Costco Wholesale Corporation

Ladies and gentlemen, thank you for standing by and welcome to the Q3 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. And to ask a question during that time, please press star 1 on the telephone keypad. And please note that this conference is being recorded. For further assistance, please press star 0. And I would now like to hand the call over to Mr. Richard Delante, CFO. Please go ahead, sir.

Thank you, Joseph, 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 third quarter of fiscal 2020. The 12 weeks ended May 10th. Reported net income for the quarter came in at $838 million, or $1.89 per diluted share. This compared to $906 million or $2.05 per diluted share last year in the third quarter. Now, this year's third quarter was negatively impacted by direct expenses of $283 million pre-tax or $0.47 per diluted share from incremental wage, safety, and sanitation costs related to COVID-19. And last year's third quarter number of $2.05 included the benefit from a non-recurring tax item of $73 million or $0.16 per diluted share. Net sales for the quarter increased 7.3% to $36.45 billion, up from $33.96 billion last year in the third quarter. On a same-store or comparable sales basis for the third quarter, For the 12 weeks on a reported basis, the U.S. was a 5.9%. Excluding gas deflation and FX impact, the 5.9% would have been for the 12 weeks an 8.0%. Canada on a reported basis was minus 2.5%. Ex-gas deflation and FX plus 3.0%. Other international came in on a reported basis at 6.2%, and again, ex-gas deflation and FX plus 12.2%. All told, the total company came in with a reported 4.8%, and again, ex-gas deflation and FX, the 4.8 would have been 7.8%. I might also note that e-commerce on a reported basis was 64.5% comp and ex-gas deflation or ex-FX 66.1%. Now, foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 110 basis points, and gasoline price deflation negatively impacted sales by approximately 190 basis points for the total company to afford the 300 basis points. Additionally, gasoline volumes or gallons were down about 20% year-over-year in the quarter as a result of less driving due to the pandemic. These adjusted figures, the impact of gasoline gallons is not in the adjusted figures that I just described above. In terms of traffic, our shopping frequency decreased in the quarter worldwide by 4.1%, and in the U.S. by 2.0%. Our average transaction, our ticket, was up 9.3% during the third quarter, and the 9.3% does include the negative impacts from gas deflation and NFX. Now our third quarter comp sales figures did reflect also that a few of our businesses, notably optical, hearing aids, and photo, were closed for much of Q3. And a good portion of our food court item offerings were eliminated, also for much of Q3. As well, we eliminated the food court seating during this time. Reopenings of these began, the ones that were closed, began on April 30th, 10 days prior to the third quarter end. with about 20 percent of the locations back operating by Q3 end. In the past two to three weeks, nearly all will be back in operation by mid-June. In terms of the food courts, which have been open, but again, a much more limited menu, we've added some but not all the items back as of now. In all, an estimated hit to the reported sales numbers that we gave you earlier in Q3 by one to two percentage points by those items being closed or restricted. Next on the income statement, membership fee income reported came in at $815 million or 2.24%, up 5% or $39 million from $776 million or 2.9% last year in Q3. XFX weakness, the $39 million increase and 5% increase would have been up $47 million or 6%. During the quarter, we had two new openings and a total of four year-to-date openings. In terms of renewal rates, at Q3 end, our U.S. and Canada renewal rate came in at 91.0%, a tick up from where we were at Q2 end, and the worldwide rate came in at 88.4%, the same as it was a fiscal quarter ago. Keep in mind that any impact on renewal rates from COVID, positive or negative, are reflected over the next several months. In terms of the number of members at Q3 end, member households and cardholders, in terms of households, We ended the third quarter with 55.8 million households, up from 55.3 million 12 weeks earlier. And total cardholders came in at 101.8 million, up from 100.9 million 12 weeks earlier. At Q3N, paid executive memberships came in at 21.8 million, an increase of 135,000 over the last 12 weeks. Going down to the gross margin line, our reported gross margin was higher year-over-year by 54 basis points on a reported basis, coming in at 11.53% up from 10.99%. Now, the 54x gas deflation would have been plus 33 basis points. As I usually do, I'll ask you to write down a few numbers in two columns, and then we'll go through that explanation. In terms of reported in Q320 year-over-year, the core merchandise was up 51 basis points on a reported basis. and