Earnings Call Transcript
COSTCO WHOLESALE CORP /NEW (COST)
Earnings Call Transcript - COST Q2 2020
Operator, Operator
Ladies and gentlemen, thank you for being here and welcome to the Q2 Earnings Call and February Sales Conference Call. All participants are currently in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. I would now like to turn the conference over to your speaker today, Mr. Richard Galanti, CFO. Thank you. Please proceed.
Richard Galanti, CFO
Thank you, Rochelle, and good morning to everyone. I'll start by stating that these discussions will include forward-looking statements. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated. The risks and uncertainties include 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 2020, the 12 weeks ended this past February 16, as well as February retail sales results for the four weeks ended this past Sunday, March 1. Reported net income for the quarter came in at $931 million or $2.10 per share, compared to last year's second quarter of $889 million or $2.01 per share. Net sales for the quarter were $38.26 billion, a 10.5% increase over the $34.63 billion last year in the same quarter. Comparable sales for the second quarter were as follows: in the U.S., for the 12 weeks on a reported basis 9.1%, excluding gas inflation and the effects of foreign exchange 8.1%; Canada, on a reported basis, 8.9%, excluding gas and foreign exchange, 6.8%; other international, 7.9% reported and 7.1% excluding gas and foreign exchange. For the total company, there was a reported 8.9% same-store sales increase and excluding gas and foreign exchange, 7.9%. Both numbers were positively impacted by approximately 0.5%, due to the Thanksgiving holidays occurring one week later this year than last year. In e-commerce, we reported a 28.4% comp for the 12 weeks and a 28% excluding foreign exchange, with the Thanksgiving holiday shift significantly impacting e-commerce performance. E-commerce sales in the quarter benefited from an estimated 11 percentage points, contributing to the 28% comp result. In terms of second quarter comp sales metrics, traffic or shopping frequency increased 5.9% worldwide and 6.1% in the U.S. Strengthening foreign currencies relative to the U.S. dollar positively impacted sales by about 25 basis points. Gasoline price inflation contributed positively by about 80 basis points. Our average transaction size was up 2.9% during the quarter, which includes the positive effects of gas inflation and foreign exchange. Later in the call I'll review our February sales results. Moving to the income statement for the second quarter, membership fee income was $816 million or 6.3% higher than the $768 million recorded in Q2 of last year, indicating a $48 million increase. The percentage increase is consistent with Q1's year-over-year result. In Q1, we had three new openings; in Q2 we had none. Looking at renewal rates, at the end of Q2, our U.S. and Canada renewal rates were 90.9%, and the worldwide renewal rate was 88.4%. These levels are consistent with what we achieved in the last two fiscal quarters. At the end of the second quarter, we had 55.3 million member households, up about 600,000 from the 54.7 million 12 weeks earlier. Total cardholders totaled 100.9 million, an increase of about 1 million from 99.9 million at the end of the first quarter. At the end of Q2, paid executive memberships stood at 21.7 million members, an increase of 321,000 during the 12 weeks or about 27,000 per week since the end of Q1. Regarding gross margin, our reported gross margin in the second quarter decreased year-over-year by 31 basis points, coming in at 10.98% compared to 11.29% a year ago. Excluding gas inflation, the reduction would have been 22 basis points lower. Looking at specific line items, the core merchandise margin decreased on a reported basis, 30 basis points year-over-year in the quarter. Ex-gas inflation, it decreased by 22. The majority of the drop in core margin was driven by an increase in sales penetration of lower-margin segments that are growing faster than the core, particularly gasoline and e-commerce, alongside start-up losses from our new poultry complex. In core merchandise categories, gross margin decreased year-over-year by 15 basis points, with six basis points attributable to the new poultry complex. Year-over-year in Q2, gross margin showed an increase in softlines, while food and sundries remained flat. Hardlines saw a quarter-over-quarter decrease, primarily due to holiday timing shifts moving promotional activities into Q2. Fresh foods were negatively impacted by price investments versus last year and by margin impacts from the new poultry complex. We are halfway through our first operational year of the poultry facility, opened September 10th, with expectations of ongoing gross margin headwinds, but a slight improvement as we reach full production capacity. Ancillary businesses reported a decrease of five basis points year-over-year, and minus two excluding gas inflation in the quarter. The 2% reward improved by four on a reported basis and by two excluding gas inflation, mainly due to adjustments in our breakage estimate for executive member rewards. Moving to SG&A, we noted a year-over-year reduction of 22 basis points, reporting 9.78% of sales, down from 10.0% a year ago. When excluding gas inflation, SG&A was lower by 13 basis points. Specific line items showed core operations year-over-year in Q2 reported at plus 17 basis points and plus 10 excluding gas inflation; central was flat; stock compensation decreased by plus four and plus three excluding gas inflation. Overall, SG&A was