Starbucks Corp (SBUX) — Q3 2022 Earnings Call Transcript

Thank you, Alex, and good afternoon, everyone, and thank you for joining us today to discuss Starbucks' third quarter fiscal year 2022 results. Today's discussion will be led by Howard Schultz, Interim Chief Executive Officer; Frank Britt, Chief Strategy Officer; Belinda Wong, Chairwoman of Starbucks China; and Rachel Ruggeri, Executive Vice President and CFO. 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 2022 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. All numbers referenced on today's call are on a non-GAAP basis unless otherwise noted. This conference call is being webcast, and an archive of the webcast will be available on our website through Friday, September 2, 2022. As a reminder, Starbucks 2022 Investor Day will be held on Tuesday, September 30, 2022. The event will be available to view from our website beginning at 7:30 Pacific Time. Also, for your calendar planning purposes, please note that our fourth quarter and fiscal year 2022 earnings conference call has been tentatively scheduled for Thursday, November 3, 2022. And with that, allow me to turn the call over to Howard.

Thank you, Tiffany. Good afternoon, and welcome to everyone on today's call. Starbucks' strong Q3 results highlighted by 9% global revenue growth to a record $8.2 billion, 3% global comp growth and 9% comp growth in North America once again demonstrates the power and resilience of the Starbucks business and brand all over the world. I've now been back as CEO for four months. During that time, I've immersed myself in every segment, region, operation and aspect of our business. Given my long history with the Company and our culture and my unique understanding and appreciation of the Starbucks brand, the drivers of our global business and the special relationship that exists among our people, our brand and our customers, we've been able to pinpoint the source of each of the issues and challenges confronting the Company upon my return. Some are definitely COVID related, some were a function of not focusing on the long term, and unfortunately, many were self-induced. More important, we now have clear line of sight on what we need to do to totally reinvent the Company and drive accelerated profitable growth around the world. The Q3 results we announced today demonstrate the early progress we have made in just four short months and serve as a proof point of the significant long-term global growth opportunity ahead for Starbucks. Each business segment contributed to our Q3 performance. I'm particularly pleased that we delivered our results in the face of stiff ongoing consumer economic and inflationary headwinds. COVID lockdowns across China kept Shanghai, our largest China market, largely closed for two months, and that continues episodically today, along with shifts in customer traffic and behaviors including materially reduced office occupancy in our largest urban markets. Our Q3 performance underscores the success of the investments we are making in our people, extending our global leadership around everything coffee and in groundbreaking beverage, food, digital and technology innovation that is deepening our connection to customers in every market and every channel. On today's call, I will highlight the drivers of our Q3 revenue comp and EPS performance. I will then turn the call over to Frank Britt, our Chief Strategy Officer, to provide an overview of our reinvention plan, the strategy underpinning the investments we are making to materially elevate our partner, customer and store experiences. Next month, at Investor Day in Seattle, you will see for yourselves how accretive to our business our reinvention plan will be, increasing efficiency, enabling us to seamlessly handle the increasing demand in our U.S. stores and most of all, elevating our partner, customer and in-store experiences. Our reinvention plan touches every aspect of the Starbucks Experience and sets us up for accelerated long-term profitable growth and value creation benefiting all stakeholders beginning in 2023. We are executing against the reinvention plan with focus, discipline and a deep sense of urgency. Next, Belinda will update you on China, where our position in the market and our aspirations for the future have never been greater. Rachel will provide a deep dive into our Q3 financial and operating results, and then we'll move on to Q&A. Starbucks' success and long-term growth strategy is our global leadership around everything coffee. No company in the world even remotely approaches Starbucks' ability to source, blend, roast and craft the world's best coffees. In Q3, we continued to extend our coffee leadership, innovate and bring further elements of customization and premiumization to the entire coffee category, including around cold, handcrafted and plant-based coffee beverages. Customer demand for customized cold coffee beverages, a category Starbucks single-handedly created and is now expanding around the world, is so strong that cold beverages now account for roughly 75% of our total beverage sales in U.S. company-operated stores. Customers are increasingly customizing their cold beverages by adding modifiers that enable the creation of a virtually unlimited range of taste, flavor and color profiles, and then sharing their unique cold beverage creations with the world through social media. Starbucks' ability to deliver handcrafted, customized cold beverages that satisfy customer desires and different need states while creating opportunities for customer self-expression deepens our connection