Costco Wholesale Corporation (COST) F4Q 2013 Earnings Conference Call October 9, 2013 10:00 AM ET
Richard Galanti - EVP and CFO
Steve Forbes – Guggenheim Securities
Matthew Fassler - Goldman, Sachs & Co.
Christopher Horvers - JPMorgan
Daniel Binder - Jefferies & Co.
Gregory Melich - ISI Group
Jason DeRise - UBS
Charles Grom - Sterne, Agee & Leach
Mark Miller - William Blair & Company, L.L.C.
Chuck Cerankosky - Northcoast Research
Budd Bugatch - Raymond James
Joe Feldman - Telsey Advisory Group
Scott Mushkin - Wolfe Research
Good morning. My name is Felicia and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter Fiscal Year ’13 operating results 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. (Operator Instructions) Thank you. Mr. Galanti, you may begin your conference.
Thank you, Felicia, and good morning to everyone. This morning we are reporting our 16 week fourth quarter and 52 weeks fiscal year 2013 operating results, which ended on September 1. These results are of course were compared to the 17 week and 53 week periods of the prior fiscal year. In addition, we are reporting this morning our September sales results for the five weeks ended this past, on the October 6.
Let me start by stating 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 fourth quarter operating results, for the 16 week quarter, reported earnings per share came in at $1.40, up a penny from last year’s 17 week fourth quarter earnings of $1.39. I will come back to this in a moment.
In terms of sales for the quarter, total sales were up 1%, which again was impacted by the extra week. Comp sales, which compares like 16 week periods were up 5% both on a reported basis and excluding gas and FX. For the quarter gas prices year-over-year were effectively flat, so no impact on the 5% U.S comp figure. However, foreign currencies weakened related to the U.S dollar year-over-year in the fourth quarter, primarily in Canada and Japan. Such that our reported 4% international comp figure assuming flat year-over-year FX rates would have been up 7%.
In terms of sales for the five week September period, total sales increased 6% year-over-year. Reported comparable sales increased 3%, and that 3 was comprised of a 4 in the U.S and zero internationally. And excluding gas and FX, comparable sales would have been up 5%. The four U.S reported would have been a five excluding gas deflation and zero internationally would have been an up six assuming FX was flat year-over-year in local currencies.
In terms of comparing our $1.40 reported earnings for the fourth quarter to last year’s fourth quarter of a $1.39, several items to note. First a few items that I’ve discussed each in the prior several earnings calls. Last year’s fourth quarter had an extra week simply dividing the 17 weeks intuitively $1.39 figure would have suggested that the benefits from that extra week was about $0.08 a share. Membership fee income of course included about $25 million pre-tax extra and that relates to the late 2011, early 2012 annual fee increase in the U.S and Canada and how that works way to our income statement based on deferred accounting over about a 23 months period.
Interest expense of course was higher in the fourth quarter by about $13 million pre-tax were $0.02 a share. This related to last December’s $3.5 billion debt offering that was done in conjunction with $7 per share special dividend.
There are also a few items that year-to-date through the first three quarters have represented a positive year-over-year profit variances, but that’s one the other way in Q4 year-over-year. For example FX on a strengthening foreign currency is relative to the U.S dollar added to earnings per share year-to-date through the first three quarters and swung the other way in the fourth quarter.
In Q4 foreign currencies -- the foreign currencies where we operate weakened versus the U.S dollar, resulting in foreign earnings in Q4 when converted into U.S dollars being lower by about $10 million pre-tax or penny and half a share then those earnings would have been had FX exchange rates been flat year-over-year. A similar year-over-year profit swing occurred in the profitability of our gasoline operations.
Year-to-date through the third quarter the gas profitability was higher year-over-year through the third quarter year-to-date. In Q4 it too swung in the other way coming in lower at Q4 year-over-year. In addition to these factors, I point out in our discussion of SG&A, a few other items that resulted in our expense percentages coming in higher year-over-year in Q4.
In terms of new openings, for all fiscal ’13 we opened 26 new locations, 12 in the U.S, three each in Canada and the U.K., five in Japan and one each in Korea, Taiwan and Mexico, ending fiscal ’13 with 634 locations worldwide. For fiscal 2014 we’ve ramped up our expansion plan on our documented plans to open 36 new warehouses with half of these in the U.S. and the remaining in international markets, including our first two plan for Spain next spring and summer.
Inevitably a few of these will probably get delayed. So I would estimate that a number in the low to mid 30s is more likely still a pretty good increase about the 16 and 26 new warehouses opened in each of the past two fiscal years.
During the first four months of 2014 through calendar year-end, we plan to open 15 of these locations, 10 in the U.S including three next week, two each in Canada and Australia and one in Mexico. Also this morning I will review with you our member trends, our e-commerce activity and of course additional discussion about margins and SG&A.
