Costco Wholesale Corporation

Ladies and gentlemen, thank you for standing by and welcome to the Q2 earnings call and February sales conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. And to ask a question during the session, you'll need to press star then the number one on your telephone. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Richard Galanti, CFO. Thank you. Please go ahead.

Thank you, Richelle, and good morning to everyone. 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 second quarter of fiscal 2020. The 12 weeks ended this past February 16th, as well as February retail sales results for the four weeks ended this past Sunday, March 1st. Reported net income for the quarter came in at $931 million, or $2.10 per share, just compared to last year's second quarter of $889 million, or $2.01 per share. Net sales for the quarter came in at $38.26 billion, a 10.5% increase over the $34.63 billion realized last year in the quarter. Comparable sales for the second quarter. were as follows. In the U.S., for the 12 weeks on a reported basis, 9.1%. Excluding gas inflation and the impacts of FX, 8.1%. Canada, on a reported basis, 8.9%. Ex-gas and FX, 6.8%. Other international, 7.9% reported and 7.1% ex-gas and FX. For total company, a reported 8.9% same-store sales increase and ex-gas and FX, a 7.9%. Both of those numbers were positively impacted as well by approximately a half a percent due to the Thanksgiving holidays occurring one week later this year than last year. On e-commerce, we reported a 28.4% comp for the 12 weeks and a 28% FX. And again, there was a bigger impact of this Thanksgiving holiday shift there given the importance of that to e-commerce. E-commerce sales in the quarter were positively impacted by an estimated 11 percentage points, and hence the 28% comp result. In terms of second quarter comp sales metrics, second quarter traffic or shopping frequency increased 5.9% worldwide and 6.1% in the U.S., Strengthening foreign currencies relative to the dollar, the U.S. dollar, positively impacted sales by about 25 basis points, and gasoline price inflation positively impacted these numbers by about 80 basis points. Our average transaction size or ticket was up 2.9% during the quarter, which includes the positive impacts of gas, inflation, and FX. Later in the call, I'll review our February sales results. Moving down the income statement for the second quarter, membership fee income came in at $816 million, or 6.3% higher than the $768 million recorded in Q2 of last year for a $48 million increase. That percent increase is about the same as it was Q1 year-over-year. In Q1, we had three new openings. In Q2, we had no new openings. In terms of renewal rates, at Q2 end, our U.S. and Canada renewal rates came in at 90.9% and worldwide renewal rate at 88.4%. These are the same levels of renewal that we've achieved in each of the last two fiscal quarters. In terms of number of members at second quarter end, in terms of member households and total cardholders, At the end of second quarter, we had 55.3 million member households, up about 600,000 from the 54.7 12 weeks earlier. And total cardholders totaled 100.9 million, up about a million from the 99.9 million we reported at the end of the first quarter. At Q2 end, paid executive memberships stood at 21.7 million members. an increase of 321,000 during the 12 weeks or about 27,000 per week increase since Q1 end. Going down to the gross margin line, our reported gross margin in the second quarter was lower year-over-year by 31 basis points, coming in at 10.98% compared to 11.29% a year ago. That 31 basis point reduction, lower number year-over-year, excluding gas inflation, it would have been 22 basis points lower. If you'll please jot down the four line items in two columns, as we usually do. First column is reported for the second quarter, and the second would be without gas inflation. The core merchandise margin was down on a reported basis, 30 basis points year over year in the quarter. Ex-gas inflation was down 22. Ancillary businesses, a minus 5 and a minus 2 basis points. 2% reward, plus 4 and plus 2. And then total, as I mentioned, 31 basis points lower year-over-year on a reported basis, and ex-gas inflation, 22 basis points lower. The majority of the lower year-over-year core margin was driven by higher sales penetration of two significant lower margin segments of our operations. which are growing at a faster rate than the core, notably gasoline and e-comm, as well as the startup losses at our new poultry complex, which I'd mentioned in the first quarter as well. Looking at the core merchandise categories in relation to their own sales, core and core, if you will, margins year over year were lower on a reported basis by 15 basis points, of which six basis points related to the losses from the new poultry complex. Within the core gross margin year-over-year in Q2, we showed a gross margin increase in soft lines. Food and sundries was about even year-over-year and decreases in both hard lines and fresh foods. Hard lines was down in the quarter primarily due to holiday timing, which shifted more promotional activity into Q2 this year. Fresh was negatively impacted by our step-up in price investments versus last year in fresh and fresh, and by the margin impact from the new poultry complex, as I had just mentioned. We're now halfway through our first year of operations of the poultry facility, which opened on September 10th, and we would expect the gross margin headwinds to decline, but continue, but to decline a little bit as we get to full production capacity and improve operations. Ancillary and other businesses gross margins on a reported basis minus five basis points year over year and minus two ex-gas deflation in the quarter. Basically, you had a few things that hurt you and a few things that helped you, but overall minus two ex-gas inflation. Two percent reward was better by four on a reported basis and by two basis points ex-gas inflation. This relates primarily to a true-up of our breakage estimate of the executive member rewards. Moving to SG&A. Our reported SG&A percentage year-over-year was lower or better by 22 basis points, coming in at 9.78% of sales, down from a 10.0 a year earlier. Without gas inflation, SG&A was lower by 13 basis points. Again, if you jot down the following few numbers, four line items in the two columns. Core operations, year-over-year in Q2 on a reported