Costco Wholesale Corporation, Q4 2010 Earnings Call, Oct 06, 2010 - NasdaqGS:COST

NasdaqGS:COST

Richard A. Galanti provided a comprehensive overview of Costco Wholesale Corporation’s fourth quarter and year-to-date results for fiscal year 2010, which ended on August 29, 2010. Here is a detailed summary of his remarks:

Fourth Quarter and Year-to-Date Results Overview

• Earnings: Reported earnings of $0.97 per share for the 16-week fourth quarter, up 14% from the previous year's $0.85.
• Earnings Comparison: The $0.97 figure compares favorably to the current First Call estimate of $0.95.
• Items Impacting Earnings: Both fourth quarters included certain items that impacted the quarter-over-quarter comparison. Last year's fourth quarter had a $16.6 million pre-tax charge or $0.02 per share LIFO benefit, with no corresponding charge or credit this year.
• Other Items Impacting Earnings: There were a few items in this year's fourth quarter that benefited the 2010 fourth quarter by about $0.02 per share.

Foreign Exchange Impact

• Fourth Quarter Impact: In the fourth quarter, currency earnings results when converted to reported U.S. dollars benefited the company by $16 million pre-tax or $0.02 per share after-tax.
• Yearly Impact: For the entire year, the impact of foreign exchange, assuming rates remained constant year-over-year, increased total reported sales by $1.6 billion (about 1.4% of total sales) and pretax earnings by $70 million ($0.10 per share).

Employee Benefits Costs

• Benefits Costs Increase: Total benefits costs were up about 14% year-over-year, with healthcare costs being the biggest driver, up 11%.
• SG&A Percentage: Despite higher benefits costs, the company's SG&A percentage was still better and lower year-over-year in the quarter by at least 12 basis points.

Net Income and Earnings Per Share

• Net Income: Net income for fiscal year 2010 came in at $1.3 billion or $2.92 per share, compared to $1.1 billion or $2.47 per share in fiscal 2009, representing a 20% increase in dollars and an 18% increase on an earnings-per-share basis.

Sales Performance

• Fourth Quarter Sales: Reported comparable sales figures showed a 6% increase, with a 4% increase in the U.S. and a 14% increase internationally.
• Normalization of Sales: Taking out gas inflation and the impact of foreign exchange, the 4% reported U.S. number in the quarter becomes 3%, and the 14% international number becomes 8% in local currency, bringing the reported 6% comp number for the quarter down to a 4% increase.

September Sales Results

• September Sales: Reported a 2% comp in the U.S., a 14% international comp, and a total company comp of just over 5%.
• Normalization of September Sales: Without the impact of gas inflation and foreign exchange, the September comp sales number would be normalized to a 4% increase on an apples-to-apples basis.

Geographical Strength and Weakness

• Geographical Strength: The regions of relative strength were Northwest LA, Midwest, and Southeast, as well as Texas. Internationally, all countries enjoyed good comp performance except for the UK, which faced challenging economic conditions.

Merchandise Categories

• September Comp Sales: All four core merchandise categories—Food and Sundries, Hardlines, Softlines, and Fresh Foods—showed positive comps in September. Softlines' positive September comps were in the low double-digit range, while Food and Sundries, Fresh, and Ancillary were in the mid-single-digit range.

Expansion Plans

• Fiscal Year 2010 Openings: Opened a total of 13 net new locations, including 10 in the U.S., two in Canada, and one in the UK.
• Fiscal Year 2011 Expansion: Planned to open 29 net new locations, including 16 in the U.S. and 13 outside the U.S., with a couple of relocations planned.
• Current Store Count: Operated 573 locations around the world, including 32 in Mexico.

Membership Trends

• Membership Fees: Membership fees were up 9% to $533 million or 2.26% of sales in the fourth quarter.
• New Membership Sign-Ups: New membership sign-ups in Q4 were down 4% year-over-year, but excluding the impact of four international Costco openings in the prior year, sign-ups would have been up 8%.
• Renewal Rates: Renewal rates continued to be strong, increasing by 1/10 to 2/10 of 1% in the past few months, reaching 87.7% in the U.S. and Canada.

Gross Margin Analysis

• Gross Margin: Gross margin for the fourth quarter was higher year-over-year by four basis points, at 10.89% versus 10.85%.
• Merchandising Gross Margin: Core merchandising gross margin was up five basis points year-over-year, while ancillary business gross margin contributed plus eight basis points.
• Gasoline Business Impact: The gasoline business and its inflationary price trends impacted the total gross margin comparisons, contributing positively to the ancillary business gross margin.

SG&A Analysis

• SG&A Percentages: SG&A percentages for Q4-over-Q4 were lower or better by 12 basis points, coming in at $10.17 million compared to $10.29 million in the previous year.
• Operations: Core operations were lower or better by plus nine basis points year-over-year.
• Central Expense: Central expense was higher year-over-year by one basis point.
• Stock Compensation Expense: Stock compensation expense was up slightly in dollars year-over-year but flat as a percent of sales.

Pre-Opening Expense and Impairment

• Pre-Opening Expense: Improved by $3 million to $9 million in the current year's fourth quarter, reflecting a decrease from the previous year's $12 million.
• Impairment and Closing Costs: Charged $3.3 million in the current year, up from $2.7 million the previous year.

Operating Income

• Operating Income Increase: Operating income in the fourth quarter was up 15% year-over-year from $598 million to $689 million, a $91.4 million increase.

Interest Expense and Income

• Interest Expense: Reported interest expense was higher year-over-year by $1.5 million, primarily reflecting the interest expense on the $2 billion debt offering from February 2007.
• Interest Income and Other: Interest income was lower by $2 million, but the income was higher by $10.3 million, largely due to higher earnings in Mexico and some foreign exchange gains.

Tax Rate

• Tax Rate Increase: The company's reported tax rate for the quarter came in at 36.1%, slightly higher than the previous year's Q4 rate of 35.2%.

Other Financial Details

• Depreciation and Amortization: $246 million in the quarter and $794 million for the year.
• Cash Position: Strong debt-to-capital ratios with significant cash reserves.
• Inventory Levels: Average inventory per warehouse was up $184,000 to $10.4 million, a 2% increase.
• Capital Expenditure: Spent $411 million in the fourth quarter and $1.055 billion for the year. Estimated CapEx for fiscal year 2011 to be in the $1.5 billion to $1.6 billion range.

Dividend

• Dividend Increase: Increased the quarterly dividend from $0.18 per share to $0.205 per share, representing a total cost to the company of about $360 million.

Online Business

• Costco Online: Sales were down in 2009 but rebounded in 2010, exceeding the high watermark from the previous year.

Common Stock Buybacks

• Buyback Activity: Repurchased 7.8 million shares for $439 million in the fourth quarter, totaling 98.7 million shares repurchased since the start of the buyback program in June 2005.
• Remaining Authorization: Currently has a little more than $1.4 billion authorized for further repurchases.

Consolidation of Mexico Operations

• Consolidation: Beginning fiscal 2011, consolidated the results of operations of the Mexico joint venture, adding approximately 2% to 3% to top-line sales, assets, and liabilities.

Throughout the presentation, Richard A. Galanti provided detailed insights into various aspects of the company's financial performance, emphasizing the company's strong renewal rates, membership trends, and operational improvements. He also highlighted the challenges posed by employee benefits costs and the positive impact of foreign exchange rates.