Starbucks Corporation
Q3 2020 Earnings Call Transcript

Published: 29 Jul 2020

[Operator:]

Good afternoon. My name is Hector, and I will be your conference operator today. I would like to welcome everyone to Starbucks Coffee Company’s Third Quarter Fiscal Year 2020 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

[Durga Doraisamy:]

Good afternoon, everyone, and thank you for joining us today to discuss our third quarter fiscal year 2020 results. Today’s discussion will be led by Kevin Johnson, President and CEO; and Pat Grismer, CFO. And for Q&A, we will be joined by Roz Brewer, Chief Operating Officer and Group President Americas. This conference call will include forward-looking statements, which are subject to various risks and uncertainties that could 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 factor discussions in our filings with the SEC, including our last Annual Report on Form 10-K and quarterly report on Form 10-Q. In addition, we estimate the impact of COVID-19 by comparing actual results to our previous forecast. These forecasts were created prior to the spread of the virus were based on information available at the time and on a variety of assumptions, which we believe were reasonable, but some or all of which may prove not to be accurate. Starbucks assumes no obligation to update any of these forward-looking statements or information. GAAP results in fiscal 2020 include several items related to strategic actions including restructuring and impairment charges, transaction and integration costs and other items. These items are excluded from our non-GAAP results. For certain non-GAAP financial measures mentioned in today’s call, please refer to our website at investor.starbucks.com to find the corresponding GAAP measures as well as a reconciliation of these non-GAAP financial measures with their corresponding GAAP measures. This conference call is being webcast and an archive of the webcast will be available on our website through Friday, August 28, 2020. Finally, for your calendar planning purposes, please note that our fourth quarter and fiscal year 2020 earnings conference call has been tentatively scheduled for Thursday, October 29, 2020. I will now turn the call over to Kevin.

[Kevin Johnson:]

Well, good afternoon, and welcome. Thank you for joining us today. It’s been three months since our last earnings call as the entire world, all of humanity has been navigating the COVID-19 pandemic through this very dynamic and challenging period. In times of adversity, values matter. And I’m very proud of how Starbucks partners around the world have responded during this global pandemic.

[Pat Grismer:]