to customers, sets us apart from any other industry participant and provides us with a significant ongoing competitive advantage in the marketplace. Iced Shaken Espresso introduced onto our Iced Espresso platform only last year is resonating so wildly with our Gen Z customers that it has already become the fastest-growing product category in our U.S. company-operated stores, growing 50% year-over-year, more than doubling year-to-date and importantly creating new customer occasions in the midday and afternoon. Iced Shaken Espresso is also resonating around the world. In China, for example, where Iced Shaken Espresso was only introduced in June of this year, it is already among our best-selling iced coffee beverages despite mobility restrictions in China. The premium customized cold coffee opportunity ahead for Starbucks globally is enormous. Let me turn to North America. The very strong demand for Starbucks Coffee in the U.S. that we reported on our Q2 call has accelerated in Q3. U.S. company-operated stores delivered record average weekly sales, 5 of the top 10 grossing sales days in our history and a $410 million sales week. In North America, overall, the combination of customer shift towards premium cold beverages, increased customization, strategic decisions on our part regarding beverage and food modifier pricing and a 19% increase in food sales drove net revenues up 13%. Additionally, our North American licensed stores business, now 7,000 stores strong and growing, also posted strong results with 24% revenue growth in the quarter. While we are sensitive to the impact inflation and economic uncertainty are having on consumers, it's critically important that you all understand we are not currently seeing any measurable reduction in customer spending or evidence of customers trading down, reflecting the strength of the Starbucks brand, deep customer engagement and loyalty, pricing power and the premium nature of our beverage and food offerings. What's driving some of the increase in traffic and the strength in our business is our Rewards program. Active Starbucks Rewards membership in Q3 totaled 27.4 million members, up 3.2 million or 13% year-over-year and 3% sequentially. Our loyal Starbucks Rewards members drove a record 53% of U.S. company-operated revenue. Mobile Order & Pay, drive-through delivery also remained quite strong, driving 72% of our U.S. revenue. Increased Starbucks Rewards membership, customer excitement over our beverage and food offerings, plus a fantastic holiday lineup that I'm certain will delight our customers gives us tremendous confidence heading into holiday and 2023. My first order of business upon returning to Starbucks in April was to meet with Starbucks retail store and roasting plant partners across the United States in order to better understand the state of our business and the challenges confronting our partners and the Company. It soon became clear that record demand in our stores was masking significant underlying issues, including, as we shared in our last call, store designs that were ill-suited to the evolving customer behavior and traffic patterns we are seeing post-COVID. Our stores, in many ways, are windows on America, and our partners everywhere shared similar anxieties over a wide range of issues affecting their families and lives around safety, mental, physical and financial health issues and the widening cultural and racial divide in our country and the world. Many questions whether the American Dream and economic mobility was still a realistic aspiration. Our partners also shared how hard it had become to keep up with customer demand and how insufficient training had left new partners unprepared for their roles, challenging partner and customer experiences alike. The conversations were raw and, in many ways, painful for our leaders to hear. But core to Starbucks culture is the requirement that we always speak with each other with honesty, transparency and without judgment or fear of appraisal. The truth is, at times, I was overwhelmed by what I heard. The challenges, fears, the desire for emotional and financial security and the sense of belonging in our partners' lives amid an unsettled world. At the same time, I found myself feeling so proud, appreciative and oftentimes in awe of our partners across the country who showed up every day committed to delivering an elevated Starbucks Experience to our customers and communities despite the personal challenges and obstacles they were experiencing. We were in a moment where Starbucks leaders needed to put themselves in the shoes of our partners and demonstrate great empathy and compassion towards them. And we needed to address our partners' concerns with urgency. What began as informal partner meetings soon evolved into focused co-creation sessions where Starbucks partners and leaders collaborated on how best to re-imagine the next Starbucks. We've since held over 100 co-creation sessions. From these sessions, our reinvention plan has taken shape. Today, over 30 cross-functional teams are focused exclusively on executing the U.S. reinvention plan you will see take shape over the quarters ahead. In time, you will see best practices shared around the world. We assembled our 200 top U.S. executives in Seattle last month to kick off Starbucks reinvention and change agenda. In a few minutes, Frank Britt, a key architect of the plan, will provide you with an overview so you can begin to understand how accretive each pillar of the plan will be to our business and brand long into the future. The strong revenue growth we delivered in North