without gas deflation up 33. Ancillary businesses was on a reported basis plus 26 basis points, ex-gas deflation plus 21. The 2% reward, minus 6 and minus 4 basis points. Other, minus 17 and minus 17. And you add up those two columns, total reported, again, up 54 basis points on a reported basis and up 33 basis points. The gross margin was up 33 basis points, ex-gas deflation. Now, the core merchandise component gross margin, again, higher by 51 or 33 ex-deflation. Keep in mind that in the quarter we had a decent sales shift from ancillary and other businesses to core businesses, which resulted in a higher contribution of our total gross margin dollars coming from the core. Looking at the core merchandise categories in relation to only their own sales, or what we call core-on-core, margins year-over-year were lower by 17 basis points, five basis points, by the way, of which was losses related to our new poultry complex. This is something I've pointed out in the last two quarters and will probably do so next quarter as well. In total, pretty similar, in fact, to our year-over-year impact in Q2. So while higher penetration of our total sales came from the core this year, it was at a slightly lower gross margin percentage year-over-year. This is mostly attributed to sales mix, both between and within merchandise categories. Our fresh foods gross margin percentage was up, again, despite any first-year headwinds from the ramp-up costs associated with the poultry complex. The strength in fresh was a result of high sales driving down our spoilage, as well as labor costs as a percent of sales being able to leverage those at a greater than normal rate. Soft lines, food and sundries, and hard lines all had lower margin percentage year-on-year. year-over-year in the quarter. One example, non-foods, which is both hard lines and soft lines, non-foods was impacted by a shift in sales towards lower margin departments, particularly things like majors and big-ticket electronics. Ancillary and other business gross margin in the two columns, higher by 26 basis points, and again, 21 higher basis points ex-gas deflation. This result was primarily due to strength in gas and e-com gross margin dollars year-over-year. partially offset by a lower penetration of ancillary sales due to lower gas prices and volumes and the closures of some of those ancillary businesses that I talked about earlier. Several of those businesses have higher gross margins. 2% reward was higher or was a hit to gross margin by six basis points on a reported basis and 4x deflation, implying that a slightly higher percentage of our sales were eligible for the executive member reward. The other line item, 17 basis points to the negative, 12 of the 17 basis points is attributable to the COVID costs, and the 12 basis points, that's about $44 million of the $283 million number that was mentioned in the press release. These are the costs for incremental wages, safety, and sanitation costs allocated to our cost departments and merchandise fulfillment operations. So it hits the margin. The other five basis points or 19.7 million came from accruing reserve for certain third party gift cards and ticket programs. This latter 19.7 million was not included in the 283 total amount that we called out as a direct incremental expenses from COVID. Moving to SG&A, our reported SG&A percentage year over year was higher by 59 basis points. Coming in at a 10.51% of sales, up from 9.92%. Ex-gas deflation, the minus 59 would have been minus 40, or higher by 40. If you begin, please jot down the following SG&A components, and then we'll go through that. Core operations reported was plus 9 or lower by 9, a benefit of 9. Ex-gas deflation, plus 24, or a benefit of 24 basis points. Central, 0 and plus 2. Stock compensation, plus 3 and plus 3. Other, minus 71 and minus 69. And you add up those two columns, you get to the reported SG&A increase of 59 basis points and X gas deflation, rather, higher by 40 basis points. Now, again, the core operations component, lower by 9 and X gas deflation lower by 24. SG&A in the core operations, that's excluding the COVID-related expenses that I'll talk about in a minute. They were, needless to say, leveraged with strong core merchandise sales. Central was essentially flat and a slight improvement, including ex-gas deflation. Stock comp, no surprises there, a slight benefit to SG&A, but three basis points. And again, the other component, the 71 or 69 ex-gas deflation, Of the 71, 66 basis points of the 71 is attributable to the incremental cost of COVID-19, or $239 million of that $283 million total amount that was in the press release. Again, these are the costs for incremental wages and safety and sanitation-related direct expenses. The balance of the 71 basis point figure was five basis points, or $18.5 million. This came from the costs associated with the acquisition and integration-related expenses of our recent acquisition