbucks Experience is worth it every time. First, our largest opportunity, meet and unlock capacity for new demand, a relentless focus on improving operational execution across our nearly 10,000 U.S. company-operated stores is the cornerstone of our near-term plan. While it is early days of progress, our plan is working. If you walk away from today's call with one thought, let it be the significant changes and long-term upside potential taking place within our U.S. stores and across our end-to-end supply chain to unlock growth, enhance the customer experience, and drive cost efficiencies. Within our stores, we've seen material positive momentum across core store health and performance metrics with notable improvements in partner scheduling and turnover, critical store issues, and inventory management. Stores ranked in our top two operational performance quartiles reached a new high during the quarter, a 28% upwards shift from Q2, but we have more opportunity. Our focus on operational excellence, driven by our reinvention plan has led to a multi-second year-over-year improvement in out-of-the-window times. The nearly 50% reduction in calls received by a customer contact center for "My order took too long" and Mobile Order & Pay and delivery uptime rates of 99%, these are key indicators of our work to drive growth by addressing customer wait times, product availability and the customer experience. This quarter, we also introduced Phase 1 of our Siren Craft Systems, which includes several process and partner-driven enhancements to our U.S. store operations. Changes include a new peak time play collar role, strategic investments in partner hours, training, new routines, simple enhancements to technology, and an evolved beverage build process. Early deployment across 1,200 stores demonstrated a material incremental improvement across key performance, throughput, efficiency, and reliability metrics. Encouraged by this, we fully deployed Siren Craft System's process improvements across our entire portfolio of U.S. company-operated stores this week. Later this quarter, we will begin rolling out a simple refit to our espresso machines, which we expect to improve espresso throughput by up to 15% without compromising quality. And with a minor software change in our store production systems, we have a similar ability to improve food throughput. When paired with Siren System equipment announced as part of our reinvention plan, these new processes become a force multiplier that we expect to drive a true step change improvement. Early assessments demonstrate the capability to drive a 10- to 20-second wait time reduction and a resulting comp opportunity range of 1% to 1.5%. Leveraging our Deep Brew analytics platform, we have identified customer experience outlier stores, approximately 10% of our network, and have developed targeted plans to address and improve them, including accelerated Siren System deployment. Similarly, we are accelerating the pace of our new store builds and renovations with 580 net new bills and more than 800 renovations planned in North America for FY 2024. We -- Store development efforts are focused on Tier 2 and Tier 3 cities, where we see population growth and forecast both underserved demand and high incrementality. Increasingly, these new store builds and renovations also include Siren system equipment. In line with prior guidance, we remain on track to deploy equipment in less than 10% of company-operated stores by the end of FY 2024 and about 40% by the end of FY 2026. Building on our pilot, Starbucks and Gopuff have agreed to terms for an expanded relationship to open 100 delivery-only kitchens across the U.S. We're also accelerating the rollout of digital storyboards with target deployment across most U.S. stores in the next two years, a year earlier than originally anticipated. Lastly, we're working on other ways to enhance the cafe experience. This includes new and expanded seating options that elevate many stores while upholding a safe and inviting place for partners and customers. A key outcome of our operational efforts has been material and sustained improvements to the partner experience. Driven by precision partner-centric staffing and scheduling efforts, we ended the quarter with a new post-pandemic low partner turnover rate. The best shift completion rate in two years and a 13% improvement in average hours per partner, now the highest on record. These initiatives create more stability in our stores, provide more predictability for our partners, and sustain our experience flywheel. Looking beyond our stores, we continue to realize new efficiencies, cost savings, and performance improvements across our end-to-end supply chain, thanks to strong support from our suppliers, and we see even more headroom. We have a structured process to realize significant continued improvements across our end-to-end supply chain. We are ahead of plan on productivity. We expect our productivity to drive efficiency and unlock capital from areas that don't touch the customer. In turn, these savings will enable us to target investments that drive value for our customers beginning later in Q4, reigniting our North America flywheel for growth. We're early days on this journey, building both our strategic sourcing and revenue management capabilities. Our second priority is to drive demand through relevant product innovation of coffee at our core. We've seen meaningful improvement here as well. This quarter, we drove traffic into our stores through an engaging and innovative pipeline of products, supported by integrated marketing campaigns. Core share was up 1% year over year, representing 76% of our beverage mix through the quarter. Our newly formulated iced coffee received positive feedback. Our strength in cold espresso innovation continued to drive the platform's growth, up 4% year over year. And we launched Starbucks Milano Duetto whole bean coffee in Milan ahead of a global launch this October. Beyond coffee, our new Summer-Berry Starbucks Refreshers, beverages with Pearls drove the highest Week 1 product launch in