America in Q3 is being replicated globally. With the exception of China, where the zero COVID policy continues to result in mobility restrictions and limited store operations, each of our international regions grew revenues by double digits in Q3. It's an extraordinary accomplishment reflecting both the strength of the Starbucks brand and strong and accelerating demand for Starbucks coffee all over the world. Our international performance also underscores the correctness of our strategies of investing ahead of the curve in beverage, digital and technology innovation that is relevant to our customers in driving new store growth in every market in which we operate. Overall, our international segment, excluding China, grew revenue 33% year-over-year or 50% excluding FX while meaningfully expanding operating margin, reflecting the strong operating leverage inherent in our complementary portfolio of company-operated and licensed stores. Last month, several Starbucks leaders joined me on a multi-country tour across several strategic theaters of our EMEA business. In every country we visited, we were inspired by what we heard, felt and observed. Product quality, service execution and knowledge of coffee across EMEA are all delivered at the highest levels. Our EMEA teams are executing well, bringing a powerful emotional connection and sense of belonging among our partners and customers, with the Starbucks Experience being the shared medium of exchange. And our EMEA partners are literally thriving, inspired and earnestly engaged in bringing our unique culture of respect, purpose, service and an authentic and aspirational love of coffee to life. Interestingly, while thousands of stores in many countries drove strong financial performance during the quarter, I want to showcase one market in particular that serves as a proxy for the strength of the Starbucks brand and demonstrates the enormity of the international opportunity ahead. Italy. Italy, a market we only recently entered and that no one ever expected us to succeed in. Starbucks is flourishing in Italy. The quality of the coffee, the food and the partner and customer experiences are second to none. Traffic in our Milano Roastery, Starbucks' shrine to coffee, is strong throughout the day, driven largely by tourist activity. But most importantly, traffic in our Italy retail stores is largely local customer driven. When I was there, I observed Italians drinking straight espresso at Starbucks. We are being warmly welcomed in Italy, the country in which our Starbucks journey literally began. Given the success we are enjoying in Milan, we are now planning to open in Rome and in Florence. Our planned expansion in Amsterdam will materially increase our roasting capacity to meet the rapidly growing demand for Starbucks Coffee across the region. Similar efforts are underway to support a supply chain team that currently handles logistics to over 4,000 stores across 42 countries in EMEA. In Switzerland, we held highly productive sessions with our partners at Nestle. Global Coffee is among Nestle's largest strategic growth categories, and our partnership with Nestle now extends across 81 markets focusing on at-home coffee and food service channels. Building on our number one share position in the United States in the at-home, retail and CPG coffee channels, we are in the very early stages of leveraging the Starbucks brand and Nestle's global coffee platforms and significant distribution capabilities to create new super premium coffee occasions on the espresso platform around the world. Our partnership with Nestle is driving meaningful competitive advantages for both companies in the marketplace and is highly accretive to our business. Looking ahead, we expect to see a closer Starbucks-Nestle partnership. This includes the introduction of Starbucks varietals onto Nespresso's digital sales platform, a channel that does not presently exist for us and represents a massive global opportunity. We're also looking forward to the launch of our ready-to-drink Starbucks coffees in Southeast Asia, Oceania and Latin America, which will begin rolling out next quarter. In China, mobility restrictions and limits on in-store dining continue to significantly impact the business. However, as Belinda will soon share, we are beginning to see green shoots of recovery with sales and comps coming out of the quarter, reflecting sequential improvement. Lastly, we have been working on an exciting new digital initiative that builds on our existing industry-leading digital platform in innovative new ways, all centered around coffee and most importantly, loyalty that we will reveal at Investor Day. We believe this new digital Web three-enabled initiative will allow us to build on the current Starbucks Rewards engagement model with its powerful spend-to-earn Stars approach while also introducing new methods of emotionally engaging customers, expanding our digital third place community and offering a broader set of rewards, including one-of-a-kind experiences that you can't get anywhere else. Integrating our digital Starbucks Rewards ecosystem with Starbucks branded digital collectibles as both a reward and a community building element, this will create an entirely new set of digital network effects that will attract new customers and be accretive to existing customers in our core retail stores. As I mentioned at the outset, we are looking forward to fully showcasing the power and the opportunity of our reinvention plan that we will unleash at next month's Investor Day. With that, I'll turn the call over to Frank Britt.