of InnoVille, that last mile delivery and installation operation for big and bulky that we acquired a few months ago. Next on the income statement is pre-opening expense. Pre-opening expense was lower by $6 million, coming in at $8 million in the quarter versus $14 a year ago. Again, we had two openings this year. Last year in the quarter, we had three, although each of these numbers relate to pending openings in Q4 as well. All told, reported operating income in the third quarter of 2020 increased by 5.1%. coming in at $1,179,000,000 this year compared to $1,122,000,000 a year ago. Now, this 5% increase is, you know, notwithstanding the incremental cost that we talked about, that I just talked about, the $283 million, as well as the 19.7 and the 18.5 that I just mentioned as well. Those were all taken in the third quarter. Below the operating income line, interest expense was higher year over year by $2 million, coming in at $37 million this year in the quarter versus $35 million a year ago. Recall that we completed a $4 billion debt offering on April 20th during the third quarter. Following the completion of the debt offering, we called the outstanding debt due May of 2021. That was a $1 billion tranche and an additional $5 million tranche that was due in February of 22. Both of these tranches we've paid off this morning after a 30-day call notice. There will be a pre-tax expense of $36 million related to the early retirement or make-hold of this debt, which will hit our Q4 results on the interest income and other line in our P&L. Next on the income statement, interest income and other for the quarter, it was lowered by $15 million year-over-year, mostly attributed to lower interest income and mostly attributed to lower interest rates within that. Overall reported pre-tax income in Q3 fiscal 20 was up 3.6%, coming in at $1.163 billion versus $1.123 billion last year. And again, the $1.163 billion is after taking the impacts of those charges that I previously mentioned. In terms of income taxes, our tax rate in Q3 this year was 26.7%. Last year, it was 18.5% tax rate. Again, last year, it included a benefit of a non-recurring tax item of $73 million. A few other items of note in terms of warehouse expansion, as I mentioned, we opened two units in the third quarter. That puts us at actually five units total through the first three quarters. We expect in Q4 to open 10, including two reloads, so a net of eight. So it looks like our net total this year will be somewhere around 13. There's been a few that have been impacted by COVID-19 in terms of construction delays and have been pushed into the first part of fiscal 21, which starts in early September. As of Q3 end, total warehouse square footage stood at 115 million square feet. In terms of capital expenditures, The third quarter fiscal 2020 total spend was approximately $626 million. And our estimated CapEx for all of fiscal 20 is currently in the $2.7 to $2.9 billion range, a slight decline from what we had estimated a quarter ago. And, again, I think that has to do with some of the delays in construction since this COVID issue. In terms of e-commerce, as I mentioned earlier, overall our e-commerce sales on a reported basis increased 64.5% and 66.1% XFX. I should note that within that 61, like many retailers out there, we saw an increasingly level of strength in e-commerce sales. over the last few months. If I look at the three four-week periods that comprise our 12-week third quarter, roughly that 64.5% reported number in the first four weeks was in the 25% range. in the next four weeks in the 50% increased range, and the last four weeks in the 90% range, but totaling that 64.5 on a reported basis. A few of the stronger departments, health and beauty aids, office, majors, housewares, and small electrics. So total online grocery grew at an incredible rate during the third quarter, as I'm sure it did in many places. The comp numbers just mentioned, again, follow. That's the 64% number. They follow our historical convention where we exclude our third-party or same-day grocery program since that comes into the warehouse to be picked up by the third party and delivered to our member. If we were to include that third party in our e-commerce number, that mid-60% comp number would be slightly over 100%. So we've seen big strength in driving the business that way. Overall, our e-comp sites have worked pretty smoothly during the quarter, despite dramatic volume increases. And as well, we're able to improve on delivery times throughout the quarter as we adjusted to the ramped-up order volumes. Now turning to coronavirus and all the issues and impacts surrounding it, from a sales perspective, as discussed last quarter and indicated by our monthly sales results that we do, we started Q3 strong. I think it started actually in the fourth week of February and into the first two and a half weeks of March with very strong sales as people were stocking