Costco Wholesale Corporation

Good afternoon and thank you for standing by. Welcome to the Q2 earnings call and February sales results. At this time, all participants are in a 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. If you require any further assistance, please press star 0. I would now like to hand the conference over to the speaker today, Richard Galanti, Chief Financial Officer. Please go ahead.

Thank you, Jerome, 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 22. The 12 weeks ended this past February 13th, as well as February retail results for the four weeks ended this past Sunday, February 27th. Net income for the quarter came in at $1,299,000,000, or $2.92 per diluted share. Last year's second quarter net income came in at $951 million, or $2.14 per diluted share. That latter number included a $246 million pre-tax, or 41 cents per share, cost incurred primarily from COVID-19 premium wages. Net income for the 24 weeks was $2.62 billion, or $5.90 per share, compared to $2.12 billion, or $4.76 per diluted share last year in the first half. Net sales for the quarter increased 16.1% to $50.94 billion, up from $43.89 billion last year in the second quarter. Comparable sales in the second quarter for fiscal 22. On a reported basis, U.S. sales increased during the 12-week period was 15.8%, excluding gas inflation, 11.3%, 11.3%. Canada, 16% reported, 12.4% ex-gas inflation and FX. Other international, 6.2%, and plus 9% ex-gas inflation and FX. For the total company, a reported number of 14.4% on a same-store comparable basis, and up 11.1%, excluding gas inflation and FX. E-commerce, on a reported basis, up 12.5%. and FX up 12.6%. In terms of our second quarter comp sales metrics, traffic or shopping frequency increased 9.3% worldwide and up 8.3% year-over-year in the quarter in the United States. Our average transaction or ticket was up 4.6% worldwide and up 6.9% in the U.S. during the second quarter. Foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 60 basis points, while gasoline price inflation positively impacted sales by approximately 390 basis points. I will review our February sales results later in the call. Going down our second quarter fiscal 2022 income statement. Membership fee income reported came in at $967 million, up $86 million or up 9.8% from a year earlier, $881 million. There was about a $6.5 million negative impact due to FX. So on an FX basis, if you will, the $86 million increase would have been up $92 million or 10.4%. In terms of renewal rates, they continue to increase. At second quarter end, our U.S. and Canada renewal rate stood at 92.0%, up four-tenths of a percentage point from the 12 weeks earlier Q1 end. And worldwide rate, it came in at 89.6%, up six-tenths of a percent from where it stood 12 weeks earlier Q1 end. Renewal rates are continuing to benefit from more members auto-renewing, as well as increased penetration of executive members, who on average renew at a higher rate than non-executive members, and higher first-year renewal rates for our new members. In terms of the number of members at second quarter end, member households, and total cardholders, total households was 63.4 million, up 900,000 from the 62.5 million just 12 weeks earlier. And total cardholders at Q2 end, 114.8 million, up 1.7 million from the 113.1 million figure 12 weeks ago. At second quarter end, paid executive memberships stood at 27.1 million, an increase of 644,000 during the 12-week period since Q1 end. Executive members, by the way, represent now 42.7% of our total membership base. and 70.9% of our total sales. Moving down to the gross margin line, our reported gross margin in the second quarter was lower year over year by 32 basis points, but up five basis points, excluding gas inflation. As I always do, I'll ask you to jot down a few numbers, two columns. The first column is reported, and the second column would be excluding gas inflation. First line item, merchandise, core merchandise. on a reported basis was down 75 basis points year-over-year and ex-gas inflation down 43. Ancillary and other businesses reported plus 40 basis points and ex-gas inflation plus 49 basis points. 2% reward plus 3 and minus 1 basis points. LIFO minus 14 and minus 14 basis points. Other plus 14 and plus 14 basis points. So, totally, on a reported basis, again, year-over-year, minus 32 basis points, and excluding gas inflation, plus 5 basis points. Now, in terms of the core merchandise component, being lowered by 75 year-over-year reported and minus 43 basis points, ex-gas inflation, recall last year in Q2 that the core reported was plus 71 basis points and ex-gas plus 63. So, still improved to where we were two years ago, pre-pandemic and ex-gas. In terms of the core margin on its own sales, in Q2, our core-on-core margin, if you will, was lower by 28 basis points year-over-year, approximately two-thirds of this coming from fresh foods and a little from foods and sundries and non-foods as well. Fresh continues to lap exceptional labor productivity and low product spoilage that occurred from the outside sales a year ago in the second quarter. Ancillary and other business gross margin was higher by 40 basis points and by 49x gas in the quarter. Gas, travel, business centers, and pharmacy were all better year over year, offset by e-comm and optical. LIFO, we had a 14 basis point hit year over year to LIFO, or a $71 million LIFO charge during the quarter, both with and without gas inflation. Recall that our Q1 LIFO charge year over year was $14 million, or in the first quarter was $14 million, or a three basis point delta versus the prior year. It's been the last three fiscal quarters that we've actually pointed out LIFO, as we saw a little bit of inflation going back to the summer or Q4 of fiscal 21, a little more in Q1 of this fiscal year, and as with everything you read in the news, quite a bit more in Q2. Our 2% reward was higher on a reported basis by three and minus one, excluding gas inflation, a reflection of increased penetration of the 2% reward executive members. And other was plus 14 basis points year over year. This is related to the COVID related costs from a year ago, about $60 million. That's the portion of COVID related wages that go into costs of sales that like related to manufacturing businesses, as well as their meat and bakery departments. Overall, pretty good showing on the gross margin, given the ongoing and increasing inflationary pressures. Moving to expenses, to SG&A, I reported SG&A in the second quarter was lower or better year-over-year by 94 basis points, and better by 63 basis points, excluding gas inflation. Again, jotting down two columns of numbers reported, and the second one, X gas inflation, Operations, plus 36 basis points and plus 9. Here a plus is good. It means it's lower year over year. Central, plus 13 and plus 10. Stock compensation, plus 3 and plus 2. Other, plus 42 and plus 42 for a total of plus 94 and plus 63. So better or lower by 94 basis points reported and better or lower by 63 basis points ex-gas inflation. Now, again, looking at the first line item operations, the core operations component better, again, by 36, but as well better by nine or lower by nine basis points, excluding the impact of gas inflation. Keep in mind that this improvement occurred despite both the permanent dollar an hour wage increase that began in March of 2021, is now anniversary, and the additional starting wage increases in from our two basic hourly scale service assistant and service clerk by an additional 50 cents an hour. That occurred in October of 2021. On a central, better by 13 basis points or 10x gas inflation. It's pretty straightforward. Operating leverage on strong sales figures. Stock comp, plus 2 and plus 2. Again, reflection of good sales. And other, this plus 42 basis points. This was the $2 COVID wages of $186 million that goes into SG&A in Q2 a year ago. So, again, on a year-over-year basis, that was that improvement. In terms of pre-opening expenses, in past conference calls, really since we went public, I think, We've covered that pre-opening expenses next on this discussion. Starting this fiscal year and going forward, pre-opening is now included in SG&A. The year-over-year change in SG&A related to pre-opening was flat year-over-year, no basis point delta year-over-year in the second quarter. All told, reported operating income in Q2 increased 35% on a reported basis. coming in at $1,812,000,000 this year compared to $1,340,000,000 a year ago in the second quarter. Below the operating income line, interest expense was $36,000,000 this year versus $40,000,000 last year. Interest income and other for the quarter was higher by $6,000,000 year over year, $25,000,000 this year versus $19,000,000 last year, primarily due to favorable FX. Overall reported pre-tax income in the quarter was up 37%, coming in at $1.8 billion compared to $1.3 billion a year earlier. In terms of income taxes, our tax rate in Q2 was slightly higher than it was in Q2 a year ago. It came in at 26.7% compared to 26.4% a year ago in the second quarter. Our effective tax rate currently continues to be projected to be in the 26% to 27% range for the fiscal year. A few other items of note. Warehouse expansion. For the year, we now plan to have 32 new units and 32 units, including four relocations. So replacing existing units to larger and better located facilities. So net total of 28. I think a quarter ago, we actually said it was a net total of 27. So one more than that. However, remember, several of these are slotted to opening Q4 or fiscal Q4. 15 of them, or 14 net new. So there's always a potential for one of those to shift into the next fiscal year. The five openings in Q2 that we had, one each in Mexico, our 40th in Mexico, our second in France, our second in China, our fourth in Spain, and one additional unit in Florida, where we now have 29 locations. Regarding capital expenditures, our Q2 spend for CapEx was approximately $723 million. and our full-year capex spend is still estimated to be approximately $4.0 billion. Moving on to e-commerce, e-commerce sales in Q2FXFX, as I mentioned earlier, increased 12.6% year-over-year, and that's, of course, on top of a second quarter fiscal 21 increase of 75% increase last year, benefiting, of course, from COVID. Stronger departments in e-commerce in terms of year-over-year percentage increases, jewelry, tires, special order kiosk items, patio and garden, and home furnishings. Our largest online merchandise department, Majors, which consists of consumer electronics, appliances, TVs, et cetera, was up in the high single digits on very strong sales increases a year earlier. In terms of an update on Costco logistics, this continues to drive big and bulky sales. For the quarter, deliveries were up year over year 22%. And now about 85% of our U.S. e-com less than truckload shipments from Costco logistics we're doing ourselves. During the quarter, we average more than 65,000 stops per week with Costco logistics, which translates into a little over $3 million planned drops in Costco logistics for the fiscal year. In terms of e-com and mobile apps, it continues to improve, much improved layout, the ability to view warehouse receipts online, the ability to reschedule e-com deliveries in the U.S. and Canada, as well as reschedule returns pickups. Later this month, we'll have our warehouse inventory, along with the Instacart inventory, online and be able to see all the detail of our in-store merchandise as well. In terms of our e-commerce platform, Costco Next, we added a few additional suppliers, so we now have 37 suppliers online and growing. Again, Costco Next has about 1,000 items on it, curated items at Costco values. Please check it out. From a supply chain perspective, similar issues that we outlined both 12 and 24 weeks ago on the past quarterly earnings calls. The factors pressuring supply chains and inflation include port delays, container shortages, COVID disruptions, shortages of various components and raw materials and ingredients and supplies, labor cost pressures, of course, as well as truck and driver shortages. Overall, we've done a pretty good job of giving these supply chains challenges. I think that's evidenced in our sales strength. They continue to be delayed container arrivals, so we continue to advance order in many