Wal-Mart Stores Inc., Q2 2011 Earnings Call, Aug-17-2010 - NYSE:WMT

NYSE:WMT

Carol Schumacher, the Former Vice President of Investor Relations for Wal-Mart Stores Inc., provided the introductory remarks and covered important changes affecting the financials, as detailed below:

• Introduction: She thanked everyone for joining the earnings call for the second quarter of fiscal year 2011.

• Information Availability: She informed that all information for the quarter, including updated unit counts, square footage, and financial metrics, is available on the company's website at walmartstores.com/investors. A full transcript of the call would be available on the website after 7 a.m. Central Time on August 17, 2010.

• Executive Team Overview: She outlined the agenda for the call, noting that Mike Duke, President and CEO of Wal-Mart Stores Inc., would cover the key highlights of the quarterly results. Charles Holley, Executive Vice President of Finance and Treasurer, would provide the details behind the consolidated financials. Bill Simon, the new President and CEO of Wal-Mart U.S., would speak next, followed by Doug McMillon, President and CEO of Wal-Mart International. Brian Cornell, President and CEO of Sam's Club, would then present. Finally, Tom Schoewe, Executive Vice President and CFO, would conclude the call with an update on the SAP implementation, the company's financial report card, and earnings guidance.

• Changes Affecting Financials:

  • SAP Implementation: She mentioned that the SAP implementation had two stages. The first stage was at ASDA, the U.K. subsidiary. The second stage began on May 1, 2010, in the United States, Puerto Rico, and Canada. This implementation enabled the company to improve its methodology for valuing inventory under the retail method of inventory accounting. As a result, the aggregation of certain inventory groups now occurs at lower levels, producing a different cost valuation for the affected inventory. The retrospective application of this accounting change impacted both segment and consolidated operating income, as well as consolidated net income.

  • Effect of Change: She shared the effect of this change on the financials, noting that for fiscal year 2010, adjusted earnings per share (EPS) are currently $3.73, up $0.01 from the reported $3.72. There were quarterly fluctuations or volatility in merchandise shipments. Last year's second quarter EPS was adjusted from $0.88 to $0.89 per share for the same quarter. The third and fourth quarters were adjusted by a negative $0.02 and a positive $0.03, respectively. These adjustments impacted the operating income of both Wal-Mart U.S. and Wal-Mart International.

  • Financial Information Presentation: She noted that financial information for all periods discussed on the call and in the second quarter earnings release is presented on a comparative basis for the retrospective application of this accounting change. Detailed explanations are provided in the notes of the press release and the website section titled "Financial Results."

  • Unit Count Change: She mentioned that starting from this quarter, the company started including Wakana units in the unit count for Wal-Mart Japan. Wakana units are fully owned, stand-alone take-out restaurants generally less than 1,000 square feet.

  • Puerto Rico Segment Change: She reminded listeners that effective with this fiscal year, the operations in Puerto Rico moved from Wal-Mart International to their respective U.S. segments. Comp sales and all information today in Wal-Mart U.S. and Sam's Club reports include results from Puerto Rico.

Charles M. Holley, the Former CFO & Executive VP of Walmart Inc., provided detailed financial results for the second quarter of fiscal 2011. Here is a summary of his remarks:

• Earnings Summary: For the second quarter of fiscal 2011, the company delivered earnings from continuing operations of $3.6 billion, a 3.4% increase from the previous year. Earnings per share (EPS) were $0.97, a 9% increase over the previous year's EPS of $0.89. This was within the company's guidance of $0.93 to $0.98 per share and above the First Call consensus of $0.96.

• Net Sales: Consolidated net sales increased 2.8% to $103 billion for the quarter. Wal-Mart International was the main driver of this growth and benefited from a currency benefit of $857 million. On a constant-currency basis, consolidated net sales increased by 2%.

• Comparable Store Sales: The 13-week total U.S. comparable store sales (excluding fuel) declined by 1.4%. Further details on Wal-Mart U.S. and Sam's Club comp sales were provided by Bill Simon and Brian Cornell later in the call.

• Expense Management: Walmart leveraged expenses for the third consecutive quarter, with expenses growing only 0.6% on a sales growth of 2.8%. Unallocated corporate overhead, which includes corporate expenses, decreased to $416 million, a decline of 15.3% from the previous year.