basis, showed an improvement. It was lower, so I'll say a plus 17 basis points. And ex-gas inflation, plus 10. Central, plus 1 and plus 0. Stock compensation was lower, or plus 4 and plus 3 on ex-gas inflation. And again, the total on a reported basis, SG&A was lower by 22 basis points, plus 22. And without gas inflation, plus 13, so lower by 13. The core operations component, again, 17 reported, 10 excluding impact for gas. This figure includes the impact of the wage increases that occurred last March of 19. This hit our year-over-year comparison by an estimated three to four basis points. We anniversary that increase just this past week, so the impact in Q3 will be minimal. SG&A also benefited during Q2 year-over-year from the shift of sales penetration to lower SG&A, if you will, lower SG&A segments of our operations, which are growing at a faster rate than the core. Again, gas and e-comm. Central was lower within SG&A. Central was lower on a reported basis by one basis point or flat year-over-year ex-gas inflation. We continue to invest and spend in IT to the tune of about five basis points higher year-over-year. That was offset by improvement in other expense items and, of course, helped by strong sales. And stock comp, as I mentioned, on an ex-gas inflation improvement of three basis points. This varies quarter to quarter. Looking at the last couple of years, generally it's a small hit in Q1 and flat to a small benefit in the other quarters. Nothing really unusual to report there. Next on the income statement is pre-opening expense. Pre-opening expense was lower. It came in at $7 million compared to $2 million in Q2 a year ago. As I mentioned earlier, this year we had no openings. Last year we had two openings, both in the U.S., one net new opening and one reload. This year's Q2 pre-opening expense in this quarter relates primarily to warehouses that will open during the third and fourth fiscal quarters. Coming up very soon, our opening in Perth, Australia, and also our first in the state of Mississippi and originally Mississippi. That will be our 45th state where we operate. Those will both open during the next couple of weeks. All told, reported operating income in the second quarter of 2020 increased by 5.2%, coming in at $1,266,000,000 this year, compared to $1,203,000,000 a year ago. Below the operating income line, interest expense was the same year over year, coming in both quarters at $34,000,000. And interest income and other for the quarter was lower by $1,000,000, so almost flat year over year. Overall pre-tax income was up 5.1%, coming in at $1,277,000,000 compared to last year's $1,215,000,000. In terms of income taxes, our rate was just slightly higher year over year. In the second quarter, it came in at a 25.9% rate compared to 25.8% in Q2 last year. For all of fiscal 2020, based on our current estimates, which, of course, are subject to change, we anticipate that our effective normalized total company tax rate to be approximately 26% to 26.5%. In terms of openings, as I mentioned, we had no openings in Q2. We plan two net new openings in Q3, and I'll give you a range for Q4, which is our 16-week fiscal quarter, of 11% to 13%. Part of that, again, most of the openings concentrated in our fourth fiscal quarter, and of course there's probably a few subject to slipping into early part of next year based on weather. As of Q2N, total warehouse square footage stood at 114 million square feet. In terms of capital expenditures, during the quarter we spent approximately $545 million, and our estimated CapEx for all of fiscal 20 remains right around $3 billion. In terms of e-commerce, again, we reported a 28.4% comp sales increase and 28 without FX. Again, a lot of that increase had to do with the Thanksgiving shift. We estimated, again, that about 11 percentage points of that related to Thanksgiving falling a week later this year and helping this number. Overall, a few of the stronger departments, majors, special or kiosk items, seasonal and toys, and housewares, these departments generally benefited from the holiday shift. In terms of total online grocery, that continues to grow at a faster rate than the store e-com comp, both Today and Instacart, the latter of which isn't included in our e-commerce numbers since they come into the warehouse to buy. Although the sales penetration is still very small, The sales are quite large in the high double-digit range year over year. During the second quarter, we successfully launched both our Japan e-commerce site in December and our Australia e-commerce site this past month in February. And not to be outdone, we recently sold another high-value large-carat diamond for a little over $600,000. If anyone's interested, please give me a call. Turning to our February sales results, the four weeks ended this past Sunday, March 1st, compared to the same period last year. As reported in our release, net sales for the month of February came in at $12.2 billion, a 13.8% increase from $10.72 billion a year ago. In terms of geography, U.S. reported comp for the four weeks 12.4%, ex-gas at FX 11.6%, Canada reported at 10.2%, ex-gas and FX at 10.4%, Other international, a 12.5%. X gas and FX, a 13.5%. So total company, a 12.1% reported and an 11.7% X gas and FX. Ecom for the four-week period, 22.6% for the reported and 22.7% FX. Our February results benefited by last week's big uptick in sales, the fourth week of last month. Mostly, we believe, related to concerns around the coronavirus. This positively impacted the month's total and comparable sales numbers by approximately three percentage points. U.S. regions with strong sales results in February were the Northwest, Texas, and the Midwest. Internationally, in local currencies, we saw strong results in Taiwan, Japan, Spain, and Mexico. For the month, foreign currencies year-over-year relative to the dollar hurt February comps sales in Canada by about 60 basis points. It impacted negatively other international by about 110 basis points and total company by about 20 basis points. Cannibalization was about a 10 basis point impact to the U.S. to the minus, 140 basis point minus impact to other international, and 30 basis points overall to the company. Moving to merchandise highlights, the following comparable sales results by category. Food and sundries were positive in the low teens. Strongest departments included foods, frozen foods, sundries, and candy. Hard lines were positive