Thank you, Howard, and good afternoon, everyone. I've had the good fortune of joining our company during one of its most exciting times, a time of reinvention. We have come together as a Starbucks community and architected a comprehensive plan to future-proof and profitably grow the Company. Our path forward is being informed by tens of thousands of daily customer experiences and our partner stories, ideas and dreams that have all helped shape over the past several months through on-hand collaboration sessions, digital surveys, live open forums and direct dialogue with our key leaders. This process is indicative of a new and wide-ranging approach to democratizing innovation at Starbucks. Our reinvention efforts will begin with our core U.S. company-owned retail business, and over time will expand across our global footprint. Specifically, we have prioritized five major strategic shifts to pivot the U.S. business in a new direction. Today, we will provide the guideposts and address the overall program, while the how of this agenda will be reviewed on Investor Day in September. To that end, first, powered by ongoing partner co-creation, we work to further connect the Company to truly operate as one global enterprise enabled by new ways of working and a range of contemporary practices and tools. For the U.S. company-owned retail business, we will focus on better integrating our culture and values across the three cohorts of our retail partners, operations partners, and support center partners. Our end game is a greater focus as a single company with agility and an empowered organization, and we see this work as the fabric that will help bind our change management agenda and will be meaningfully catalytic to our long-term operating and financial performance. Secondly, we are fully embracing the need to radically improve our in-store partner experience. We know that our partners are vital to bringing an elevated Starbucks brand to our customers every day, and we seek to honor, empower and affirm their strategic importance. The first principles of our new partner engagement approach include both greater safety and kindness in our stores, personalized career paths that drive advancement and opportunity, and an explicit and personal emphasis on improving overall partner well-being. To that end, as we shared in our last earnings call, we have several high-impact improvement efforts in flight, including this week's wage acceleration for all U.S. in-store partners, doubling in-store partner training investments, reintroduction of our iconic Black Apron and Coffee Masters credential and the implementation of a new digital partner engagement platform. We also expect to roll out both universal tipping and a new recognition and badging platform by calendar year-end 2022. Each of these substantial actions are part of a multiphase path to reinventing the retail partner experience that we expect will have a direct positive effect on partner retention, customer connection and essential brand affinity metrics. Third, we must reimagine our stores. This starts with the core engine of production that must be better calibrated for today's customer habits and deliver superior experiences through personalization across every format and in every channel. Innovations such as new bar configurations, patented coffee technology, novel store prototypes are high priorities in the plan designed to improve throughput and heavily customized beverages, along with both customer and partner experience. Our high-priority improvement efforts include key equipment acceleration to drive more efficient and effective operations such as Clover Vertica, an expansive renovation and new store agenda. Fourth, we will further evolve how we reconnect with customers, mindful that each individual consumer must be provided a uniquely personal experience that is unified across channels. Building on our strong track record of superior customer engagement, representative initiatives include a reimagined approach for customer-facing products and platforms, new models of effortless digital ordering and further growing the value proposition of our loyalty programs through novel and new strategic partnerships. Fifth, we will redesign what partnership means at Starbucks, creating new ways to continue to evolve us from a listening company to a co-creation company. This translates into new approaches to shared innovation, shared accountability and shared success. This is both a competitive and a generational necessity and for us, it's natural. Starbucks is built through the power of our partners' ideas and voices, and we know that reinvention must first unleash and then harness the power within every one of our partners. Finally, it's important to be declarative that within our highly integrated change agenda, coffee innovation is far more than an initiative or a project. Instead, the role of coffee will be threaded throughout each of our priorities and serve as our inspiration, foundation and fiercest differentiator in defining the future of Starbucks. In summary, we firmly believe that when you combine the five strategic reinvention areas, bolstered by a rich tapestry of aligned initiatives and the reaffirmation of the importance of coffee, you will begin to see the emergence of a Starbucks that once again drives outsized performance financially and socially, and creates a work environment where all of our partners feel greater personal agency and are provided a personalized career path that matches their unique needs and aspirations. In the end, our goal is to become a wholly new kind of company that again sets a new higher standard for our industry and our business overall. We look forward to sharing more details on our Investor Day in September. And now I'll turn the call over to Belinda.