• Gross Margin: Consolidated gross margin decreased by 32 basis points to 24.7%. The decrease was driven by Wal-Mart U.S., and Bill Simon elaborated on this later in the call.

• Operating Income: The company was able to grow operating income at 4.4% over the previous year. This growth rate was slightly faster than sales. The company's operating income of $6.2 billion included a $46 million benefit from currency exchange rate fluctuations. On a constant-currency basis, operating income grew by 3.6%.

• Membership and Other Income: Consolidated membership and other income increased by 30 basis points to $710 million for the quarter.

• Tax Rate: The effective tax rate for the quarter was 34.3%. The company expects the tax rate for fiscal 2011 to be between 34% and 35%, though there will be some quarterly fluctuations.

• Return on Investment: Return on investment for the trailing 12 months was 19%, up from 18.4% at the same time last year.

• Inventory: Inventory grew by 4.3% for the total company compared to the end of the second quarter last year, and on a 2.8% sales increase. Wal-Mart U.S. and Wal-Mart International contributed to the increase in inventory, primarily due to the comparisons versus last year's significant inventory reduction and the new Wal-Mart U.S. strategies.

• Payables and Free Cash Flow: Payables grew at 17.9%, so the accounts payable to inventory ratio was 97.6%, up from 86.3% at the same time last year. The high payables to inventory ratio should moderate in the second half of the year. Free cash flow for the first half of fiscal 2011 was $4.5 billion, compared to $4.2 billion last year.

• Balance Sheet Strength: The company's balance sheet remained strong, with excellent access to credit markets. The debt-to-total-capitalization ratio at the end of the quarter was 43.2%, slightly up from 40.4% last year at the same time.

• Capital Expenditures: Capital expenditures for the second quarter were $3 billion, slightly below last year's capital expenditure of $3.1 billion. Year-to-date, Walmart has spent $5.6 billion in capital expenditures.

• Share Repurchase: This was the second quarter in a row that Walmart set a record for share repurchase. In the first quarter, the company repurchased $3 billion or 55.6 million shares. In this quarter, it repurchased $4.1 billion or 81.3 million shares.

• Dividends and Shareholder Returns: Walmart paid $1.1 billion in dividends in the second quarter. The dividends and share repurchase of $4.1 billion represent $5.2 billion that the company returned to shareholders in the quarter. Year-to-date, Walmart has returned $9.4 billion to shareholders.

Holley concluded by expressing pride in how the company manages its business and noted that the strength of the balance sheet serves as a foundation for the company's commitment to growth, leverage, and returns.

William S. Simon, the then Executive Vice President and CEO of Walmart U.S., provided an overview of the Wal-Mart U.S. business performance and strategy during the second quarter of fiscal year 2011. Here is a detailed summary of his comments:

• Leadership Transition: He expressed his honor in leading the Wal-Mart U.S. business and highlighted the challenges and opportunities present.

• Action Alleys and Rollbacks: He noted that in the first two months of the quarter, Action Alleys were clear of merchandise and the stores featured deep rollbacks on prices. While these rollbacks improved price perception, they did not generate the desired top-line sales.

• Core EDLP Model Emphasis: In July, the focus shifted back to the core EDLP (Everyday Low Price) model, with associates emphasizing to customers that Walmart is the price leader.

• Supplier Engagement: Simon mentioned that Walmart engaged with suppliers to review assortments and ensure the breadth of inventory that customers expect. There is a plan to win in every category and allow customer purchasing decisions to drive the assortment.

• Assortment Improvements: Assortments are becoming more relevant with the right mix of new and innovative products. Thousands of products are being restored to the assortment and new items added.

• Autonomy for Store Managers: Store managers have more autonomy to make decisions appropriate for their customers. Merchandise has been returned to Action Alleys.

• Q2 Results Overview:

  • Net sales were flat for the quarter.
  • Comparable store sales declined by 1.8% for the 13-week period.
  • Traffic trends improved sequentially during the period.

• Operating Income Impact: Investments in rollbacks in the first two months of the quarter caused a decrease in operating income by 22 basis points, with the gross margin rate down year-over-year.

• Inventory Levels: Wal-Mart U.S. inventory is up 4.4% compared to the previous year, attributed to increased inventory in Action Alleys and increased assortment.

