Costco Wholesale Corporation (NASDAQ:COST) Q2 2024 Earnings Call Transcript March 7, 2024

Costco Wholesale Corporation  isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by. At this time, I would like to welcome everyone to Costco Wholesale Corporation's Fiscal Second Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Richard Galanti, CFO. Please go ahead.

Richard Galanti: Thank you, Debbie, 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.

Comparable sales and comparable sales excluding impacts from changes in gasoline prices and foreign exchange are intended as supplemental information and are not a substitute for net sales presented in accordance with GAAP. In today's press release, we reported operating results for the second quarter of fiscal 2024, the 12 weeks ended February 18th, as well as February retail sales for the four weeks ended this past Sunday, March 3rd. Reported net income for the 12-week second quarter came in at $1.743 billion or $3.92 per diluted share, up from $1.466 billion or $3.30 per diluted share in the 12-week second quarter last year. This year's results included a tax benefit of $94 million or $0.21 per diluted share due to the deductibility of the $15 per share special dividend to the extent received by our employee 401(k) plan participants.

Net sales for the second quarter was $57.33 billion, an increase of 5.7% from the $54.24 billion in the second quarter last year. Net sales were negatively impacted by approximately 1.5% in the US and worldwide from the shift of the fiscal calendar as a result of the 53-week 2023 fiscal year. The following comparable sales reflect comparable locations year-over-year and comparable retail weeks. For the -- in the US, we reported a 4.3% comparable. Excluding gas, deflation, and FX, the 4.3% would have been a 4.8%. Canada reported comp of -- for the quarter 9.2%, 9.0% ex-gas and FX. Other International 8.6%, and 8.2% ex-gas and FX. Total company 5.6% reported for the quarter, and a 5.8% excluding gas, deflation, and FX. E-commerce was an 18.4% reported, and an 18.2% excluding FX.

In terms of second quarter comp sales metrics, our traffic or shopping frequency increased by 5.3% worldwide and 4.3% in the US. Foreign -- our average transaction or ticket was up three tenth of a percent worldwide and up one tenth of a percent in the US. And foreign currencies relative to the US dollar positively impact sales by approximately two tenth of a percent. While gasoline price deflation negatively impacted sales by approximately four tenth of a percent minus. Moving down the income statement to membership fee income. We reported membership fee income of $1.111 billion, up $84 million or up 8.2% year-over-year in the quarter. In terms of renewal rates, at second quarter end, our US and Canada renewal rate came in at 92.9%, which is up one tenth of a percent from Q1 and 12 weeks earlier.

And the worldwide rate came in also at 90.5%, similar to the last quarter. Membership growth continues. We ended the second quarter with 73.4 million paid household members, up 7.8% versus last year, and 132.0 million cardholders, up 7.3%, with continuing growth throughout the quarters. At Q2 end, we had 33.9 million paid executive members, an increase of 646,000 during the 12-week second quarter. Executive members represent a little over 46% of paid members and a little over 73% of worldwide sales. Moving down the income statement line, next, to the gross margin. Our reported gross margin in the second quarter was higher year-over-year by 8 basis points, coming in at 10.80% compared to 10.72% last year in the quarter, and at 4 basis points excluding gas deflation.

Writing down the little matrix that we usually do with two columns, both reported and excluding gas deflation. First line item is core merchandise, plus 5% -- plus 5 basis points year-over-year on a reported basis, and plus 2 basis points ex-deflation -- gas deflation. Ancillary and other, plus 7 basis points and plus 6 basis points. 2% reward, minus 7 basis points and minus 7 basis points. LIFO, plus 3 basis points and plus 3 basis points. And all told, total reported, again, gross margin year-over-year up 8 basis points and up 4 basis points excluding gas deflation. In terms of the core margin on their own sales, again, while the number I just read you was a plus 5% -- plus 5 basis points and plus 2 basis points ex-gas deflation. In terms of core margin on their own sales, our core-on-core margins were up 25 basis points year-over-year, with food and sundries and non-foods being positive year-over-year and fresh being negative.

Ancillary and other businesses, gross margins were higher by 7 basis points and higher by 6 basis points ex-gas. The increase year-over-year was driven largely by e-comm and partially offset by gas. 2% reward, again higher 7 basis points -- lower by 7 basis points both with and without gas deflation, with higher sales penetration coming from our executive members. LIFO, plus 3 basis points. We had a $14 million LIFO credit in the second quarter of this year compared to no LIFO charge or credit in the second quarter of last year. Moving to SG&A. Our reported SG&A in the second quarter was higher year-over-year by 3 basis points or minus 3 basis points would be higher, coming in at -- this year at 9.14% compared to last year's 9.11%. And the higher 0.3% would have been lower by 1 basis point excluding gas deflation.