Thank you, Frank. In Q3, China faced its most severe COVID disruption since the onset of the pandemic. Mobility restrictions and lockdowns were implemented faster and eased more slowly under China's zero COVID policy. Shanghai, our largest market with more than 940 stores, was completely locked down for approximately two-thirds of the quarter. In Beijing, 150 stores, or roughly one-third of our stores in the market, were closed for almost six weeks, with the balance of our Beijing stores operating without indoor dining. We entered Q3 with over 1,300 stores close to one-quarter of our total portfolio temporarily closed. We exited the quarter with roughly 2,000 stores across nearly 50 cities operating with mandated reductions in seating capacity or other COVID restrictions. Similar patterns remain today with COVID restrictions being eased in some cities and new restrictions imposed in others. We continue to expect our recovery in China to be nonlinear. In Q3, we continued to deepen our partnerships with suppliers, landlords and local authorities, streamline and adapt our supply chain, add new chapters to our COVID playbook and position the business for accelerated profitable growth as soon as COVID restrictions are fully lifted. Together, these efforts have provided us the flexibility and strength we need to continue to operate as efficiently as possible given current market challenges. As a result, we were able to move quickly to reopen 90% of our Shanghai stores just within a few days of the reopening. We continue to put our partners first, ensuring their safety and well-being and compensating them fully even when our stores were closed. In turn, our partners continue to deliver exceptional experiences for our customers, as reflected in the record high customer connection scores we achieved in Q3. COVID is forcing Starbucks to become more flexible, resilient and agile in China and get even better at operating and executing at scale. The benefit of our investments in our people and our operations will become increasingly evident in post-COVID quarters and years ahead. COVID-related headwinds in Q3 resulted in Starbucks net revenue in China declining 40% and sales comp declining 44% versus last year. But I'm pleased to report that we saw immediate improvement in traffic and sales following Shanghai's reopening in early June, with steady sequential improvement in both metrics through the month, and exited the quarter with a negative comp of 24% after indoor dining restrictions in Shanghai were partially lifted at the end of June. The improvement was fueled by customers returning to our stores and celebrating the reconnection and familiarity with the Starbucks brand. We are seeing a strong positive correlation between comp improvement and the easing of COVID restrictions, giving us confidence that we'll see both a strong rebound in sales and improved flow-through once mobility restrictions in China are fully lifted. We continued our store expansion in Q3, opening up 107 net new stores and entering three new cities despite the headwinds and now operate 5,761 stores across 228 cities and we remain on track to have 6,000 stores in China by the end of this year. Our new stores continue to achieve best-in-class returns and profitability. The investments we're making to elevate our customers' digital experience and strengthen their connection to Starbucks are paying off. Mobile ordering sales mix increased to a record high of 47% in Q3, up 13% over the prior year and up 4% over Q2 as we adapted to COVID-driven changes in customer behavior. We also continue to invest in product innovation and extend Starbucks coffee leadership in China. As Howard mentioned, Iced Shaken Espresso introduced only in June has already become one of our best-selling iced coffee beverages among our Gen Z customers, driving both sales and incremental traffic. Our Q3 performance demonstrates the resilience of the Starbucks brand and business in China and that we're continuing our relentless focus on the long term even as we navigate short-term disruptions, positioning us to resume accelerated and long-term sustainable growth in China as soon as COVID restrictions are fully lifted. I want to sincerely thank all of our partners in China for their dedication, commitment and deep loyalty and for taking care of our communities, our customers and each other during this unprecedented time. With that, I'll turn the call over to Rachel.

