Costco Wholesale Corporation

Thank you, Dave, and thank you for standing by. Welcome to the Quarter 3 Earnings Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. And if you require any further assistance, please press star 0. I would like to hand the conference over to your speaker today, Mr. Richard Galanti. Sir, you may begin.

Thank you, Sarah, 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 that 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 2021. The 12 weeks ended this past May 9th. Reported net income for the quarter was $1,220,000,000, or $2.75 per diluted share. Last year's third quarter net income came in at $838,000,000, or $1.89 per share. This year's third quarter included $57 million pre-tax or $0.09 per share in COVID-19 related costs. Last year's third quarter included $283 million pre-tax or $0.47 per share of COVID-19 related costs. Net sales for the quarter increased year over year in the quarter by 21.7% from $44.38 billion this year from $36.45 billion a year ago. Comparable sales for the third quarter of fiscal 21 were as follows. In the U.S., on a reported basis, comparable sales were up 18%. Ex-gas inflation up 15.2%. Canada, on a reported basis, up 32.3%. Ex, both gas and strong Canadian dollar, ex-gas and FX, up 16.7%. Other international reported, plus 22.9%. X gas and FX plus 13.1%. All told, company reported comp sales of 20.6%. And again, X gas and FX, 15.1% up. E-commerce on a reported basis was 41.2%. XFX was up 38.2%. And that's on top of a year ago in the third quarter when it was up 66.1% in Q3 a year ago versus the prior year to that. In terms of Q3 comp sales metrics, traffic or shopping frequency increased 12.5% worldwide and plus 11.9% in the U.S. Our average transaction or ticket was up 7.3% worldwide and up 5.7% in the U.S. during the third quarter. And these numbers include the positive impact both of gas inflation and FX. So adjusting for that, they would be in the 1.8% and 2.7% in the U.S., adjusted for those. Foreign currencies relative to the U.S. dollar positively impacted sales by approximately 290 basis points, and gasoline price inflation positively impacted sales by approximately 260 basis points. Going down the income statement, membership fee income reported for the third quarter, $901 million, or 2.03% of sales. Again, we had strong FX, and so adjusting for that out, the $86 million reported increase would have been up $67 million, so FX of 8.2% on a reported basis of 10.6%. In terms of renewal rates, the U.S. and Canadian rate came in at 91.0%, the same as it was at Q2 end. Worldwide, our total company renewal rate was 88.4% at Q3 end, or 0.1% lower than the prior quarter end. China entered the renewal calculation for the first time this fiscal quarter. First-year renewal rates generally lag those of later years, and excluding China, the worldwide rate would have actually improved 0.1% versus the prior quarter. In terms of number of members at Q3 end, both member households and total cardholders, At the end of third quarter, total paid households, 60.6 million, up from 59.7 million 12 weeks earlier. Total cardholders, 109.8 million, up from 108.3 million at the end of the second quarter 12 weeks ago. At Q3 end, paid executive membership totaled 24.6 million members, an increase of 817,000 during the 12 weeks since Q2 end. Moving down the gross margin line, our reported gross margin in the third quarter was lower year-over-year by 35 basis points, coming in at 11.18% compared to a year ago at 11.53%. As I usually do, I ask you to jot down a few numbers, two columns, both the reported year-over-year change in gross margin and the second column, X gas inflation. On the merchandise core, reported minus 52 basis points year over year and X gas inflation minus 29 basis points. Ancillary and other businesses reported plus 2 basis points and X gas inflation plus 7 basis points. 2% reward plus 1 basis point and minus 2 basis points. Other plus 14 basis points in both columns. Total, therefore, reported gross margin, again, year-over-year, was reported down 35 basis points and ex-gas inflation down 10 basis points. The core merchandise component, as I mentioned here, was down 52 basis points year-over-year and down 29 on ex-gas inflation. This is primarily a function of sales shifting from core to ancillary versus last year as we begin to revert back to more historical sales penetrations. Recall last year we saw a significant shift of sales out of ancillary and other businesses and into the core. In terms of the core margin on their own sales, in third quarter, the core and core margin were better by plus 27 basis points, with non-foods up significantly, rebounding from last year's lows, food and sundries flat year over year, and fresh foods down from last year, the latter still strong by historical standards. Fresh, as we've mentioned over the last few quarters, is lapping exceptional labor productivity and low product spoilage that occurred from the outsized sales that began a year ago in Q3 with the onset of COVID. Ancillary and other business gross margins, again, ex-gas inflation was up seven basis points year over year in the quarter. We have a lot going on here as of last year. Last year, we had closed the hearing aid and optical departments and had SEVERELY LIMITED THE SERVICE AND SELECTION AT OUR FOOD COURTS FOR MOST OF Q3 LAST YEAR. GAS HAD A PARTICULARLY GOOD QUARTER A YEAR AGO WHICH HAD HELPED OFFSET SOME OF THOSE CLOSURES A YEAR AGO. THIS YEAR WE'RE SHOWING MARGIN IMPROVEMENT IN OPTICAL, FOOD COURT, ECOM AND HEARING AIDS SOMEWHAT OFFSET BY GAS. THE 2% REWARD WAS AGAIN ON EXCLUDING GAS INFLATION WAS LOWER BY TWO BASIS POINTS INDICATING HIGHER SALES PENETRATION TO OUR EXECUTIVE MEMBERS. and the rewards associated with that. And other is plus 14 basis points. Nine of the 14 basis points is attributable to lower COVID-19 costs year over year. $44 million hit to margin in Q3 a year ago versus a $14 million hit to margin this year in the third