COST

Costco Wholesale Corporation (COST)

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Costco Wholesale Corporation (COST)

Q3 2010 Earnings Call

May 27, 2010 11:00 am ET

Executives

Richard Galanti – CFO

Analysts

Robbie Ohmes – Bank of America

Mark Miller - William Blair

Charles Grom - JPMorgan

Mark Wiltamuth - Morgan Stanley

Adrianne Shapira - Goldman Sachs

Peter Benedict – Robert W. Baird

Robert Drbul - Barclays Capital

Laura Champine – Cowen & Company

Deborah Weinswig - Citigroup

Colin McGranahan – Sanford C. Bernstein

Neil Currie – UBS

Dan Binder – Jefferies & Co.

Damian Witkowski – Gabelli & Co.

Presentation

Operator

Welcome everyone to the third quarter earnings release conference call. (Operator Instructions) Mr. Richard Galanti, you may begin your conference.

Richard Galanti

Good morning to everyone. This morning’s press release reviews our third quarter fiscal 2010 operating results for the 12 weeks ended May 9th.

As with every conference call, I’ll 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 our 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.

To begin with our 12-week third quarter fiscal 2010 operating results for the quarter, earnings per share came in at $0.68, up 42% from last year’s reported third quarter earnings per share of $0.48. As will be discussed in more detail in a moment, both this year’s and last year’s Q3 results and the comparison of these results included a couple of items of note.

These were outlined in this morning’s press release and include the following. First you will recall that last year in Q3 we took a pre-tax charge of $34 million related to a litigation settlement covering our membership renewal policy.

This charge hit the membership fee income line of our income statement last year in Q3 for $27 million and our SG&A line item for $7 million, negatively impacting last year’s third quarter earnings by $0.05 a share.

This year in Q3 our SG&A line was reduced or benefited by a $14 million pre-tax reversal of part of a charge related to a Canadian tax liability that we had previously taken in the second quarter of fiscal 2007. This had to do with stock option protection, the option issues and protecting our employees in Canada who received such options.

This is an SG&A impact not an income tax impact. So adding back the $0.05 to last year’s third quarter EPS of $0.48 and subtracting the $0.02 EPS pick up I just described, year over year Q3 EPS would have gone from $0.53 last year to $0.66 this year for a 25% year over year increase.

As I’ll discuss there are other items of note that impacted each of last year’s and this year’s fiscal third quarter results, some positive items, some negative, from income tax rates to LIFO to FX, closing costs, etc.

I will mention the FX issue right now, what I refer to as FX tailwinds, as you know the US dollar this year as compared to last year relative to several of the foreign countries and countries in which we operate, had weakened so our foreign earnings results when converted and reported in US dollars has helped us this and has helped us in Q3 by a little over $28 million pre-tax or $0.04 a share.

That is assuming FX exchange rates were flat year over year, this year’s foreign operating results in Q3 would have been lower by that amount. In all we look at our Q3 results as a continuation of positive trends that we saw in Q2.

In terms of the sales for the 12-week quarter reported total sales were up 12% and our 12 week reported comparable sales figure was up 10%. For the quarter both total sales and comp sales were partially impacted by gasoline price inflation and by the strengthening foreign currencies relative to the US dollar year over year.

On a comp sales basis the plus 6% US sales increase in Q3 that’s outlined in the press release, if you exclude gas inflation that would have been a plus 3%. Similarly the reported plus 26% international comp figure assuming flat year over year FX rates would have instead been plus 8%. And total company comps, again we reported a plus 10% for the quarter.

Excluding both the gas inflation and excluding FX changes would have been plus 4% for the company during the fiscal quarter. Other topics of interest, our operating activities and plans, we opened one new location in Q3 in Pacoima, California, that’s within the city limits of Los Angeles.

In Q4 which began on May 10 we plan to open six new locations. The first of these six opened this morning in St. Johns, New Brunswick, Canada. This is our 78th Canada warehouse location and brings our total warehouses worldwide to 568.

The five additional buildings we plan to open by fiscal year end include two additional ones in Canada, one in Queens, New York, in an area called Rego Park, one in Roseburg, Oregon, and our 22nd location in the UK in Coventry, which is about 95 miles northwest of London.

Also this morning I’ll review with you our expansion plans for fiscal 2011 which are up, Costco online results, membership trends, certainly a discussion a little bit more about margins and SG&A, an update on our stock buyback activities, and a couple of other items of interest.

In terms of a discussion on the quarter’s results, again sales for the quarter were $17.4 billion, up 12% from last year’s Q3 of $15.5, again on a reported comp basis it was a plus 10. The plus 10 third quarter comp was comprised of a 9 in February, a 10 in March and an 11 in April.

There were some seasonal, some holiday changes, but essentially pretty close range there. And again excluding gas and FX, the 9, 10, and 11, for February, March, and April, would have been a 4, 3, and 4.

The 10% reported comp was positively impacted by about just under 4% due to the year over year strengthening of foreign currencies relative to the dollar and as I mentioned the local currency comp rate if you will for all the foreign countries was a plus 8 but when converted into US dollars because of the FX was plus 26.

As I mentioned gasoline had a big impact, about three percentage points such that the reported US comp of 6 would have been a 3 without that. Our average transactions increase was a little over 6% for the quarter which of course includes gas inflation and FX. And the average frequency increase was a little more than 3.5%.

In fact the frequency trend during the past three calendar reporting months of February, March, and April, was a 3.7, a 3.5, and 3.7 so pretty consistent. I think most importantly that these frequency figures are on top of a roughly 4-plus percent frequency increase during Q3 of 2009 so pretty strong frequency continuing, recognizing people seem to be coming in more frequently but are buying a little less each time, perhaps buying a little more on the food side as well.

For the quarter in terms of sales comparisons by geographic region, for the quarter the Midwest, southeast and Texas were the strongest, followed by a good showing in the northwest. California actually trend wise over the last four quarters have also had a good, an improving track record but at a lower level.

Internationally in local currencies, we’re doing quite well despite all the craziness around the world. Canada in local currency is up close to 10%, with Taiwan, Korea, averaging in the mid teens. UK is closer to flat. In terms of merchandise categories for the quarter, soft lines was the strongest core category followed by fresh foods, food and sundries, with hard lines being the relative weakest of those four.

Within food and sundries, every sub category was positive in the quarter ranging from 1% up to 12% up. Tobacco was actually a little bit higher than the 12 but that was an anomaly related to I believe an increase last year that tends to greatly vary sales levels based on a pending tobacco tax increase.

Read the rest of this transcript for free on seekingalpha.com