Thank you, Kevin, and good afternoon, everyone. I will start by echoing Kevin’s appreciation for all Starbucks partners who have worked tirelessly to deliver safe, convenient and familiar experiences for our customers and to support our communities under very challenging circumstances. They are the heartbeat of our company and our inspiration. Although the impacts of COVID-19 weighed heavily on our Q3 financial results, we are encouraged by the fact that our sales and profits across all our operating segments recovered more quickly than we expected, and that our very strong balance sheet has allowed us to make significant and important investments in the business for the long-term, while weathering the pandemic. For the quarter, Starbucks reported global revenue of $4.2 billion, down 38% from the prior year. We estimate the COVID-19 impact on consolidated revenue to be approximately $3.1 billion, primarily due to temporary store closures, restricted sales channels, shortened operating hours and reduced customer traffic. Non-GAAP EPS in Q3 was a loss of $0.46, down from a profit of $0.78 in the prior year inclusive of an estimated $1.20 negative impact of COVID-19, which includes flow through on the revenue impact that I noted earlier as well as significant investments that we made in response to the pandemic, which I will outline later. Non-GAAP EPS was considerably better than the preliminary guidance range that we provided in our 8-K on June 10, driven by better than expected sales and margins. I will first provide some highlights of segment operating results and consolidated margin performance for Q3. I will then discuss our guidance for Q4 and fiscal 2020, followed by a preliminary perspective on fiscal 2021. At $2.8 billion revenue for our Americas segment was 40% lower in Q3 than the prior year, largely due to a 41% decline in comparable store sales, including minus 40% in the U.S. We estimate the decline in Americas revenue and operating income attributable to COVID-19 in Q3 to be approximately $2.3 billion and $1.5 billion respectively. This equates to a flow through rate on lost sales of approximately 65% for Q3, which was a significant improvement from Q2, but still materially higher than the 50% variable flow through rate that we typically observe in our business, primarily due to incremental partner support costs, net of certain government stimulus program benefits as well as incremental store operating expenses. Importantly, both sales and profitability trended positively across the quarter with sequential improvements in each month and comparable store sales were towards the better end of our guidance range. The U.S. business posted a comparable sales decline of 19% in June, improving from minus 43% in May, restoring the business to positive profitability for the month. Moving on to International. The segment’s comparable store sales declined by 37% in Q3 relative to the prior year, but exceeded the expectations we shared last month, primarily driven by Japan’s faster than expected pace of sales recovery, boosted by successful seasonal product promotions. The segment’s comparable store sales in Q3 also reflect a 2% benefit related to temporary value-added tax or VAT exemption in China. This benefit was largely offset by traffic softness that emerged in Beijing in the last two weeks of the quarter due to a resurgence of COVID-19 in that city. For the month of June, China’s comparable store sales declined 16% after excluding an 8 percentage point VAT exemption benefit, about half of which was related to a true-up for the first two months of the quarter. This was a notable sequential improvement to May’s comp on a like-for-like basis. For the third quarter, China’s comparable store sales declined 19% including VAT favorability of 4 percentage points. International’s revenue of $950 million in Q3 was a 40% reduction versus the prior year, primarily due to the 37% decline in comparable store sales. Also contributing to the decline were lower product sales to our licensees as a result of lost sales related to the COVID-19 outbreak as well as temporary royalty relief that we granted our international licensees. And there was an additional 2% revenue dilutive impact of transitioning our Thailand business to licensed operations last year. These adverse year-over-year revenue impacts were partially offset by net new store growth of 9% over the past 12 months. We estimate that the COVID-19 impact to decline in International’s Q3 revenue and operating income with approximately $760 million and $420 million respectively. The improvement in International’s flow through rate on lost sales up roughly 55% in Q3 from 60% in Q2 was attributable to favorable items unique to the period, primarily temporary government relief programs, the temporary extension of China loyalty program benefits during the pandemic and limited time rent concessions in both China and Japan. On to Channel Development. Revenue was $447 million in Q3, a decline of 16% from the prior year. When normalizing for the 21% unfavorable impact of lapping, Global Coffee Alliance transition-related items that benefited the prior year, including higher inventory sales as Nestle prepared to fulfill customer orders, Channel Development’s revenue grew 5% in Q3 over the prior year. The growth was driven by strong packaged coffee and single serve product sales, offsetting the adverse impact of COVID-19 on the segment’s foodservice business. Channel Development’s non-GAAP operating margin was 35.6%, an improvement of 120 basis points over the prior year. Normalizing for the 460 basis point impact of the transition activities I just mentioned, Channel Development’s non-GAAP operating margin contracted 340 basis points in Q3. The contraction was due primarily to a business mix shift within Channel Development as well as deleverage on fixed coffee manufacturing costs shared across the company’s operating segments driven by lower retail production volumes, resulting from COVID-19. At the consolidated level, non-GAAP operating margin was minus 12.6% in Q3, down from 18.3% in the prior year. As you would expect, much of the year-over-year reduction in our operating margin was due to sales deleverage as well as incremental expenses to provide a safe experience in our stores, all related to the impacts of COVID-19. We estimate this to be approximately 80% of the margin decline. The remaining 20% primarily reflects substantial and very intentional investments that we are making in the brand and to build trust with key stakeholders, recognizing that these relationships are an essential part of our brand and critical to our ability to not only recover from the effects of the pandemic, but also to strengthen our competitive position for long-term growth. These investments totaled approximately $350 million in the quarter and were focused on three key areas. First, we invested in our partners as they are critical to the Starbucks experience and instrumental to our long-term success. For most of the quarter, including during the period of extensive store closures, we provided our partners with salary, wage and benefits continuation as well as temporary premium pay in the U.S. and Canada for those who work on the front lines of our business and enhanced assistance related to personal care and well being, net of subsidies from certain government stimulus program benefits. This represented about 85% of our total investments for the quarter. Second, we supported our international licensees who are our partners in driving long-term growth globally by temporarily extending more flexible development terms and royalty relief. And third, we helped several strategic suppliers weather this crisis with certain accelerated payments in effect through July. And by honoring minimum supplier commitments during periods of depressed sales volumes so they can sustain the supply of our proprietary products and services in support of our ongoing product innovation. We are fortunate that the scale of our business and the strength of our balance sheet enabled us to invest as we did consistent with our mission and values as a company, while positioning us well for the future. Our $3 billion bond issuance in May enabled us to fund these investments, cover our capital expenditures, pre-fund next year’s bond maturities at attractive rates, and of course, sustain our quarterly dividend payments, honoring our commitment to shareholders. Importantly, as we exited Q3, we were cash flow positive with upward momentum, setting us on a solid path to reduce our financial leverage in future quarters. Moving on to our outlook for Q4 and fiscal 2020, starting with the metric that, in our view, defines recovery for our retail business comparable store sales growth. Globally, we expect comparable store sales for Q4 and for fiscal 2020 to decline between 12% and 17%, demonstrating sustained sequential improvement, including across both of our key markets of the U.S. and China. We also expect Americas and U.S. comparable store sales to be down 12% to 17% for Q4 and for fiscal 2020. While the recent flare-ups of COVID-19 in several parts of the U.S. underscore the persistent uncertainty in our operating environment, we expect continued improvement in our U.S. business in Q4, bolstered by the focused actions that Kevin described in relation to our contactless customer experience, digital capabilities and beverage innovation. Currently, with modified operations and limited cafe seating in nearly 40% of our stores as well as 4% of the portfolio remaining closed, we estimate that our fiscal July comparable store sales for U.S. company-operated locations will be approximately minus 14%, a sequential improvement from the minus 19% that we delivered in June even as we dialed back some of our U.S. operations in response to some regional COVID-19 flare-ups. Moving on to our International segment. With the expectation of COVID-19 impacts continuing to ease in the fourth quarter, particularly in Japan, we now expect International’s comparable store sales to decline between 10% and 15% in Q4, including a 3% favorable VAT impact. For China specifically, we expect Q4 comparable store sales to range between flat and minus 5%. Although this is generally in line with our previous guidance and now reflects both a new tailwind and the new headwind, the new tailwind is the temporary VAT exemption, which I mentioned earlier, benefiting China’s fourth quarter comp sales growth by about 4 percentage points. The new headwind is a combination of factors. First, COVID-related emergency response measures in Beijing where Starbucks currently has over 360 locations. And second, a prolonged slowdown in international and domestic travel, impacting Starbucks locations at China’s airports and tourist venues. For the full fiscal year, we expect China’s comparable store sales to decline in the range of 15% to 20%, including a 2% favorable VAT impact. And for International, we expect full year comparable store sales to decline in the range of 20% to 25% in fiscal 2020, including a 1% favorable VAT impact. As an indication of a continued recovery that we’re seeing in this business, we estimate that China’s comparable store sales growth will decline approximately 12% to 14% for the month of July when excluding a 4 percentage point benefit from the temporary VAT exemption. This is sequentially better than June’s results when China’s comparable store sales growth declined 16% when excluding VAT favorability at 8 percentage points. We expect the VAT exemption will expire at the end of December. Finally, Channel Development. This segment’s revenue is expected to decline between 5% and 6% on a reported basis for the full year and fiscal 2020, relative to the prior year as we lap certain transition items related to the Global Coffee Alliance that benefited the segment’s top-line growth in fiscal 2019. Adding it all up at the enterprise level, globally, we expect revenue to decline between 10% to 15% in Q4 versus the prior year, primarily reflecting the negative impact of COVID-19, which we estimate to range between approximately $1.4 billion to $1.65 billion. We estimate the operating income decline related to COVID-19 to be approximately $850 million to $1.1 billion globally, reflecting a flow through rate of roughly 60% to 65% on lost sales in Q4. This is roughly comparable to the flow through rate that we delivered in Q3 as we expect improved sales leverage in Q4 will be offset by the absence of non-recurring margin benefits that we realized in Q3. With continued sales and margin recovery, we currently expect the business will return to profitability in Q4 with EPS improving very meaningfully compared to Q3. We now expect GAAP EPS in Q4 of $0.06 to $0.21 and non-GAAP EPS of $0.18 to $0.33. This current outlook for Q4, coupled with our better than expected results in Q3, yields a rates to our full year expectations for EPS in fiscal 2020 compared to our prior forecast. We now expect GAAP EPS in fiscal 2020 of $0.50 to $0.65 and non-GAAP EPS of $0.83 to $0.98. Now I’d like to share some perspective on our U.S. and China recovery curves going forward. Based on what we’ve learned as we’ve navigated the impact of COVID-19 for the past six months as well as the innovations and growth that we planned for next year, and barring any new major and sustained waves of infection and/or global economic disruptions, we anticipate that comparable store sales will substantially recover in China and the U.S. in fiscal 2021 by the end of our first quarters and second quarters respectively. Additionally, we expect that margin recovery for each business will trail sales recovery by about two quarters. As we believe we are now past the depth of the pandemic and are on a steady path to full recovery, and as we successfully bridged our liquidity needs, we will now return to our normal cadence of investor updates and look forward to sharing our continued progress with our fourth quarter earnings report in October. In summary, Starbucks sales and profits are recovering nicely. Our liquidity position remains strong and continues to improve. And we are continuing to invest in growth and the future of our business. It has been a very challenging quarter for Starbucks, as it has for many other businesses, but we believe the worst is behind us. We’ve developed a new level of agility and resilience for the future. The considerable investments we have made in our partners and other stakeholders, which honor our company mission and values combined with evolving our store portfolio, leave us as confident as ever in a unique strength and appeal of our brand and position us to unlock the full potential of Starbucks. And with that, Kevin and I are happy to take your questions joined by Roz Brewer, as Durga outlined at the top of our call. Thank you. Operator?