Thank you, Belinda, and good afternoon, everyone. As Howard mentioned at the top of the call, we delivered record-breaking revenue performance during the quarter, driven by continued strong customer demand globally despite a greater-than-expected impact from mobility restrictions in China. We also exceeded our earnings expectations, demonstrating our ability to effectively deliver results while executing on planned investments and navigating a dynamic environment. In Q3, we delivered record quarterly global revenue of $8.2 billion, up 9% from the prior year, or 11% when excluding the 2% impact of foreign currency translation. Our strong growth was driven by double-digit revenue growth in the U.S. as well as nearly all major markets and channels across our global portfolio, partially offset by a 40% decline in China revenue. Q3 consolidated operating margin contracted 350 basis points from the prior year to 16.9%, primarily driven by ongoing inflationary headwinds, significant investments in labor, including enhanced store partner wages and deleverage related to COVID lockdowns in China. These were partially offset by pricing in North America and leverage outside of China. Q3 EPS was $0.84, declining 15% from the prior year but ahead of expectations. I will now provide segment highlights for Q3. North America delivered revenue of $6.1 billion in Q3, up 13% from the prior year and also an all-time record, primarily driven by a 9% increase in comparable store sales, including an 8% increase in average ticket, as well as net new store growth over the past 12 months. Compelling growth in our U.S. licensed store business also contributed to the segment's strong revenue performance. Our U.S. business posted 9% comparable store sales growth, driven by ticket, a remarkable feat considering we were lapping a record-breaking quarter from last year. Our average ticket reached an all-time high yet again, with the year-over-year increase driven by strategic pricing actions and food attach. Strong food attach is a direct result of continued innovation which resonates with our customers. New items, including our lime frosted coconut bar and staples such as the Grilled Cheese Sandwich, both performed well. Our creative innovation approach has led to successful beverage and food pairings, fueling food attach and driving day part growth. While transactions remained below pre-pandemic levels, average weekly sales and unique customer counts reached record levels in the quarter, demonstrating that the Starbucks brand is reaching more customers than ever, and customers are highly engaged when they frequent our stores. As both Howard and Frank discussed, we are singularly focused on executing the reinvention plan. Although measurable benefits of the reinvention plan investments will begin to manifest in FY '23, we are encouraged by the investments made so far this year, as we've already experienced increased labor availability and stability, more predictable operating hours as well as higher partner engagement scores in the U.S. Our tenured partner turnover, those with one to two years of tenure, has also improved, evidence that our targeted investments to address wage compression are making a difference. We know based on data across our more than 9,000 U.S. company-operated stores that stores with lower turnover and higher partner engagement tend to have better operational and financial metrics relative to their peer set, often leading to better overall customer connection scores. We believe our intentional and targeted investments, which are part of the reinvention plan, will meaningfully elevate the Starbucks experience for partners, stores and customers. North America's operating margin was 22.2% in Q3, contracting 250 basis points from the prior year, primarily due to ongoing inflationary headwinds, labor investments including enhanced store partner wages and new partner training support costs, partially offset by pricing. While we begin executing investments under the reinvention plan, we were also focused on taking disciplined actions to offset margin pressures. Such measures include targeted pricing actions, store throughput initiatives and prioritization of discretionary spend, enabling the segment to fund critical investments while delivering Q3 performance as planned. Moving on to international. The segment delivered third-quarter revenue of $1.6 billion, down 6% from the prior year or up 3% when excluding a 9% unfavorable impact from foreign currency translation. We saw strong sales growth across every major market in the segment outside of China and increased our net new store count by 8% over the last 12 months. The growth was partially offset by an 18% decline in comparable store sales, reflecting the severe impacts of COVID lockdowns across China, as Belinda noted. Outside of China, the tremendous growth of our international markets across our global portfolio continued into Q3, growing at 50% and more than offsetting the revenue challenges we experienced in China when excluding the impact of foreign currency translation. Virtually all of our key markets and regions posted double-digit revenue growth, including our licensed markets. Most of these markets' revenues have reached or exceeded pre-COVID levels and have set new record highs in recent quarters, driven by strong innovation and expanded digital capabilities. Strong momentum combined with the sizable opportunity afforded by new store formats, gives us great confidence in the long runway of growth ahead for our international markets. Operating margin for the international segment was 12.4% in Q3, down 950 basis points from the prior year, mainly driven by the leverage related to COVID impacts in China, sustained inflationary headwinds, lapping higher prior year government subsidies as well as partner investments, partially offset by strong sales leverage across markets outside of China. Looking ahead, however, the international segment may face near-term challenges. Given the prolonged lockdowns in China with limited mobility recovery in Q3, the headwinds now extend into Q4 as the market continues to recover. The current pace of recovery implies that China's operating income contribution as a percent of global operating income may be reduced further than what we had previously anticipated to roughly one-quarter of the contribution realized in a typical fiscal year. Outside of China, the increase in COVID cases around the world may temper the rapid growth we are currently seeing in many markets. Moving on to channel development, the segment's revenue grew 16% to $480 million in Q3, driven by growth in both the Global Coffee Alliance and our ready-to-drink businesses. Channel development continues to play an essential role in amplifying and diversifying the Starbucks presence around the world and creating new occasions. Starbucks remains the market leader in both the total U.S. at-home coffee and ready-to-drink categories. As Howard mentioned, our partnership with Nestle continues to strengthen, and we're pleased with the competitive advantage it has created and excited about the heightened performance the strategic partnership will unleash. Newer platforms continue to be significant drivers of growth for the Global Coffee Alliance, including Starbucks By Nespresso and Starbucks Creamers. Within our ready-to-drink lineups, we continue to be pleased with our recent product innovations like our new chilled cup offerings in our international markets with robust innovations in the pipeline, fueling continued long-term growth. The segment's operating margin was 40% in Q3, down 670 basis points from the prior year, mainly driven by a decline in joint venture income related to our U.S. ready-to-drink business, primarily due to inflation and business mix shift. Now moving on to the balance of fiscal year '22. While our guidance remains suspended for the balance of this fiscal year, we wanted to provide some insights regarding Q4. We now expect our Q4 margin and EPS to be lower than Q3 with greater year-over-year pressures primarily due to three reasons: First, the start of mobility recovery in China was later than expected, impacting the pace of recovery previously assumed in Q4. Second, our Q3 performance benefited from approximately $0.05 of nonrecurring benefits, including the release of a customs duties accrual, tax credits, government subsidies and other items which we do not expect to continue in Q4. Third, as previously announced, Q4 will be impacted by a sequential step-up in our investments as well as our typical seasonality. Between executing the reinvention plan and other investments such as increases in wage benefits announced earlier this year, we expect our U.S. investments to more than double from Q3 to Q4. Although these factors will impact our Q4 results, they're expected to be transitory in nature, and our commitment to accelerating long-term growth remains intact. From a shareholder return perspective, although we announced the suspension of share repurchases for the balance of fiscal year '22, we have nearly returned $6 billion between share repurchases and dividends during the first three quarters of fiscal '22. Additionally, we remain committed to sustaining an attractive dividend and continue to target an earnings payout ratio of approximately 50%, which is near the top end of growth companies of our size and scale. Our commitment reflects our confidence in the strength of the business and to returning compelling cash distributions to shareholders while retaining balance sheet flexibility and funding our investments. In closing, here are key takeaways from my discussion today. Our Q3 performance underscored continued strength in customer demand for Starbucks Coffee across the globe, balanced with our ability to execute investments despite macroeconomic and operational headwinds. Our commitment to deliver shareholder value has not wavered, and we are making the right decisions and investments today for the future of Starbucks, balancing the value we create for all stakeholders. Our acceleration of long-term growth is rooted in our ability to execute against our reinvention plan, and we're looking forward to sharing details and providing a comprehensive update on our business outlook for FY '23 and beyond at our Investor Day in September. As always, the real trend for our success belongs to all of our Green Apron partners around the world who strive to deliver the best Starbucks experience possible each and every day. They have our greatest respect and appreciation as we reinvent the next phase of Starbucks together. With that, we will open the call to Q&A.