down by 22 basis points reported and 13 excluding gas inflation. The core operations component includes the impact of wage increases from March 2019, which influenced year-over-year comparison by an estimated three to four basis points. We anniversary that increase recently, minimizing the Q3 impact. SG&A also benefited from a sales shift to lower SG&A segments growing faster than the core, particularly gas and e-commerce. Central SG&A was lower, reported down by one basis point and flat excluding gas inflation. Continued IT investments came in at five basis points higher year-over-year, balanced by improved performance in other expense items and strong sales. Stock compensation trends vary but generally show a small hit in Q1 and flat to a slight benefit in other quarters. Next on the income statement was pre-opening expense, which came in lower at $7 million compared to $2 million in Q2 last year, related primarily to a future warehouse opening in the coming quarters. Our upcoming openings include one in Perth, Australia, and one in Mississippi. Reported operating income for the second quarter increased by 5.2%, reaching $1.266 billion this year compared to $1.203 billion last year. Below the operating income line, interest expense remained unchanged year-over-year at $34 million, while interest income and other decreased slightly. Overall, pre-tax income was up 5.1%, reaching $1.277 billion compared to last year's $1.215 billion. Our income tax rate was slightly higher year-over-year at 25.9% compared to 25.8% last year. For all of fiscal 2020, we anticipate an effective normalized total company tax rate of approximately 26% to 26.5%. We had no new openings in Q2 and plan two new openings in Q3. For Q4, expected openings range from 11 to 13, mostly concentrated in that quarter. As of the end of Q2, total warehouse square footage was 114 million square feet. Capital expenditures for the quarter were approximately $545 million, and our estimated CapEx for all fiscal 2020 remains around $3 billion. In e-commerce, we reported a 28.4% comp sales increase, benefiting from the Thanksgiving holiday shift. Strong departments included major specials, seasonal items, toys, and housewares, while total online grocery continues to grow faster than store comps. We launched our Japan and Australia e-commerce sites recently, along with a successful high-value diamond sale. For February sales results, net sales for the month came in at $12.2 billion, a 13.8% increase from $10.72 billion last year. In terms of geography, U.S. reported comp for four weeks was 12.4%, excluding gas and FX at 11.6%; Canada reported 10.2%, ex-gas and FX at 10.4%; and other international at 12.5%, ex-gas and FX at 13.5%. Total company reported 12.1% and 11.7% ex-gas and FX, with e-commerce at 22.6% reported and 22.7% ex-FX. Our February results benefited from a last week sales surge tied to concerns around the coronavirus, positively impacting total and comparable sales by about 3 percentage points. Regions with strong sales included the Northwest, Texas, and the Midwest, while internationally we saw strong performances in Taiwan, Japan, Spain, and Mexico. Foreign currencies hurt February comp sales in Canada by about 60 basis points and impacted other international by about 110 basis points. Cannibalization affected the U.S. by 10 basis points, leading to a total company impact of 30 basis points. Merchandise highlights showed comparable sales in food and sundries positive in the low teens with strong performances in several categories. For February, traffic or frequency was up 9.2% worldwide and 8.9% in the U.S. The average transaction was up 2.7%. Regarding the coronavirus, we are closely monitoring its developments and impacts on operations, health and safety, and our supply chain. Our warehouses have generally remained open, although some locations experienced temporary closures. Members are seeking various items associated with preparing for the virus, which has led to higher demand and some stock challenges. We have implemented quantity limits at some locations based on supply levels. Our buying staff has been working diligently, and our warehouse employees have been exceptional during this busy time. Our suppliers have also been supportive during this crisis. Cleanliness and sanitation measures have been enhanced at our warehouses. The supply chain was affected by extended closures in manufacturing facilities, but production levels are gradually improving. Transportation issues have also been decreasing. Domestically, truck capacity is abundant, while exporting certain items has faced some challenges. We are managing potential out-of-stocks by shifting to alternative items and categories, particularly in domestic goods and fresh. Our travel business is currently experiencing reduced demand and increased cancellations. It is difficult to predict the financial impact on future results at this point, but we will keep monitoring sales trends. We will announce March sales results on April 8. Now, I will open the floor to questions and turn it back over to Rochelle. Thank you.
Operator, Operator
Thank you. Your first question comes from Simeon Gutman from Morgan Stanley. Your line is open.
Simeon Gutman, Analyst
Hey, Richard. Can you hear me okay?
Richard Galanti, CFO
Yes. Yeah.
Simeon Gutman, Analyst
Okay. Good. Thank you. First question is on the gross margin. I think if we take the core-on-core down 15% and you get rid of the chicken production costs, you're down 9%. Did you say within that? What the e-commerce mix shift is? And how that compares to prior quarters up to the prior run rate?
