Costco Wholesale Corporation

Ladies and gentlemen, thank you for standing by. Welcome to the Q4 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. Thank you. I would now like to hand the conference over to your respective hosts Mr. Richard Galanti, CFO. Sir, you may begin.

Thank you, and good afternoon to everyone. I'll start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results, and or performance to differ materially from those indicated by such statements. The risks and uncertainties include but are not limited to those outlined in today's call, as well as other risks identified from time to time in the company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and the company does not undertake to update these statements, except as required by law. In today's press release, we reported operating results for the fourth quarter and fiscal year 2019. The 16 and 52 weeks ended September 1st. Reported net income for the quarter was $1.097 billion, or $2.47 a share. That compared to $1.043 billion a year ago, or $2.36 a share. This year's fourth quarter was negatively impacted by a $123 million pre-tax reserve to SG&A, or $96 million after-tax, or $0.22 per share, related to a product tax assessment. In terms of this $123 million pre-tax reserve, or charge to SG&A, Last week we received an assessment related to certain product taxes. It covered a seven and a half year period from January of 2009 through July 2016. While we'll be following a protest to this, a reserve for this assessment was recorded in the fourth quarter in accordance with U.S. GAAP. Excluding this reserve, Q419 net income would have been $1.19 billion or $2.69 a share, a 14% increase over last year's fourth quarter. Net sales for the quarter came in at $46.45 billion, a 7% increase over the $43.41 billion last year. And for the entire fiscal year, net sales in fiscal 19 came in at $149.35 billion, a 7.9% increase over last year's $138.43 billion. In terms of comp sales, as was reported in the release, For the 16-week fourth quarter, reported U.S. was 6.2. Excluding gas deflation, FX, and revenue recognition, it was 5.2. Canada reported 2.6. Ex deflation, FX, and rev rec, 4.7. Other international reported 1.9. Ex those items, 5.0. So total company, both for the 16 weeks, with and without those items, was a 5.1. E-commerce was a 19.8% reported comp and a 21.9% XFX and RevRec. In terms of the Q4 comp sales metrics, fourth quarter traffic or shopping frequency increased 3.7% worldwide and 3.6% in the U.S. Weakening foreign currencies relative to the U.S. dollar negatively impacted sales by about 60 basis points. Gas price deflation was a negative 50 basis points. And REVREC benefited comp sales in the quarter by plus 110. So those three things together essentially zeroed out. Our average transaction or ticket during the fiscal quarter was up 1.4%, both with and without the impacts of GAF, FX, and REVREC. Next on the income statement, our membership fee income reported in the fourth quarter was $1,050,000,000, up 53 million or 5.3% over last year's fourth quarter. X the impact of FX, the $53 million increase would have been $58 million, or up 5.8%. During the fourth quarter, the 23-month cycle to recognize the incremental P&L benefit of the fee increases that began in June of 2017 was completed, and the impact in the Q4 results was almost zero, less than a million-dollar benefit to the quarter. In terms of renewal rates, At Q4 end, our U.S. and Canada membership renewal rate came in at a 90.9%, up 0.2% from 90.7% as of the end of the last quarter. And worldwide, the renewal rate was 88.4, up from 88.3% a quarter ago. Both of these figures, all-time highs. In terms of number of members at Q4 and fiscal year end, we had 53.9 million members. Member households, that's up from a quarter ago of 53.1 million. And total cardholders at the end of the year, 98.5 million, up from 97.2 million at the end of Q3. During the quarter, we had 10 net new openings, eight in the U.S., one in the U.K., and our first warehouse opening in China and Shanghai. At fourth quarter end, paid executive memberships totaled 20.8 million. which was an increase during the quarter of $362,000 or $23,000 a week. In terms of going down the gross margin line, our reported gross margin in the fourth quarter was higher year-over-year by a reported 14 basis points and X gas deflation and rev rec up by 20 basis points. As usual, I'll ask you to jot down a few items for explanation purposes. In the fourth quarter, you'll have two columns, both reported and then without gas deflation and RevRec. The line items would be, the first line item would be merchandise, core merchandise. On a reported basis, year over year, it was down eight basis points. X gas and RevRec, it was down three basis points. Ancillary businesses, up 29 basis points. And X those items, up 31 basis points year over year. 2% reward, minus three and minus four basis points. Other, minus 4 and minus 4. If you add those up, you get the plus 14 basis points as reported, and again, X gas and Rev Rec up 20. Now, in terms of the core merchandise component of gross margin, it was lower by 8 or might really lower by 3 X gas and Rev Rec. Looking at the core merchandise categories in relation to their own sales, or what we call core-on-core, margins year-over-year were higher by 4 basis points. Subcategories within that year-over-year