our history. Their success buoyed the entire Starbucks Refreshers beverage platform to an all-time high during the quarter. As mentioned in Q2, we continue to build out our 24-month product pipeline while accelerating our pace of innovation. For example, recognizing the growing appeal and opportunity created by the energy category, we launched a new handcrafted Iced Energy beverages across our U.S. stores in just three months compared to a normal 12 to 18. Looking forward, we believe our Q4 product offerings, including the return of Pumpkin Spice, combined with supporting marketing activities and offers provides the right formula to drive customer interest, demand, and deeper engagement with both new and existing customers. Our third and final near-term priority is to reach new customers and demonstrate the value we offer by ensuring the Starbucks experience is worth it every time. Recognizing the premium position of our brand we've been measured in our use of offers. During this quarter, only 14% of our transactions were driven by offers compared to a competitive average of 29%. And of offer-driven transactions, 10% was star-based offers targeted to Starbucks Rewards members. Only 4% were driven by price-based offers. Our best offers are in the app. Together, offers and other integrated marketing activities, when paired with exciting product innovation, successfully grew Starbucks Rewards membership, reactivated many lapsed toward members, and drove customer traffic on promotional days and product launch weeks. Active U.S. Starbucks Rewards members grew to 33.8 million during the quarter. Members across every decile increased the frequency of their visits. We're focused on the continued growth of the program because the average active member spends materially more annually and drives a higher lifetime value for the business than a nonmember. Research also tells us that most inactive Starbucks Rewards members don't realize they've lapsed. This demonstrates a continued opportunity to drive return visits, active member growth, and deeper customer loyalty. Looking forward, we will continue to use more targeted offers coupled with select pricing actions, funded by efficiency initiatives to drive traffic and conversion. We plan to leverage a mix of paid media acquisition and retention, offers disruptive signage and partner education to drive transactions, and increase the frequency of visits with a focus on product launches and continued Starbucks toward member growth. It's worth remembering the ubiquity of the Starbucks brand and our ability to intercept customers. For instance, our business is up 13% in airports and up 9% in hotels, pointing to these trends, leveraging our brand and our ability to intersect customers while demonstrating value, not just in price, but with the premium experience, remains a sizable opportunity across our entire store portfolio. Moving on to digital. As part of our action plan, we made continued improvements to our Starbucks app, including wait time algorithm enhancements that have improved order-ready accuracy by nearly 50 percentage points. This combined with in-app offers helped drive a 10% year-over-year growth in Mobile Order & Pay revenue and a 7% year-over-year increase in MOP transactions. Looking deeper, our data shows that one in four non-Starbucks Rewards members want the ability to use mobile order pay. Nearly 80% of those customers don't want to join a rewards program or create an account to do it. In response, we opened MOP for all to provide those customers the convenience they see while removing perceived barriers to entry. We believe these enhancements to the digital experience, coupled with more effortless ordering will continue to drive Starbucks toward membership over time with customers increasing frequency and spend. Once customers are in our digital ecosystem, they're more likely to remain engaged across channels and drive greater lifetime value. In summary, our plans are beginning to work. We're recovering our brand from its perceptions. We're rebuilding the operational foundation of our stores and supply chain. We're reducing costs to support investments with sustaining partner experience improvements and we're working to make the Starbucks experience worth it every time. While it's early days, I'm confident in the trajectory of our U.S. business and the operational improvements we're making, and I'm reassured by the impact our work is expected to deliver in FY 2025 and beyond. Looking outside the U.S., we continue to see weakness in parts of our international business and strength in others. Headwinds persist in the Middle East, Southeast Asia, parts of Europe, driven by widely discussed misperceptions about our brand. In some European markets, consumers are stretched. At the same time, we see significant strength in markets like Japan and parts of Latin America. China is one of our most notable international challenges and an area I'd like to talk about in more detail. The competitive market dynamics in China are reflected in our recent results. We've continued to face a more cautious consumer spending and intensified competition. In the past year, unprecedented store expansion and a mass segment price war at the expense of comp and profitability have also caused significant disruptions to the operating environment. Still, we have made progress in important areas. Through Q3, metrics like average daily transactions, weekly sales, and operating margin improved sequentially quarter over quarter. Starbucks Rewards members grew by 1.6 million to a record-high 22 million active members. And customer connection scores reached a new high, while partner turnover reached a new low. We've built an amazing business in China over the past 25 years, a business for China built by an outstanding local team. We've pioneered the growth of the premium coffee industry in market with our Starbucks and Starbucks Reserve brands and brand equity remains distinctive. We are incredibly committed and expert partners with an unmatched depth in coffee and craft. Our stores are distinctive and industry-leading, and our supply chain is world-class. New stores have expanded our presence to more than 900 county cities and continue to drive exceptional cash-on-cash returns and a payback of less than two years. We're looking beyond near-term challenges and toward long-term opportunities in the market. We built Starbucks in China around three principles. A great customer experience is grounded in a great partner experience. Our coffee will always be distinctive and high quality, with low penetration relative to other markets, which provides continued headroom. Our beautiful stores will celebrate the culture and traditions of China and their local communities. Even in a challenging market, we have stayed true to these principles and our relative premium positioning. This is reflective in the competitive margins we have sustained in the face of price competition. Over the past 25 years, we've gone through different phases of growth in China and have relied on different strategic partnerships to grow our business and capabilities, like joint ventures and strategic partnerships in technology, real estate, and supply chain. As we look forward, we see higher growth and margin opportunities in China. We're building the next generation of Starbucks, grounded in our premium brands and with a business that is even more digital innovative, and locally relevant. To do so, as our strategy evolves, we are in the early stages of exploring strategic partnerships to further enhance our competitive position to accelerate growth and innovate to win in the long term in China. We remain completely committed to our business and our partners in China, for the next 25 years and beyond. The long-term opportunity for us is significant. Before I close, I would like to confirm that Elliott Management is a shareholder in our company, and our conversations to date have been constructive. On the business, my continued confidence is rooted in the focus, energy, and effort of our partners across the business and around the globe. Our growing culture-focused innovation and relentless execution continues to enhance our capabilities, operational muscle, and executional discipline, driving forward our action plan and our long-term Triple Shot strategy while helping return the business to sustainable algorithmic growth. And with that, I'll turn this over to Rachel. Rachel Ruggeri -- Executive Vice President, Chief Financial Officer Thank you, Laxman, and good afternoon, everyone. As Laxman shared, we're seeing progress against our three-part action plans. Additionally, our efficiency efforts, which are tracking ahead of expectations, partially offset investments associated with the cautious consumer environment. With continued focus on our action plans, efficiency efforts, and disciplined operational execution, we expect progress as we close out the year. With that, let me turn to our results. Our Q3 consolidated revenue was $9.1 billion, up 1% from the prior year, demonstrating sequential revenue growth quarter over quarter, consistent with what we guided. Revenue growth over the prior year was driven by 8% net new company-operated store growth, partially offset by a 3% decline in comparable store sales from a 5% decrease in transactions and a 2% increase in average ticket as we continue to navigate through a value-driven consumer environment. U.S. led the average ticket increase of 4%, driven by pricing and multi-beverage orders. The increase in average ticket in the U.S. reflects how our innovative products and thoughtful promotions resonated with customers in our quest to offer enhanced value, indicating that our action plans are starting to take hold. Shifting to transactions. U.S. posted a comparable transaction decline of 6%, primarily driven by non-SR members. Across SR customers, as Laxman shared, we saw improved frequency across all deciles. Mobile Order & Pay in the U.S. remained strong in the quarter with positive year-over-year total transaction growth of 7% as customers continue to value both the experience and convenience of the Mobile Order & Pay channel. As we open our app for all with MOP guest checkout, which launched earlier this month, we expect to create and deliver value across a broader population, expanding our universe of known customers to deepen engagement, driving increased frequency and spend. In addition to strong SR program growth in the U.S., we saw strong SR program growth in China. SR members grew to a record 22 million 90-day active members in China, and in June, we also enhanced the program through extending rewards and introducing new diamond tier, which provides exclusive benefits to our most loyal SR members. We're pleased with the SR member growth across both the U.S. and China and expect to see the benefit from this growth in future quarters as new members provide a longer-term benefit. Shifting to margin. Our Q3 consolidated operating margin contracted 70 basis points from the prior year to 16.7%, primarily driven by increased promotional activities, investments in store partner wages and benefits as well as deleverage. The contraction was partially offset by pricing and our continued execution against reinvention-related in-store operational efficiencies as well as out-of-store efficiencies, which primarily center around our supply chain. As you've heard Laxman discuss, we're focused on improving operational execution and efficiencies, and -- which is now more important than ever as we build resiliency in our business. Our efficiency efforts are built on creating sustainable improvements in our operations and end-to-end supply chain, allowing us to both reinvest in our business and drive margin expansion. A testament to these efforts includes the achievement in excess of 200 basis points in year-over-year efficiency gains as of Q3 and -- across both in-store and out-of-store areas, manifesting through our business and reduced store operating expenses and product and distribution costs, respectively. Collectively, these line items represent approximately 85% of our annual spend. Our in-store focus, a combination of efficiencies and staffing and scheduling as well as enhancements in our store equipment and new store format design, has fueled a reduction in partner turnover, creating greater stability in our stores. We believe that stability not only creates opportunity to nurture stronger connections with customers but also increases productivity, which translated to roughly 110-basis-point improvement in store operating expense in the quarter. Our efficiency focus also extends outside of the store, as we've been taking a hard look across our supply chain and other areas, including G&A. As Laxman shared, we're working collaboratively with suppliers to identify opportunities to leverage our scale for cost reductions without compromising product quality or distribution timeliness, which led to meaningful savings in the quarter of approximately 100 basis points between rebates and rate savings. In addition, we believe our end-to-end supply chain focus gives us the opportunity to increase inventory availability with the right products at the right time, enhancing the customer experience while reducing waste. As we've shared G&A was elevated at more than 7% of revenue through Q2 as we have deliberately invested in resources to continue to grow our technology capability. We have, however, reduced G&A in Q3 and expect it to remain closer to 6% of revenue in the second half of this fiscal year as we balance investments for our long-term growth. When considering our progress this fiscal year, our in-store and out-of-store year-to-date efficiency efforts collectively amounted to nearly 300 basis points of margin improvement. Our significant efficiency runway coupled with sales growth, gives us confidence to drive margin expansion over time. Given this, we have ample opportunities to deliver above our initial goal of $3 billion, driving to $4 billion in efficiencies over the next four years. Q3 EPS was $0.93, down 6% from the prior year. The decline was driven largely by the cautious consumer environment, which in response drove increased promotions and marketing in the quarter, partially offset by our efficiency efforts. Additionally, our higher effective tax rate had a $0.03 unfavorable impact driven by fewer discrete items relative to the prior year. With segment results being discussed in detail in today's Q3 earnings release, I'll now touch on our capital allocation and financial resilience and then move into guidance. As a reminder, our disciplined approach to capital allocation continues to drive financial flexibility, allowing us to continue to make the necessary investments in our business to drive long-term growth. Our new stores continue to be a meaningful part of our growth equation with approximately 85% of our capex allocated to our stores, both new stores and renovations. These high-return growth-oriented investments have superior economics while adding incrementally to our business. Even with over 16,700 stores across the U.S. and another 7,300 in China, we have abundant white space ahead, particularly as populations continue to move to more suburban and rural areas. Take a Tier 3 market in U.S., for example. a place like Joplin, Missouri. A drive-thru in that market boasts a Year 1 ROI in excess of 65%, with cash margins approaching 30% and a payback period of less than two years. Year 1 AUVs reach approximately 2 million with opportunity ahead as we build out the trade area. Importantly, our new store revenue is highly incremental, adding an average of nearly 90% to the trade area attained by our world-class store development partners and the rigorous work that leverages AI-assisted strategic site selection process. We see that in China as well. Take a New County City, for example. We're in only about 900 of the nearly 3,000 across the market. Today, we see Year 1 ROI as high as 70% with cash margins averaging over 30% as we've successfully managed both store development and operating costs even in the current macroeconomic backdrop. We believe this is a great investment and accretive to shareholder value, building out the long-term opportunity. With our disciplined approach to capital allocation, underpinned by our strengthening store portfolio, we are reinforcing our financial resilience, while remaining committed to our compelling dividend. We continue to target an earnings payout ratio of approximately 50%, near the top end of growth companies of our size and scale, resulting in a significant portion of our earnings going directly back to our shareholders. And currently, we have maintained a leverage target below three times lease-adjusted EBITDA, ensuring a strong financial foundation and consistent with our investment-grade credit rating of BBB+, which allows us to continue to access capital efficiently. Collectively, our disciplined approach enables us to preserve both balance sheet strength and flexibility, positioning us to successfully navigate through the current macroeconomic environment. Moving to our fiscal year 2024 guidance. We are encouraged with our progress this quarter, and we're pleased to reaffirm all metrics of our full-year 2024 guidance. Our confidence is underpinned by the result of our action plans, coupled with the continued efficiency unlocked both in and out of store. In summary, here are key takeaways from my discussion today. First, we are seeing progress against our action plans. Second, our efficiency efforts partially offset investments associated with the cautious consumer environment. Third, we believe our financial fortitude and disciplined capital allocation strategy positions us well for the long term. And last, our full-year 2024 guidance remains intact. Before I close, I want to acknowledge all of our partners across the globe, working tirelessly each and every day to elevate the Starbucks experience in our stores, at our roasting plants, and in our support centers, you are and always have been our superpower. Thank you, partners. And with that, we'll open the call for questions. Operator? Operator Questions & Answers: |
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