Richard Galanti, CFO
We weren't that specific, but a lot of it has to do with the fact that particularly that one week, where it's so important to e-commerce on promotional items for Black Friday, Cyber Monday, the weekend, and the three days leading up to Thanksgiving, so you do have some lower-margin categories in there to start with, as well as, we do a lot more promotional stuff, as most retailers do, with that week of Thanksgiving.
Simeon Gutman, Analyst
Okay. So this was a little bit unusual, given the timing and the holiday period was in that number?
Richard Galanti, CFO
And I want to stand corrected, there's a couple of people here just correct me. The e-com numbers are not in the core-on-core. So that would be outside of that.
Simeon Gutman, Analyst
Got it. Okay.
Richard Galanti, CFO
But it's still the strength in majors.
Simeon Gutman, Analyst
Got it. But generally speaking, the increased proportion of e-commerce is likely to negatively impact gross margin overall, correct? And is this due to the types of products being purchased or the discounts and markups associated with those items?
Richard Galanti, CFO
It's both. I mean, as we try to build new categories over the last year or so like apparel, we're giving some hot deals out there. If you buy one shirt, it's X; if you buy two, it's a little less for delivery or whatever else. So, we're driving that business. And again we've talked about, yes, but the big thing is electronics. Electronics tends to be a low-margin business not only TVs, but all the computer and phone things.
Simeon Gutman, Analyst
Got it. Okay. My follow-up is about overall reinvestment. Your business is growing at a high level with high single-digit comps. I'm not sure if you anticipated that growth, and the core-on-core is generally performing well; it's not down 20 or 30 percent. The SG&A spending appears to be somewhat aligned, but I assume you may not be fully capitalizing on the leverage from this model. So my question is where are you identifying areas to reinvest? It doesn't seem like the core-on-core is declining enough to indicate that you're reinvesting in pricing. Are you finding other areas to allocate in SG&A?
Richard Galanti, CFO
I believe we are reinvesting a significant amount back into pricing. Consider all the different revenue streams we have discussed historically, including membership fees, tax reform, and changes in credit cards. These areas continue to grow, enabling us to remain competitive. Strong sales motivate us to reinvest further. Additionally, there are numerous initiatives underway that I won't detail exhaustively, but we are very active. It's not only the five basis points I mentioned in IT; we are also focused on e-commerce fulfillment and the chicken complex, along with various other projects, including the California Privacy Act. Although these might seem minor, each contributes to our overall performance. We don't always highlight challenges because there are often offsets. Ultimately, we have many projects in progress, and we are optimistic about managing our expenses effectively.
Simeon Gutman, Analyst
Okay. Thank you.
Operator, Operator
Your next question comes from the line of Gregory Melich from Evercore ISI. Your line is open.
Gregory Melich, Analyst
Hi, thanks. Richard two things I wanted to follow-up. One is on the membership fee income could you give us what that is in constant currency. And also if you're seeing any membership sign-ups in Flex like the way sales and traffic have in the last couple of weeks?
Richard Galanti, CFO
Its $2 million, is it? $2 million? It's $2 million even with FX.
Gregory Melich, Analyst
Once we adjust for that. Got it. And then on the sign-ups, have you seen any change there in the rate of sign ups?
Richard Galanti, CFO
I honestly don't know. I know even a few people mentioned that the shopping frequency has been extremely high over the last few days. You can see it on social media with people sharing pictures. So, I have to believe there has been some increase, but it's not enough to significantly impact our results.
Gregory Melich, Analyst
Got it. And then secondly, regarding gasoline, what was the average selling price this quarter? Additionally, if you have any trends on the gallons, that would be great as well.
Richard Galanti, CFO
I don't have the information readily available. I believe there was inflation in gas, correct? In the second quarter, it was 7.9% inflationary.
Gregory Melich, Analyst
Inflationary. And that's the average selling price per gallon versus a year ago?
Richard Galanti, CFO
Yes. $2.75 versus $2.55.
Gregory Melich, Analyst
Got it. And then last I'll sneak in things. I know it's coming. The balance sheet, very strong, more volatile markets, how should we think about buyback capital structure in the current rate environment and environment of the world?
Richard Galanti, CFO
Well, every banker calls us every day to let us know that rates are even lower today time to borrow. But, no, look we continue to look at it. We talked about it in every Board meeting and all I can tell you is stay tuned.
Operator, Operator
Your next question comes from the line of Chris Horvers from JPMorgan. Your line is open.
Chris Horvers, Analyst
Thanks. Good evening. So a few follow-ups. First on March, I mean you are limiting some of those high-volume items. It does look like you've got some pretty low in stocks out there. Do you see the potential for comp risk later this month?
