Costco Wholesale Corporation (COST: chart)
Q1 2009 Earnings Call Transcript
December 11, 2008 11:00 a.m. ET

Executives

Richard Galanti – EVP & Chief Financial Officer

Analysts

Deborah Weinswig - Citigroup
Dan Binder - Jefferies & Company
Charles Grom – JP Morgan
Adrianne Shapira - Goldman Sachs
Robert Drbul – Barclay’s Capital
Uta Werner - Sanford Bernstein
Peter Benedict – Wachovia Capital Markets
[Mark Wiltemuth] – Morgan Stanley

Presentation

Operator

Good morning. My name is Rachel and I’ll be your conference operator today. At this time I’d like to welcome everyone to the Costco Wholesale Corporation first quarter earnings conference call. (Operator Instructions) All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there’ll be a question-and-answer session. If you’d like to ask a question during this time simply press * then the number 1 on your telephone keypad, if you’d like to withdraw your question press * then the number 2. Thank you. I would now like to introduce Richard Galanti, Chief Financial Officer. Sir, please go ahead.

Richard Galanti – Chief Financial Officer

Thank you, Rachel. Good morning. This morning’s press release reviews our first quarter fiscal 2009 operating results for the 12 weeks which ended November 23. As with every call, let me start by stating that the discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and that 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.

So to begin with, 12-week first quarter, for the quarter we came in at a reported $0.60 a share. This compares to our October 8th conference call guidance range of $0.61 to $0.65. First call at the time as you recall was at $0.64. Most recently then at $0.61 and then yesterday it jumped to $0.62 as a couple of the data points in there had raised the rest of it over the last day or two.

So essentially coming down, I think I believe as analysts are responding to the slightly weaker sales trends in October and November as compared to September. Last year’s first quarter of course we came in at $0.59 a share. As outlined in this morning’s release this year’s first quarter results included several items; some helping and others hurting our results for the quarter. These include very strong gas profits this year in the first quarter. Two charges to our P&L related to what’s going on in our view in the stock market and the credit markets together representing a $34.2 million pre-tax or $0.05 charge to first quarter earnings. Next item that I will term foreign exchange headwinds, as I had mentioned on the last conference call our foreign earnings results when converted and reported in US dollars essentially hit us in the first quarter by an estimated $0.03 a share, that is assuming FX exchange rates were flat year-over-year. Our foreign operating results, which are about 20% of our company, would have been pre-taxed $22.7 million or $0.03 a share higher. We would expect that had, assuming currency stayed the same for the year of course you can see that all year.

Additionally the trend during the quarter of weaker comps mostly on the non-food side of our business, needless to say that hit earnings as well as the trend line from September to October to November was slightly down each quarter, the underlying comps. And with those weaker sales results I might add things were despite more aggressive pricing, a conscious effort on our part to drive sales during the quarter. We estimate that to be a penny or two. Also while our inventories were clean and we believe well managed during the quarter, some seasonal markdowns to keep them clean. I talked to our head of non-foods merchandising and he estimated that somewhere less than a penny a share, but nonetheless several million dollars of markdowns to get out of some of the seasonal stuff early. LIFO was actually a small pick-up. I believe on the fourth quarter conference call back on October 8th, we had estimated and of course then it was before gas plummeted and the economy changed a little bit and we started to see an exact opposite of inflationary trends, we did get a pick-up of $2 million in the quarter of LIFO income, LIFO credit if you will.

I believe at the last call we indicated that that could be about a penny a share hit and so that was a positive for the quarter. And lastly as it relates to our first quarter earnings performance, one of the other things that jumped out at us was healthcare costs particularly during the month of October and into early November. In talking to our third party administrators of the plan they said they’ve seen this a lot of places around the country and putting two and two together myself, its almost in sync with the stock market decline we saw that we saw healthcare costs go up dramatically above and beyond what you see at the end of the calendar year anyway when people are just, they’ve already hit their deductibles and they want to make sure they get their free eye exam in or their teeth cleaned. In terms of sales for the quarter, first of all if you just added up the things that I just outlined, the negative slightly outweighed the positives but not by much. In terms of sales for the quarter as previously reported total sales were up 4% and our 12-week comparable sales figure showed an increase of up 1%. For the quarter both total sales and comp sales were significantly impacted by the strengthening dollar. The 4% total sales number includes a hit if you will of about 3.25 percentage points due to FX such that the 4% total sales increase and the 1% comp reported figures essentially would have been 7% and 4% without the FX impact.

By the way gas inflation or deflation now, gas inflation helped September sales pretty dramatically, was essentially a non-issue in October as prices were falling and as they continued to fall gas deflation hurt November sales. So essentially a non-factor for all the quarter but certainly a big change in factor from where we entered this fiscal year and where we ended this quarter in terms of how that impacted sales. Other topics of interest I’ll review with you, our opening activities and plans. We opened a total of eight new locations in the first quarter; seven net in the sense that we closed our original Las Vegas location. It will reopen in the first quarter as a Costco business center but that is currently closed. So a net increase of seven during the quarter and we’ll see Vegas go back into the equation into Q3. Of the eight new locations, six were in the US. One was in Canada and one in the UK. As of quarter-end we operated 550 locations around the world which includes of course the 31 in Mexico that we currently do not consolidate into our figures.