in the high singles. Better performing departments were lawn and garden, health and beauty aids, and tires. Soft lines were up in the mid-single digits. Better performing departments included housewares, domestics, and jewelry. And finally, fresh foods were up in the low double digits. Better performing departments included meat and produce. Within ancillary, pharmacy gas and hearing aids had some of the better comp sales increases in February. Gas price inflation, I think I mentioned this, positively impacted total reported comp sales by about 60 basis points. Lastly, our comp traffic or frequency for February was up 9.2% worldwide and 8.9% in the U.S. Now, given the impact in week four where we really saw the big uptick, as I know many did out there, related to the concerns over coronavirus, The first three weeks, within that 9.2 worldwide for four weeks, the first three weeks stood at 7.6%. And again, within the 8.9% U.S. frequency number for the four weeks, within that, for the three weeks, it was 6.9%. So still a good showing prior to that. For February, the average transaction was up 2.7%. Now, turning to the coronavirus and all the issues and impacts surrounding it, Like everyone, we are keeping a close eye on the developments around the coronavirus, including the impact on operations, the health and safety of our members and employees, and, of course, our supply chain. As already discussed, we saw strength in our February traffic and comp sales related to the news and concerns about the virus, particularly in the last week of the month, and that's continuing in the first few days of this week. Our warehouses have overall remained open, with only a few total days of closures at a couple of locations in Korea. As well, our Shanghai location, there's been some limitations required on the number of people in the facility at a given time. Members are turning to us for a variety of items associated with preparing for and dealing with a virus, such as shelf-stable dry grocery items, cleaning supplies, Clorox and bleach, water, paper goods, hand sanitizers, sanitizing wipes, disinfectants, health and beauty aids, and even items like water filtration and food storage items. And we're doing our best to stay in stock on these and other items. We're getting deliveries daily, but still not enough given the increased levels of demand on certain key items. It's been a little crazy this past week in terms of outside shopping frequency and sales levels, and not only in the United States. In terms of placing quantity limits on what a member can purchase, we are doing that in some instances. It tends to be at all locations, but may differ regionally based on supply levels. I do want to give three big shout-outs. Our buying staffs, both here regionally and abroad, are working in some cases around the clock to procure supplies from both existing suppliers and from other sources where possible. Second, a shout-out to our warehouse employees. These last nine or so days has been beyond busy. Even with the traffic jams in the parking lots and the long lines to check out, they've been absolutely awesome. And anecdotally, we're hearing that daily from members. We hear a few other things occasionally, too. And lastly, our suppliers, both domestically and abroad, we feel our strong long-term relationships have helped through this crisis. We've been there for them, and they are certainly there for us now. Overall, in terms of what the coronavirus-related demand items, in terms of that, it's looking better but not perfect. We'll see what each day brings. At our warehouses... In terms of cleanliness and sanitizing, we have enhanced sanitizing protocols and safety procedures have been implemented at all the locations. Some examples, wiping down cart handles with sanitizing wipes, placing of sanitizing wipes, stands at entrances, also along the fresh line wall at food courts. Enhanced procedures at the food courts, patio tables, condiment tables, dispensers and pin pads, et cetera. The general things you might expect and that we see in all the recommendations. In terms of supply chain, closures of many, many manufacturing facilities extended well beyond the typical one-week Chinese New Year holiday, which was the last week in January. In many cases, factories over there were closed for one to two additional weeks. That's now improving each week. Initially, two to three weeks of factory. So initially, there were two to three weeks of factory closures, not one. Then about three weeks ago, and just polling some of the buyers that deal with the factories. They felt there was a rough number of 20% to 25% production levels, moving up to 40% and now as high as 60% to 80%. But again, it's improving and still has a little ways to go. In terms of transportation issues, with its Chinese New Year and then a couple of additional closure weeks, there were not only product issues but also trucking and port issues. These are also abating with port capacity in China improving each day as well. And I say port capacity, it's also the shipping lines that come to the various ports. Domestically, truck capacity is plentiful. However, exporting items, including KS items as well as other U.S. manufactured items to our locations in Asia and Australia, it's been a little bit of a challenge because of some container shortages here. But overall, okay, it's just taking a little more work. We're finding other ways to handle any potential out-of-stocks by shifting SKUs to alternative items and categories. particularly in the areas of domestic goods, food and sundries, and fresh. And as you might expect, our travel business is impacted due to reduced demand as well as higher than normal cancellations of previously booked trips, particularly as it relates to cruises and international travel. I don't think there's any surprise with that. At this point, it's hard to quantify what the financial impact will be to our future results. Again, the first Weekend half of this fiscal quarter, the last weekend half has been quite good with the sales, but we'll see what tomorrow brings. We'll continue to pass that information along, and, of course, we do report monthly sales results. Finally, in terms of upcoming releases, we will announce our March sales results for the five weeks ending Sunday, April 5th, on Wednesday, April 8th, after the market closes. With that, I will open it up to Q&A and turn it back over to Rochelle. Thank you.