Richard Galanti, CFO
We don't have a definite answer. People have asked us about the impact of stockpiling certain items. While there are daily out-of-stocks, overall, the numbers are impressive due to the high volume of customers. They are also purchasing a variety of other products. It's uncertain what tomorrow holds. When asked if customers are buying additional items like water and shelf-stable foods for later use, it likely varies. Some may be storing them, while others may be reducing dining out. I believe it's a mix of these factors. What we do know is that starting Tuesday or Wednesday last week, following a surge in news coverage, we experienced a significant increase in customer traffic that continued through the weekend and intensified at the beginning of this week. We'll see what tomorrow brings. On the supply side, it’s evident that items like sanitizers are still hard to find, both at Costco and elsewhere. Although we receive daily shipments in limited amounts, they tend to sell out quickly. I expect this situation will improve over the next several weeks, but it largely depends on the progression of the virus.
Chris Horvers, Analyst
I visited a store on Saturday right after it opened, and I've never seen a line that stretched all the way back to the dairy section. My follow-up question, which may be difficult to answer, is that I believe a primary concern for investors is understanding consumer behavior. While there is obviously some stockpiling happening, your company also sells a significant amount of general merchandise and large-ticket items. Were you able to identify any decline in spending patterns over the past week or so in those more discretionary and higher-priced categories?
Richard Galanti, CFO
What's interesting is that I spoke to our senior buyers yesterday and noted that you might expect items like patio furniture to be affected since they are big-ticket discretionary purchases. However, they mentioned that sales are going extremely well. Although the average purchase per customer might be slightly down due to the influx of new customers, the overall number of customers has increased. Additionally, lawn and garden products are also performing well, which the buyers attribute to weather conditions in certain markets.
Chris Horvers, Analyst
Did you say TV? Were you going to say TV?
Richard Galanti, CFO
No lawn and garden sales are influenced by the weather. In terms of electronics, while some items are performing well, others, like certain laptops and phones, are facing supply chain challenges. Overall, I believe that larger discretionary items might be adversely affected at this moment. However, any negative impact has been more than balanced in the past few days by an increase in shopping frequency. I can't predict the implications for tomorrow; we will have to wait and see.
Chris Horvers, Analyst
Understood and super helpful. And I'm sure all the media outlets are picking this a lot. My other question, two quick ones; one is, have you expanded the number of SKUs in the MVM. It seems to have picked up over the past couple of months, but wanted to get your thoughts there? And then lastly it looks like you have a new grocery delivery option in the app and on your website sort of an extended delivery option, not the 2-day and not the same day. So sort of what's been the strategy there? And is that new? Or just a repackaging of something you already have?
Richard Galanti, CFO
Generally there's been no change in MVM items. I mean if it's up a little or down a little I think that's random not planned. And as it relates to shipping at least the people in the room with me here are not aware of that. Was it?
Chris Horvers, Analyst
Okay. It must be just a repackaging of something that you already have. Yes. Okay, thanks very much. Best of luck.
Richard Galanti, CFO
Sure. Thank you.
Operator, Operator
Your next question comes from the line of Chuck Grom from Gordon Haskett. Your line is open.
John Parke, Analyst
This is actually John Parke on for Chuck. Can you guys provide a little bit of an update on the performance of same-day and Costco 2-day and how that's impacting kind of total spend from these customers that are utilizing it?
Richard Galanti, CFO
It's still relatively new for us over the last year. Overall, my understanding of this is a couple of months old. There’s been a slight improvement. The concern is that as customers make more purchases and receive their deliveries within one or two days, they tend to shop less frequently. Although they are coming in a bit less regularly, the overall trend is still acceptable. Again, it's too early to determine whether this will continue as is or if it will change slightly. We are still monitoring the situation, but we are also actively engaging with customers through various promotional efforts to encourage them to return to the store, particularly for in-store promotions.
John Parke, Analyst
Got it. And then I guess, just going back to the coronavirus. I mean, is there any way to kind of indicate whether the margin on these sales are materially different than your traditional shop?
Richard Galanti, CFO
Food sundries overall is about in line with the company averages.
Operator, Operator
Our next question comes from the line of Karen Short from Barclays. Your line is open.
Karen Short, Analyst
Thank you very much. I have a couple of questions. Richard, you mentioned the decline in fresh gross margin, and I would appreciate it if you could provide some insight on that, excluding poultry. You referred to this as a step-up in price investments.
Richard Galanti, CFO
Yes. At the end of the day, we consider ourselves merchants, and our goal is to drive business. Fresh products also help increase customer frequency. So, my comment is more of an observation than an indication of a significant change in strategy.