quarter. Last year, we incurred 10 weeks of the incremental $2 an hour premium wage. That portion you see here relates to the labor associated with our fulfillment manufacturing businesses. This year, we incurred two weeks of the incremental $2 an hour premium wage, and the program was discontinued at the end of the second week of Q3 after 52 weeks in place. The other plus five basis points, or $19.7 million, came from accruing a reserve last year in Q3 for certain third-party gift cards and ticket programs that were adversely impacted by the onset of COVID-19. One other comment, as I discussed during our March 4th Q2 earnings conference call, in conjunction with the discontinuing of the $2 an hour premium pay, we implemented a permanent wage increase for our hourly employees as well as most of our salaried manager employees, which took effect in week three of this fiscal quarter. Since it's a permanent wage increase going forward, its impact is simply in our reported numbers and not separated out as COVID-related. Moving to SG&A, our reported SG&A in the third quarter was lower or better year-over-year by 107 basis points. Again, to jot down these following two columns of numbers, first column is reported and second column excluding gas inflation. In terms of operations, year-over-year plus 37 basis points, meaning lower or better by 37 basis points, ex-gas inflation plus 20 basis points. Central, plus 4 basis points and plus 1 basis point. Stock compensation, plus 5 and plus 4. Other, plus 61 and plus 61. For a total, on a reported basis, again, SG&A year-over-year was lower or better by 107 basis points on a reported basis, and excluding gas inflation, lower by 86 basis points. Again, looking here, the core operation was better by 37 and better by 20, excluding the impact of gas inflation. A good result, particularly given that we implemented the permanent dollar an hour wage increase for the last 10 of the 12 weeks that comprise Q3. Central, nothing surprising there. Same with stock comp. And other, the plus 61 basis points, ex-gas inflation, 56 of the 61 was attributable to the lower cost from COVID-19. $239 million hits SG&A in Q3 a year ago, compared to $44 million in Q3 this year. The balance, or plus five basis points, or lower by five basis points, was $18.5 million were costs associated with the acquisition and integration of Interval a year ago. Next on the income statement is pre-opening expense. Basically, this year came in at $10 million, $2 million higher than the $8 million in Q3 of fiscal 20. Nothing out of the ordinary with the pre-opening this quarter. All told, reported operating income in Q321 increased 41%, coming in at $1,663,000,000 this year, compared to $1,179,000,000 a year ago in the quarter. Below the operating income line, interest expense was $40 million this year versus $37 million a year ago. Interest income and other for the quarter was higher by $6 million or better by $6 million. Interest income was actually lower by $2 million year over year due to lower interest rates. Additionally, FX and other was higher by $8 million year over year. Overall reported pre-tax income in the third quarter was up, reported pre-tax income was up 42%, coming in at $1,650,000,000 this year compared to $1,163,000,000 a year ago. In terms of e-commerce, our e-commerce sales, as I mentioned earlier – I'm sorry, before I go to e-commerce, our tax rate in the third quarter came in at 25.2% compared to 26.7% a year earlier. This quarter benefited from a one-time discrete tax item that benefited our number one. For all of 21, based on our estimates, which of course are subject to change, we anticipate that our effective normalized total company tax rate for the year to be in the 26 to 27% range. A few other items of note in terms of warehouse expansion. In Q3, we opened six new warehouses, one in the U.S., three in Canada, and two internationally. We also have plans in Q4 to open seven additional ones, five in the U.S., and two others internationally. And that would put us at a total of 21 net new warehouses for the fiscal year, 23 which included two relocations, so 21 net. In addition to the 21 planned openings for fiscal 21, we are looking to open about 25 new units, net new units in each of the next two fiscal years, including a second warehouse in China in fiscal 22, which would be towards the end of calendar 21. and a third expected to open in late calendar 22, which would be early fiscal year 23. Regarding CapEx, the third quarter fiscal 21 spend was approximately $1.03 billion. Our full year CapEx spend is now estimated to be in the $3.3 to $3.5 billion range, increased a little from our estimate made 12 weeks earlier to include the recent $340 million purchase of a distribution facility on the West Coast to support our big and bulky delivery activities. Now turning to e-commerce. Again, e-commerce sales in the third quarter, XFX, increased 38.2% year-over-year. Stronger departments included jewelry, home furnishings, sporting goods, hardware, and majors, which of course includes both everything from appliances to consumer electronics. In terms of Costco logistics and an update there, we anniversary the purchase of Innovel, now called Costco Logistics, this fiscal quarter. Costco Logistics continues to drive big and bulky sales with the U.S. e-com sales on these items up 53% during the quarter. Costco Logistics fulfilled about 70% of all U.S. big and bulky orders, and we also continue to add some new big and bulky vendors. Overall, we've improved delivery time on many items from up to two weeks to, in several cases, now five to seven days. As well, we've taken several items that were previously vendor drop-shipped and and are now being direct imported, allowing us to not only speed up delivery but reduce prices to our members. From a supply chain perspective, port delays are continuing to have an impact. We are utilizing additional carriers in some cases to help alleviate some of that. Containers