Alright, thank you. And as a reminder, to ask a question, you will need to press star and then the number one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Simeon Dittman from Morgan Stanley. Your line is open.

Hey, Richard. Can you hear me okay?

Yes.

Okay, good. My first Good. Thank you. First question is on the gross margin. I think if we take the core-on-core down 15 and you get rid of the chicken production cost, you're down 9. Did you say within that what the e-commerce mix shift is and how that compares to prior quarters or to the prior run rate?

We weren't that specific, but a lot of it has to do with the fact that particularly that one week where it's so important to e-commerce on promotional items for Black Friday, Cyber Monday, the weekend, the three days leading up to Thanksgiving. So you do have some lower margin categories in there to start with, as well as we do a lot more promotional stuff as most retailers do with that week of Thanksgiving. Okay.

Okay, so this was a little bit unusual given the timing and given just the fourth quarter or the holiday period was in that number.

Well, and I want to stand corrected if there's a couple people here just correcting me. The e-comm numbers are not in the core on core. So that would be outside of that.

Got it, okay.

But it's still the strength in majors.

Right, okay. Got it. But broadly speaking, the greater mix of e-com, Richard, is going to depress – well, you're saying it's not in that number, but it's unfavorable to gross margin broadly, though. Is that fair? And is that because of the mix of products that are being bought or because of the discounts or the markup that you're putting on those items?

It's both. You know, I mean, as we try to build new categories over the last year or so, like apparel – We're giving some hot deals out there. If you buy one shirt, it's X. If you buy two, it's a little less for delivery or whatever else. So, you know, we're driving that business. And, you know, again, we've talked about... Yeah, but the big thing is electronics. Electronics tends to be a low-margin business. Not only TVs, but, you know, all the computer and phone things.

Got it. Okay. My follow-up is on just overall reinvestment, right? Your business is growing at a really high level. high single-digit comps. I'm not sure if you plan for that level. And the core-on-core in general is doing relatively well. It's not down 20 or 30. And I guess the SG&A that you're spending seems somewhat in line, but I assume you're not flowing through all the leverage that's coming through this model. And so my question is, where are you finding places to reinvest? Again, it doesn't seem like the core-on-core is getting is going down enough to suggest you're putting it back in price. Are you finding other places to spend in SG&A?

Well, I would argue that we are putting a lot of it back in price. Keep in mind of all the buckets we talk about historically, from the membership fee income to the tax reform to the changing credit card, those things keep growing and allows us to be competitive. And when we see strong sales, I think it encourages us to do more of that. And the other thing is I'm not going to go through 10 different things, but there's lots of things. We're very busy. It's not just the five basis points I mentioned in IT. We've got a lot going on with, you know, with e-com fulfillment, with the chicken complex, which I mentioned. There's a lot with CCPA. These are small things, but each of these are various numbers of basis points. You know, CCPA is the California Privacy Act. We don't point it out because I'm sure there's something that goes the other way sometimes, but at the end of the day, there's a lot of things going on, and we feel pretty good about where our expenses are, though we're always going to try to improve them.

Okay. Thank you.

Your next question comes from the line of Gregory Melich from Evercore ISI. Your line is open.

Hi, thanks. Richard, two things I wanted to follow up. One is on the membership fee income. Could you give us what that is in constant currency? And also, if you're seeing any membership signups inflect like the way sales and traffic have in the last couple weeks.

It's $2 million even with FX.

Got it. Once we adjust for that. Got it. And then on the signups, Have you seen any change there in the rate of signups?

You know, I honestly don't know. I know even a few people, I mean, the shopping frequency is off the charts the last few days. And you see it on social media with people, you know, sending in pictures. So I've got to believe there's been a little bit of it, but not enough to move the needle.

Got it. And then secondly, it was just on gasoline. Did you have the average selling price this quarter? And if you have any sort of trends on the gallons, it would be great as well.

I don't have it in front of me. I know that gas was inflationary, correct? Yes. Hold on a minute. Gas price. In Q2, it was 7.9% inflationary.

Inflationary. And that's the average selling price per gallon versus a year ago?

Yes. $2.75 versus $2.55.

Got it. And then last, I'll sneak it in because I know it's coming. The balance sheet, very strong, more volatile markets. How should we think about buyback capital structure in the current rate environment and environment of the world?

Well, every banker calls us every day to let us know that rates are even lower today. Time to borrow. But no, look, we continue to look at it. We talk about it at every board meeting, and all I can tell you is to stay tuned.

All right. Thanks. Good luck, guys.

Your next question comes from the line of Chris Harvest from J.K. Morgan. Your line is open.

Thanks. Good evening. So a few follow-ups. First on On March, I mean, you are limiting some of those high-volume items. It does look like you've got some pretty low-end stocks out there. Do you see the potential for, you know, comp risk later this month?

Well, we don't know. You know, what people have asked is what happens when people, you know, have been bulking up on certain items. And, yes, you know, there's out-of-stocks every day too. But overall, the numbers are incredible because there's so many people coming in. And they're buying other stuff as well. So, you know, I don't know what tomorrow brings. You know, when asked the question, you know, are people going to go through this additional purchasing of water and shelf-stable food items and everything, I guess it depends. Are some of them putting it in their basements for another day? Are some of it related to the fact that people aren't eating out as much? I think it's a combination of those factors. All we know is that last week, starting Tuesday or Wednesday, which is when a lot of the news in the U.S. went even further, we had a huge pickup in traffic, which continued over the weekend and increased the first few days of this, even further the first few days of this week. And so we'll see what tomorrow brings. And again, on the supply side, There's clearly not just at Costco but other places, you know, you really can't go in and generally find sanitizing items and what have you. And while we're getting shipments daily somewhere in the U.S., whatever limited amounts we get or allocated is gone pretty quickly. And I would assume that over the next few weeks or several weeks that will abate, but it depends what else happens with the virus itself.

Yeah, I was at a store on Saturday. I've never – Right after the open, I've never seen a line that long, all the way back to dairy. My follow-up question is, this might be hard to parse out, but I think the big question on investors' minds is how the consumer is going to behave. Obviously, you have the pantry load, but you also sell a lot of general merchandise. You also sell a lot of big ticket. So we're able to sort of tease out if you're seeing any pullback relative to trends in the past week or so in some of the more discretionary and larger ticket categories?