Quickly on the start to the call here in terms of fourth quarter results, more detail. Sales for the year's fourth quarter were $31.8 billion, up 1% from last year's 17 week fourth-quarter of $31.5 billion. Again if you normalize the 17 weeks by taking 16, 17 --, if you will, would have been up 7% on a normalized comparable week basis.
Our reported comp basis, Q4 comps were up 5% for the quarter. For the quarter our 5% reported comp was a combination of almost flat average transaction for the quarter that included the detriment of FX of about 80 basis points. So we are moving up slightly without assuming flat FX and an average frequency increased in the quarter of 4.5% up.
In terms of comparisons by geography regions most U.S regions registered mid single digit comp increases for the quarter with Texas, Midwest and Southeast being the strongest. Internationally in local currencies, Korea and Taiwan were on the weak end due in part to cannibalization on relatively small base of existing units. With Canada and Mexico the strongest in terms of comp sales increases.
In terms of comp sales by merchandised category for the quarter, within food and sundries, which were mostly in the mid single digits. Deli, wine and spirits, beer, frozen foods and candy were all relative standouts. Within hardlines, fairly flat numbers year-over-year. The departments with the strong results for office, health and beauty aids and hardware. Electronic sales, which is a relatively large size sub department within hardlines was weaker year-over-year in the fourth quarter.
For softlines low-double digits for the quarter; small electrics, housewares, domestics and apparel were standouts and the same old department media continuing being the relatively weak department there.
In fresh foods, comp sales in the mid-single digits; deli and produce showing the best result. In September, the five-week month, sales were $9.9 billion, up 6% from last year's September reporting period. On a comp basis, September comps were reported – were up a reported 3% for the month.
That 3% included a negative 1.3% average transaction. This includes the detriment of FX of about 1.5 percentage points and deflationary gasoline which deflated quite a bit, about 1 percentage point. So the 1.5% and the 1%, those 2.5 percentage points negative is included in that minus 1.3% transaction. Average frequency up about 4%. Excluding FX and gas effects, comp sales for the month of September were plus 5%.
In terms of sales by geography from September, most of U.S. regions were in the low to mid single digit comps with Southeast and Texas being on the strong end. Internationally, Korea and Japan were on the weak side of all the international countries with Canada and Mexico showing the strongest comp sales increases in local currency.
In terms of category sales for September, food and sundries, low to mid singles; hardlines, low singles similar to the quarter. Softlines in the low to mid teens, up a little bit from the quarter. Fresh foods continues in the mid single digit range, led again by produce and service deli.
And lastly ancillary business comps were slightly negative on a reported basis basically due to the gasoline business which experienced 8% deflation year-over-year in the average price per gallon during the five-week monthly reporting period. Gallons in terms of gas were slightly positive.
Moving on down the line items in the income statement, membership fees were up 3% or about $22 million, an increase of 4 basis points year-over-year to $716 million. Both membership fee members for this year's fourth quarter and last year's had some items to look at. Within the $716 million, of course it was – this year it included the $25 million benefit as I talked about from the fee increase.
And last year's $694 again it was a 17-week quarter, taking one-seventeenth out of that it would reduce that number by 41 million. So I think the 3% reported increase in dollars again adjusting it for those two anomalies would have been up about 6%. But the 3% is what we reported.
In terms of membership, renewal rates remain strong both in the U.S. and Canada and worldwide. We continue to strengthen our executive membership program. New member sign ups in the quarter companywide were very strong, up 9% year-over-year despite one less week in the quarter. That strong performance was mostly reflective of very strong sign up and our three Japan openings that opened in the fourth quarter. As I've mentioned in the past, we get very strong opening sign ups at locations in Asia and Australia.
In terms of number of members at fourth quarter end, Gold Star and in the quarter and year at 28.9 million up from 28.2 million 16 weeks earlier. Primary business remained at 6.6 million. Business add-on remained at 3.5 million. Again you get some of those add-ons moving into other categories as they opt for executive. Total paid memberships went from 38.3 million at Q3 end and 39 million at fiscal year end. And total cards went from 69.9 million at third quarter end to 71.2 million at fiscal year end.
Executive members continue to increase. We're up over 13.5 million at the end of the fiscal year which is about 250,000 increase in terms of members since Q3 end or about 15,000 a week added during the quarter. As I've mentioned before, executive members are over third of our member race and about two-thirds of our sales as well.
In terms of membership renewal rates, they too continue strong. Our business renewal rates went from 93.9 at the end of the third quarter tweaked up to 94.0. Gold Star went from 88.9 to 89.1, so total business in Gold Star went from 89.9 to 90.0. Those numbers by the way are for U.S. and Canada which we've always showed in the aggregate. That's a little over 82%, 83% of our business.