Karen Short, Analyst
But not necessarily also comment on the competitive landscape.
Richard Galanti, CFO
No that is – the increased level of competition that I've talked about that goes back a year and a half plus ago. And that hasn't changed.
Karen Short, Analyst
Okay. And then can you just maybe clarify a little bit on the – I guess the true-up of the breakage estimates.
Richard Galanti, CFO
Well, I mean at the end of the day it's a small amount of basis points. When we issue a significant amount – you can kind of back into the number yourself of what percentage of our sales are the 2% reward. And we send out those certificates and there's always going to be some slippage. Notwithstanding the fact that, we send out reminders to our members that you haven't cashed this. At the end of the day we tend to be – we do our best guess to accrue for slippage. And I'd like to think that we tend to be a little conservative. And therefore when there's a review it picks up the other way. But at the end of the day we – accounting rules say, you do your best guess of what it should be. And then when you re-review it you adjust that.
Karen Short, Analyst
Okay. And then I just want to switch gears to the Shanghai store and I think you said you'll be opening a second one soon. But maybe any thoughts on what you think the actual annual volumes could and will settle out at for that store? And then any update on the number of members at that store since the last call. And then I mean, I ask it in the context that to the extent that China is an opportunity, it's not so much about the units. It's actually about the volume per unit.
Richard Galanti, CFO
Right. Well, it's hard to say because this one is so off the charts. I mean, again the last few weeks – the last several weeks with some limitations on the number of members for some of that period of time, it's changed a little bit. But I mean that was either a top or second largest location in our company for the several weeks leading up to that. And the number of members is again off the charts. Nearly five times the company.
Karen Short, Analyst
Okay. And but would we take that same number and apply that to the total revenue for that box? Or how should we think about that?
Richard Galanti, CFO
No, no, no. Because given the population of Shanghai and the fact that this thing went throughout social media and it was very popular over there. You have a somewhat higher renewal rate, we don't know yet because we opened it in August. But we know from other countries – I'm sorry, lower – lower rental rate. And no, you can't just simply multiply that out. But our – but the unit overall is again either number one or two, up until the last few weeks with what's going on over there with coronavirus was one of our top two units.
Karen Short, Analyst
Okay. And then just last question for me. I don't think I've asked this for a while but do you have any – are you willing to give an update on what you think or what the – where the average ticket is in the U.S. of an executive member today versus just the basic membership and how that's trended in the last several years? Because it does seem like the momentum is really continuing to increase in terms of your share gains?
Richard Galanti, CFO
Yes. Look, we don't disclose that but more executive members and more penetration of executive members is good. More members who have the – in the case of the United States, the co-brand credit card is good. And if they have both in the executive and that it's even better. All those things help our sales growth.
Operator, Operator
Your next question comes from the line of John Heinbockel from Guggenheim. Your line is open.
John Heinbockel, Analyst
Richard, the price investments you mentioned in fresh food, was that actually proactive price investments or more delays in passing through vendor increases? And then, where those investments occurred, was that more protein as opposed to other categories?
Richard Galanti, CFO
It’s definitely proactive on our part, and I believe it encompasses all of it. It’s about protein and fresh produce.
John Heinbockel, Analyst
Okay. If you look at the fresh food comparable sales, you mentioned a low double-digit increase, which included the final week. That was the best fresh food comparable sales performance in a while. Can you break down if the increase in that final week was related to coronavirus or primarily due to price investments?
Richard Galanti, CFO
Who knows? Clearly, week four was different than weeks one, two, and three for everything. And just a sheer number of people coming into the warehouse. I personally believe that given that restaurants probably have been impacted a little bit the last couple of weeks. They're buying more at supermarkets and more at Costco, so those things help a little bit as well.
John Heinbockel, Analyst
Lastly, considering the margin on some of those items is generally in line with the average, how do you view the costs related to restocking and managing that volume, especially in relation to the EBIT margin? Typically, the incremental margin would be much higher. Is this not the case here due to the expenses associated with maintaining that volume?
Richard Galanti, CFO
There are definitely additional costs involved. While it's not a significant amount, there is likely some air freight expenses. When you're dealing with high-cube, high-weight, low-value items like water, which is priced around $2.99 per hectoliter, and you sell it faster than you can restock it, it leads to increased labor and other costs. However, it's still a net positive overall. I'm unsure if it slightly impacts the bottom line positively or negatively. And the other thing is, they're not just coming and getting those five items and moving. They're shopping a little bit. Again, I personally was surprised that patio furniture is strong. And maybe per person it's a little weaker, but there's a lot more persons.
John Heinbockel, Analyst
Okay. Thank you.
Operator, Operator
Your next question comes from the line of Mike Baker from Nomura. Your line is open.
