Costco Wholesale Corporation

Ladies and gentlemen, thank you for standing by and welcome to Costco Wholesale Corporation's fiscal Q3 2023 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, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Richard Galanti, CFO, you may begin your conference.

Thank you, Josh, 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 third quarter of fiscal 2023. The 12 weeks ended this past May 7th. Reported net income for the quarter was $1.30 billion or $2.93 per diluted share. This compared to $1.35 billion or $3.04 per diluted share a year ago in the third quarter. This year's results included a non-recurring charge to merchandise costs of $298 million pre-tax or 50 cents per share, primarily for the discontinuation of our charter shipping activities. Last year's results included a non-recurring $77 million pre-tax charge or 13 cents per share for incremental employee benefits. As many of you know, two years ago, we initially leased three ships and thousands of containers to help mitigate some of the significant overseas freight challenges that we were experiencing. Later, we added four additional vessels and several thousand additional containers with commitments made for up to then three additional years. Procuring these ships and containers was integral to us being able to stay in stock for our members during those challenging times. It also allowed us to do so initially at a lower cost than the market rates at that time. Shipping and freight markets have improved dramatically since that time, which led us to reevaluate our position. As you recall, in fiscal first quarter of this fiscal year, we took a charge to downsize by two vessels our charter shipping activities. Since then, shipping and container rates have continued to fall, and in this third quarter, we concluded that it would be appropriate to completely discontinue the remainder of our charter shipping activities. As a result of this decision, we recorded an impairment charge for all remaining charter assets. This decision allows our merchandising teams to take full advantage of the current shipping market rates as opposed to much higher contracted charter rates. In turn, this allows us to do what we do best and lower prices for our members. In terms of sales, net sales for the third quarter increased 1.9% to $52.6 billion versus $51.61 billion reported last year in the third quarter. Comparable sales for the quarter were as follows. In the U.S., on a reported basis, minus 0.1%. And excluding gas deflation and FX, plus 1.8%. Canada, reported minus 1.0%. Ex-gas and FX, plus 7.4%. And other international, reported plus 4.1%. And ex-gas and FX, plus 8.4%. So total company reported basis 0.3% comp sales and X gas deflation and FX at plus three and a half percent. And now e-commerce on a reported basis was minus 10.0 and minus 9.0 excluding FX. In terms of third quarter comp sales metrics, traffic or shopping frequency remains pretty good, increasing 4.8% worldwide and 3.5% in the US during the quarter. Our average daily transaction or ticket was down 4.2% worldwide and down 3.5% in the U.S., impacted in large part from weakness in bigger ticket non-foods discretionary items. Foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 1.5%, and gasoline price deflation negatively impacted sales by approximately 1.7%. Next on the income statement is membership fee income. For the quarter, we reported $1,044,000,000 of membership fee income or 1.98% of sales compared to $984,000,000 or 1.91% a year ago in the third quarter. So a $60,000,000 or 6.1% increase in membership fees. Excluding the headwinds in FX, the $60,000,000 increase would have been higher by $17,000,000 or up year over year, 8% adjusted for FX. In terms of renewal rates, at third quarter end, our U.S. and Canada renewal rate was 92.6%, and our worldwide rate came in at 90.5%. These figures are the same all-time high renewal rates that were achieved in the second quarter, just 12 weeks earlier. Membership growth continues. We ended Q3 with 69.1 paid household members and 124.7 million cardholders. both up approximately 7% versus a year ago. At third quarter end, we had 31.3 million paid executive members, an increase of 681,000 or 57,000 per week during the 12-week fiscal third quarter. Executive members now represent a little over 45% of our paid members and approximately 73% of worldwide sales. Moving down the income statement, next is our gross margin. Our reported gross margin in the third quarter was higher year over year on a reported basis by 13 basis points, coming in at 10.32 as compared to a 10.19% number a year earlier. The 13 basis point positive X gas deflation was minus 3 basis points. Both of these numbers, of course, includes the little more than 50 basis point impairment charge to margin mentioned in today's earnings release. As I normally do, I'll ask you to jot down a few numbers, two columns, a reported column, and then the columns excluding gas deflation. The first item would be for the third quarter of 23, core merchandise margin. On a reported basis, it was up year-over-year 39 basis points, and ex-gas deflation up 24. Ancillary and other, plus 13 and plus 9. Two percent reward, minus 11 and minus 9. LIFO, plus 25 and plus 25. and other minus 53 and minus 52. If you add up the two columns, again, you get to the reported number of on a reported basis gross margin year over year in the quarter was up 13 basis points and X gas deflation down three basis points. So starting with the core, again, core was up on a reported basis 39 basis points year over year and 24 X gas deflation. In terms of core margins on their own core sales or core and core margins, they were higher by 17 basis points. with food and sundries and non-foods being up and fresh foods being down a little. Ancillary and other businesses' gross margin was higher by 13 and again higher by 9x gas deflation. Within the ancillary businesses, gas, the lean, business centers, food court, and travel were better year over year, offset in part by e-comm. 2% reward, again higher by 11 basis points and higher by 9x gas deflation. Higher sales penetration coming from our executive members is certainly part of that. LIFO, plus 25 basis points year-over-year, both with and without gas deflation. As you recall, a year ago in the third quarter, we had $130 million charge for LIFO. In this fiscal year, we had no LIFO charge, so $130 billion year-over-year improvement on that line item. Note also that in the fourth quarter, a