Costco Wholesale Corporation

Ladies and gentlemen, thank you for standing by and welcome to Q2 Earnings Call and February Sales Conference. I would now like to hand the call over to your speaker today, Mr. Richard Galante. He may begin your conference.

Thank you, Buena, and good afternoon to everyone. I will 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 2021, the 12 weeks ended February 14th, as well as February retail sales results for the four weeks ended this past Sunday, February 28th. Reported net income for the quarter was $951 million, or $2.14 per share, compared to $931 million, or $2.10 per diluted share last year. This year's results included a $246 million pre-tax or $0.41 per diluted share in costs incurred primarily from COVID-19 premium wages. Net sales for the quarter increased 14.7% to $43.89 billion from $38.26 billion a year ago in the second quarter. Comparable sales for the second quarter of fiscal 21 were as follows. For the 12-week period, U.S. comps were reported at 11.4%, and excluding gas deflation and FX, 12.6%. Canada reported at 13.4%, ex-gas deflation and FX, 10.6%. Other international reported at 21.5%, ex-gas deflation and FX, 17.7%. All told, total company reported at 13.0% and X gas deflation and FX 12.9%. E-commerce on a reported basis was 75.8% and FX 74.8%. In terms of the second quarter comp sales metrics, our traffic or shopping frequency increased 1% worldwide and up 2.7% in the U.S. on a year-over-year basis during the quarter. Our average transaction or ticket was up 11.9% total company and 8.5% in the U.S. during the second quarter. Foreign currencies relative to the U.S. dollar positively impacted sales by approximately 110 basis points, and gasoline price deflation negatively impacted sales by approximately 100 basis points. I'll review our February sales results a little bit later in the call. Going down the income statement, membership fee income came in reported at $881.5 million or 2.01% compared to $816.4 million or 2.13% in the quarter a year ago, so up $65 million or 8%. Excluding the impact of FX, the $65 million increase would be $56 million, which would represent a 6.9% increase excluding the impact of FX. No openings occurred in the second fiscal quarter, both this year and last year in the fiscal quarter. In terms of renewal rates, the U.S. and Canadian renewal rate came in for Q2 at 91.0%. As of Q2 end, this was up one-tenth of a percent from the 90.9% at the end of the prior fiscal quarter. Worldwide, our total company renewal rates were 88.5%. as of Q2 end, also up one-tenth of 1% from the prior quarter's number of 88.4%. In terms of number of members as of Q2 end, both member households and cardholders, in terms of households at Q2 end, we came in at 59.7 million, up from 59.1 million 12 weeks earlier. And total cardholders, 108.3 million, up from 107.1 million 12 weeks earlier. As of Q2 end, paid executive members were 23.8 million, an increase of 506,000 during the 12 weeks since Q1 end. Moving down the income statement to the gross margin, this year's gross margin came in at 10.96%, two basis points lower than last year's second quarter on a reported basis of 10.98%. Excluding gas deflation, it would have been 11 basis points lower. As I always ask you, we'll do a little chart here to show some of the components of margin. Two columns reported and the second column without gas deflation. First line item would be core merchandise. On a reported basis, core merchandise margin year-over-year came in at plus 71 basis points. Ex-gas deflation, plus 63 basis points. Second line item, ancillary businesses, minus 53 basis points, and then without gas, minus 55. 2% reward, minus 6 and minus 5. Other, minus 14 and minus 14. So all told, on a reported basis, year-over-year, minus 2 basis points, and again, ex-gas deflation, minus 11 basis points. So, as you can see from this chart, the core merchandise component was higher by gas deflation by 63 basis points. Similar to the last several fiscal quarters, sales penetration has shifted to the core business, resulting in higher contribution of our total gross margin dollars coming from the core operations versus a year earlier. Looking at the core merchandise categories in relation only to their own sales, core and core, if you will, margins year over year were higher by 71 basis points. Fresh foods was, again, the biggest driver here. With strong sales in fresh, we benefited from the efficiency gains in labor productivity and significantly lower spoilage. That being said, the other three major merchandise categories, food and sundries, soft lines, and hard lines, all had higher margin percentages year over year in the quarter as well. Ancillary and other business gross margin was lower by 53 basis points and by 55x gas deflation in the quarter, with most of the negative impact coming from gas and to a lesser extent from the aggregate of travel, hearing aids, pharmacy, and food courts, offset a little bit by a positive impact from e-comm. Costal logistics, which was our interval acquisition a year ago, impacted ancillary margins by six basis points to the negative. 