• Expense Leverage: SG&A expenses were reduced by 159 basis points, driven by:

  • A 2.8% increase in labor productivity.
  • A decrease in the accrual for the management incentive plan due to sales shortfall.
  • A change in advertising strategy to align with historical trends.

• Sustainability Initiatives: Efforts to broaden and accelerate key sustainability initiatives, focusing on energy improvements, improved fleet efficiency, and the expansion of fuel cell technology to power stores.

• Sales Trends:

  • Grocery sales generated slightly positive comp sales in a mostly deflationary food environment.
  • Fresh categories, including dairy and meat, showed modest inflation, offset by deflation in other areas.
  • Health and wellness comp sales were slightly negative due to higher generic utilization and a shift to 90-day prescriptions.
  • Initial back-to-school sales indicated customers are shopping closer to the event, with a focus on school supplies, electronics, apparel, and dorm items.

• Apparel Business: Apparel comps remained negative, but Simon expressed confidence in seeing better comps by the fourth quarter, with a focus on offerings for the core shopper.

• Home Category: Home comps were negative, with soft sales in categories like grills, lawnmowers, and patio sets.

• Hardlines Category: Hardlines had a negative comp, but sales in automotive and hardware categories improved as customers looked for DIY items.

• Entertainment Category: Entertainment comp sales were negative, but there was improvement in back-to-school related areas.

• Wireless Business: The wireless business remained strong, supported by the popularity of the Straight Talk offering and sales of iPhones.

• Walmart Financial Services: Experienced double-digit growth, led by check cashing and the Walmart MoneyCard.

• Walmart.com: Continued rapid growth, with significant traffic increases and strong sales in categories like Health and Beauty, Home, and Entertainment.

• Store Remodels: The final group of 550 store remodels scheduled for the year is underway, with improved processes to minimize disruption for customers and associates.

• Chicago Expansion: He expressed pleasure about the City Council's approval to open stores in Chicago, part of the goal to build several dozen stores across Chicago in the coming years.

• Future Outlook:

  • Confidence that changes being made will improve top-line sales by the fourth quarter, with a focus on the right assortment, price leadership, driving traffic, and delivering an unbeatable customer experience.

  • Forecasting a comp of minus 2% to plus 1% for the 13-week period from July 31 through October 29, 2010.

  • Expectation of modest inventory increases in stores and distribution centers as merchandise is brought back to meet customer needs.

  • Expectation of the gross margin rate for the second half of the year to be essentially flat compared to the previous year.

Brian C. Cornell, the then-President and CEO of Sam's Club, provided an update on the performance and strategy of Sam's Club during the second quarter of fiscal year 2011. Here is a detailed summary of his remarks:

Key Highlights

• Business Performance: Sam's Club reported a 1% increase in comparable sales, excluding fuel, for the 13-week period, which met the upper end of guidance.
• Expense Control: Excluding the impact of interchange fees related to the Sam's Rewards credit program, Sam's Club leveraged expenses for the third consecutive quarter.
• Shopping Experience Enhancements:
  • Announced plans to upgrade all clubs with Wi-Fi by the end of the year, allowing members to use their smartphones while shopping and enabling associates to demonstrate network devices.
  • Announced carrying the iPhone 4 in clubs.

Financial Results

• Net Sales: Excluding fuel, net sales increased to $11.4 billion, a 0.6% increase over the prior year.
• Fuel Sales: Including fuel, second quarter sales were $12.5 billion, a 2.2% increase versus the prior year, primarily due to higher fuel prices.
• Comparable Sales: Excluding fuel, club comparable sales increased by 1%.
• Traffic and Ticket: Comp ticket increased for the 13-week period, while comp traffic, excluding fuel, declined.
• Category Performance:
  • Positive sales in Fresh and Health and Wellness categories, including produce, meat, snacks, baby care, and pharmacy.
  • An uptick in discretionary spending, with positive performance in mattresses, jewelry, domestics, and housewares.
  • Improvement in apparel sales due to the introduction of key brands.
  • Success in seasonal categories such as grills, patio, and seasonal decor.
  • Positive tobacco sales.
  • Negative trends in Entertainment and Technology, with reduced promotional activity and recent improvements.
• Gross Margin Rate:
  • Excluding fuel, increased by 50 basis points, driven by a shift in merchandising mix towards higher-margin fresh products.
  • Including fuel, increased by 8 basis points.
• Operating Income: Increased 2.4% versus the prior year to $428 million, including a $60 million contribution from fuel profit.
• Inventory: Increased slightly by 0.8% versus the prior year.

