COST

Costco Wholesale Corporation (COST)

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Costco Wholesale (COST)

Q2 2011 Earnings Call

March 02, 2011 11:00 am ET

Executives

Richard Galanti - Chief Financial Officer, Executive Vice President and Director

Analysts

Gregory Melich - ISI Group Inc.

Mark Miller - William Blair & Company L.L.C.

Robert Drbul - Barclays Capital

Adrianne Shapira - Goldman Sachs Group Inc.

Mark Wiltamuth - Morgan Stanley

Robert Ohmes - BofA Merrill Lynch

Deborah Weinswig - Citigroup Inc

Neil Currie - UBS Investment Bank

Charles Cerankosky - Northcoast Research

Charles Grom - JP Morgan Chase & Co

Presentation

Operator

Good morning. My name is Debbie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter and Year-to-Date Operating Results for Fiscal Year 2011 and February Sales Results Call. [Operator Instructions] Mr. Richard Galanti, Chief Financial Officer, please go ahead.

Richard Galanti

Thank you, Debbie. Good morning to everybody. This morning's press release reviews our second quarter of fiscal 2011 operating results for the twelve weeks ended February 13 and, of course, our four-week February sales, which ended Sunday, February 27.

As with every conference call, I'll start by stating that the discussions we're 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.

To begin with, our 12-week second quarter of fiscal '11, for the quarter, our earnings per share came in at $0.79, up 18% from last year's second quarter earnings per share of $0.67. As was noted in the press release, in last year's second quarter, we had a $22 million or $0.03 a share charge that was recorded related to a change in the company's employee benefits. Excluding this charge, Q2 EPS last year would have been $0.70 and the 18% EPS increase would have been 13% on a more normalized basis. Looking at the year-over-year Q2 earnings comparison, there are just a few other items I'll quickly note here. As was in the case in Q1 year-over-year with rising gas prices, our gasoline operations were still profitable in Q2 this year but less so than in Q2 last year to the tune of about $0.02 a share. So that hurt us a little bit year-over-year.

As was previously disclosed, we're taking a 4.9% pretax accrual in the second quarter to pay pending court approvals, some attorney's fees and a derivative suit. LIFO is back after at least nine fiscal quarters, with no LIFO charges, and in fact, back in '09, all four quarters had LIFO credits. We recorded in Q2 here a $6 million pretax LIFO charge that's based on the way things are looking, we would expect more in the coming fiscal quarters.

Lastly, currencies' foreign FX. Many of the foreign currencies in the countries in which we operate have strengthened relative to the dollar year-over-year. And as compared to the U.S. dollar such that when we consolidate the profits from these foreign operations by converting such profits into U.S. dollars, this helped Q2 by approximately $0.02 a share. If you take those four items that I just mentioned, gasoline profitability, the $4.9 million accrual for legal fees, LIFO of $6 million and the FX benefit added together, these four items collectively hit this year's Q2 EPS by approximately $0.02 a share.

One other item of quick note. As I mentioned in last quarter's conference call, effective the start of this fiscal year back in September, we began consolidating the results of our Mexico operations, our Mexico joint venture. Historically, before this fiscal year, these operations were treated on the equity investment method. Thus, we only reported our 50% share of the joint venture's net income within the non-operating interest income and other line item on our income statement.

Since the beginning of this fiscal year, we now fully consolidate the Mexico venture. In effect it adds 2% to 3% to the top line sales, assets and liabilities, 100% of the venture's financial statements are included in our P&L and balance sheet and cash flow and then the 50% portion held by our joint venture partners then backed out at the bottom of our income statement to offset it, such that there is no effect to our bottom line or our earnings per share. It does, however, impact the discussion of the percentages of gross margin and SG&A alike and earnings basis points, and I'll point that out as I discuss our results in the next few minutes.

In terms of sales for the second quarter, our reported total sales were up 11.4% and our 12-week reported comparable sales figure was up 7%. For the quarter, as has been the case for several quarters now, both total sales and comp sales were impacted by gasoline price inflation and by the strengthening foreign currencies relative to the U.S. dollar year-over-year. On a comp basis, the reported 5% U.S. sales increase, if you exclude gas inflation, would have been 3%. The reported 12% international comp figure, assuming flat year-over-year, FX rates would have been plus 8% resulting in the total company comps which again we reported as plus 7% excluding gas inflation and excluding FX, would have been plus 4% for the company.

In terms of the four-week month of February, which we are also reporting this morning, it's directionally similar to the quarter, again, excluding gas inflation. The 6% reported U.S. comp would be plus 4% and the 14% reported in international comp would be plus 7% in local currency. Such that excluding both gas inflation and FX, the February's four-week reported comp number of 8% would be plus 5%. And again, for the month of February, this what I'll call the normalized plus 5% compares to a normalized plus 4% for the entire second quarter.

Other topics of interest that we'll review this morning, our open activities and plans. After opening eight new locations in Q1, we opened two new locations in Q2, one is a new location in the suburbs of Minneapolis in Burnsville, Minnesota and our second location in Vancouver, Washington, which is just north of the Oregon, Washington border, north of Portland. We also closed a unit in the quarter in San Marcos, California. This unit is being torn down and rebuilt on the same site. They will open again later this summer before the fiscal year end.

Since Q2 end on February 13, we have not opened any new locations, but we'll open a third unit in Tucson, Arizona in mid April and our plans are for additional 14 buildings to open by fiscal year end, including the reopening of the San Marcos site. All told, that would put our fiscal year 2011 opening schedule at 24 net new units. That would include 14 in the U.S., three in Canada, five in Asia, all of which are planned for our fourth quarter construction, which starts in early May and two in Australia, which would be our second and third units in Australia.

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