2% reward, you can see, was impacted negatively by five basis points, implying that higher penetration over sales are coming from the executive membership group. And other is the minus 14 basis points. All of this is attributable to the costs of COVID-19, or about $60 million of the $246 million previously mentioned. These are the direct costs for incremental wages allocated to our manufacturing, production, and fulfillment operations. Moving on to SG&A, our reported SG&A in the second quarter was higher or worse year-over-year by 11 basis points on a reported basis, coming in at 9.89% versus 9.78% a year earlier. The minus 11 ex-gas deflation would have been a minus 3. Again, doing a little chart of comparison with two columns, both reported and then without gas deflation. First line item would be operations. A plus 31, so lower or better by 31 basis points, core operations was on a reported basis. Without gas deflation, plus 38, so lower or better by 38 basis points. Central, minus 3 basis points and minus 2. Stock compensation, plus 3 and plus 3. And other, minus 42 and minus 42. You have those columns up on a reported basis again. SG&A was higher year over year by 11 basis points and ex-gas deflation higher by 3. The core operations component, when you look at that, was better by 31 or 38, excluding the impact from deflation. SGA in the core, excluding the COVID-related expenses, which I'll discuss in a moment, was significantly leveraged with the strong core merchandise sales increases. Central, again, minus 2x gas deflation, stock comp plus 3, both small year-over-year basis points changes together, pretty much a wash. And other was a minus 42 basis points hit to SG&A, which were our incremental wage and benefit costs related to COVID, or $186 million of that $246 million total amount. So $60 million of the $246 million hits the margin, and $186 million of the $246 million hits SG&A. I'd like to take a minute here and discuss our COVID-related expenses and how they are changing effective this past Monday, March 1st. Over the past 12-month period, March 2020 through February 2021, company-wide we expended approximately $1.6 billion pre-tax on COVID-related items. Of this amount, approximately $825 million related specifically to the $2 an hour extra hourly pay. The remaining $200 million plus was made up of several other items, including the few-month period where employees 65 and older were paid to stay home. This was early on during the original lockdowns. cleaning and mask supplies, paying wages for several weeks to our third-party demo service employees, and assisting employees with paid child care leave, which continues. With the $2 an hour extra pay having been paid in for a full year, that extra amount has been discontinued as of this past Sunday, February 28th. And effective March 1st, a few days ago, we have implemented a permanent wage increase for hourly employees as well as most salaried warehouse employees, In the U.S. and Canada, we are permanently increasing our starting wage and most wage steps above that by $1 an hour and increasing our top-of-scale hourly wage by $0.45 an hour on top of the previously planned $0.55 an hour increase for top-of-scale. With these changes, our entry-level hourly wages will increase from $15 and $15.50 an hour to $16 and $16.50 an hour. Similar type increases are occurring in other countries where we operate. With this change, along with the reduction and or elimination of several components of the $200 million plus expenses I just discussed, on a going forward basis, this billion dollar plus expense over the past 12 months will be reduced by a little over one half starting March 1st, which is the beginning of week three in the current fiscal third quarter. Next on the income statement is pre-opening expense. Pretty much the same year over year. This year came in at $9 million compared to last year, $7 million, so $2 million higher. At both fiscal quarters, there were zero openings, although this relates to upcoming openings as well. All told, reported operating income for the second quarter of 2021, including the $246 million mentioned earlier, showed an increase of 5.8%, coming in at $1,340,000,000 this year compared to $1,266,000,000 last year. Below the operating income line, interest expense was $40 million this year versus $34 million last year. Interest income and other for the quarter was lower by $26 million year-over-year. Interest income itself was lower by $19 million due to lower interest rates. Additionally, FX and other was lower by $7 million. Overall reported pre-tax income in the second quarter was up 3.3%, coming in at $1,319,000 this year compared to $1,277,000 a year earlier. In terms of income taxes, our tax rate in the second quarter was 26.4%, a little higher than the 25.9% recorded in Q2 of last year. For all of 21, based on our current estimates, which of course these are always subject to change, we anticipate that our effective normalized total company tax rate for the fiscal year to be in the 26 to 27% range. A few other items of note in terms of warehouse expansion, as I mentioned, there were no openings in Q2. There were eight net new openings in Q1, so we're eight year to date. In the second half of the fiscal year, both this quarter and the fourth fiscal quarter, we plan to open 13 more net new units. Five of those will be in the U.S., three will be in Canada, and five will be overseas. Regarding CapEx, in the second quarter of fiscal 21, we spent approximately $573 million. Our full-year CapEx spend is still estimated in the $3 to $3.2 billion range. Moving on to e-commerce. E-commerce sales overall for the quarter, XFX, increased 75% year-over-year. A few of the stronger departments, over-the-counter pharmacy, garden and patio, small electrics, health and beauty, and majors, including consumer electronics. Total on-going grocery grew at a very strong rate in the second quarter. The comp numbers just mentioned follow our usual convention, which excludes our third-party same-day grocery program, which was up 450% year-over-year in the quarter. If we include the third party same day in our e-comm comps, the 76% reported comp number would have been 96%. Costco Logistics, formerly known as Innovel, continues to fulfill a greater percentage of our delivery items and has steadily increased since its acquisition a year ago March. In Q2, we made it a priority to enhance our white glove service, which includes assembly or complex installation. It's now standard on many items and offered as an upgrade on many others. Turning to COVID-19 and some of the issues and impacts surrounding