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Costco Wholesale Corporation (COST)

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Costco Wholesale Corp. (COST)

Q2 2016 Earnings Call

March 03, 2016 11:00 am ET

Executives

Richard A. Galanti - Executive Vice President, Chief Financial Officer

Analysts

John Heinbockel - Guggenheim Securities LLC

Joshua M. Siber - Morgan Stanley & Co. LLC

Christopher Michael Horvers - JPMorgan Securities LLC

Daniel Thomas Binder - Jefferies LLC

Michael Louis Lasser - UBS Securities LLC

Brian W. Nagel - Oppenheimer & Co., Inc. (Broker)

Paul E. Trussell - Deutsche Bank Securities, Inc.

Peter S. Benedict - Robert W. Baird & Co., Inc. (Broker)

Oliver Chen - Cowen & Co. LLC

Matthew J. Fassler - Goldman Sachs & Co.

Bob S. Drbul - Nomura Securities International, Inc.

Kelly Ann Bania - BMO Capital Markets (United States)

Scott A. Mushkin - Wolfe Research LLC

Gregory Melich - Evercore ISI

Sean P. Naughton - Piper Jaffray & Co (Broker)

Presentation

Operator

Good morning. My name is Brittney and I will be your conference operator today. At this time I would like to welcome everyone to the Q2 Earnings Call and February Sales Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you.

Mr. Richard Galanti, CFO, you may begin your conference.

Richard A. Galanti - Executive Vice President, Chief Financial Officer

Thank you, Brittney. Good morning to everyone. I'll start by stating that our discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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. Forward-looking statements speak only as of the date they are made and we do not undertake to update these statements except as required by law.

So last night's press release reported our second quarter and first half fiscal 2016 operating results for the 12 and 24 week periods ended February 14 as well as our monthly sales results for four week reporting month of February which ended this past Sunday, February 28. For the quarter, reported earnings came in at $1.24 a share compared to last year's second quarter earnings per share of $1.35.

Note that last year's earnings were positively impacted by two discreet income tax items that together benefited last year's second quarter earnings by $43 million or $0.10 a share, and that, excluding these two items, earnings for the second quarter last year would have been $1.25 a share. Among the factors that impacted our second quarter year-over-year earnings comparison, foreign exchange FX as compared to a year ago. During the quarter the foreign currencies where we operate continue to weaken versus the U.S. dollar in all countries but primarily in Canada, Mexico and Korea, resulting in our foreign earnings in the second quarter when converted into U.S. dollars being lower by about $32 million or $0.07 a share and if exchange rates had been flat year-over-year.

Second item of comparison is our co-branded credit card transition in the U.S. that relates to that. As you know we're transitioning to a new co-branded credit card relationship in the U.S. this year as we wind down our current relationship. New co-branded credit card's signup stopped several months ago. The short-term negative earnings impact to the loss co-branded credit card signups was $18 million pre-tax or a $0.03 per share hit to the second quarter. Recall that the earnings impact was $15 million pre-tax or $0.02 a share last fiscal quarter, and it will continue to impact earnings in Q3 and a little even into the first month of Q4.

As of today, we expect to have the new co-branded Visa cards in the hands of our members in May with a go-live transition date in June. While I can't give you any specifics regarding the new card, contractually I can't do that yet. I do look forward to sharing more details with you at that time.

Third item, IT modernization. Our major IT modernization efforts continue to impact SG&A expense percentages especially as depreciation begins on the new systems that are now being placed into service. In the second quarter on an incremental year-over-year basis these costs impacted SG&A by about $10 million or an estimated 3 basis points – 2 basis points without the gas deflation, which was about $ 0.01 a share.

There is a light at the end of this tunnel with the SG&A headwinds. Based on our current estimates we expect the year-over-year basis point impact to SG&A is likely to be just a couple of additional basis points in fiscal year 2017, and then flatten out, hopefully a little better than flattening out over the next couple of years after that.