You know, what's interesting, I'm just looking at some handwritten notes that I spoke to our senior buyers yesterday. You would think things like patio furniture would be impacted because it's a big ticket discretionary items. The comment was we're selling it extremely well. Now, part of that is we've got a bunch more people coming in. So maybe per customer category, The purchase per customer is down a little, but there's a lot more customers. And what else? Lawn and garden is doing well. The buyer's view is that's more weather-related in certain markets. There has been some impact. Excuse me?

Did you say TV? Were you going to say TV?

No, I said lawn and garden, weather-related. And then in some electronics items, while some are strong, there's others like some laptops and some phones where there's been some supply chain issues. But I would say overall, my initial thought is that big-ticket discretion items might be negatively impacted right now. To the extent they are, it's been more than offset, at least in these last several days, by the influx of shopping frequency. I don't know what that means for tomorrow. We'll have to see.

Understood. Super helpful. I'm sure all the media outlets are picking this all up. My other questions, two quick ones. One is, have you expanded the number of SKUs in the MVM? It seems to have picked up over the past couple months, but want to get your thoughts there and then Lastly, it looks like you have a new grocery delivery option in the app and on your website, sort of an extended delivery option, not the two-day and not the same day. So sort of what's been the strategy there, and is that new or just a repackaging of something you already had?

Generally, it's been no change in MVM items. I mean, if it's up a little or down a little, I think that's random, not planned. And as it relates to shipping... At least the people in the room with me here are not aware of that. Was it?

Okay. It must be just the repackaging of something that you already had. Okay. Thanks very much. Best of luck. Sure. Thank you.

Your next question comes from the line of Chuck Rom from Garden Haskett. Your line is open.

Hey, good afternoon. This is actually John Park on for Chuck. Can you guys provide a little bit of an update on the performance of Same Day and Costco Today and how that's impacting kind of total spend from these customers that are utilizing it?

You know, it's still relatively new for us over the last year. Overall, and my knowledge of this is a couple months old, it's a slight improvement. You know, the concern, of course, is they buy more having it delivered in one day and two day, and then they come in less frequently. but how less frequently, and they are coming in a little less frequently, but the sum of the two still is fine. Again, it's too early to tell in our view, does fine continue or does it change a little bit? We're still, but keep in mind also, we continue to do a lot of things consciously, even through emails to get you to come back into the location with certain promotional things that are in store only.

Got it. And then I guess just going back to the coronavirus, I mean, is there any way to kind of indicate whether the margin on these sales are materially different than your traditional shop?

You know, food sundries overall is, you know, yeah, it's about in line, I would say, on the company averages.

All right, perfect. Thank you.

Your next question comes from the line of Karen Short from Barclays. Your line is open.

Hi, thanks very much. A couple questions. Richard, you commented on the fresh gross margin decline, and I'm wondering if you could just give a little bit of color on that, and that's obviously excluding the poultry. You kind of called it a step up in price investments.

Yeah, we're just – I mean – At the end of the day, our heart is we're merchants, and we try to drive business. And fresh is an area that also is a frequency driver. So my comment is more anecdotal than some new change in strategy.

But not necessarily also comment on the competitive landscape.

No. The increased level of competition that I've talked about, that goes back a year and a half plus ago. And that hasn't changed.

Okay. And then can you just maybe clarify a little bit on the, I guess, the true-up of the breakage estimates?

Well, I mean, at the end of the day, it's a small amount of basis points. When we issue a significant amount, you can kind of back into the number yourself of what percentage of our sales get the 2% reward. and we send out those certificates, and there's always going to be some slippage, notwithstanding the fact that we send out reminders to our members that you haven't cashed this. At the end of the day, we do our best guess to accrue for slippage, and I'd like to think that we tend to be a little conservative, and therefore, when there's a review, it picks up the other way, but At the end of the day, accounting rules say you do your best guess of what it should be, and then when you re-review it, you adjust that.

Okay. And then I just want to switch gears to the Shanghai store, and I think you said you'll be opening a second one soon, but maybe any thoughts on what you think that the actual annual volumes could and will settle out at for that store, and then any update on the number of members at that store since the last call? And then, I mean, I ask it in the context that, you know, to the extent that China is an opportunity, it's not so much about the units. It's actually about the volume per unit.

Right. Well, it's hard to say because this one is so off the charts. I mean, again, the last few weeks, the last several weeks with some limitations on number of members for some of that period of time, it's changed a little bit. But, I mean, that was either our top or second largest location in our company for for the several weeks leading up to that. And the number of members is, again, off the charts. Nearly five times the company.

Okay, but would we take that same number and apply that to the total revenue for that box, or how should we do that?

No, no, no. No, because given the population of Shanghai and the fact that this thing went you know, throughout social media, and it was very popular over there. You have a somewhat higher renewal rate. We don't know yet because we opened it in August, but we know from other countries. I'm sorry, lower renewal rate. And no, and you can't just simply multiply that out. But the unit overall is, you know, is... Again, either number one or two. Up until the last few weeks with what's going on over there with coronavirus was one of our top two units.

Okay. And then just last question for me. I don't think I've asked this for a while, but are you willing to give an update on what you think or where the average ticket is in the U.S. of an executive member today versus just a basic membership and how that's trended in the last several years? Because it does seem like the momentum is really continuing to increase in terms of your share gain.

Yeah, look, we don't disclose that, but more executive members and more penetration of executive members is good. More members who have, in the case of the United States, the co-brand credit card is good. And if they have both, an executive and that, it's even better. All those things, I think, help our sales growth.

Okay, thanks.

Your next question comes from the line of John Heinbuckle from Guggenheim. Your line is open.

Richard, the price investments you mentioned in fresh food, was that actually proactive price investments or more delays in passing through vendor increases? And then where those investments occurred, was that more protein as opposed to other categories?