In terms of Q2 year-over-year, the operations component of SG&A, doing the matrix, was 11 basis points higher, or minus 11 basis points. Ex-gas deflation, minus 8 basis points, so 8 basis points higher. Central, plus 4 basis points and plus 5 basis points. Stock compensation, plus 4 basis points and plus 4 basis points. And total would be 3 basis points higher year-over-year and plus 1 basis point or 1 basis point lower year-over-year or better. And with regard to the operations component being higher by 11 basis points reported and 8 basis points excluding deflation. As compared to a year ago, since -- during the past year, we included two last March's extra top-of-scale increase in wages, which was about a 2 basis point hit to the SG&A line.

As well, in the first quarter of this year we raised the starting wage in the US and Canada. We estimate the impact of that new wage also was a roughly 2 basis point. So, about 4 basis points of that 8 basis points or 4 basis points of that 11 basis points were related to those two wage increases, more than normal. Below the operating income line, Central I mentioned was better by 4 basis points or 5 basis points, and the rest was pretty much straightforward. Below the operating income line, interest expense was $41 million this year versus $34 million last year and interest income and other for the quarter was higher by $102 million year-over-year. This was driven by an increase in interest income due to higher interest rates and higher average cash balances, as well as FX which was favorable versus last year.

We'll see less benefit from interest income going forward following the January payment of the $6.7 billion special dividend. In terms of income taxes, our tax rate in the second quarter came in at 22.1% compared to 26.1% in Q2 last year. As discussed earlier, this year's rate benefited from the tax deductibility of a special dividend paid to 401(k) participants. The fiscal 2024 effective tax rate including discrete items is currently projected to be in the 26% to 27% range. And excluding the special dividend tax benefit in Q2, our Q2 tax rate instead of being -- coming in at 22.1% would have been 26.3%. Overall, reported net income was up 18.9% in the quarter on a reported basis. And again, excluding the special dividend-related income tax benefit, it would have been up 12.5% year-over-year.

A few other items of note. In terms of openings in the second quarter, we opened four net new warehouses, including three new locations in the US. Actually, two of them were Costco business centers, and one new Costco Wholesale warehouse, and one unit in -- our sixth in China in mid-January in Shenzhen. That's our six in China. There's been a lot of press about it. We have an estimated 10,000 people who were at opening and there are just under 200,000 members currently, including more than 20,000 members who signed-up from Hong Kong. And we've seen all kinds of things over there from tour agencies doing bus trips over to shop. For the full year 2024, we estimate 30 total openings, including two relo's, so for a net increase of 28 new units.

And that puts the remainder of fiscal 2024 for Q3 and Q4, we plan on opening a total of 15 net new locations, 11 in the US, two in Japan, and one each in Korea and in China. Regarding CapEx, fiscal second quarter spend was approximately $1.03 billion. And for the year, it remains in the north of $4.4 billion to $4.6 billion, in that range. One additional comment on China. This past Monday, we launched in our Pudong, China location, the ability for our members to order online about 400 items from our -- of our items to be delivered that day. This -- and the delivery will be within about an eight kilometer radius of the warehouse itself. That's getting a lot of social media attention over there and we plan to launch it in the other four Shanghai area locations by month-end, as well as in Shenzhen sometime the following month.

In terms of e-commerce, e-commerce sales in Q2 ex-FX increased 18.2%. E-com showed strength in several areas, led by sales of gold and very recently silver. As well, appliances were very, very strong, as was gift cards and e-tickets. As well, Costco Logistics enjoyed record-breaking deliveries. Much of that -- many of those items are sold via e-commerce. In Q2 of 2024, we completed over 1 million deliveries, up 28% versus Q2 a year ago. In terms of e-commerce sales over the past few months, we believe we've done a much better job explaining to our members the significant value propositions we offer compared to traditional competitors in several big-ticket categories. Under the Why Buy At Costco banner and The Price You See Is The Price You Pay banner, we share with our members what's included in the price of appliances, tires, televisions, computers, and mattresses.

You can see these online on our website of Why Buy At Costco. Just to give you one example. If you take a four-set of high-end tires compared to a traditional retailer, we include, of course, installation, rotation, balancing, a five-year road hazard warranty. Typically that's a lot less road hazard warranty than other places, or you'd have to pay for it extra, ongoing flat repairs, nitrogen, and disposal of the prior tires. So, just one of the examples where the price of the tires itself might be very close to us. When you put in all the differences of those additional items, it's anywhere from a 15% to 25% savings on any of these items. Next on my list, talk about costconext.com, a couple of comments on the seller platform. This allows -- costconext.com allows our members to exclusive asset -- access to direct-to-consumer sites for top-quality brands at Costco value pricing.

Currently, there are about 70 -- there are 70 Costco Next brand sites, with 15 additional sites in development. We will likely end this calendar year with about 90 sites and continue to grow from there. Costco Next offers everything from home improvement to apparel to pet to home to kitchen to electronics to accessories, as well as sports, bicycles, and toys. You should check it out, it's a pretty good site. Progress continues to be made in our e-com, mobile, and digital efforts. A couple of recent enhancements. In February, we rolled out our new native mobile application homepage on iOS. The native homepage now loads in less than 2 seconds compared to 8 seconds previously. Needless to say, that's important when about 60% of our e-com business, both visitors and orders, are now done via our mobile app and browser.