up prior to the implementation, the concern about availability of certain key products, as well as the implementation of various stay-at-home orders. The middle of the quarter was weaker as many of the geographies in which we operate had issued mandates limiting movement as well. We had implemented our own restrictions during these times. Recently, our sales have started to recover somewhat as states have begun to relax restrictions. Within the merchandise categories, foods, fresh, and other essentials have been very strong. despite out of stocks on some items throughout the quarter, such as toilet paper, paper towels, cleaning supplies, et cetera, meats and proteins toward the end of the quarter, hand sanitizers and the like. Office and majors were also strong during the quarter, driven by work-from-home initiatives, while most other discretionary categories were a little weaker during the quarter, such as jewelry, luggage, third-party gift cards. They were generally weak. Other weak categories, which include things like sporting goods, lawn and garden, patio and apparel, while they were weak, they've rebounded somewhat towards the end of the quarter. From a supply chain perspective, I'll give you a 40,000-foot view of that. On the non-food side, as it relates to imports from China, most of the factories are now up and running. Other major country suppliers, India for textiles and domestics, Mexico primarily for things like TV assembly. A few weeks behind China in terms of getting back to normal, but each week is showing improvement. On the foods and sundry sides, paper goods still on allocation and item limits on certain items in certain regions. Sporadic limited limits on canned food items like tuna and chicken. The toughest areas, again, are still hand sanitizers, disinfecting wipes, and Lysol sprays and the like. Items like milk and butter are generally okay. And we've also, we have eliminated like frozen, certain frozen proteins like chicken and beef items. In terms of fresh, on the protein side, you know, the merchandise is there, but challenging from a production and processing side. Currently for us, pork is the least affected, but somewhat affected. But what we've done for the last couple of three weeks, I believe, on fresh beef, chicken, and pork items or those protein items, we limit three fresh items in total. We also have limits of one per skew on certain frozen items like 10 pounds of hamburger patties or chicken breasts or the like. In terms of seafood and produce, that's all good. And again, talking to our buyers in these categories, they're generally, again, probably with the exception of the hand sanitizer because it's not just people who are hoarding it. There's a great increase in use and demand of those items continued. But we expect continued improvement generally each week. And lastly, Costco travel. It was, needless to say, significantly impacted during the quarter due to reduced demand as well as cancellations of previous book trips. Members are now starting to actually book travel again, although generally further out than we have historically seen. And, of course, we book those results when the trips or activities occur. Our warehouses have overall remained open, although we did operate at reduced hours at most of our U.S. locations for several weeks during the quarter. Regular hours resumed May 4th with an additional hour on weekday mornings for seniors and persons with disabilities. Warehouses are still following social distancing and sanitizing guidelines. Additionally, as discussed, some of our warehouse businesses, like hearing aid, optical and photo, and to a partial extent the food courts, were closed or mitigated during the majority of the quarter. Also effective May 4th, we now require all members and employees in the warehouses to wear masks. During the quarter, including that, again, that big $283 million number, we spent about $32 million on masks, gloves, and incremental cleaning and cleaning supplies and things like plexiglass partitions and you name it, all related to COVID. But that's in that $283 million number. Some of the initiatives related to 283 and costs will extend into Q4. We would expect the incremental expenses related to COVID, these types of expenses related to COVID, to exceed $100 million in Q4, but be quite a bit lower than the $283 million that we had in Q3. We'll have to just wait and see, though. Finally, in terms of upcoming releases, we will announce our May sales results for the four weeks ending this Sunday, May 31st, next Wednesday, June 3rd, after market close. With that, I will open it up for Q&A and turn it back to Joseph. Thank you.

Thank you, sir. At this time, for the participants to ask a question, please press star 1 on your telephone keypad. Again, that's star 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster. We have our first question from Simeon Gutman from Morgan Stanley. Your line is open.