It's definitely proactive on our part. And I think it's all of the above. It's protein. It's fresh. I mean, it's produce.

Okay. And then if you look at the fresh food comp, right, so I think you said low double digit, and that included the final week, right? So that was the best fresh food comp you've had in a while. I don't know if you can parse out, maybe you can looking at the final week, how much was some of that coronavirus-related? or was a lot of that step up related to the price investments?

Who knows? Clearly week four was different than weeks one, two, and three for everything, just a sheer number of people coming into the warehouse. I personally believe that given that restaurants probably have been impacted a little bit the last couple of weeks, they're buying more at supermarkets and more at Costco. So those things help a little bit as well.

And then lastly, when you think about it, I know you said the margin on some of that stuff is sort of, you know, in line with the average. When you think about the sort of the cost associated with, you know, restocking and dealing with that volume, and you think about, I don't know, an EBIT margin tied to that volume, normally the EBIT margin will be, the incremental margin will be a lot higher. Is that less the case here because of the cost required to keep, you know, keep up with that volume?

Well, yeah, I think there's a lot of additional things that cost you. I mean, there's not a lot of it, but I'm sure there's a little air freight going on. And I'm sure there's – when you've got a high-cube, high-weight, low-value item like water, you know, 40 half liters for $2.99 or something, and you're going through it faster than you could put it on the floor, you know, there's more labor and everything else. So – But it's still a net positive. In the scheme of things, I don't know if it helps or hurts the bottom a little bit. Okay. Yeah, and the other thing is they're not just coming and getting those five items and leaving. They're shopping a little bit. Again, I personally was surprised that patio furniture is strong. And maybe per person it's a little weaker, but there's a lot more persons. Okay, thank you.

Your next question comes from the line of Mike Baker from Nomura. Your line is open.

Okay. Thanks. A couple questions. One, can you tell us how gas profits were this year versus last year? And then remind us, if you could, how much that helped 2Q19 versus 2Q18. Okay.

I believe, I don't have it in front of me, but I believe last year we said gas helped us relative to the prior year. Uh, it was pretty, it was, it was, it wasn't worth talking about plus or minus either way. This year versus last.

Got it. Uh, okay. Shifting gears a couple more, if I could. Um, so February, even if you take out the, first of all, the 300 base points, can we take that out per rata across, you know, international and the U S or is it, uh, Did it impact one region more than the other? And the real question is, when you strip that out, February was much stronger than you've been running even so. In other words, I presume the first three weeks were strong. So what do you think is behind that uptick even before you got to week four?

It must be those investments in price. No, at the end of the day, it is generally around the world. I think Korea has felt a little less of that benefit, but there was an outbreak there that had a lot of publicity, and I think there were more people perhaps staying home or not going out. But when I look at U.S., Canada, and several other countries, all of them had big upticks in the past nine or so days. I'm sorry, what was the last part of the question?

So weeks one, two, and three were obviously strong as well because when you take out depth around your basis points, it's still your high single digits. So what do you think is behind that big uptick?

There's probably lots of little things. My mother would say we're good merchants and great stuff at low prices. There's nothing that stands out completely. Certainly there was not a lot of press out there about issues around coronavirus, even though it was in the news a little bit. So maybe on a macro basis, there's a little bit of that in there. I think there may have been some weather issues a year ago that may have impacted a little. But overall, we were in those three weeks, forgetting about week four, which was off the charts. We were feeling pretty good about it, that some of the stuff we're doing is working from a merchandising standpoint and a pricing standpoint.

Okay, fair enough. I appreciate the time.

Your next question comes from the line of Rupesh Parikh from Oppenheimer. Your line is open.

Good afternoon. Thanks for taking my questions, and thanks for all the comments on the coronavirus. So I guess, Richard, just going back to your comment here on the supply chain, so as you guys look forward at this point, do you expect any impact on your supply chain related to coronavirus, or is it too early to tell for later in the year?

Well, I think, first of all, there has been an impact on it, It's now starting to get a little bit further back to normal on regular stuff. On some of the virus-related items that people are buying, like water and sanitizing items and paper towels and things like that, that's going to take a little bit while longer. When I ask the buyers, they're working day-to-day with suppliers. You've got suppliers that are literally working around the clock to produce and to ship. But again, people are... coming in and buying stuff, if you will, for their basement.

And what about, I guess I'd ask you more on some of the other categories, like electronics and some of those categories that may come from Asia. Just curious if you expect an impact.

Well, I think I mentioned that we've seen some little impact on some laptops and some cell phones. And I think that's related to some of the things that we all read about in the paper about some shortage, some delays because of some of the component parts. I think one thing that helps us a little is we're able to pivot a little bit. So if there was a shortage or something with one area, we're able to put something else in its place since we sell pretty much everything. But we just don't know what's going to happen tomorrow. First order of business is to get the supply chains back open and running well. There are two kinds of supply chain issues. There's the supply chain issues related to all these very high-demand items related to fighting and protecting yourself, you know, the waters, the sanitizing, the things like that. And then there's just stuff. I mean, you know, everything from furniture to apparel to electronics coming from China. And on the latter, it seems at least while the one week – and keep in mind, given the planned Chinese New Year week, there was stuff brought in early, not only by us but I'm sure others – And so, but then there was two more weeks of closures. So those kinds of things over the last three weeks, in terms of talking to our buyers, the supply chain has, the manufacturers are now back open. They went from zero, if you will, to 25 to 40 to 50 to 60, 80%. And now it's getting to the ports. And some of those things are also being abated, some of the issues there. So my guess is if, everything got better tomorrow from a concern standpoint, you still have a few weeks here where it takes time to fill those supply chains.