Great. Thank you very much. I appreciate all the color and the update. Just one question, two parts. The first just relates to the new CEO. Just wondering your thoughts in terms of whether that leader will have the ability to perhaps blaze a different path than that laid out at the Investor Day. It would just seem like there is some risk in terms of that hiring with the reinvention plan already laid out. So any color you could provide on the CEO search would be great? And then just as a follow-up, is there any color you can share in terms of the tweaks you're thinking about the long-term top or bottom line algorithm? I know you previously alluded to some maybe acceleration of unit growth, but anything you can share in terms of early insights into the long-term algorithm changes would be great.

I'll take the first question, which I think is the easier one. There is absolutely no risk whatsoever to the reinvention modernization plan that we've outlined in terms of CEO succession. The biggest piece of this puzzle, in addition to experience and domain understanding of the market and a global perspective, is an understanding of the culture, values and guiding principles of the Company, someone who really has a conscience regarding the humanity in Starbucks. All the candidates that we are talking to are in agreement with what we're doing in terms of investing ahead of the growth curve, reinventing the partner customer and store experience and the equity and power of the brand. No one on this call should think that there’s any risk in terms of this plan not being executed. I've committed myself to stay as long as necessary to ensure that the new CEO has a smooth transition into the Company, that we have a long immersion process, and then I transition to the Board so I can mentor the next CEO. I'm encouraged by the quality of the candidates. They understand the economic and geopolitical landscape and the power of the Starbucks brand and, most importantly, the humanity of the Company.

And Jeffrey, I'll take the second part of your question. As it relates to FY '23, as you know, we've suspended guidance for the remainder of this fiscal year, and we look forward to sharing more about our long-term growth algorithm with you at Investor Day. We'll be looking forward to updating you then regarding what we're expecting for FY '23 and beyond.

I know there's a lot of conversation about the U.S. business that's seeing record customer demand, but the overall number still suggests that same-store traffic is still down somewhere in the double digits versus 2019. I wanted to drill down in terms of what some capacity or efficiency enhancements at the store level might mean. Firstly, is there a plan? Or do you have a thought of returning that core morning day part business, the ritual business, the real habit-driven business that was long such an important part of everyone's life in the U.S.? Is it just a return to normal from a customer side? Or do you have some specific initiatives to bring that customer back? And the second part of the question, as it relates to adding capacity in the afternoon, we've seen a shift to food, we've seen a shift to cold. How much capacity can be added to that afternoon business through things like better training hours and procedural changes versus what might be more complicated and time-consuming around equipment and actual physical store design?