Mike Baker, Analyst
Okay. Thanks. A couple of questions. One, can you tell us how gas profits were this year versus last year? And then, remind us if you could, how much that helped 2Q, 2019, versus 2Q, 2018.
Richard Galanti, CFO
I believe last year we mentioned that gas had a positive impact compared to the previous year. It wasn't a significant point of discussion either way.
Mike Baker, Analyst
Got it. Okay. Shifting gears a couple more, if I could. So, February, even if you take out the 300 basis points, can we take that out pro-rata across international and the U.S.? Or does it impact one region more than the other? The real question is, when you strip that out, February was much stronger than you've been running, even so? In other words, I presume the first three weeks were strong. So what do you think is behind that uptick, even before you got to week four?
Richard Galanti, CFO
It must be those investments in price. Generally speaking, this trend is happening around the world. Korea might not be experiencing as much of that benefit. There was a significant outbreak there that received a lot of media attention, leading to more people possibly staying home instead of going out. However, when I look at the U.S., Canada, and several other countries, all of them saw significant increases in the past nine days. I'm sorry, what was the last part of the question?
Mike Baker, Analyst
Just why do you think weeks one, two, and three were obviously strong as well because when you take out that 300 basis points, it's still high single digits. So, what do you think is behind that big uptick?
Richard Galanti, CFO
There are many small factors I could mention. My mother would say we are good merchants, offering great products at low prices. Nothing stands out entirely. There wasn't much media coverage on coronavirus, even though it was mentioned briefly. Perhaps on a broader scale, that played a minor role. I believe some weather issues from a year ago might have had a slight impact as well. However, overall, during those three weeks, aside from the fourth week, which was exceptional, we feel optimistic that some of our strategies in merchandising and pricing are proving effective.
Operator, Operator
Your next question comes from the line of Rupesh Parikh from Oppenheimer. Your line is open.
Rupesh Parikh, Analyst
Good afternoon. Thanks for taking my questions and thanks for all the comments on the coronavirus. So, I guess, Richard, just going back to your commentary on the supply chain. So, as you guys look forward, at this point, do you expect any impact on your supply chain-related to coronavirus or is it too early to tell earlier in the year?
Richard Galanti, CFO
There has been an impact on the situation. It is starting to return to normal for regular items. However, for some virus-related products that people are purchasing, like water, sanitizers, and paper towels, it will take a bit longer. When I speak with the buyers, they are working closely with suppliers, who are working around the clock to produce and ship. People are still coming in and buying items, especially for their basements.
Rupesh Parikh, Analyst
I was wondering about some of the other categories, like electronics, and whether you expect any impact from those categories that may be sourced from Asia.
Richard Galanti, CFO
I mentioned that we have observed some minor impacts on a few laptops and cell phones, likely due to the shortages and delays associated with some component parts. One advantage for us is our ability to adapt; if we face a shortage in one area, we can substitute with other products since we have a diverse range of offerings. However, we cannot predict what will happen in the near future. The primary objective is to restore supply chains to full operation. There are two types of supply chain issues at play. One is related to high-demand items necessary for protection and hygiene, while the other involves a wide array of products from furniture to apparel to electronics coming from China. It appears that efforts have been made to stock up in advance of the planned Chinese New Year, but there are still additional weeks of closures to consider. Over the past three weeks, as manufacturers have reopened, their capacity has gradually increased, now reaching significant operational levels. Some supply chain challenges are starting to ease. If conditions improved immediately, there would still be a waiting period to fully replenish those supply chains.
Rupesh Parikh, Analyst
Great. And one follow-up question. Just on the holiday season. You guys had a really strong performance even with fewer selling days, so just curious if there's any surprises or what do you think contributed to the really strong outperformance?
Richard Galanti, CFO
I believe we have performed exceptionally well, supported by strong sales in key categories such as electronics, patio furniture, and lawn and garden products, as well as other hardlines and softlines. Fresh items continue to be a significant driver for our business. When asked about the main factors impacting our business, we consistently highlight fresh, gas, and executive membership. We aim to be aggressive in our pricing strategy, whether sales are strong or weak. Increased sales help to boost our overall profitability.
Rupesh Parikh, Analyst
Great. Thank you.
Operator, Operator
Your next question comes from the line of Scott Ciccarelli from RBC Capital Markets. Your line is open.
Scott Ciccarelli, Analyst
Good afternoon, guys. Richard, you talked about expecting margin pressure to moderate a bit from the poultry plant ramp. And I know there was an incubation period there. So is that plant actually turning out product at this point? And related to that can you give us an idea of what the incremental benefit you guys are expecting once you're in full production mode?