Strategy and Initiatives

• Project Portfolio: Completed work on 33 "Pure Project Portfolio" clubs and 17 remodels incorporating aspects of Project Portfolio. The main focus is to increase the assortment of highly productive merchandise categories like Fresh and Health and Wellness.
• Membership and Other Income:
  • Increased by 1.2% versus the prior year, primarily due to Plus membership upgrades.
  • Plus membership with eValues and other benefits, such as earlier shopping hours, shows good momentum.
  • Add-on business memberships face headwinds due to challenges for small-business owners.
• Innovative Initiatives:
  • Launched a pilot program to help business members get access to credit and capital.
  • Hosted a stock-up event in July to drive membership and traffic, resulting in incremental sign-ups.

Future Outlook

• Back-to-School Season: Strategically aggressive in key events like back-to-school and anticipates a solid season.
• Third Quarter Guidance: Expected comp sales, without fuel, to range from flat to positive 2% for the current 13-week period from July 31, 2010, through October 29, 2010.

Leadership Announcement

• Todd Harbaugh: Appointed Executive Vice President of Operations upon the announcement of Nacho Pérez's retirement.

Thomas M. Schoewe, the Former Chief Financial Officer, began by providing an update on the SAP implementation, noting that it had been operational for three months and that, despite some challenges, it had not impacted the company's ability to complete its monthly close processes successfully.

He then proceeded to discuss the financial report card for growth, leverage, and returns:

Growth

• Sales Growth: For the second quarter of fiscal 2011, sales grew nearly 3%, driven primarily by Wal-Mart International.
• Square Footage Increase: Net square footage of retail space increased by approximately 5 million square feet, reaching 961 million square feet by the end of the second quarter.
• CapEx Forecasts and Square Footage Goals: Updates would be provided at the October meeting for the investment community.

Leverage

• Expense Leverage: Wal-Mart achieved three consecutive quarters of expense leverage, contributing significantly to the bottom line results.

Returns

• Free Cash Flow: Free cash flow for the first six months of the fiscal year was $4.5 billion, compared to $4.2 billion for the same period last year.
• Return on Investment (ROI): ROI for the 12 months ended July 31 was 19.0%, up from 18.4% the previous year. This improvement was driven by strong operating performance and a focus on the productivity loop, resulting in a near 9% growth in adjusted operating income.

Guidance

• Third Quarter Diluted Earnings Per Share: Expected to be between $0.87 and $0.91 per share, considering the impact of the new retail inventory valuation methodology.
• Full Year EPS Guidance: Raised to a range of $3.95 to $4.05 per share, assuming currency exchange rates remain at current levels.

Closing Points

• EPS Performance: Delivered strong EPS ahead of First Call consensus.

• Expense Leverage: Remained a strategic priority.

• ROI Health: Extremely healthy and above the prior year due to solid operating performance.

• Earnings Growth and Shareholder Returns: Consistent earnings growth and solid returns to shareholders through share repurchases and paper dividends.

Michael Terry Duke, the then-President and CEO of Wal-Mart Stores Inc., provided an overview of the company's performance and highlighted key points in the second quarter of fiscal year 2011. Here is a detailed summary of his remarks:

• Earnings Per Share (EPS): Duke expressed satisfaction with the company's second quarter EPS, noting that despite a challenging sales environment, Wal-Mart managed the business effectively, delivering on expense leverage through its commitment to the productivity loop. He reported EPS of $0.97, within the guidance range of $0.93 to $0.98, and highlighted a 9% growth in EPS.

• Earnings Guidance: Duke mentioned that the company is raising its full-year EPS guidance to a range of $3.95 to $4.05, indicating confidence in the business's performance.

• Net Sales and Operating Income: He noted that net sales for the quarter were up nearly 3% to over $103 billion, and operating income exceeded $6 billion, up more than 4%.

• Expense Leverage: Duke emphasized that Wal-Mart leveraged expenses for the third consecutive quarter, which remains a priority throughout the company.

• Worldwide Unit Count: He mentioned that Wal-Mart surpassed 8,500 worldwide units in July, representing various formats, and added almost 5 million square feet of retail space in 15 countries during the quarter.

