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.