Worldwide the number went from an 86.4 at the end of the third quarter to an 86.3 and the reason there is with all these new international openings you're always going to have much lower renewal rates in start-ups years of new occasions, and particularly in new markets.
Going down the gross margin line, again I'll ask you to jot down a few numbers. We'll have four columns. The columns would be reported and without gas and the second column without gas. That will be Q3 '13 and Q3 '13. The third and fourth columns would be reported for Q4 '13 without gas for Q4 '13. As I mentioned in Q4, there was no inflation so the third and fourth columns will be the same numbers.
The line items, the first one will be core merchandizing. Going across to the four columns would be minus 5 basis points year-over-year, minus 11, minus 4 and minus 4. Ancillary and other businesses; plus 6, plus 5 and then plus 3 and plus 3 in the last two columns. 2% reward minus 2 across the board. LIFO, plus 6 and plus 6 in the Q3 columns and plus 7 and plus 7 in the Q4 columns. And other there was plus 7 and plus 7 in the Q3 columns and 0 and 0 in Q4 columns. That related to a loss in recovery that we mentioned last quarter.
All told, reported in Q3 year-over-year, gross margin was up 12 basis points. But again taking out gas inflation, it was up 5. This year both on a reported and without gas, it was up 4 basis points. I'll provide a little color on these numbers. Core merchandize component to gross margin was down 4 basis points year-over-year. Three of the four core categories; food and sundries, hardlines and softlines showed higher year-over-year gross margin percentage on their own sales in the 10 to 25 basis point range each while year-over-year in Q4 fresh food margins were lower by about 80 basis points.
As I mentioned in the last few earnings calls, our investment in pricing occurs throughout many merchandizing departments but has been most notable in fresh foods. Ancillary business gross margins were up 3 basis points year-over-year in Q4. I guess in food court margins coming in a little lower than Q4 last year with others like pharmacy, optical, hearing aids coming a little bit better.
The impact from the increasing executive membership business represented a reduction in gross margin of 2 basis points reflecting the cost of higher penetration of sales going to the executive member reward program. LIFO with the fourth quarter, we recorded an $8 million pre-tax credit this year in the fourth quarter compared to the $11.5 million pre-tax charge last year in the quarter, so that was a year-over-year 7 basis point swing in our favor. All-in-all, a pretty good margin result in the fourth quarter.
Now moving to reported SG&A, our SG&A percentages Q4 over Q4 were higher by 9 basis points coming in at 975 this year compared to a 966 last year. Again, we'll jot down a few numbers. The same four columns; reported and without gas and then again reported and without gas. And the first two columns will be for Q3 year-over-year and the third and fourth columns will be Q4 year-over-year. Going across operations; plus 2 reported in Q3 '13, plus 7 without gas. That means – plus sign means better or lower. In Q4 it was minus 9 and minus 9.
Central; plus 2 and plus 2 in the columns one and two; plus 3 and plus 3 in columns three and four. RSUs or equity compensation minus 1 and 0 and minus 3 and minus 3. All told, in Q3 year-over-year we reported a plus 3 or SG&A better by 3 basis points. Without gas inflation it was actually better by 9 basis points looking at it that way and again in Q4 year-over-year it was higher or minus 9 basis points.
The core operations component again was 9 basis points year-over-year. There are several moving parts to that. For example, benefits to worker's comp expenses were higher year-over-year in the fourth quarter by 5 basis points, 4 in the benefits side and 1 in the worker's comp side. In part due to year-end true-ups of various expense accruals as well as some increases. So again some of that I would say would be more normal, some of it is just how we true-up things at year end.
Several additional basis points of our expense comparisons in Q4 year-over-year resulted from a variety of other year-end expense true-ups that in the aggregate had helped us a little last year in the quarter intended to hurt us a little bit this year in the quarter. These items now withstanding within core operations our payroll as percent of sales continue to improve year-over-year.
Central expense it was better or lower by three basis points as you saw on the chart. This benefited by bringing back a little bit of our bonus accrual for the year. That benefit was somewhat offset by ongoing IT monetization costs. I’m happy to mention also that -- I want to mention also that IT expense as a percent of sales will continue to be, negatively impact the SG&A throughout the upcoming fiscal year as we continue these monetization efforts.
Lastly our equity compensation which has provided us part of a compensation package to more than 3000 people in Costco represented a three basis point hit to SG&A in the quarter. So told there are few other things I think were anomalies and few they were a little higher expense all resulting of course the reported higher SG&A. In terms of the income statement pre-opening expense $15 million last year up $2 million to $17 million this year, no real surprises. Last year we had six openings, four in the U.S. and two international. This year we had seven openings in the quarter, two U.S. and five international.