in the fourth quarter showed increases in fresh and soft lines, partially offset by a little down year-over-year in hard lines, with food and sundries being relatively flat year-over-year. Ancillary and other business, as mentioned, was higher by 29 basis points and 31 higher ex-gas and rev rec. Most of that was attributable to strong gasoline margins. Other was minus 4 in both columns. Moving to SG&A, I'll ask you to jot down the following. Again, two columns reported in gas deflation and rev rec. Operations, plus three basis points and minus two. So minus two means higher by two. Central, minus five and minus five are higher by five. Stock compensation, plus two and plus two, so lower by two basis points year over year. And then other, minus 27 and minus 27. And with that, you would get to a reported SG&A percentage year-over-year being higher or worse by 27 basis points, coming in at 10.09% of sales, up from 9.82% of sales a year ago. Again, excluding the one-time item discussed earlier, the SG&A would have been flat year-over-year on a reported basis, and X gas and rev rec higher by five. Now, in terms of the components here, The core operations component, excluding the impacts of gas and REVRAC, again, was two basis points higher. This figure included the impact of the two wage increases that were taken in June of 2018 and March of 2019, which essentially hit the year-over-year comparison by an estimated five to six basis points in the quarter. We estimate that once the first one anniversary is now during the quarter, we estimate that the impact in Q1 and Q2 until that one anniversary will be about a three to four basis point hit. Central was higher year-over-year by five basis points, both with and without gas and rev rack. IT was the biggest driver of that increase. In terms of stock comp, again, that helped the SG&A by two basis points. And again, lastly, as discussed earlier, the $123 million hit to SG&A decidedly counts for the 27 basis points. Next on the income statement, pre-opening expense. Pre-opening expense for the fourth quarter came in at $41 million, $10 million higher than the $31 million fourth quarter of last year. This year in the fourth quarter, we had 12 total openings, 10 net plus two reloads. A total pre-opening was up year-over-year primarily due to the pre-opening costs related to our chicken plant in Nebraska. It's now open for business, and we'll have an estimated 45-week ramp-up to full production from the September 10th go-live date. All told, reported operating income in Q4 increased 1%, coming in at $1.463 billion this year compared to $1.446 billion last year. And again, excluding the one-time item discussed earlier, operating income was up 9.7%. Below the operating income line, interest expense was $3 million lower or better year over year, coming in at $45 million, down from $48 million a year earlier. And interest income and other for the quarter was higher or better by $23 million year over year. Actual interest income was better by $15 million, a combination of both higher invested cash balances and higher interest rates, with a balance of $8 million positive variance, primarily favorable FX-related items year over year. So overall, pre-tax income, again reported, including the one-time item, was up 3%, coming in at $1,492,000,000 this year, up from $1,449,000,000 last year. And again, excluding the one-time SG&A charge discussed earlier, operating income would have been up about 11.5%. In terms of income taxes, our tax rate in the fourth quarter came in at 25.7%. compared to 27.4% in the fourth quarter a year ago. This quarter tax rate benefited from a few favorable discrete tax adjustments. A few other items of note. Again, in the fourth quarter, as I mentioned, we opened 12 total locations, net of reloads to 10 net new locations. For the whole year, we opened 25 total locations, including five relocations, so a net increase of 20. About three-quarters of those were in the U.S. and a quarter of them international. At Q4N, our square footage stood at 114 million square feet. Regarding CapEx, fiscal 2019 total spend was right at $3.0 billion. We'd estimate the CapEx for the upcoming year will be that or slightly above that, not that different than the past fiscal year. In terms of stock buybacks in the fourth quarter, we repurchased 52 million shares, 194,000 shares at an average price. per share of a $268.08. That brought the total year to $247 million on 1.097 million shares at an average price of $225.16. Moving on to a couple other items of note, e-commerce, again, as mentioned, for the quarter on X gas and RevRec was up 21.9%. We saw particularly strong growth during the quarter in what we call majors, electronics and appliances and the like. Total Online Grocery continues to grow at a very healthy clip, recognizing it's still pretty small. That both includes the two-day as well as one-day fresh with the help of Instacart. Ecom, for the first time this past quarter, carried some new items like KitchenAid appliances and Weber grills and several high-quality beauty brands for the first time. In addition... We rolled out a few examples of if you've shopped in the warehouse, what we call merchandise roadshows, kind of a treasure hunt for the warehouses. Some of those things are now being put online. We sold another large diamond ring during the quarter for $220,000. And we have