Costco Wholesale Corporation (COST)
Q2 2010 Earnings Call Transcript
March 3, 2010 10:00 a.m. ET

Executives

Richard A. Galanti - Executive Vice President and Chief Financial Officer
Robert Nelson – Vice President, Investor Relations

Analysts

Deborah Weinswig – Citigroup
Charles Grom – J.P. Morgan
Mark Miller – William Blair
Adrianne Shapira – Goldman Sachs
Daniel Binder – Jefferies & Company
Robert Drbul – Barclays Capital
Joseph Parkhill – Morgan Stanley
Colin McGranahan – Sanford Bernstein
Peter Benedict – Robert W Baird
Laura Champine – Cowen and Company
Sandra Barker – Montag & Caldwell

Operator

Good morning, my name is Tina and I will be your conference Operator today. At this time, I would like to welcome everyone to the second-quarter and year-to-date results and February sales release 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. If you would like to ask a question during this time, simply press star then a number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I would now turn the conference over to Richard Galanti, CFO. Mr. Galanti, you may begin.

Richard A. Galanti

Thank you, Tina and good morning to everyone. This morning''s press release reviews both our second quarter fiscal year 2010 operating results for the 12 weeks ended February 14th and our four weeks sales results for the month of February, which ended this past Sunday, February 28th.

As you may recall, let me 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/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 operating results -- excuse me, for the quarter reported EPS came in at $0.67, up 22% from last-year''s second quarter of $0.55. As noted in this morning''s release, a $22 million pretax charge or $0.03 a share was recorded in the quarter related it a change in the company''s employee benefits whereby certain unused time off will now be paid annually to the employee. Excluding that non-recurring charge, second quarter EPS would have been $0.70 or 27% increase over last- year''s results.

As we will discuss in more detail in a moments, our second-quarter results and a comparison of these results with last-year''s second quarter included several other items of note. They include the following. First, you recall that last year in Q2, we took some very aggressive pricing markdowns on a variety of commodity items estimated around $0.04 a share. Items like milk, cheese, butter, rotisserie chickens in order to drive sales. No similar events occurred this year in Q2. So that helped the comparison year over year.

Second, we had a positive a year-over-year swing in our gasoline profits. Last year in the second quarter, we lost a little money. This year we made some money. Third, LIFO, LIFO was one that actually went the other way. Last year in Q2, we had a $7 million LIFO credit or about a $0.01 a year pickup and despite recent levels of deflation there''s no corresponding pickup this year in the second quarter, as our cumulative LIFO balance is in a net credit position and you can''t go below zero.

Fourth, in the last several -- last couple of years we''ve talked about FX headwinds, we''re now talking about FX tailwinds. Our foreign earnings results, when converted and reported in U.S. dollars, helped us this year in the second quarter by a little over $20 million pretax or $0.03 a share. That is assuming FX exchange rates were flat year over year, this year''s foreign operating results in Q2 would have been lower by that amount.

And lastly on the expense side, while we made -- we have made improvement from Q1, a variety of our employee-related benefits costs, notably healthcare costs and accruals for both workers'' compensation expense and bonuses, were higher year over year in Q2. Healthcare costs continue to be a challenge but we are currently anniversarying when they began increasing in a big way last year in Q3.

If you recall, last year there were two issues. One is there is ongoing healthcare cost inflation. We -- kind of a double whammy for us over the last 12 to 15 months, have been that as we lowered the number of openings and existing employees weren''t -- while the turnover''s always been low it got even lower over the past year and a quarter with the economy as it is, that we saw the number of covered employees jump from the low 80s as a percent of our total workforce in America to the low 90s. That certainly is anniversaried now, as well.

In terms of sales for the 12-week quarter, reported total sales were up 11.3% and our 12-weeks reported comp sales figure was up 9%. For the quarter, both total sales and comp sales were impacted by both gasoline price inflation and by the strengthening foreign currencies relative to the U.S. dollar year over year.

On a comp basis -- this is for the quarter -- the 5% U.S. sales increase in Q2 excluding gas inflation, would have been 2% and the reported 26% international comp sales increase figure, assuming flat year-over-year FX rates, would have been 10%; still a good number but not the 26%.

Total company comps, as you saw, for the quarter we reported a 9% comp, excluding both gas inflation and FX changes, that would have been plus 3% for the company. And in terms of sales for the four-week month just ended, it''s similar to the quarter. Excluding gas inflation the 5% reported U.S. comp would be plus 2%, excluding FX the 26% international figure would have been 10% and excluding both gas and FX, February''s total company reported comp of plus nine would have been a plus four.

Other topics of interest I''ll review this morning are opening activities. After opening six new locations in Q1, we opened two new locations this year in Q2; one in Hayward, California and the relocation of our Warrenton, Oregon facility. Since second quarter end two weeks ago, we have not opened any new locations, but tomorrow morning we will open a new Costco in Los Angeles in Pacoima. It''ll be our 117th California locations and our plans for the remainder of the fiscal year to open up to eight more locations, probably seven or eight.