it, we continue to enjoy strong core merchandise sales. I think our buying teams have done a great job keeping our buildings in stock despite outsized demand on some items and some supply chain challenges as well. From a supply chain perspective, overseas freight has continued to be an issue in regards to container shortage and port delays. This has caused timing delays on certain categories, including furniture, sporting goods, lawn and garden, and even some food and sundries items, like seafood and imported cheeses and oils. We expect these pressures to ease in the coming months, but it's impacting everyone, of course. Regarding the pressures from high consumer demand, examples of areas where we have some supply issues on the non-food side, Certain electronics due to chip and component shortages like TVs, computers, and smart home-related items. Exercise equipment, bikes and outdoor activity items, lawn and garden items, and appliances. On the food side, canned beverages have some shortages due mostly to the aluminum can issue of shortages. Bacon is up 45% in pounds, and so for whatever reason, there's a lot of demand there, so there's a little bit of a challenge there. gloves, surface cleaning wipes, and sanitizing sprays, and some paper goods. Fresh Foods overall is looking pretty good. Our three warehouse curbside pickup test next, our three warehouse curbside pickup test in Albuquerque is ongoing. We don't really have a lot to add at this time as the test is recent and continuing. The pilot's going well and members have responded to it and basket size have actually surpassed our expectations. Our focus, of course, is how can we be more efficient at doing it to determine if this offering can become scalable and make economic sense for us. Turning to our February sales results, the four weeks ended this past Sunday, February 28th, compared to the same period last year. As reported in our release, net sales for the month of February came in at $14.05 billion, an increase of 15.2% from $12.2 billion last year. Again, going down the numbers that were in the release, on the U.S., on a reported basis, we're up, on the same store sale basis, we're up 10.3%. That's both reported and without gas and FX. Canada reported 21.6%. XFX, 15.7%. Other international, 25.7%. XFX, 20.6%. Total company, 13.8%. Reported, XF, gas and FX, 12.3%. Within those numbers, e-comm 91.1% reported and without gas and FX 89.4%. As with the quarter, these numbers would, the e-comm numbers would be higher if we included the third party same day fresh. When we discussed last year's February sales results, we pointed out that the fourth week last year had a big uptick in sales. That's kind of was the beginning of what we felt was a little bit of consumer pressure for consumers to buy in for fear of lockdown. again, primarily related to consumers buying ahead of the anticipated COVID lockdowns and closures. That positively impacted last year's February sales by approximately three percentage points. Similarly, sales in week four of this February, this week, week four of this year, February, were lower as we anniversary that unusually strong week from a year ago. The estimated negative impact to the February month was approximately three and a half percentage points. So the reported numbers of 13.8 and X gas and FX at 12.3 would have been higher excluding that impact. Our comp traffic or frequency for February was flat to last year worldwide and up 0.7% in the U.S. Again, some impact of that last week. Worldwide, the average transaction was up 13.8%, which included positive impacts of 140 basis points from FX and 10 basis points of gas inflation. Foreign currencies year-over-year relative to the dollar benefited February comps in Canada by 540 basis points, other international by approximately 570 basis points, and total company by 140 basis points. Gas price inflation, again, positively impacted total reported comp sales by about 10 basis points, whereas the average selling price was about a percentage point higher year over year. In terms of regional and merchandising categories, the general highlights, U.S. regions with the strongest results were Southeast, Midwest, and Texas. Internationally, in local currencies, we saw the strongest results in Korea, U.K., and Japan. Moving to merchandise highlights, the following comp sales results by category for the month, and these exclude the positive impact of FX. Food and sundaes were in the positive high single digits. Departments with the strongest results were liquor, frozen foods, and cooler. Hard lines were positive in the high 20s. Better performing departments were toys and seasonal, sporting goods, hardware, and majors, which again is both white goods and consumer electronics for the most part. Soft lines were also up in the low 20s. Better-performing departments included housewares, small appliances, and home furnishings. And finally, fresh foods were up in the low 20s. Better-performing departments included meat and deli. Ancillary business sales, as mentioned earlier, were down, and they were down in terms of sales in the mid-single digits in February, primarily due to lower year-over-year sales in food court, hearing aids, and gasoline. Overall, a relatively good fiscal second quarter, impacted, of course, by COVID expenses, impacted both plus and minus by various aspects of our business due to COVID, and certainly, as I mentioned in the ancillary, gas had the biggest of the ancillary hits. Finally, in terms of upcoming releases, we will announce our March sales results for the five weeks ending Sunday, April 4th, on Wednesday, April 7th, after the market closed. With that, I will open it up to Q&A and turn it back to Buena.

Thank you, sir. As a reminder, to ask a question, you will need to press star one on your telephone. Your first question is from Michael Lasser of UBS. Your line is open.