upcoming e-com sites planned for two new countries, Japan and Australia later this fiscal year, sometime mid-fiscal year. In terms of the Costco app, we've started to add a few things to it, including it can be used as your digital membership card. That was added in July. We now have over 2.5 million activations during the quarter. Currently, the app allows, in addition to digital membership, the register as well. View current gas prices. Executive members can view their growth in their annual 2% executive member reward. We have a few things related to the pharmacy in terms of refilling and managing pharmacy prescriptions, as well as being able to renew and upgrade, and the beginnings of some new shopping lists and current promotional offerings. There will be plenty of additional enhancements that are in the works, and we'll continue to roll those out and more tie-ins with Costco both in warehouse and online. I mentioned earlier that during the quarter we opened our first unit in China in the city of Minhang, part of Shanghai. Okay. That was on August 27th to great interest. Due to the overwhelming crowds, it was actually closed about four hours into the opening day. Subsequently to that, crowds have been well managed and sales have remained very strong over the past month. We've had record sign-ups there. I think it's been helped by the first one that we've opened there as well as the social media presence. We currently have over 200,000 members signed up. Just to put that in perspective, worldwide, the average Costco, ones that have been open for months and ones that have been open for 35 years, all told have approximately 68,000 member households per location. Our next opening is planned for early 2021 and also in Shanghai in the area of Pudong. In terms of tariffs, next item. And a quick update, there continues to be a lot of moving parts and changes and a few increases along the way. A few comments. As you're probably aware, the first three lists, which total about $250 billion of imports from China, includes things from water pitchers and air purifiers to bicycles to steel shelving to furniture to luggage to shredders to things like that. Those are currently being tariffed at 25%. With the current plan, we understand to possibly go to 30% effective October 15th, but we'll just have to wait and see. List 4A, which is about $110 billion, includes things like kitchenware and cookware and domestics. It includes TVs, although I don't think we source from there on that. That started at 15% tariff on September 1st, and we'll see where that goes. And then List 4B, which is an additional $155 billion worth of goods, including electronics, laptops, tablets, toys, small appliances, some apparel and footwear as well. That's currently planned to go to 15% tariff effective December 15th. Again, we'll wait and see. Since the beginning of these tariffs over a year ago, we continue to be active in managing and, where possible, mitigating their impact. Where we can, we accelerate shipments before a tariff is being put into effect or is being planned for an increase in terms of the tariff percentage level. We are working with suppliers daily. We've gone to pretty much every supplier on every item to see what we can do to both reduce costs and figure out how to do that. In some cases, we've reduced our commitments on certain items, and again, based on the impact of what we expect. We've looked at alternative country sourcing where possible and feasible, although again, there's a limited amount of that ability to do that. And we've taken advantage of lower pricing on a few U.S. items that have been picked the other way. The exchange rate, by the way, between our two countries has helped a little bit. So all those things. As you might expect, it's all over the board. Every item and every vendor is a little different. In some cases, we're able to hold off on some, and some we need to push it forward to pass it on. And we'll continue to pursue that. Overall, we think we're in a good position relative to retail overall, given our size and scale and our ability and relationships with our vendors. The last thing on tariffs, just another area of potential tariffs. It relates to yesterday's WTO announcement that the U.S. can legally impose tariffs of up to $7.5 billion in EU-produced goods annually. Later yesterday, the USTR released a list of products it plans to target with duties planning to take effect October 18th. Some of the products included on the list include 25% duties, certain whiskeys and apparel items from the UK, various cheeses and olive oils from certain European countries, and certain pork products, butter and yogurt from various European countries, to name a few. So that's pretty much it in terms of what we have to say. Lastly, in terms of upcoming releases, we will announce our September sales results for the five weeks ending this coming Sunday, October 6th, on Wednesday, October 9th, after the market closes. With that, I'll open it up to questions and answers and turn it back to the operator. Thank you.

Thank you. And at this time, I would like to remind everyone, In order to ask a question, please press star, then the number one on your telephone keypad. Again, that's star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. We have your first question coming from the line of Michael Lasser from UBS. Your line is now live.