Costco Wholesale Corporation

Good day. My name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco wholesale second quarter fiscal year 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, Again, press the star 1. Thank you. Richard Galante, CFO, you may begin your conference.

Thank you, Emma, 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 being 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 23. The 12 weeks ended this past February 12th. as well as February retail sales for the four weeks ended this past Sunday, February 26th. Reported net income for the quarter came in at $1.466 billion, or $3.30 per share, compared to $1.299 billion, or $2.92 a share per diluted share last year, an increase of 13%. In terms of sales, net sales for the second quarter increased 6.5% to $54.24 billion, compared to $50.94 billion reported a year ago in the second quarter. Comparable sales for the second quarter were as follows. In the U.S., 5.7% for the 12-week period, excluding gas inflation, a 5.8%. Canada, 3.5% reported, a 9.6% excluding gas inflation and NFX. Other international, a 3.8% reported and a 9.5% ex-gas inflation in FX for a total company of 5.2% reported and 6.8% excluding gas inflation in FX. E-commerce was a minus 9.6% for the 12 weeks reported and minus 8.7% excluding FX. In terms of second quarter comp sales metrics, traffic or shopping frequency increased 5% worldwide and 3.7% in the United States. Our average transaction or ticket was up 0.2% worldwide and up 1.9% in the U.S. during Q2. Foreign currencies relative to the dollar negatively impacted sales by approximately 1.8%, and gasoline price inflation positively impacted sales very slightly by approximately 0.2%. I'll review our February sales results later in the call. Next on the income statement is membership fee income. Reported in the second quarter, $1.027 billion of membership fee income or 1.89%. That's for this year's second quarter compared to $967 million a year earlier. So a $60 million increase in dollars or up 6.2%. Excluding the headwinds and FX, the $60 million increase would have been higher by 20 additional million dollars. So on an FX-adjusted basis, membership fee income was up just over 8 percentage points. In terms of renewal rates, at second quarter end, our U.S. and Canada renewal rate was 92.6%, up a tenth of a percent from Q1 end, and worldwide rate came in at 90.5%, also up a tenth of a percent from our prior quarter. Both represent all-time highs. Membership growth has remained strong. We ended the second quarter with 68.1 million paid household members and 123.0 million cardholders, both up more than 7% versus a year earlier. In terms of Q2N, we had 30.6 million paid executive memberships. This is an increase during the 12-week quarter of 630,000 members. since Q1 end. Executive members now represent 45% of paid members and about 73% of worldwide sales. Moving down the income statement, next is our gross margin. On a reported basis, gross margin was higher year over year by eight basis points, coming in at 10.72% as a percent of sales, as compared to a year earlier, second quarter, at 10.64%. Now the eight basis points up and then excluding a gas inflation, it would be, have been up nine basis points. Uh, as I always ask you to draw a little chart with two columns reported and excluding gas inflation, and then we'll go down the line items. Uh, core merchandise was minus six basis points reported. And my also minus six X inflation, gas inflation, ancillary businesses were plus two and plus three basis points year over year, 2% reward minus two and minus two basis points. LIFO, since we had a charge last year, nothing this fiscal quarter, was plus 14 and plus 14. For a total, again, reported eight basis points up year-over-year and X gas inflation up nine basis points. Starting with the core, core merchandise grow margin, again, was lower by six basis points year-over-year. In terms of core margin on their own sales, our core-on-core margin, if you will, it was lower year-over-year by 26 basis points. Most major departments in general were down, with fresh foods being down a little more than others. We're continuing to hold or drop prices where we can due to dry traffic and improve our competitive advantage. Overall, core sales benefit from sales shifting from ancillary and other businesses to core. Ancillary and other businesses' gross margins, again, were higher by two and three basis points X gas in the quarter. Gas, business centers, and travel were better year-over-year, offset in part by e-comm and pharmacy. Two percent reward, lower by two basis points. That's reflective of the higher sales penetration coming from our executive members. LIFO, as I mentioned, was a year-over-year variance of plus 14 basis points. We had no LIFO charge this fiscal quarter compared to a $71 million charge in Q2 last year. Moving on to expenses, SG&A. Our reported SG&A for the second quarter was higher year-over-year by 13 basis points. This year, it was 9.11% compared to 8.98% in the second quarter of last fiscal year. Jotting down some numbers for the two columns, first column being reported, and second, ex-gas inflation. Operations was down higher, or I say minus two basis points, higher by two basis points, so minus two and minus two. Central, minus 9 and minus 9, so higher year-over-year and central by 9 basis points. Stock compensation, minus 2 and minus 2. And then all told, that would be 13 basis points higher, both on a reported basis and ex-gas inflation. The core operations component of SG&A, again, higher by 2 basis points and also higher by 2 ex-inflation. This includes the wage and benefits increases implemented last March and last year's third fiscal quarter. and last year's third fiscal quarter, and an additional profit scale wage increase that went into effect July 4th, which was in our fourth quarter of last year. Central, as I mentioned, was higher by nine basis points year over year. About half of this increase is a charge related to a tax audit covering several prior years. Stock comp, pretty much as expected, just a couple basis points. Below the operating income line, interest expense was $34 million this year, $2 million lower than the $36 million figure in Q2 of last year. Interest income and other for the quarter was higher by $89 million year over year. This was driven by an increase in interest income due to both higher interest rates being earned and on higher cash balances. The increase in interest income was slightly offset by unfavorable effects. In terms of income taxes, our tax rate in the second quarter was 26.1%. down slightly from the 26.7% figure in Q2 last year. The effective rate for the