• Balance Sheet Strength: Duke commented on the strength of the company's balance sheet, which he described as world-class and reflective of the underlying strength of the business.

• Operating Segment Highlights:

  • Wal-Mart U.S.: Duke highlighted the speedy leadership transition with Bill Simon taking charge of the largest operating segment. He acknowledged the challenging quarter for Wal-Mart U.S. with total sales and operating income flat to the prior year, and comps declining 1.8%. However, he praised Simon's focus on assortment and pricing, and the urgency with which he and his team are executing changes.
  • Sam's Club: Duke expressed pleasure with Sam's Club's 1% comp growth, which was at the top of guidance. He noted the increase in operating income and the focus on membership and merchandise.
  • Wal-Mart International: Duke recognized the segment as an impressive growth engine, with net sales growing 11% and operating income growing faster than sales. He called out Mexico and China for their aggressive growth and mentioned Wal-Mart Canada reaching the 100th supercenter milestone in July.
  • Global E-commerce and Sourcing: Duke mentioned Eduardo Castro-Wright's role in leading global e-commerce and global sourcing, emphasizing the company's focus on positioning itself as the global leader in multichannel retail.

• Business Model: Duke reaffirmed the company's commitment to its EDLC-EDLP (Everyday Low Cost – Everyday Low Price) business model and its focus on listening to customers and associates. He acknowledged the impact of the slow economic recovery on customers and their spending habits.

• Leadership Team: Duke concluded by expressing confidence in the strength and focus of the leadership team across the company on priorities of growth, leverage, and returns, and reiterated the company's commitment to building the Next Generation Wal-Mart.

C. Douglas McMillon, the President, CEO, and Director, provided an overview of the Wal-Mart International segment’s performance and highlighted the following points:

1. Strong Sales and Operating Income Growth: He expressed satisfaction with the double-digit sales and operating income growth in the quarter.

2. Sales Increase: International net sales for the second quarter were $25.9 billion, an increase of 11% from the previous year. This increase includes $857 million from the relative strengthening of many currencies against the U.S. dollar. On a constant-currency basis, sales increased by 7.3%.

3. Operating Income Growth: International's operating income for the second quarter was $1.3 billion, up 16.8% from the previous year and an increase of 12.7% on a constant-currency basis.

4. Expense Leverage: For six consecutive quarters, the segment has leveraged its constant-currency expenses, with tight expense management in almost all of the operating company countries, except for slight headwinds in Mexico and Canada.

5. Gross Margin and Other Income: On a constant-currency basis, gross margin as a percentage of sales increased slightly, while memberships and other income declined as a percentage of sales.

6. Inventory Management: The segment continues to make good progress in reducing days on hand compared to the previous year, despite headwinds in China and Japan. Overall, international inventory grew slower than the rate of sales growth.

7. Country-Specific Highlights:

   • Mexico and Central America:
     • Walmex's sales for the quarter increased by 9.8%, and comparable store sales were up 2.7%.
     • Customer count was up 3.7% at comparable stores, and average ticket declined by 90 basis points due to EDLP price investments.
     • Operating income grew at 19.4%, which was faster than sales.
   • Brazil:
     • Sales growth was 13.3%, and comparable store sales grew by 3.1%.
     • Customer traffic at comparable stores declined by 5.2%, and average ticket increased by 9.1%.
     • Expenses as a percentage of sales improved.
   • Japan:
     • Overall sales and comparable store sales both declined by approximately 0.8% due to continued deflation in grocery and consumables.
     • Expenses as a percentage of sales decreased significantly from the previous year.
   • China:
     • Sales increased by 15.4%, and comparable store sales growth remained strong at 6.1%.
     • Average ticket grew significantly, but traffic declined as customers continued to buy more per trip.
     • Operating income grew faster than sales.
   • United Kingdom (ASDA):
     • Sales grew in the low-single digits, while comp sales, without fuel, declined by 40 basis points.
     • Operating income grew faster than sales.
   • Canada:
     • Second quarter sales growth was 4.2%, largely due to the supercenter expansion program.
     • Canada's gross margin rate increased over the previous year.
     • Despite the increase in expenses, Canada's second quarter operating income grew faster than sales.

McMillon concluded by expressing encouragement about the progress being made in leveraging Wal-Mart knowledge globally to improve the customer proposition and increase shareholder value.