Richard Galanti, CFO
I believe it was around mid-September when we processed our first chicken at the plant. The plan indicated that 45 weeks later, we would be processing about 2.2 million birds each week, roughly from September to August. We are now slightly beyond the halfway point in this timeline, and in terms of production, we are also past the halfway mark, aiming for about one million birds each week, though there may be some variation. A significant factor is that the large facility is currently operating at well below its capacity. The impact on margin related to this in the second quarter was less severe than in the first quarter, and we anticipate it will decrease further in the third quarter and beyond. Once we reach full capacity, I expect some operational enhancements over the initial years as well. Ultimately, we are focused on simplifying sourcing, and we believe we can improve the cost per bird, although we don’t have concrete figures yet. We have spent slightly more than anticipated because we upgraded the facility to air chilling instead of water chilling, making it a state-of-the-art, high-volume facility in the U.S. Currently, everything is proceeding as planned regarding the 45-week ramp-up. I am optimistic that in six months or two quarters, the impact on margins will be a non-issue.
Scott Ciccarelli, Analyst
Got you. I appreciate that.
Richard Galanti, CFO
A little bit. I don't think it'll be that wrong.
Scott Ciccarelli, Analyst
Got it. I know you experienced a surge in that fourth week due to the coronavirus, and it's clear that warehouses were quite full. However, I'm interested to know if you've noticed an even greater increase from e-commerce. Have you observed any changes in consumer behavior, or is it mainly all about the activity in the warehouses?
Richard Galanti, CFO
No, we observed some increase, but not significantly. Throughout February, there was a rise in e-commerce. However, for customers seeking urgent items like water and essentials, we have those available online. In certain regions, key products like peanut butter and crackers may experience availability issues.
Scott Ciccarelli, Analyst
Got it. All right, thanks guys.
Operator, Operator
Your next question comes from the line Judah Frommer from Credit Suisse. Your line is open.
Judah Frommer, Analyst
Hi, thanks for taking the question. I was hoping maybe you could help us with kind of how things trended in Korea over the last few weeks. You have exposure there potentially weeks ahead of where the U.S. could be worst-case scenario for the virus. So in terms of demand and kind of stock up and then potentially demand falling off as the virus spread there any insights there?
Richard Galanti, CFO
I think the only insight is that more people are staying at home and not even going out. However, I appreciate the attention that Washington and King County are receiving, as there are still people out and about. There's been a slight decrease in traffic on the highways, but despite that, some highways are still bringing people to see us.
Judah Frommer, Analyst
Got it. And then kind of changing gears. We've seen some stuff about potentially requiring membership and some food courts in the press, anything behind the thought process there?
Richard Galanti, CFO
First of all, it has received more media attention than it merits. Currently, there are seven locations on the West Coast that we are focusing on, all of which are outdoor venues. One challenge has been that in busy areas, non-members frequently visit and eat there, leading to member complaints about having to pay for access to Costco. As a result, we are testing a members-only policy at these seven locations. This is relatively simple to implement in places with indoor food courts, but for many locations in regions with favorable weather, like California and Arizona, the setting is outdoor. We will see how it goes. It's important to note that we are testing this at just seven locations out of 540, yet it has garnered significant media coverage.
Judah Frommer, Analyst
Okay, got it. And if I could squeeze in one more, anything on supply in pharmacy and any people stocking up there and potentially running out of inventory?
Richard Galanti, CFO
The FDA and other sources are indicating that there are disruptions to medical products. Currently, manufacturers have stated that no specific drugs are experiencing shortages due to COVID-19. In discussions with our Head of Pharmacy, he mentioned that we've noticed some patients with long prescriptions are coming in wanting all their refills immediately. In some situations, even if their insurance doesn't cover the costs, they are willing to pay out of pocket to stock up on their medications. This behavior resembles what we've seen with the hoarding of paper goods. However, from a supply and availability perspective, we have not encountered any significant issues yet.
Judah Frommer, Analyst
Okay. Thanks.
Richard Galanti, CFO
Why don't we take two more questions.
Operator, Operator
Okay. Next question from the line of Oliver Chen from Cowen. Your line is open.
Oliver Chen, Analyst
Hi, Richard, regarding the supply chain and what you're seeing, what are your thoughts regarding the price increases or potential price increases, whether that be from transportation costs or other and what your buyers think may happen there. And the second question is related to e-commerce. You made a lot of progress on your mobile app. Just what's ahead for changes to the mobile app? And also more broadly, capital investments related to e-comm and supply chain? Thank you.