Also this morning I’ll review with you our ancillary business results which seem to be pretty good, online results, which as you might expect have weakened along with big-ticket electronics items and the like and membership trends which remain pretty strong. I’ll also explain these two charges that totaled the $34 million, the bigger piece going to SG&A and the smaller piece going to interest income, a reduction in interest income, I’ll mention that. I’ll go through the preliminary balance sheet, give you a few comments on the directional change of inflation to deflation and how that impacted LIFO. I’ll make a brief comment on Mexico operations and our partner Commercial. You’ve seen that in the news with the issues that our partner down there has had and lastly what I will call limited guidance. I’m going to be conservative, and perhaps a little more vague, given that it’s so hard to predict given all the headwinds and the tailwinds out there.

I’ll take you through the discussion of our quarterly results, sales for this year as I mentioned, were $16.0 billion, up 4% from last year’s $15.5 billion, again on a reported comp basis up 1%, add three percentage points to each of those numbers to account for the FX if you wanted to look at it in local currency sales increases. In terms of the 1% reported first quarter comp it was comprised of a reported 7% figure in September, a minus 1% in October for the company, and a minus 5% in November. But again such monthly figures greatly impacted by both FX and by gasoline price changes. If you just added up the two that Bob Nelson talks about each month in the monthly sales call recording, the sum of those two things in September was a positive 130 basis points, in October minus 400 basis points and in November minus 760 basis points, so almost a nine-percentage point swing in just 8 to 10 weeks. So, quite a bit of swing in those things which just makes it a little more difficult to understand the numbers but that’s what they are. The 1% recorded comp, our international comps in local currency as you saw expressed in US dollars our international comps for the quarter were minus 7%. It was actually plus 7% in local currency and I might add that they were even stronger as the quarter progressed.

They are all positive in local currencies both in November and the quarter-end and in the past couple of weeks. As I briefly mentioned, which is by the way not the case as I mentioned to you already in the US, as I briefly mentioned gasoline had essentially no impact on Q1 comps as relative price inflation year-over-year during the first month, month and a half, was offset essentially by price deflation relative to the year-over-year for the last six weeks of the quarter. The average transaction decrease, to get to our 1% reported comp, just in terms of simple math it’s an average transaction decrease of 1.5% for the quarter. Again you’d have to add the three percentage points of FX in there to get kind of an underlying local currency transaction increase of 1.5% to 2% and average frequency increase of just a shade under 3%. So, frequency has continued strong in the high 2s and low 3s for many months in a row now, in terms of cannibalization, small impact of about 0.05% in the fiscal quarter.

In terms of sales comparisons by geographic region, if you look at the comps as compared to back in the summer, again they strengthened a little bit in September, were a little weaker in October and still a little more weak in November. Again I’m taking out FX. I’m taking out gas inflation and deflation. Trend-wise Northwest has weakened a little more than average although it has been the stalwart holding up a little more than average for a long time here. California has been pretty much proportional to the overall US, still lower but that gap between California’s comps and the best of the US not widening and holding up the best has been the Northeast. Internationally all of Asia is doing great in local currencies in the mid-teens or better with Canada in the mid-singles. In terms of merchandise categories for the quarter within food and sundries which is about half our business, high singles, again I’m adjusting the detriment of FX out of that. Tobacco continues to be mid-singles negative, otherwise virtually all subcategories were up year-over-year with dry groceries, canned goods, and what have you being the strongest comp in the mid-teens. Just looking through the list I was surprised to see given all the craziness out there that alcohol was flat, beer and wine and spirits.

Within hard lines comp which has been in the mid to high single negative digits, nothing very thrilling. Generally everything is low single-digit negative to up as much as 20% minus comp in the hard lines. The one bright point has been the electronics while it still is overall a low negative comp. Our television sales have been way up in November. I heard Bob mention this on the recording, but we had unit sales up over 50% in the four weeks but that translated into a dollar sales increase of only 3%. If you go onto Costco.com you can see that we’re selling two packs of flat screen televisions for less than $1500 for the both of them and so we’ve seen a lot of, notwithstanding what’s going on in the economy and with big ticket items we have taken an advantage of being opportunistic and going to vendors that have been stuck with inventory when other cancellations have occurred elsewhere and taking advantage of that, within the soft lines comp, again in the mid to high single-digits negative, kind of a repeat of hard lines, nothing thrilling. Generally everything is in the minus 5% to minus 20%, 25% comp range. Probably the one-standout again slightly negative but still standout relative to other subcategories is apparel. Again I think it has to do with the fact of availability of branded items in that category.