Great. And one follow-up question. Just on the holiday season, you guys had a really strong performance, even with fewer selling days. So just curious if there's any surprises or what do you think contributed to the real strong outperformance?

Well, I think that's what we do. I mean, I think we've done a great job You know, we've been helped by, you know, strong big-ticket categories like electronics, like patio furniture and lawn and garden right now, and other hard lines and soft lines areas. Fresh continues to drive our business. You know, as you know when we're asked what are the two or three big factors that drive our business or categories, it's fresh, it's gas, it's executive membership. And, again, utilizing those different buckets, you know, Even when sales are good, we want to be aggressive in pricing. And when sales are bad, we want to be more aggressive in pricing. And when sales are good, we want to be more aggressive in pricing. The top line improvements drive the bottom line.

Great. Thank you.

Our next question comes from the line of Scott Siccarelli from RBC Capital Market. Your line is open.

Good afternoon, guys. Richard, you talked about expecting margin pressure to moderate a bit from the poultry plant ramp, and I know there was an incubation period there. So is that plant actually turning out products at this point? And related to that, can you give us an idea of what the incremental benefit you guys are expecting once you're in full production mode?

Well, I think it was mid-September when the first chicken went through the plant, if you will. The plan was that 45 weeks later, there would be approximately 2.2 million birds a week being processed. And so call it September to August. And so we're a little bit past the halfway mark on that. And I believe in terms of production, we're a little bit past the halfway mark on that. Call it a million birds a week. I could be off a little bit on either side. And so a lot of this has to do with the fact that you've got this big facility that is running at well below capacity. The amount of impairment to margin related to that in Q2 was less than Q1. We would expect it to be less than in Q3 and further. So once we get to full capacity, I think, and then I'm sure there's going to be some operational improvements over the first couple years as well. At the end of the day, it's a combination of sourcing, just simplest supply, and our view is we can improve if you will, the ultimate cost per bird. But we don't know that yet. We spent a little more than we planned, but we also upgraded the facility to be air chilled instead of water chilled. It truly is a state-of-the-art facility for the U.S. and a very high-volume facility. And I would say right now things are going as planned in terms of that 45-week cycle. And I would like to think that a year from now, six months from now or two more quarters from now, It's not going to be an issue that we really even talk about as it relates to how it impacted margin.

Gotcha.

I appreciate that. I don't think I'll be that wrong. Got it.

And then I know you obviously had the surge in that kind of fourth week, as you pointed out, because of coronavirus. Warehouses are obviously jammed. Everyone kind of sees that. I'm curious if you happen to see an even larger increase from e-com in terms of, like, has there been some sort of, shift in consumer behavior at all, or is all the activity concentrated in warehouses?

No, I mean, we saw an increase, but not really. I mean, mind you that, you know, we saw, you know, throughout February, we saw some increase on e-commerce, but, you know, again, if people are looking for those, the sense of urgency, I'm going out right now and get it, and, you know, things like water and everything, And some of those key items, like peanut butter and crackers and the like, we have online as well. And those two, in some regions, they might be in and out of stocks.

Got it. All right. Thanks, guys.

Our next question comes from the line of Judah Farmer from Credit Suisse. Your line is open.

Hi. Thanks for taking the question. I was hoping maybe you could help us with kind of how things trended in Korea over the last few weeks. You have exposure there. They're, you know, potentially weeks ahead of where the U.S. could be, worst case scenario for the virus. So in terms of demand and kind of stock up and then potentially demand falling off as the virus spread there, any insights there?

Well, I think the only insight is, from what I've read, it is the issue that more people are staying at home and not even going out. Whereas even near the, you know, all the publicity that the state of Washington and King County is getting with the few of the deaths, you know, there are people out and about. There's a little less traffic on the highways, but notwithstanding that it's on the highways coming to see us.

Got it. And then kind of changing gears, We've seen some stuff about potentially requiring membership in some food courts in the press. Anything behind the thought process there?

Well, first of all, it's gotten more press than it deserves. There are, I believe, seven current locations on the West Coast where we – and I believe they are all outdoor locations. And one of the challenges we've had is particularly on very busy locations where – people that are non-members just come and eat there every day. You've got member complaints saying, why are you, you know, I have to pay to come to Costco. And so we took, we're testing in seven locations that we are limiting it to members only. You know, it's easy in locations where you have the food court inside, but in many of the ones in areas where the weather is generally good, like California, Arizona, things like that, you have a lot of them that are outside. And so we'll see. But again, seven locations out of 540 we're testing it at, and it's gotten a lot of press.

Okay, got it. And if I could squeeze in one more. Anything on supply in pharmacy and any people stocking up there and potentially running out of inventory?

This is just a quote from the FDA yesterday. It said, while the FDA and other outlets are reporting... disruptions of medical products are possible. At this time, manufacturers are reporting that no specific drugs are experiencing a shortage due to the impact of COVID-19. And talking to our head of pharmacy yesterday, he said the only thing that we've seen, there's been a little pickup there as well. Let's say somebody has a year-long prescription, so a prescription plus three 90-day refills, and they'll come in and they'll want all four of them filled now. And in some cases, even when their particular insurance plan doesn't cover it, they're paying cash. They're just hoarding up on their prescription to make sure we're not running out. But that's more, again, I think, the same thing you're seeing with paper goods. But from a supply and availability standpoint, we haven't seen anything yet. Okay, thanks. Why don't we take two more questions?

Okay. The next question comes from the line of Oliver Shen from Colin. Your line is open.