Richard Galanti, CFO
As it relates to costs, the general view of the buyers is, is that we have – I get back to the comment I made earlier about strong relations. To the extent that there's some raw materials cost increases because of shortages, that's going to rain on everybody. In our view, it rains on us a little less. But I think we – given the limited number of items we buy and the amount of things we – the amount of any given item that we buy, our buyers, we feel, know a lot more about the cost structure. And so I haven't seen any commentary on that internally other than there was one small comment I can't find it in my mess of papers here, that there may be – in some small cases, some raw material increases on some particular item – some particular raw material for some manufacturing process. But overall, there's not been a big issue. Right now, the only increase in transportation has some very limited items where there's been a little bit of air freight, what we're finding is that the ports are getting back to capacity and there's plenty of space. And so that's not been as big an issue. As it relates to an e-comm investment. There's not a lot I have on my plate to tell you today, we're working on more things related to our app, to our membership digital app. And we certainly have some things going on the fulfillment side of e-commerce. And we've been focused on getting two more countries opened, as I mentioned in the last quarter. We think – there are a few other things that we've got going on that I'll be happy to chat with the next time around.
Oliver Chen, Analyst
Okay. And is buy online, pick up in-store going as you like? And do you expect a lot of enhancements ahead to that as customers like it?
Richard Galanti, CFO
Well, customers like it, but we don't like it necessarily. We're doing buy online and pick up in-store for some small high-value items. But we're not at the point where we're looking for members to buy online they come up and pick up their whole grocery baskets. So we're trying to figure out our way. And certainly – again, the last nine or so days notwithstanding, things seem to be working pretty well for us in that regard. We continue to work on the – where we've had good sales and good strength over the last few years in e-commerce is taking certain big and bulky things out of the warehouse, white goods and things that are delivered, in some cases, installed, and so we continue to work on those kind of things as well.
Oliver Chen, Analyst
And lastly, Richard, with the surge in demand and the traffic trends that you've seen, how have you managed, like, this customer and guest satisfaction and also labor in your stores, those kinds of things that we're curious about?
Richard Galanti, CFO
How do we measure customer satisfaction and manage it effectively? We strive to ensure that our customers are happy and that we maintain appropriate staffing levels in response to fluctuations in demand. Over the past week and a half, things have been quite hectic. We closely monitor member feedback and renewal rates, and our operators, including Craig, review weekly updates on comments. It's remarkable how many people reach out to us with their concerns. We also keep track of the positive feedback we receive. On the operations side, while merchandising is key, we empower warehouse managers and assistant managers with some flexibility in merchandising decisions. For instance, we have defensive promotional goods in electronics, while fresh products are positioned at the back. Ultimately, a portion of merchandising is delegated to the regional and warehouse levels, which I believe propels our business forward.
Oliver Chen, Analyst
Great. Thank you. Best regards. Great job.
Operator, Operator
Next question from the line of Peter Benedict from Baird. Your line is open.
Peter Benedict, Analyst
Hey, Richard, I have two quick questions to finish up. It seems like the business is likely performing in the 20% range for that last week, and the demand may actually be even higher since it looks like you're running out towards the end of the day. How do you view the club's capacity to maintain that demand if this continues for three or four more weeks? Do you believe your supply chain can handle that level of demand, or are you reaching a point where you won't be receiving another delivery for a particular category?
Richard Galanti, CFO
Yes, I think it's quite variable. Recently, some counties in California, like Los Angeles or San Diego, announced increased concerns. Similarly, King County in Seattle did this a few days ago. Such announcements can motivate people to go out and purchase more items. I hope that this situation peaks and starts to improve. It really depends on the developments tomorrow. Our team is a bit worn out, but we continue to work diligently. We have about 90% of our warehouse employees working hourly, with slightly more than half being full-time and slightly under half being part-time. There are definitely employees who wish to work more hours, and we've managed to provide some additional hours. Everyone is feeling a bit fatigued, but that's part of the job.
Peter Benedict, Analyst
Okay. My last question is about lawn and garden, which you've mentioned a few times in relation to the seasonal trends. Could you elaborate on that? Specifically, where are you noticing the strongest activity? It seems like there's an early start to spring, so I'd like to hear more about what you're observing in that area.
Richard Galanti, CFO
I mentioned that while preparing for today's call, I spoke with several senior merchants across different categories. Without referring to specific numbers, I initially thought some big-ticket discretionary items might be weaker because customers were more focused on essential items. To my surprise, they indicated that certain categories like patio furniture and lawn and garden were performing well. They suggested that the strength in lawn and garden sales was likely linked to regions where the weather has already improved. Furthermore, there has been a noticeable increase in the number of customers visiting stores each day compared to usual.
Peter Benedict, Analyst
That makes sense. Fair enough. Thanks so much.
Richard Galanti, CFO
Okay. Well thank you everyone. Have a good afternoon and we're around to answer any questions. Have a good day.
Operator, Operator
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.