[Operator:]

Thank you. Your first question comes from the line of Jeffrey Bernstein with Barclays. Please proceed with your question.

[Jeffrey Bernstein:]

Great. Thank you very much. Just looking to talk a little bit about the broader outlook from a consumer perspective. It seems like on the heels of COVID, most consumers and investors alike seem like we are entering a recession. So couple of questions related to that. I’m just wondering if you could talk about your performance a dozen or so years ago and why maybe the brand better insulated this go around, maybe comparing and contrasting the U.S. versus China? And then just to clarify, I think you mentioned that the China comps you expect to substantially recover by the end of fiscal 1Q, perhaps a little bit of a delay from I think you were previously saying by the end of the fiscal fourth quarter. I’m wondering whether you’re seeing any signs of a China consumer slowdown at all in recent weeks? Thank you very much.

[Kevin Johnson:]

Yes. Jeffrey, this is Kevin. I’ll take your questions. First of all, I’ll start with your second question, China. I think as we see a resurgence of cases, similar to what we’ve seen in Beijing, that causes a little bit of – that’s what’s caused a little bit of the delay by a quarter in China. Not significantly, it’s about, I’d say, four or five weeks and now Beijing is back on a positive trajectory. But because it was such a large market, I think that’s what’s slowed it down. But it has nothing to do, in my opinion, with the – anything related to the economic. It was more – it’s more just as a resurgence happens in a large market like that that we – when it happens like that, we’re able to sort of turn the dial back slightly on the range of customers’ experiences we serve through to the principles that we outlined and we help support government and local health officials as they contain the spread of the virus. They successfully have done that Beijing. And so then we start turning the dial backup and opening up those customer experiences. And I think that’s a very positive thing because I think as a company, we’ve now taken this playbook that was developed in China and adapted for the U.S. and we basically have embedded it into our store protocols and our operating procedures. So that in 32 stores around the world, if there happens to be a flare-up in a certain city or a certain portion of a market, the stores in that market has the agility to basically turn the dial down if they need to or turn it back up if things are recovering. And that puts us in a position of confidence in how we can continue to navigate the global pandemic as it evolves. And so that was the contributing factor in China. In terms of recession, I’ll leave the predictions of economic growth to the economists. But what we’ve seen is continued demand for Starbucks. In fact, you look at what we’ve outlined. The number one thing we can do to continue to grow our same-store comps and the recovery is basically increase the throughput in the channels that are safe, familiar and convenient. And that’s why, for example, we’re deploying these handheld point-of-sales. I don’t know how many of you have seen a drive-thru, Starbucks drive-thru. There is typically cars lined up and often times out into the street. So where we deploy this handheld point-of-sale, we can now have a Starbucks partner out there taking orders walking through that line of cars, which is going to dramatically increase the throughput at drive-thru. Similar, enabling curbside will open up more customer occasions for us to continue to drive more transactions into our stores. And so I think based on what we’re seeing in terms of the demand and by being able to increase throughput in those channels that are viewed as safe and convenient by our customers, that’s going to help us on the recovery curve. In terms of should recession – recessionary period start to hit, I think we’ve differentiated ourselves. We’ve got lots of points of presence. We’re serving customers. I think the brand is strong. Our digital reach is strong. And I think we’re well positioned to navigate anything that might come our way.