year ago, we had a $223 million LIFO charge. So we'll see how that goes in the fourth quarter this year. Other was lower by 53 basis points reported and 52x gas deflation. This was net of items from both years. This year, there was a 57 basis point negative impact from the $298 million pre-tax charge, again, primarily related to terminating our charter shipping activities. This was partially offset by lapping last year's $77 million charge for incremental employee benefits, of which 20 million are four basis points related to gross margin. The remaining $57 million, I'll talk about it in a minute, under SG&A. Moving on to SG&A, our reported SG&A this year was 9.11% compared to 8.62% a year ago, so on a reported basis higher by 49 basis points, and ex-gas deflation higher by 34%. As with gross margin, I'll ask you to jot down two columns of numbers, both reported and one with excluding gas deflation. First item is operations, minus 48 basis points or higher by 48 basis points and minus 35 basis points. Central, minus 11 and minus 9. Stock compensation, zero in both columns. Pre-opening, minus 1 and minus 1. Other, plus 11 and plus 11. If you add all those up, again on a report, basis, 49 basis points higher year over year, and next gas inflation 34. Now the core operations, this negative included, of course, the impact of slower sales growth, as well as the impact of a few of the wage increases that we did that are typically out of the normal cycle over the last year, over a year. And that included the impact of four weeks of wage and benefits increases implemented last March, the additional top of scale increase that went into effect July 4th, and eight weeks of this March is higher than normal top of scale increase. Despite the slowing sales growth, we've continued to invest in our employees over the past year, and that's always been a priority for us. Central, higher by 11 and higher by 9x gas deflation. Again, sales growth, no big single item was an outlier there, but sales growth overall, in my view, was the impact. Stock comp flat, both with and without gas deflation, so no impact there. Pre-opening, again, higher by one basis point. We had five openings this year and a quarter and three last year. But, again, one basis point delta year over year. And other, the 11 basis point positive, both with and without gas deflation, this is a result of lapping that $77 million charge, but within SG&A lapping 57 of that $77 million charge for the incremental employee benefits, again, discussed earlier in the release. Below the operating income line, interest expense came in at $36 million, a million dollars over last year's $35 million number. And interest income for the quarter was higher by $57 million year over year. This was driven by an increase in interest income due to higher interest rates and cash balances. And the increase in interest income was partially offset by less favorable FX versus last year. In terms of income taxes, our tax rate in the third quarter came in at 26.5%. That compared to 24.9% in Q3 last year. The fiscal 23 effective rate, excluding discrete items, is currently projected to be in the 26 to 27% range. Overall, reported net income was down year over year by four percentage points. Net of the two non-recurring items in both years' third quarters, net income would have been up 8%, even with being reflected with that higher income tax rate. In terms of warehouse expansion, to date, we've opened 17 locations in the first three quarters and also including three relocations, so net of that 14 net new locations. In Q4, we have nine new openings with no reloads, so a net of nine. That'll put us at 26 openings, less the three reloads, to be a 23 net new for this year. In the quarter, again, we opened five with four being net new. In addition to the relocation in Canada, we had two new buildings in the U.S. open, and one additional building opened in each of Japan and China. We have, again, the nine new buildings planned for our fiscal fourth quarter. That includes our North Tulsa, Oklahoma opening that opened this morning, and our fourth and fifth buildings in China planned for June and August. These Q4 planned openings will bring our full year count to 26, less than three, or dead of 23. And that is made up of 13 in the U.S. and 10 outside of the U.S. Regarding capital expenditures, in Q3 of the fiscal year, we spent approximately $819 million. Our estimate for all of fiscal 23 CapEx is approximately $4 billion. Moving on to e-commerce, you saw in the release that e-commerce was at minus 10% sales decline. On a comp basis, an XFX of minus 9%. Ecom sales, more to the same story in terms of the sales as I discussed on our second quarter call and in our monthly sales recordings. In Q3, big-ticket discretionary departments, notably majors, home and furnishings, small electrics, jewelry, and hardware, were down about 20% in ecom and made up 55% of ecom sales. These same departments were down about 17% in warehouse, but they only make up 8% in warehouse sales. A few comments on inflation. Inflation continues to abate somewhat. You go back a year ago to the fourth quarter of 22 last summer. We had estimated the time that year-over-year inflation at the time was up 8%. And by Q1 and Q2, it was down to 6% and 7%, and then 5% and 6%. And this quarter, we're estimating that year-over-year inflation in the 3% to 4% range. We continue to see improvements in many items, notably food items like nuts, eggs, and meat, as well as items that include as part of their components commodities like steel and resins on the non-food side. Switching over to inventory levels, inventories overall are in pretty good shape. As of quarter end, our inventories year over year as of the end of the third quarter were down 7%. Recall that they had been up during some of the supply chain challenges of last year. Finally, in terms of upcoming releases, we will announce our May sales results for the four weeks ending this Sunday, May 28th, next Thursday on June 1st after market close. And also remember that our fiscal fourth quarter has an extra week this year, so our quarter ending September 3rd of 2023 will have 17 weeks versus 16 weeks in the fiscal fourth quarter. With that, I'll open it up for questions and answers and turn it back over to Josh. Thank you.

Reminder, if you would like to ask a question at this time, please press star followed by the number one on your telephone keypad. Your first question comes from the line of Michael Lasser with UBS. Your line is open.