Hi, Richard. Regarding the supply chain and what you're seeing, what are your thoughts? regarding the price increases or potential price increases, whether that be from transportation costs or other and what your buyers think may happen there. And a second question is related to e-commerce. You made a lot of progress on your mobile app. Just what's ahead for changes to the mobile app and also, more broadly, capital investments related to e-com and supply chain? Thank you.

As it relates to costs, the general view of the buyers is that we have, I get back to the comment I made earlier about strong relations. To the extent that there's some raw materials cost increases because of shortages, that's going to rain on everybody. In our view, it rains on us a little less. But I think given the limited number of items we buy and the amount of a given item that we buy, you know, our buyers, we feel know a lot more about the cost structure. Uh, and, uh, and so, uh, I haven't seen any commentary on that internally, uh, other than there was one small comment. I can't find it in my mess of papers here that there may be in some small cases, some raw material increases on some particular item, some, some particular raw material for some manufacturing process. But overall, there's not been a big issue right now. Um, The only increase in transportation is on some very limited items where there's been a little bit of air freight. What we're finding is that the ports, again, are getting back at capacity, and there's plenty of space. And so that's not been as big an issue. As it relates to an e-com investment, there's not a lot I have on my plate to tell you today. We're working on more things related to our app, to our membership digital app. And we certainly have some things going on on the fulfillment side of e-commerce. And we've been focused on getting two more countries open, as I mentioned, in the last quarter. And we think there are a few other things that we've got going on that I'll be happy to chat with the next time around.

Okay, and is buy online, pick up in store going as you like, and do you expect a lot of enhancements ahead to that as customers like it?

Well, customers like it, but we don't like it necessarily. We're doing buy online, pick up in store for some small items, small high-value items, but we're not at the point where we're looking for members to buy online and come up and pick up their whole grocery basket. So we're trying to figure out our way. Certainly, again, the last nine or so days notwithstanding, things seem to be working pretty well for us in that regard. We continue to work on where we've had good sales and good strength over the last few years in e-commerce is taking certain big and bulky things out of the warehouse, like white goods and things that are delivered and in some cases installed. And so we continue to work on those kind of things as well.

And lastly, Richard, with the surge in demand and the traffic trends that you've seen, how have you managed this customer and guest satisfaction and also labor in your stores, those kinds of things we were curious about?

How do we measure it?

How have you managed it and just tried your best to make sure that customers are happy and also you have the appropriate labor levels relative to spikes and changes in demand?

Well, again, the last week and a half notwithstanding because it's been nuts. No, first of all, member comments and basic member renewal rates. I mean, we actually, the operators and all the way up to Craig, see weekly – information on comments. You can't imagine how many people call and email when they have something that they're concerned about. And we also measure the least expected, but the positive letters to that effect. On the operations side, the key is still, aside from merchandising, the art of merchandising out there and giving the the warehouse manager, the assistant managers, and the merchandisers, warehouse merchandisers, some leeway. I mean, certainly electronics is when you walk in and there's defensive promotional goods and fresh is in the back. But at the end of the day, there is a bit of merchandising that is pushed down to the regional and warehouse level, and that's what I think drives our business there. In terms of the front end, managing the front end, I think we've got, last count, 120 of our 540-ish locations in the U.S. with self-checkout, and we plan another 100 in the next three months. And so always trying to figure out and measuring the number of member transactions through the front end per hour.

Great. Thank you. Best regards. Great job.

Next question from the line of Peter Benedict from Barrett. Your line is open.

Hey, Richard. Just two quick ones here to close out. So it looks like the business is probably comping in the 20% range there in that last week, and certainly the demand is probably even higher than that, just given that you guys are running out towards the end of the day. How do you think about the ability for the club to kind of keep up with that pace of demand? I mean, if this – if this were to go on for three, four more weeks, do you guys think you've got the supply chain able to keep up with that level of demand? Or are you hitting a point where, you know, you're just not going to get another delivery tomorrow of pick your category?

Yeah. No, well, I think it's all over the board. You know, yesterday I think there was a couple of either Los Angeles or San Diego counties that announced a heightened level of concerns. King County here in Seattle did that a couple of days ago. When that happens, that's another catalyst to push people to go out and get more stuff. I would hope, look, we would all hope this thing peaks and starts to slow down. It depends what happens tomorrow. We'll, you know, we'll be tired, but still working hard given that half of our, employees, roughly a little over half of our, of the 90% of employees in our warehouses that are hourly, about a little over half of those 90 are full-time and a little under half are part-time. Certainly there are employees that want to work more than part-time, and so we've been able to accommodate some additional hours there. But everybody's a little tired, but that's what you do.

Okay, and then my last question is just on lawn and garden. You mentioned that a couple times, and you talked about seasonal. Maybe expand on that a little bit. Where in particular are you seeing the strong, I guess it's an early start to spring, but maybe talk a little bit about what you're seeing on that front.

Well, the only thing I mentioned there was is that in getting ready for today's call, I had spoken to several of the senior merchants in the different categories, and One thing, without even looking at the numbers, I thought is I assume some of the big-ticket discretionary items might be a little weaker because people are not running in to get those items. They're running in to get other concerned items. And the fact was, to my surprise, that they said that certain items like patio furniture and lawn and garden was strong. They felt, and again, it was just their view, that patio furniture lawn and garden was more related to some of the areas of the country where the weather's turned already. And, but clearly because you got X percent more people coming in every day than normal.

No, no, that makes sense. Fair enough. Thanks so much.

Okay. Well, thank you everyone. Have a good afternoon and we're around to answer any questions. Have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.