[Pat Grismer:]

Jeffrey, this is Pat. One thing I would say to build on what Kevin has said is that if you compare Starbucks today to where we were during the last economic recession. Today, we have an industry-leading digital platform and a rewards program that didn’t exist back in 2008, 2009. And that’s an important part of competitive advantage and gives us more resilience today compared to 10 years ago.

[Operator:]

Your next question comes from the line of Sara Senatore with Bernstein. Please proceed with your question.

[Sara Senatore:]

Hi, thank you. I just wanted to ask a bit about the guidance, if I could. You said that sales and operating profits recovered more quickly than expected. But to me, it looks like the big difference is more on the profit line with the comps this quarter kind of pretty consistent maybe with guidance. I was just curious, basically what the – why there was sort of better than expected flow through considering how much of it was a function of discretionary investments? And then if I look at 4Q, just trying to understand again the comps actually maybe the midpoint of the same or a bit lower in most markets, but are you being conservative again on the EPS? Just trying to understand, there’s a lot of moving parts. But if I sort of reconcile the top-line versus the EPS, it seems like there has been a little bit of a disconnect this quarter, and I’m trying to figure out if that will happen again in 4Q or even next year since you’ve said that profit recovery might lag top-line? Thanks.

[Kevin Johnson:]

Thanks, Sara. Pat, do you want to take that one?

[Pat Grismer:]

Yes. Thank you, Sara. So in relation to Q3, compared to the expectations we had when we filed our 8-K on June 10, you’re absolutely right. We saw a much better flow through, more profit performance than we did improvement in sales. We did see stronger than expected sales recovery across the month, but the profit improvement was outsized in relation to the sales recovery, as you highlighted. And that’s primarily due to the fact that as we have increasing the better visibility to the shape of our sales recovery curve, our operators are in a much stronger position to manage with much greater efficiency labor deployment and the inventory. And so as a consequence, we saw much better profitability than we had anticipated. I would also highlight in particular the performance of our Japan business because they had a rather strong improvement in sales. And because they are a company-owned market, we saw that – saw with that a significant improvement in profit for the month of June compared to our original expectations. In relation to Q4, I think it’s fair to say that our outlook is pretty comparable to what we had forecasted as of that June 10 8-K. We have narrowed the range for the U.S. business and for the Americas generally because we have more visibility to our results for the quarter as we’re nearly one month into our fourth quarter. At the same time, we have much better visibility to our ability to manage the middle of the P&L. And so we feel very comfortable with the ranges that we’ve given for EPS as well. In relation to next year, you asked about fiscal 2021, and I’ve provided in my prepared remarks a very preliminary perspective on the shape of our sales recovery curve, noting that our margin recovery would likely lag sales recovery by a couple of quarters. The fact is that it’s very early to predict what next year is going to look like. But based on the experience we’ve gained to-date, based on how well we know our brand and how consumers are responding to our brand, based on the strength of our rewards program and our digital platform, we are building operating plans for next year that presume the levels of sales and profit recovery that I mentioned. So it is on that basis that we’ve provided preliminary perspective, and we’ll continue to keep investors updated as we go. Looking forward to providing more refined perspective with our Q4 earnings call, by which time, we will have developed our operating plans for fiscal 2021. Thank you.

[Operator:]

Your next question comes from the line of David Tarantino with Baird. Please proceed with your question.

[David Tarantino:]

Hi. Good afternoon, and congrats on navigating through what we hope is the worst of the COVID shock here. But I have a question really on the U.S. business. And I think, Kevin, you mentioned the morning routine business is going to be the most difficult to build back. And I was wondering if you could elaborate on what the plan is to build that back specifically? And perhaps, what you’ve seen in the markets where the economies maybe opened up earlier, if you’re starting to see that business come back, for example, in the southeast or other markets that might have opened earlier than some of the core markets?

[Kevin Johnson:]

Yes, David. Thanks for your question or your comments and for your question. Why don’t I let Roz describe sort of the initiatives we have focused on that morning daypart, and then I’ll sort of punctuate a couple of things. So Roz, let me hand it over to you.

[Roz Brewer:]

Thanks, Kevin. Thanks, David for the question. First of all, morning daypart, as you well described is important to us. We have seen a shift in the customer in terms of how they view their morning. And we’re seeing a shift to mid-morning around that 9

[Kevin Johnson:]

Thank you, Roz. I think you hit the right thing, the digital customer relationships. Just keep in mind, we just added 3 million new digital customers that registered for the rewards program and being able to communicate with them personally. And then as Roz said, the work they’ve done on increasing throughput at drive-thru and watching curbside, that just opens up new channels. So that’s spot on. Thank you, Roz.

[Operator:]

Your next question comes from the line of Sharon Zackfia with William Blair. Please proceed with your question. At this time, there is no response from Ms. Zackfia’s line. As your question has been withdrawn, and I will proceed to the next question. The next question comes from the line of John Glass with Morgan Stanley. Please proceed with your question.

[John Glass:]

Thanks, and good afternoon. I wanted to go back to the comment, Pat, you made about the margins recovering slower than sales. Just to add a high level, a lot of retailers or restaurants have determined they can do more with less during this period of time, and they’ve learned that they can make labor more efficient, menus more efficient. Why wouldn’t that be the same case for Starbucks in margins? Like, it should be the opposite. And I would also think the digital transactions are more profitable, so that would sort of accelerate that or is there some embedded assumption about reinvestments so that some of these new channels actually aren’t as margin accretive as maybe I’m assuming?

[Kevin Johnson:]

Yes, John. Happy to answer your question. We do expect margins will improve gradually as we move through the fourth quarter and into next year. But in the next couple of quarters, we do expect margins will continue to lag prior year. And although the margin impacts of partner benefits and inventory reserves are expected to subside considerably in Q4, the leading driver of margin pressure will be continuing to deleverage a fixed costs, such as occupancy and depreciation expense as we work to restore sales. So it’s largely a function of the speed with which we can recover sales and then how we manage some incremental cost to our business, because we do expect to see certain costs persist due to our new way of operating, that includes cleaning supplies and the associated labor. But it is premature to say whether those costs will drive a structural change to our operating margin as we continue to innovate our operating systems and technology to improve throughput and drive efficiencies. We also expect a margin tailwind from the transformation of our U.S. urban market strategy as that is rolled out and includes the repositioning of some existing assets, and that will help to offset any new incremental costs. And we also expect margin benefits from ongoing efforts to renegotiate operating leases. So we do expect to see a combination of margin headwinds and tailwinds, but far away the biggest driver of the margin recovery will be the sales recovery. We do expect that there will be a lag between sales recovery and margin recovery as we continue to refine our ability to operate differently in the new environment.

[Operator:]

Your next question comes from the line of Sharon Zackfia with William Blair. Please proceed with your question.

[Sharon Zackfia:]

Hi. Hope you guys can hear me now?

[Kevin Johnson:]

Hi, Sharon. We can hear you.

[Sharon Zackfia:]

Okay, perfect. So I wanted to follow-up on Roz’s comments about the pay-as-you-go feature for Starbucks Rewards. Is that just rolling out in the U.S. or are you also making any modifications overseas? And can you help us think about where that has the greatest impact? I mean, is it a customer acquisition tool? Does it really widen the funnel? Is it a frequency dynamic? And any kind of initial margin thoughts. I know that the rewards is a little bit less frequent, I think than the regular rewards program. But any clarity around that would be helpful.

[Kevin Johnson:]

Great. Go ahead, Roz.

[Roz Brewer:]

Sure. So Sharon, first of all, the current Starbucks Rewards members, they will continue to enjoy all the benefits of the current program, current loyalty program and usage of the app. And then those members can choose to keep paying with their pre-loaded Starbucks card to earn two stars per $1. And they now have the option to earn one star per $1 spent when you pay with a credit or debit card, cash or select mobile wallet. So that is – so it serves two purposes. One, to expand the funnel on the customer base. But we actually believe it will get even deeper penetration with our Starbucks Rewards members as well. So it will do both of those things. We are rolling this out in U.S. and in Canada. So this program is just to North America at this time, and there is a different program that we use in China.

[Operator:]

Your next question comes from the line of John Ivankoe with J.P. Morgan. Please proceed with your question.

[John Ivankoe:]

Hi. Thank you so much. First a follow-up on the efficiency question then a separate one on efficiency as well. It would be kind of be apparent that you would be able to run stores with less operating hours if there is a shift towards digital, if there is a shift towards off-premise. If you can give a comment on that specifically, because that’s what we are hearing from other restaurants? And then secondly, as we kind of think about the organization and the overall – growth plan that the company has, what types of efficiency and effectiveness exercises have perhaps emerged beyond what you’ve previously said on a corporate or G&A perspective, a support perspective as we think about 2021 and 2022 of perhaps optimizing some of the organizational structure?

[Kevin Johnson:]

Thanks, John. Roz, why don’t you take part of John’s question on what we’re doing with operating hours and sort of efficiency in the store? And then, Pat, why don’t you take the back half of this question on G&A and how that all comes together on the P&L. Roz?

[Roz Brewer:]

Yes. So first of all, John, what we’re doing to prepare for labor in the stores is critical for us. As you can imagine, labor being for any retailers are greatest expense. And so being very efficient in terms of how we manage those labor hours in addition to the productivity. And so we have productivity tools in the store that help us manage when labor hours are needed. We’re watching things as simple as infectious rates. And so when those rates rise in certain areas, we will adjust the hours in those stores, we’ll know that we have partners available to work and we will apply them to the store. And so we do have methods in place to make sure that we’re managing just as efficiently as possible in these uncertain times. So we have that work ongoing. We’ve also – you’ve likely heard earlier, probably four to six weeks ago where we made an adjustment in our stores around partners who wanted to return to the stores and those who decided that they wanted to work elsewhere and find a new career. And so we’ve adjusted appropriately. However, we continue to run hours based on store and demand in that area, and we’ve created our own decision tools to decide what that looks like. So we continue to work that like we’ve done in the past with a lot more visibility over what’s needed to fulfill the demand in those stores.

[Pat Grismer:]

And then, John, just to pick up on some additional aspects of our margin outlook. It’s important to bear in mind that as we do innovate new channels of distribution at our stores, for example, curbside delivery or as we anticipate the longer term growth of third-party delivery, those channels require incremental costs, but they are necessary in order to capture the incremental sales. So those would be a couple of examples where we see growth that may be margin percentage dilutive, but dollar profit accretive. And so to Roz’s point, the team continues to work through ways that we can improve operating efficiency in the store to help offset some of these incremental investments, to accommodate an evolution in the overall shape of our business.

[Roz Brewer:]

Pat, I’d also like add that we are also working, as we’ve talked about before, to look at equipment efficiencies in our stores. And so the Mastrena 2 is at 4,000 stores as we speak. And so we continue to look at equipment and all operations behind the bar as well.

[Operator:]

Your next question comes from the line of Andrew Charles with Cowen & Company. Please proceed with your question.

[Andrew Charles:]

Great. Thank you. Roz, I’m trying to get a better sense of the size of the prize at curbside delivery. So just curious, how many stores are offering the curbside pickup up now in the context of how many stores that are non-urban stores that are drive-thru in the portfolio? And curious on how you see this progressing and really what limits the speed at which you can add this capability given it obviously is a lot easier from a process perspective relative to the new real estate you’re exploring in some of these smaller format locations?

[Kevin Johnson:]

Roz, do you want to take that?

[Roz Brewer:]

Sure. Andrew, thanks for the question. So we were in test of about 250 stores, really pleased with what we saw in those stores with curbside, which encouraged us to accelerate, and we will be in close to 1,000 stores in short order here. So we continue to push curbside. The interesting thing about curbside for us is that it is tech-enabled. So you can access a curbside from the app where it is available currently. And so we’re continuing to roll that out. And so we expect to continue to see what we saw in that 250 store test trial that we’ve been running just prior to COVID. So this is an acceleration of a plan that we’ve already had. And so we look forward to curbside to give our customers just one more contactless opportunity and our partners a chance to deliver the best customer service to our customers.

[Operator:]

Your next question comes from the line of Matt DiFrisco with Guggenheim. Please proceed with your question.

[Matt DiFrisco:]

Thank you. Just had one follow-up on the dayparts. I guess, from the text it says, I mean, you’re seeing growth and it seems to be shifting in the later part of the morning. But I guess with the down 14% in July, is it correct to assume that the afternoon daypart or post-10

[Kevin Johnson:]

Thank you, Matt. Roz, why don’t you go ahead and take both of those questions if you could?

[Roz Brewer:]

Sure. So Matt, to your first question about daypart, one of the things that we’re seeing also as it shift to later morning and another pickup in the afternoon is we’re seeing expanded ticket. So we are seeing group ordering where we believe we’re seeing larger beverage size and additional beverage and food attached. And so we talked about that increase being 25% of what we’ve seen in our ticket expansion. So we are seeing that. To the rest of your question around marketing, we’ve continued marketing. In the very beginning, we ceased marketing because we had so many stores that were in transition from cafe to drive-thru. We reignited marketing. You’ve seen it in our work with our Happy Hour, our Double-Star Days and then the initiation of our summer time beverages, and then the discussion around our plant-based menu. You will see us coming into the fall with excitement around our work with Pumpkin Spice Latte. You’ll see us market for holiday beverage plans. And then the work that we plan to do to market, the new loyalty program. And the new loyalty program again is another way for us to have a new customer base attached to an app that we can speak to frequently and bring them into the store and increase frequency. So we have marketing plan for the remaining of the year and throughout fiscal year 2021.

[Pat Grismer:]

And just to build on what Roz just said in relation to our fiscal 2020 spend, to Roz’s point, the level of spend in Q3 was markedly higher as a percentage of revenue than Q2, in part due to some of the deferral of our marketing activity. We do anticipate that our level of overall marketing spend in Q4 as a percentage of revenue will be pretty comparable to our full year rate. We are not anticipating that that overall level of spend will diminish going forward. But I would highlight that as a concept, our advertising spend has historically been pretty low because of the strength of our brand and the amount of marketing that we attract.

[Operator:]

Your next question comes from the line of Brian Bittner with Oppenheimer. Please proceed with your question.

[Brian Bittner:]

Thank you. Pat, just unpacking your comments on the 2021 same-store sales recovery, do you anticipate store level volumes in the U.S. fully recovering to pre-COVID levels by 2021 or do you really need an environment to shift where employment is fully restored and people are back to their pre-COVID routines or can you get back there in this new normal environment we’re all living in?

[Pat Grismer:]

Yes. Brian, thanks for your question. As I said in my prepared remarks, our preliminary perspective on fiscal 2021 presumes that there will be no major second wave or no major macroeconomic dislocation. It’s nearly impossible to predict whether and when those might happen. Based on what we know today, based on how we see our business is recovering, we anticipate and we are developing an operating plan around the assumption that our U.S. business fully recover sales, meaning back to pre-COVID-19 levels by the end of the second fiscal quarter, and that would be end of March. We’re expecting China will fully recover about one quarter sooner. And then as I mentioned, we’re anticipating margin recovery will lag sales recovery by about two quarters. So it’s a very preliminary perspective. Just to share with the investment community how we’re thinking about the shape of next year, I’m not being able to predict whether and when some other events might happen. We have to get on with our business. We have to prepare operating plans and focus our teams on continuing to deliver results. We’re pleased overall with the progress we’ve seen to-date. We still have a long ways to go to get back to full recovery. But we’re optimistic based on the strength of our brand and the strategies and the initiatives that we have to drive sales and to improve margins.

[Operator:]

Your next question comes from the line of Jon Tower with Wells Fargo. Please proceed with your question.

[Jon Tower:]

Great. Thanks for taking the question. A lot of them have been answered already. But I am curious how you think about this potential longer term shift in work from home for many consumers? And how you think about product innovation around that? Specifically, do you see yourselves potentially offering some new items that you wouldn’t be able to if consumers were not working from home as often? And also even with curbside, do you see potential to add some new products that you might not be able to add without that option?

[Kevin Johnson:]

Yes. Jon, let me comment then Roz I’ll let you add anything, I think, look, we’ve always been really clear that the three things that we focus on that really drive our growth is; number one, the customer experience. That’s the experience in our stores and these different channels we’re talking about. Number two is extending that experience in our store to digital customer relations – relationships. And number three is primarily beverage innovation. We’re beverage first company and then we attach food. And so I think that same formula works whether you work from home or you work from work. I do think what is the focus right now until there’s a vaccine, we just realized that we’ve got to focus on those experiences that customers optimize around whether they’re working from home or not, which are safe, familiar and convenient. And so our beverage innovation is going to continue to focus on all the great things we’ve been doing around our cold beverage lineup, with cold foam, coffee forward beverages, our refreshers, all of that is going to continue to move forward. And I don’t necessarily see that as being a driver of the fact that people work from home or we have curbside. We’re going to continue to innovate in ways that are relevant to our customers independent of the channel by which they buy from us. I do think, as Roz pointed out, we’re seeing larger ticket. And I think part of that is a function of people work from home. They make a Starbucks run and they buy for the whole family or they’re buying more group sort of orders. They’re attaching more food. And I think that bodes well for the innovation that we’ve been driving and announcing around our plant-based offerings. Plant-based is becoming a very popular whether it’s plant-based milks or the Impossible breakfast sandwich that we launched in the U.S., the Beyond Meat offerings that we put on the menu in Canada and China. And so our innovation agenda is going to continue to drive around the things that we know are relevant to our customers, things that inspire our partners and stay true to handcrafted beverages, that’s what differentiates us. And I think we’re going to maintain a focus on those things. Roz, I’ll let – if there’s anything else you want to add or – and then Pat who got some comments too. So let’s go to Roz.

[Roz Brewer:]

Yes, just a few things. First of all, although our sales mix has really tilted to more towards launch and afternoon since the onset of COVID, morning still remains a significant daypart for us. So we’re not walking away from that. There are some things that we’re considering in terms of innovation and then there are some things that we are accelerating in the innovation pipeline. For instance, we are going to be introducing a plant-based protein box because we know in the afternoon there is this extra boost needed. And so that will come forward quicker than planned. We’re also looking at things like, for instance, with curbside, we’re trying to bring the lobby to door side. So just recently, we added merchandise to the app. So then if you wanted to order for gift-giving, some of our serveware, a mug, a nice cup. So we’ve done some of those things, and we’ll continue to do that because we’re really listening to the customer and understanding what they need and we can evolve and then we can accelerate our innovation pipeline just as quickly as we can. Pat, you wanted to add something?

[Pat Grismer:]

Yes. Thank you, Roz. I’d like to highlight specifically how our Channel Development business has benefited from work from home and how the team is looking at opportunities to capitalize on that. The volume we were seeing in at-home coffee remained at elevated levels across the quarter. Starbucks outperformed the category. We gained share. And our core strategies for at-home coffee are generally the same, but we are looking at opportunities to sustain the momentum that we gained as consumers adjusted their at-home routines. For example, we’re focusing on accelerating e-commerce based on the shift in shopping patterns and meeting consumers’ evolving needs. We’re also looking at premiumizing the category, expanding consumption and driving loyalty through our Channel Development business as well. Thanks.

[Operator:]

Your next question comes from the line of Chris O’Cull with Stifel. Please proceed with your question.

[Chris O’Cull:]

Thank you. Roz, would you help us understand the potential sales lift for a store that adds curbside? And maybe describe some of the other initiatives that you believe could have a meaningful impact on capacity and throughput? And then, Pat, do you expect the benefit from the qualified payroll credits to be smaller in the fourth quarter than they were in the third.

[Kevin Johnson:]

Roz, why don’t you take the first part and then Pat will comment.

[Roz Brewer:]

Sure. Let me start off. First of all, Chris, your question around curbside and what would we expect in terms of upside there. It’s encouraging what we saw in our trial base. So – and we know that contactless experience for our customer is more present than ever. So we believe in this new channel for us. But it’s really too early for us to tell what the real benefit will be. But we’ll come back to you as this thing grows. We’ll let you know how that’s working for us. In terms of capacity and what we think could help, for instance, our drive-thru. This new handheld, that capacity that we are creating, allows us to do what a lot of retailers call busting the line actually. And so we’re able to get out of the store, get out in that line, put an order and in a queue much faster and get those out-the-window times down and get the beverage and food items to the customer much quicker. We’re also doing work that handheld will enable if you wanted to just – if the line began to get long, if you are picking up and trying to walk into the stores. So between handheld and curbside, we feel like we’re going to be able to deliver a different customer service and it will unlock and enable some efficiencies that we need and speed. And so we’re looking at those two as key drivers.

[Pat Grismer:]

And Chris, in relation to your question regarding the government stimulus program benefits. The lion’s share of our investment in Q3 was around catastrophe pay, a form of partner support and care. And that’s where the government stimulus program benefits kicked in on helping to offset a portion of that. So for Q4, since we have effectively sunsetted our catastrophe pay, we’re not anticipating significant expense in Q4. And as a result, we would not anticipate significant government stimulus program benefits by way of payroll tax credits.

[Operator:]

Your last question comes from the line of Dennis Geiger with UBS. Please proceed with your question.

[Dennis Geiger:]

Great. Thanks. Kevin, you talked some about how solid customer demand remains, and perhaps, it sounds maybe little changed from pre-COVID levels, and therefore, I think you’re highlighting the importance of throughput and operations to continuing to drive sales. But anything more you can share with respect to existing customers using the brand a little bit less for net now that their brand – that their routine has changed, perhaps, offset by new customers that you gained or that have become heavier users over the last few months? And ultimately, is that a net benefit because the new customers become sticky, existing customers return to their routines? Anything more there – metrics to share or just kind of how you’re thinking about that customer dynamics? Thanks.

[Kevin Johnson:]

Yes. Thanks for the question. I’ll start by saying, throughout this quarter, we have navigated the pandemic in a way that I consider very consistent with Starbucks mission and values. And in many ways, we navigated this by prioritizing the safety and the health and well being of our partners and the customers we serve. And unlike many, many others in the industry, in April, – yes, In April, we closed all our stores with the exception of drive-thrus. And that was clearly to provide a safe environment for our partners and as well as the contactless experience for us to handcraft beverages and food items for our customers. During that period, we had significant demand through the drive-thru. It was quite amazing. The lines and the amount of time the customer wait in line in drive-thru to get their Starbucks. And so that was the first indication that there is a very powerful customer affinity to Starbucks, even in a global pandemic. Now, as we started re-opening stores in May and customers – we began to – with mobile ordering and contactless entryway pickup, we continue to see customers coming back to us. Clearly, the priority or the customer behavior was around safe, familiar, convenient experiences. And so that’s why I think we saw such a dramatic increase in the number of app downloads and customers that joined the rewards program because that is the safest way to order. You order on your phone and then you can pick it up contactless or you can get it for delivery. And so that was another indication. So we quickly figure out, if we launch curbside, we’re going to get more customers. If we put handheld point-of-sale at the drive-thru lines, we get drive-thru. When we open our stores for to-go orders or even limited seating, we see customers come back. And yet at the same time, we stayed true to the principles that we outlined, which is prioritize the health and well being of our Starbucks partners, the customers we serve, to also support government, local health officials as they work to contain the spread of the virus, and third is to just show up in a positive and responsible way in every community we serve. Now when I look at the data, our customer connection scores are at an all-time high. And part of that is, I believe, the way that we’ve navigated this has built trust. It’s built trust in our Starbucks partners that we’re always going to do the right thing. We put people ahead of profit, whether it was providing economic certainty for our partners or ensuring that our customers had safe ways to interact with us. I think that deposit in the reservoir of trust is building and strengthening customer affinity. Obviously, the deployment of mobile reach is building more customers that become sticky. They build that relationship with Starbucks, we can communicate with them, we can serve their needs, we can personalize that experience for them. And then the investments we’re making to make it easier for customers to have those experience is just is continuing to unfold. And we saw that certainly in the month of June where we saw a very good response from customers that helped us exceed expectations on what we would see in sales and then that’s continued into July to progress. So when I look at the fact that our share in the month of June, we gained share in the month of June, and I’m confident that we’re on a path to continue to gain share. So if there is any question that closing stores was going to create a longer term loss of market share is disproven because we saw clearly in the month of May, we did – we were even on share in the month of June, we gained share. And I suspect as we keep doing these things, we’re going to continue to gain share. And in the process, customer connection scores are at an all-time high and our customer affinity that we measure on a regular basis is also very strong. So I think we have line of sight visibility to what our customers need and want. And as we deliver that, they respond. And I think the plan that we have in place in accelerating the strategic initiatives are right in the sweet spot of customer shift and customer behavior. So I think about this as the investments we made this quarter, we’re playing the long game. This is about building trust with our customers and then positioning Starbucks for long-term sustainable growth. And I feel very good about the fact that we’re now in a position where we’ve operationalize these store protocols and we know how to adapt very rapidly and we do that with distributed leadership. 32,000 stores around the world. There’s 32,000 store managers, each one of them is paying attention to what’s happening in their community. They have the playbook. They know how to adapt. And so we are in many ways we’re back in March, April, people would describe this as we are navigating a crisis, this global pandemic. Well, today, we’re not – this is not a crisis any longer in my opinion. We are navigating a global pandemic, but we know exactly how to do it. That’s woven into the fabric of how we operate, and partners are rising to the occasion. So I feel very good about where we’re at. I feel very good about the strategic initiatives. And the data that we see on customer response is spot on. So that’s where we are from where we were 90 days ago when we spoke with you last on the earnings call. And it’s all credit to our Starbucks partners. They’ve done a phenomenal job.

[Operator:]

And that was our last question today. I will now turn the call over to Kevin Johnson.

[Kevin Johnson:]

Let me just thank all of you for joining us today. My hope is that through this discussion we’ve been able to give you a sense of the confidence we have in our ability to navigate this global pandemic. Our recovery strategy is working. And we’re accelerating the strategic initiatives that further differentiate Starbucks for the future. We’re doing this in a way that is true to our mission and our values, and we’re on the front foot right now. But also acknowledging that like everyone else in this world, we’ve got to monitor and adapt and be agile. But I’m very proud of my Starbucks partners and how they’ve responded. And I just want to take an opportunity to thank all of you, our stakeholders, for your support and we look forward to the continued dialog. So thanks everybody.

[Operator:]

This concludes Starbucks Coffee company’s third quarter fiscal year 2020 conference call. You may now disconnect.