Stock compensation expense was higher year-over-year, second quarter by $14 million or $0.02 a share. And lastly in terms of the year-over-year comparison LIFO. Last year in the second quarter we recorded a pre-tax LIFO credit of $4 million. This year in the second quarter, with deflation being a little more impactful than in the past couple months, we had a LIFO pre-tax credit of $15 million resulting in a year-over-year delta of $11 million or $0.02 a share.

Now turning to our second quarter sales. Reported sales were up 3% and our 12 week reported comp sales figure was up 1%. For the quarter, sales negatively impacted by gasoline price deflation to the tune of 80 basis points. And by weakening foreign currencies relative to the U.S. dollar by minus 340 basis points. Such that excluding gas deflation, the reported plus 3% U.S. comp for the second quarter would have been a plus 4%. The reported Canadian comp of a minus 7% in the second quarter would be a plus 10%, excluding both gas deflation and assuming flat FX rates year-over-year. And the report minus 3% international comp figure for the quarter, excluding gas and FX, would have been a plus 6%.

Total comps again reported 1% for the quarter, and excluding gas and FX would have been up 5. For the four-week month of February, which again ended this past Sunday, reported comps came in flat at 0%. That consisted of a plus 2% comp on a reported basis in the U.S., minus 2% reported in Canada and a minus 8% other international. As we discussed last month, the calendar shift of Super Bowl moved sales out of January reporting period into February. We estimated that this shift benefited our U.S. sales for the month of February by about 0.75% and the total company by about 0.5%.

Sales were negatively impacted by again gas deflation which started to head down again during the month. About 180 basis point negative impact to the number and also by weakening FX currency – foreign currencies relative to the U.S. dollar to the tune of 250 basis points. Excluding gas deflation in the U.S., the reported plus 2% U.S. comp for February would have been a plus 4%. Excluding gas deflation and FX, in February minus 2% comp in Canada would have been a plus 10%. And the reported minus 8% international comp would have been flat year-over-year ex gas and FX.

Total company comps reported, again zero for the month would have been a plus 4% excluding gas and FX. I might mention that the other international normalized number in other words ex gas and FX was zero. Mostly related to the time of the Chinese Lunar New Year holidays. We don't think that will be an issue after the timing of that.

Final comment on deflation. Beyond gasoline price deflation that we've always pointed out each month, we have seen a little additional deflation across many merchandise categories such that sales have been impacted a bit by – a little bit more in the past couple of months.

In terms of new openings. Our opening activities and plans, we opened 13 new units in Q1. Including two relos, so a net of 11 new locations in the first quarter. In Q2 we opened one new business center in Westminster, California. For all of fiscal 2016 we're still on a target to do 30 net new locations, 21 of which will be in the U.S., three in Canada, two in Japan, and one each in the U.K., Taiwan, Australia and Spain.

Also this morning I'll review with you our e-commerce activities, membership trends and renewal information, additional discussion, of course, on margins and SG&A, and a couple of other items of note.

Okay. In terms of the second quarter results, sales for the quarter were $27.57 billion up 3% from last year. On a reported comp basis, Q2 comps were up 1% for the quarter, up 5% ex gas and FX. For the quarter, our plus 1% reported comp was a combination of an average transaction decrease of minus 2.5% and an average shopping frequency increase of just over 3%.

Now in terms of the minus 2.5% average transaction decrease, again, taking FX and gas out of that number, that minus 2.5% would have been a positive number that would be just under plus 2%.

In terms of sales comparisons geographically, in the U.S., the Midwest, Texas and California regions were strongest. Internationally in Q2 in local currencies better performing countries were Mexico, Canada, Australia and Taiwan.

In terms of merchandising categories for the quarter – for the second quarter within food and sundries, overall flattish. Meat, deli and sundries were the leaders. Tobacco, negative in low-double digits as we continue to eliminate tobacco SKUs from various locations.

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