And last week, we rolled out Apple Pay to all members online, both web and mobile, on February 28th. App downloads during the quarter were up 2.8 million and currently total around 33 million. On the product side, a couple of other new items to comment on. In our food courts, we recently replaced the churro with an awesome freshly baked 5.5-ounce chocolate chip cookie for $2.49. It is awesome. It's a great-tasting -- and a great-tasting turkey sandwich for $6.99, with the rollout of the latter being completed this week. In addition, we recently opened our first fully operated sushi offering in Issaquah, Washington, across the street from our headquarters, with two more planned to open in the very near future. This operation is what we have successfully done for years -- for many years, and throughout our Asia Costcos and several countries over there.

The sushi program has proven to be a category where we can be successful in both quality and price, and we're looking forward to seeing more of that in the future. A couple of comments about inflation. In the last quarter, in the first quarter, we estimated that year-over-year inflation was approximately zero to 1%. We'll now say that in Q2, it was essentially flat. And notwithstanding essentially flat, we're taking price reductions where we can. Anecdotally, everything from simple items like reading glasses from $18.99 to $16.99, the 48 count of Kirkland Signature batteries from $17.99 to $15.99, a 24 count of Pellegrino from $16.99 to $14.99, and even a four pounds of frozen three berry fruit blend from $14.99 down to $10.99 with new crop pricing.

So, we continue to do that. We always want to be the first out there trying to lower prices. Many new items in sporting goods and lawn and garden are being set with lower prices year-over-year, and overall, mostly due to reduced freight costs and lower commodity costs versus a year ago. And overall, our inventories and SKUs are in good shape across all channels. Overall, we've had good seasonal sell-through during the quarter. In terms of shipping and supply chain issues, we've been asked about that often of late. There are some delays, generally just a couple to three weeks, but mostly now planned for. First, there was an issue a while back with the Panama Canal challenges. Then, of course, the Red Sea challenges. A lot of that has to do with changing the way ships are being routed.

No meaningful pricing issues because a lot have been placed contracts. Finally, turning to our February sales results, the four weeks ended this past Sunday, March 3rd, compared to the same retail calendar weeks last year. As reported in our release, that sales for the month came in at $18.21 billion, an increase of 6.9%, versus $17.04 billion for the same four retail weeks last year. Again, just to announce what we did in the announcement earlier today, the US reported comp of 3.4% for February, ex-gas and FX, 4.1%. Canada, 8.4% and 8.3%. Other international, 10.8% and 11.3%. For our total Company, a 5.0% reported and a 5.6% ex-gas and FX, with e-com coming in at a 16.2% reported and a 16.0% ex-FX. Our comp traffic or frequency for February was up 6.2% worldwide and up 5.0% in the US.

Foreign currencies year-over-year relative to the dollar negatively impacted total and comparable sales as follows: Canada by about one tenth of a percent negative; other international by approximately 0.5%; and total Company by approximately one tenth of a percent. Gasoline price deflation negatively impacted total reported comp sales by approximately 0.5%, and the average worldwide selling price per gallon of gas was down approximately 3.5% versus last year. Worldwide, the average transaction for February was down about 1.1%, which includes the negative impacts from FX and gas deflation. In terms of regional and merchandising categories, the general highlights are as follows: US regions with the strongest comps were Midwest, Southeast, and Northeast.

In terms of other international in local currencies, we saw strength in Mexico, Australia, and Korea. Moving to merchandise highlights, food and sundries were positive in the mid-single-digits. Fresh foods were up high-single-digits, and non-foods were positive mid-single-digits. And ancillary businesses were up in the low-single-digits. Food court, pharmacy, and optical were top performers, with gas down low-single-digits on a lower price per gallon. In terms of upcoming releases, we will announce our March sales results for the five weeks ending Sunday, April 7th on the following Wednesday, April 10th after market close. And lastly, before I turn it back to Demi for Q&A, I'd like to take a moment to say thank you to many of you who have turned in to each quarter, some for many years, to allow me to share with you Costco's results, both our ups and our downs, and thankfully many more ups than downs, and provide some fun and informative color on how we're doing along the way.

Since going public in December of 1985, I have hosted all but one call and it's been an absolute privilege and honor to do so. So, thank you all. As you know, in early February, it was announced that I will be ceding the role of CFO to Gary Millerchip effective March 15th after our second quarter 10-Q is filed, and retire, including from our Board, next January. It's a bit surreal of late, but what a wonderful journey it has been with such a great Company and great people, including many of you on the call today. I have certainly been very fortunate. The good news, Gary joined Costco last week, and along with David and Josh, will continue to provide to you all with the transparency and straightforwardness that we are known for. It will be a positive and seamless transition.

With that, I will be happy to turn it back to Demi to open it up for Q&A.

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