and pallets are also facing shortages. Anecdotally, 35% to 50% increase in incoming containers this year versus a year ago, Some of that's pent-up demand, but just from the low points a year ago. The turnaround of a container hitting the U.S., delivering its contents and being back at the U.S. port to head back overseas has gone from approximately 25 days to 50 days, so a combination of things in terms of delays. Ship shortages are impacting many items from an inflation standpoint, some items more than others. And again, as I mentioned with regard to containers and shipping, transportation costs have increased as well. Despite these issues, we continue to work to mitigate cost increases and supply chain delays in a variety of different ways as best we can. The biggest way we've handled supply chain delays is adjusted ordering and front-loading, if you will, orders of many items. We think we've got that pretty well under control. The feeling is this will continue for the most part of this calendar year. We've had a lot of questions about inflation over the past few months. There have been and are a variety of inflationary pressures that we and others are seeing. Inflationary factors abound. These include higher labor costs, higher freight costs, higher transportation demand, along with a container shortage and port delays that I mentioned, increased demand in various product categories. Some shortages, various shortages of everything from chips to oils and chemical supplies by facilities hit by the Gulf freeze and storms. And in some cases, higher commodity prices. Some inflationary soundbites, if you will. You know, price increases on items shipped across the ocean with suppliers paying up to double for containers and shipping. Price increases of pulp, paper goods, some things up 4% to 8%. Plastic and resin increases from trash bags to plastic cups, plates, et cetera, and plastic wraps. Metals, aluminum foil, mid-single-digit cost increases, also cans for sodas and other beverages. Higher import prices on cheeses, a combination of the product itself as well as some FX strength of some foreign currencies as well as freight. Anywhere from 3% to 10% increases on certain apparel items, not all. In terms of fresh, higher protein prices. For example, meat overall year over year is up 7%. Beef in the last month has been up as much as 20%. Some of that is due to feed and labor and transportation costs, as well as restocking some of the additional increased demand coming now from institutional needs as restaurants start to reopen. And the list could go on and on. Now, all this being said, I was asked back on our March 4th second quarter call at what level we felt inflation was running overall at that time. with our goods, I stated that our best guess was somewhere in the 1% to 1.5% range. As of today, we'd guess that overall price inflation at the selling level, and excluding our gasoline sales, would be estimated to be probably more in the 2.5% to 3.5% range. Some items are up more, and some items, the sell prices haven't yet changed, and some items are even down a little bit. We think, again, we've done pretty well in terms of controlling that as best we can, but the inflation pressures abound. In terms of sampling and demos in the warehouse, as you all know, we eliminated our popular food sampling and demo activities in our warehouses last March at the onset of the pandemic. As various states opened and closed last summer and fall, we tried a few sampling events, a few single-serve items like cookies and crackers. take-out only, no cooked or prepared sample items, and a few enhanced talking demos such as items for display only. I'm happy to report that over the next couple of weeks, we're beginning a phased return to full sampling. This will come in waves. The first wave of locations, about 170 of our 550-ish locations in the U.S., will be activated by the first week of June, with most of the remaining locations returning towards the end of June. The first wave will actually determine how fast we roll out and what and when restrictions are lifted. I'm sure there will be a few states with unique restrictions as well. Increased safety protocols are and will be in place, including all samples prepared behind plexiglass, prepared in smaller batches for better safety control, and distributed to members one at a time. Food courts, same thing as well. I'm pleased to report that our food courts are also coming back over the next few weeks in a bigger way. Last March, again, in 2020, as the pandemic took hold, we paired back the menu, basically to hot dogs and pizza and soda and smoothies, and we eliminated all seating. It was takeout only. We began several weeks ago adding back tables and seating at a handful of outdoor food courts in a few states. Over the past few months, we've also added back a few more food items, including bringing back a new and improved churro, which will be at all U.S. locations by the 4th of July. and adding a high-end soft ice cream to replace our frozen yogurt. And by June 7th, we plan to have tables and seating back at most locations, but with more physical separation, tables of four instead of six and eight, and about half the seating capacity as we had before. Again, these are still subject to doing this in waves and see how it goes and subject to any additional state rules or restrictions in a few cases. Finally, in terms of upcoming releases, we will announce our May sales results. for the four weeks ending this Sunday, May 30th, on next Thursday, June 4th, after market closes. With that, I will open up to questions and answers, and I'll turn it back over to Sarah. Sarah?

Yes, sir. As a reminder, to ask the question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Again, if you would like to ask the question, press star then number 1 on your telephone keypad. Please stand by while we compile the Q&A roster. Your first question comes from the line of Michael Lusser from UBS. Your line is open.