year excluding discrete items is currently, it continues to be projected in the 26 to 27% range. Overall net income was up about 13%. In terms of a few other items of note, warehouse expansion. In the second quarter we opened three net new warehouses, two in the US and one in Australia. Additionally, next week, we'll open our third warehouse in China with our fourth and fifth China openings, new openings scheduled to open in the fourth quarter of this fiscal year. So a total of three this fiscal year in China. In fiscal 23, we expect to open a total of 27 warehouses, including three relocations, so a net increase of 24 new warehouses. These 24 planned new openings are made up of 14 in the U.S. and 10 in other international warehouses. The 10 and under international includes the three in China, along with our first Costco's in each of New Zealand and Sweden, both of which were open during the fiscal first quarter. Regarding capital expenditures, our second quarter fiscal 23 capital spend was approximately $900 million. Our estimate for the year remains in a range of $3.8 to $4.2 billion based on timing. In terms of e-commerce, as I mentioned, e-commerce sales in Q2FX decreased 8.7%. This weakness was driven mostly by our online mix of sales. Big ticket discretionary departments like majors, home furnishings, small electrics, jewelry, hardware, these were down 15% in the quarter and make up 58% of our e-com sales. These same departments, by the way, were down 11% in warehouse but only make up 8% of total warehouse inline sales. Now, a few comments regarding inflation. It continues to seem to improve somewhat. Recall back in the fourth fiscal quarter, which ended last August, our estimated year-over-year price inflation was 8% for that prior fiscal year. During Q1, the estimate on a year-over-year basis came down to 6% to 7%. In Q2, we estimate that the equivalent year-over-year inflation number has come down to 5% to 6% range. and even a little lower than that towards the end of the quarter, according to the buyers. We continue to see some improvements in many items. Commodity prices are starting to fall, not back to pre-COVID levels in some examples, but continue to provide some relief, things like chicken, bacon, butter, steel, resin, nuts. Switching over to our inventory levels, again, both in Q3 and Q4 fiscal year ends a year ago, in fiscal 22, On a year-over-year basis, our inventories were up 26% year-over-year. And then in our first quarter of this year, they were up 10%, so a good improvement there. As of this quarter end, our inventory year-over-year, as of the end of Q2, was down 2% year-over-year. Regarding the 2% drop, we were a bit over-inventoried last year as a result of supply chain challenges, causing inventory to be backed up at the ports. And talking to the buyers a year ago, their estimate of just timing of... Getting things across the ocean was 70-plus days. Today it's back down to 30-ish days. And so supply chain improvement across the board and rates, of course, coming down. Now turning over to our February sales, the four weeks ended this past Sunday, February 26th. As reported in our release, net sales for the month were $17.06 billion, an increase of 4.7% from $16.29 billion a year earlier in the month of February. Recall from January's sales results that the Lunar New Year, Chinese New Year, occurred on January 22nd this year, 10 days earlier this year. The shift positively impacted February's other international by about 2% and total company by about a quarter of a percent. Additionally, February's results for both the U.S. and total company were negatively impacted by approximately 1%, we estimate, as a result of substantially worse weather this year over a year. I believe most of that was on the traffic side rather than the ticket side. Same-store sales, again, in the release. The U.S. has reported 3.4%. XGas, 3.5%. Canada reported 1.2%. XGas and FX, 7.3%. Other international, 6.5% reported. XGas and FX plus 11.5%. Total company, the 3.5% reported, which XGas and FX was 5.0%. In terms of e-com, minus 11.2 reported compared to a minus 10.3 without FX. That's actually an improvement from our January e-com results. Our traffic or frequency in February was up 4.9% worldwide and 3.1% in the U.S. Foreign currencies year-over-year relative to the dollar negatively impacted total and comparable sales as follows. Canada impacted it by 5.5 percentage points. Other international by approximately 5.7%, and total company by approximately 1.5%. Gasoline prices were essentially flat year over year, ever so slightly inflationary, but essentially flat. Worldwide, the average transaction for February was down 1.3%, including the negative impact from FX that I just mentioned. In terms of regional and merchandising categories, general highlights for February that we normally do on the monthly sales call, the U.S. region's With the strongest comp sales were the Midwest, the Northeast, and the Southeast. In terms of other international and local currencies, we saw the strongest results in Spain, UK, and Mexico. Year-over-year inflation for food and sundries and fresh foods, while still elevated, were at their lowest levels in nearly a year, with food and sundries inflation dropping to the high single digits and fresh foods to the low to mid single digits. Moving to merchandise highlights, the following comparable sales results by category for the month which exclude the negative impact from foreign exchange. Food and sundries were positive low double digits. Cooler food and sundries were the strongest. Fresh foods were up mid-single digits. Better forming departments included bakery and meat. Non-foods were negative mid-single digits. Better forming departments included tires, health and beauty aids, and apparel, as well as majors, jewelry, and housewares. I'm sorry, in apparel, majors, which were electronics and big ticket electronics items, jewelry, housewares, domestics, and small appliances and hardware were the worst performers, consistent with Q2 overall. Ancillary businesses sales were up mid-signal digits, with food court, hearing aid, and pharmacy were the top performers there. Finally, in terms of upcoming earnings and sales releases, We will announce our March sales results for the five weeks ending Sunday, April 2nd, on the following Wednesday, April 5th, after market close. And with that, I'm happy to turn it back over to Emma for questions and answers. Thank you.

Thank you. As a reminder, if you would like to ask a question, press star followed by the number one on your telephone keypad. Your first question today comes from the line of Simeon Goodman with Morgan Stanley. Your line is now open.