John, this is John Culver. We're very bullish on our business right now just in terms of the overall growth prospects and the number of customers that are walking in our doors each day. Clearly, the composition of customer visits has shifted versus what we saw pre-pandemic, and new routines are being established. We're seeing that particularly in suburban areas and convenience channels like drive-through, mobile order, and delivery, which accounted for 72% of our revenues. Generally, we see single transactions in those channels with much higher tickets, translating into higher ticket for the quarter. Regarding day parts, we see morning continuing to grow in the quarter, representing 51% of our sales, which is beginning to return to normal. That will be driven by the urban core opening back up, and we did see for the fifth consecutive quarter positive comp growth in the urban core. We're optimistic that those morning routines will come back, driving higher transactions and likely a bit lower ticket at that time. We continue to see strong overall beverage growth, 9% in the quarter, with cold beverages contributing 74%. We're seeing growth across all categories, and our average weekly sales are at an all-time high, up 30% versus pre-pandemic levels. Unique customer visits are up 6% versus last year and up 9% versus last quarter. We feel good about the path that we are on.

Just wondering if there's any way to quantify the current wage increase and the wage inflation that you've managed and put in response to some of the partner issues. Where does this go next? Is it more of a benefits issue? Do you think this latest increase sort of gets you to the optimal place?

Andy, I can start with part of that question, and then I'll turn it over to Frank for a little more color. What I can say regarding the wage investments that we've taken in is that our broader investments overall include an incremental $1 billion this year, largely related to wage increases. In Q3, that was about 2% of our consolidated revenue. It will be about 4% next quarter. This foundational investment supports our reinvention plan, which aims to improve the experiences for our partners and customers. In FY '23, we will share more, but setting the stage for an elevated experience for our partners is our aim.

I want to emphasize that our reinvention approach will personalize the experience for our partners, alongside increased compensation and to meet a variety of other staff needs based on where they are in their lives and careers. Expect greater personalization in the approach with services, flexibility, credentialing models, and training options that cater to individual experiences.

Howard, you mentioned no measurable reduction in customer spending or trade down. Can you provide insights into the performance of Rewards customers versus non-Rewards customers? Are there differences in behavior between the cohorts? Also, Starbucks Rewards launched back in 2008. Can you remind us of the reasons for that launch and its evolution over the last 15 years? How do you foresee its role in a more challenging consumer environment?

Certainly. In terms of the performing Rewards and non-Rewards customers, we've seen our customer counts reach an all-time high this quarter for both SR and non-SR members. SR members increased at a greater rate, and their spending also hit an all-time high. This growth comes from strategic pricing, premium offerings, and personalization, enhancing customer engagement. The Starbucks Rewards program was initiated to strengthen customer loyalty and personal connection, and over the years, it has evolved significantly, solidifying its value proposition. In a challenging consumer environment, we see the Rewards program as a key value driver, enabling us to offer discounts and maintaining strong customer relationships.

Thanks for the comments, especially regarding customer response to pricing. I wanted to ask about transactions. Transactions could have stalled a bit when compared to pre-COVID levels, why do you think that is? What factors do you think are inhibiting a more robust recovery in transactions?

While we have seen transactions improve in comparisons to last year, they have not returned to FY '19 levels. We attribute this to shifts in consumer behavior and evolving work patterns. We've modified customer engagement strategies to meet them where they are while still driving revenue growth. Average ticket increases have compensated for some lost transactions, and we're focused on continuing to attract customers and drive engagement.

It’s vital to note that our relevance with young customers, specifically Gen Z, is stronger than ever. Understanding how our demographic evolves is crucial for long-term success. Our brand’s positioning and innovative beverages allow for robust engagement, which we intend to accentuate moving forward. Additionally, morning routines will undoubtedly return, enhancing overall customer engagement and operational leverage.

I want to come back to the reinvention plan. Specifically, can you provide context on what reimagining the stores means? Are we talking about more store closures or remodels? What is the investment needed for 2023?

We don’t anticipate material store closures. September 13 will showcase how we're reinventing the store model and customer journey with improved equipment and capacity. It’s not about fewer stores but enhancing existing ones for customers and partners alike.

We've initiated investments this year as part of our $1 billion target, focusing on reimagining our stores. Improving our stores' equipment, uptime, and innovation fosters efficiency, which is critical in today’s operating environment.

As we implement our reinvention plan and technology advancements, our primary goal is creating seamless experiences for partners and customers in stores. We are investing in our operations to enhance store efficiency, speed, and transaction capabilities, which will pave the way for us to grow.

I am excited about the results we had. We were up 50% ex-China and international, which is driven by strong growth across all regions. We're inspired by the resilience of our brand and elevated innovation efforts. As travel resumes, we expect these markets to grow even further.

Regarding our investments, we are working towards significant enhancements in our stores. Upgrades are underway in equipment and operational standards to drive higher efficiency and improve partner and customer experience, including investing in our cold beverage offerings.