cases as we are able to. Virtually all departments are impacted. Less product and packaging challenges, but still a few. Still some limitations on key items, but again, that's improving a little. Ship shortages are still one of the things that are impacting many items, some more than others, but again, we're managing to have our shelves full and driving sales. One of the things that we've done that I mentioned last quarter, last quarter I mentioned we had chartered three small container vessels to help provide us with additional flexibility on shipping. We have now chartered a total of seven ocean vessels, up from those three for the next three years. These are transport containers between Asia and the US and Canada. We've also leased containers for use in these ships. With these additions, about a quarter of our annual Trans-Pacific containers and shipment needs are being accommodated this way, which gives us additional supply chain flexibility. Despite all the supply chain issues, we're staying in stock and continue to work to mitigate cost and price increases as best we can. Every day and every week, you're going to see in different items in different departments certain things on allocation or short, but other things are filling its place. And again, some things are seeming to get a little better. Moving to inflation, inflation, of course, continues as evidenced by our life-out charge. The inflationary pressures that we and others continue to see include higher labor costs, higher freight costs, as well as higher transportation demand, along with the container shortage and port delays that I just mentioned. Increased demand in certain product categories. Various shortages of everything from computer chips to oils and chemicals to resins. Higher commodity prices from food service oils to additives and motor oils to plastics to detergents to paper products as well. On the fresh side, proteins and butter and eggs and things like that. Not very different than what you hear and read and see from others, but again, we think we've done a pretty good job of corralling it as best we can. For the first quarter, a quarter ago, I mentioned that we estimated at that time overall price inflation to have been in the 4.5% to 5% range. For the second quarter, in talking with senior merchants, estimated overall price inflation was in the 6% range. All of this said, again, I want to give another shout out to the job that our merchants and our traffic department and operators have all been able to do in order to keep the products that we need, pivot when and where necessary, and keep our warehouses full by keeping prices as low as we can for our members and continuing to show great value versus our competitors. Now turning to our February sales results. The four weeks ended this past Sunday, February 27th, compared to the same four-week period a year ago. As reported in our release, net sales for the month of February came in at $16.29 billion, an increase of 15.9% from $14.05 billion a year earlier. Recall from January sales results that Lunar New Year, Chinese New Year, occurred on February 1st. That's 11 days earlier this year than last. This shift negatively impacted February's other international by about four percentage points and total company by about a half a percentage point. Comparable sales for the four weeks on a reported basis, U.S. was 17.4. Ex-gas and FX, 12.9. Canada reported 11.7. Ex-gas and FX, 8.8. Other international, minus 0.9. and X gas and FX at 1.3 to the positive. Total company, 14.0 and 10.6. And e-com within that number is 10.2 reported and 10.4 X gas and FX. Our comp traffic and frequency for February was up 8% worldwide and 8.2% in the United States. Foreign currencies year over year relative to the dollar negatively impacted total and comp sales as follows. Canada by approximately two-tenths of a percent, Other international by approximately 4.5%, and total company by approximately 7 tenths of a percent. Gas price inflation positively impacted total reported comps by about 4%, and average worldwide selling price per gallon was up year over year by 37%. Worldwide, the average transaction for February was up 5.5%. Our U.S. regions with the strongest sales were Texas, the Southeast, and the Northeast. Other international and local currencies saw the strongest results in Australia, Mexico, and the U.K. Moving to merchandise highlights for the month of February, food incendiaries came in at a positive high single digits, fresh foods in the mid-single digits, and non-foods in the positive high single digits. Ancillary businesses' sales were up mid-40s. with gas being certainly a driver of that, as well as food court and hearing aids were the top performers. With that, I want to mention just a couple of recent executive changes. A month ago, we reported that Ron Vakris became president of Costco. Ron started his career 39 years ago at Price Company, at Price Club, at the young age of 17. Most of his career was in operations through 2015. Then he spent a little over a year in real estate traveling the world and working on both worldwide and domestic expansion. And since that time in 2016 has been in merchandising with certainly responsibly not only for inline merchandising but online merchandising as well as very involved with logistics and transportation. As well, just this week internally we reported that taking Ron's previous spot as head of merchandising is Claudine Adamo. Claudine has been with us for 30 years. She began in an hourly position in our Kirkland warehouse in 1992, 30 years ago. But a year later, came into buying and has been in buying ever since. And most recently was senior VP of non-foods sales, of non-foods merchandising. And again, she'll be taking over, looking over all of merchandising. Finally, in terms of upcoming releases, we will announce our March sales results for the five weeks ending April 3rd, on a Sunday, April 3rd, on Wednesday, April 6th, after the markets close. With that, we'll open it up to Q&A and turn it back to Jerome. Thank you very much.

Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from the line of Michael Lusser from UBS. Your line is now open.