All told reported operating income in the fourth quarter increased slightly year-over-year, I mean last year at $949 million versus $954 million this year. Again lots of reasons for this, the extra week and many of the items I pointed out earlier in this discussion. Below the operating income line reported interest expense was $14 million higher year-over-year with Q4 ’13 coming in at $36 million versus $22 million in last years quarter. This difference relates to additional interest expense again in the December 12, $3.5 billion debt offering which equates to about $44 million pre-tax a year and about between $13 million and $14 million for the 16 week quarter.
Interest income and other was lower year-over-year by $2 million coming in at $36 million this year from $38 million a year ago. Actual interest income within this figure came in at $14 million compared to $16 million a year ago. The other component of interest income and other amounted to income of about $22 million in each of the fourth quarters; essentially it was same over year-over-year. Overall pre-tax income was down $11 million versus last year's fourth quarter coming in at $954 million this year versus $965 million last year. Again last year's fourth quarter included one more week of earnings results and this year's 16-week fourth quarter.
In terms of income taxes, our Company’s tax rate this quarter came in at 34.8% versus 35.6% a year ago, so a little less about 8/10 th of a percent lower year-over-year tax rate. While many of the items I talked about in expenses tended to go against us in the fourth quarter this year versus last year. There are few discreet items in taxes that tended to help us and reduce that rate a shade from a year-ago. Overall net income was up $8 million versus last year's fourth quarter from $609 million last year to $617 million this fiscal year in the fourth quarter.
Now for a quick renown of other topics, while the finance balance sheet is included in this morning’s press release, a couple of balance sheet informational items. Depreciation and amortization for the quarter totaled $295 million and therefore $946 million for the entire fiscal year. Merchandize accounts payable, again and then when you look at accounts payable on the balance sheet it includes majority of it is merchandize related, the other component is typically construction related.
So anyway on the balance sheet a reported AP ratio was 100% this year down from 103% just using merchandized accounts payable to inventories, it was 89% down from 90%. Average inventory per warehouse; last year it was $11.7 million per warehouse. This year it was $12.5 million or about $800,000 per warehouse or about 7% up year-over-year. The $800,000 increase is really spread throughout many merchandized departments and overall our inventories regain shape our fiscal inventories at fiscal yearend came in as good as they’ve ever been.
In terms of CapEx, in the first three quarters of this year we spent $488 million, $455 million and $435 million respectively. So in Q4 we spent $705 million not only as it’s more weak in the fiscal quarter but again it's in -- and expect it's related to all the openings we’ve had coming on this fall. So for the total year we spent $2,083,000,000. I’d estimate that our fiscal ‘14 CapEx given the planned 36 openings will be approximately $2.3 million to $2.5 million again the lower end of that range taken account that probably there’s a couple of things that will slip during the period.
Costco Online, currently costco.com which is our U.S. ecommerce, costco.ca and costco.co.uk. For Q4, sales and profits were up over last year even with the extra week last year. Q4 ecommerce sales were up 8%, again if you extrapolated that for the extra week it would have been about 15% normalized. Ecommerce is again a little over 2% of our sales. We re-platform dot com sites; our dot come sites last fall as I mentioned and we also launched the Android and Apple apps during the same time. costco.uk was launched last fall and in this fall we plan to begin ecommerce operations in Mexico.
In terms of expansion, for the year again this assumes that we opened the 36 that I mentioned at in our plan. It would be 14 in the first quarter, two in the second quarter including one which is before calendar yearend that’s how we had the 15 earlier; nine in Q3 and 11 in Q4. So with fiscal ’13 the 26 we added represented about 4.5% square footage growth. Assuming 36 on a base of 634 this year, that would be 5.5% square footage growth. If you assume that the low end perhaps 30 that would be about 4.7% square footage growth. So something in the 4.5% to 5% -- closer to 5% range should be our expectation this year.
The new locations by country assuming 36 figure, half would be in the U.S, three would be in Canada, seven would be in Asia between four in Korea and three in Japan, five would be in Australia, one in Mexico and two would be in Spain as I mentioned we’d enter in the spring and the fall. As our fourth quarter end some of you asked about square footage. We stood at -- square footage stood at 90,805,000 square feet, an increase year-over-year of 4.5%.
In terms of dividends, our current quarterly dividend stands at $0.31 a share or $1.24 annualized that was up 13% from the previous $0.275 per share quarterly dividend. This $1.24 annualized dividend represents the total cost to the company of about $541 million and of course these quarterly dividends were in addition to the $7 per share a special dividend which totaled a little over $3 billion that we paid to shareholders back in December of 2012 our fiscal second quarter of ’13.
The usual supplemental information will be posted on the Costco investor relation site later this morning. And lastly our fiscal ’14 first quarter scheduled earnings release date will be Wednesday, 11 th of December that will be for the 12-week fourth quarter ending on November 24 th .
With that, I will turn it over to Felicia.
Earnings Call Part 2: