OPERATOR: Good morning. My name is Julie Ann, and I will be your conference operator tiffany on sale. At this time, I would like to welcome everyone to the conference call discussing the fourth quarter and year-end results and September sales results.
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. I would now like to turn the conference over to Mr. Richard Galanti, Chief Financial Officer. Please go ahead, sir.
RICHARD GALANTI, CFO, COSTCO WHOLESALE CORPORATION: Thank you, Julie Ann, and good morning to everyone. This morning we reported our 16-week fourth quarter and 52-week fiscal year-end operating results for fiscal 2009, both ended August 30, as well we reported our five-week September sales results for the five weeks that ended this past Sunday, October 4.
As with every conference call, I will 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 tiffany jewelry on sale 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 quarter, we reported EPS at $0.85 a share, down 6% from last year’s reported Q4 EPS of $0.90. The $0.85 figure for this year’s Q4 also compares to First Call EPS estimate of $0.77 per share that was out there this morning.
As outlined in this morning’s release, both fiscal fourth quarters included the impact of certain items that complicate a little bit the quarter-over-quarter comparison. Last year’s fourth quarter included two items of note, a $32.3 million pretax, or $0.05 a share, LIFO charge and a $15.9 million pretax, or $0.02 per share, charge related to a litigation settlement. Together these two items impacted last year’s $0.90 reported Q4 results by $0.07 a share.
So excluding last year’s Q4 results would have been $0.97 a share. Conversely, this year’s fourth quarter results included a $16.6 million pretax, or $0.02 per share, LIFO benefit. So when you compare our Q4 over Q4 earnings results these three items, two of them negatively impacting last year’s fourth quarter results, and one helping this year’s fourth quarter results, represented a $0.09 per share year-over-year swing.
Now several other factors also impacted the comparison of this year’s Q4 results versus those of last fiscal year, and generally went the other way, ie, that is they represented a negative year-over-year impact. I’ll talk about some of these later but these include FX headwinds. Our foreign country earnings results when converted and reported in US dollars has hurt us all fiscal year since last fall when the US dollar greatly strengthened against many of the currencies with which we operate.
In the fourth quarter, we were hurt by a little over $21 million pretax or $0.04 a share after tax. That is assuming FX exchange rates were flat year-over-year, our foreign country operating results in Q4 when reported in US dollars would have been higher by that amount.
By the way, for the entire fiscal year, the impact of FX, assuming FX rates had remained constant, was to reduce our total Company reported sales by $2.42 billion and reduce pretax earnings by almost $95 million pretax or $0.14 a share after tax. This calculation simply takes the currency exchange rates for the prior fiscal year and assumed that they remained at those levels throughout fiscal 2009.
The next item, higher employee benefits costs mainly consisting of higher US healthcare expense, that discount tiffany about $0.04 per share negative impact in the fourth quarter. And when we say the $0.04 per share that’s what we estimated was above and beyond normal increases in those charges. I’ll talk further about this later in our discussion.
As you can see in our income statement, our income tax rate while lower than it had been over the last several years, was, in fact, higher year-over-year in Q4 and that had to do with the fact in that both quarters there were some discrete items that went our way, if you will, and, therefore, lowered the tax rate, but the tax rate this year was 35.5% in the fourth quarter, up from 34.5% last year. Not a big item, but, again, this represented a little over $0.01a share impact to this year’s fourth quarter results.
Two final items impacting our Q4 P&L, recall that gas profits in Q4 2008 and very much so in Q1 2009 during this time when gas prices were plummeting profits were great. This year’s Q4 gas profits were good, but nearly $0.04 a share lower than the year earlier Q4.
Lastly, in terms of year-over-year things that we believe looked like they stood out, with interest rates earned on investable cash balances down substantially from a year ago interest income this year in Q4 was $15 million pretax or $0.02 a share lower than a year ago. So you’ve got a $0.09 swing one way as I described in our press release, and you have about $0.15 swing the other way. All in all our results came in, I think, much better than many of you out there expected.
Earnings for the 2009 fiscal year came in at a reported $1.086 billion, or $2.47 a share compared to $1.283 billion or $2.89 in last year’s fiscal 2008. In terms of sales for the fourth quarter, we reported on September 3 our 16-week reported comparable sales figures and they showed a 5% decrease, a minus 6% in the US, and a minus 3% internationally as expressed in US dollars.
Excluding cash deflation and the impact of FX from the US dollar strengthening year-over-year, the minus 6% US comp would be a minus 1%. The minus 3% international comp, reported international comp, would be a plus 7%, and the minus 5% total Company comp for the fourth quarter would be a plus 1%.
Now we also reported this morning our September sales results for the five weeks of September which ended this past Sunday. These were with the US coming in at a reported minus 1%, international a reported plus 6%, and total Company, therefore, a reported plus 1%. Again, you still have throughout this year, it will soon be anniversarying, but the impact of gas deflation and FX.
For the five-week September period the minus 1% reported US comp would be plus 3%, but — and that’s without the roughly 3.5% impact of gas deflation. Given the US dollar’s relative strength vis-a-vis other currencies in the past month, our reported 6% international comp would have been plus 9% if expressed in local tiffany jewelry sale. Excluding gas and FX, our reported 1% plus September comp for total Company would be a plus 4%.
A couple of other comments on September sales results. The reported plus 1% comp sales result was comprised of a 6.5% plus traffic increase. That’s helped a little bit by week one of the five-week period with the shift in Labor Day. If you look back over the last nine weeks of August and September, the combined traffic increased, so taking that impact of how Labor Day fell was a 5.5% increase in traffic on average over the nine weeks.
Offsetting that, of course, was 5.5% average ticket decrease, and this is September still. Now, in September the minus 5.5% average transaction decrease included the combined negative impact of gas and FX of about 3.5 percentage points.
Other topics of interest I will review this morning, our opening activities and plans, we opened a total of 15 net new locations during the fiscal year, during the past fiscal year, which ended this past August 30. Plus one in Mexico. Of the 15, eight new in the US, two in Canada, and one each in the UK, Taiwan, Korea, and Japan. And, of course, just a few weeks ago we opened our first location in Australia in Melbourne.
We also relocated two units in 2009 to bigger, better located facilities. Now for fiscal 2010, we plan to open somewhere in the 15 to 18-range of new locations, about three-quarters of it in the US as well as up to two to three relocations. I’ll talk about expansion a little bit later.
Since fiscal year end, we have opened one new location in Phoenix, Arizona at the Paradise Valley shopping center with five additional openings planned before our November 22 Q1 end. One relo in Redwood City, California. Possibly a second, although I think it’s been delayed a week, so it will be in the first week Q2, and a new locations in each of Colorado, Missouri, and Ohio, and on November 12 we open our first unit in Manhattan at 116th Street and FDR Drive.
We now operate 560 locations around the world and that includes the 32 in Mexico which we do not consolidate as we are a 50% owner, not more than 50%. Also this morning, I will review with you our online results, membership, additional discussion about margins, and also our balance sheet for this fiscal year ended.
Okay, to the discussion of our quarterly results. Very briefly, sales for the fourth quarter were $21.9 billion, down 3.3% from last year’s $22.6 billion in the fourth quarter. And on a reported comp basis, again, the Q4 comp sales were down 5%, but excluding gas and FX, the minus 5% figure would be plus 1%.
For the quarter, our minus 5% reported comp sales were a combination of an average transaction decrease of minus 9.5%, and an average frequency increase of plus 4.5%. Included in the average decrease of 9.5% minus, a weak FX represented a little over 2% negative and the quarterly comps in gasoline deflation a little over four percentage points.
Cannibalization has not been a big impact in the last several quarters. It’s about a 40-basis-point hit to the comp number, but that’s been pretty consistent as compared to, not that much different as compared to past recent months and quarters. Now that we’re at fiscal year end, the average volume of our — all our locations Company-wide for fiscal 2009 averaged $131 million.
That’s about 4.4% lower than the $137 million average a year ago. Of course, a chunk of that is gas deflation and FX. The $131 million Company-wide compares to the US only of $133 million.
Now, in terms of geographic — sales comparisons geographically, couple comments. Within the US, all but one small region showed improvement from Q4 comps results to the September comp results. The largest positive delta, and when I say positive delta I’m saying what were the comps for this region and for all of the fourth quarter versus what were they in September. And, of course, September overall was better than the fourth quarter.
The largest positive delta was Southern California, followed by the Bay Area, then the Northwest, then the Northeast. In September, just looking at September geographically, all of California came in at a minus 1% or a plus 2% without gas deflation. In terms of merchandise categories, September comp sales all four core merchandise categories, food and sundries, hard lines, soft lines, and fresh foods, showed positive comps in September.
In fact, hard lines and soft lines positive September comps represented the first time since over a year ago that these departments had comp sales figures without a negative sign in front of them. Within Q4, in terms of merchandise categories, within food and sundries comps were slightly positive. No real standouts, a pretty narrow range among sub-departments.
Keep in mind that it is in many of these categories where we’ve been experiencing pretty decent levels of consumer products price deflation. Within hard lines we showed positive comps in majors, mid-single-digits. Everybody asks about how TV sales were.
They were, in terms of units, up 35%, again, mid-single-digits in terms of — by the way, that’s not quarter, that’s September. Hard lines also in September, [arhaba] in high-single-digits. Hardware, low-double-digits and sporting goods double-digits.
Within positive soft lines comps, again, not a whole lot of standouts for the quarter. However, for September, we saw decent numbers with housewares, small appliances and domestics, the latter two of those being right around 10%. Fresh foods was also up mid-single-digits which is an improvement from the past few months.
In the past few months, as well as September, the standout has been unit sales increases in the low-double-digits. Deflation is still there, but not as strong level of deflation as July and August.
While we can’t predict where these go in the future, by the end of this month we will have anniversaried both peak gas prices and the strengthening — what happened last year when the dollar strengthened against many of the currencies. So those two things hopefully will help but we’ll have to see. We really can’t predict that.
Moving down to the line items of the income statement, we’ll start with membership fees. Reported in the fourth quarter, membership fees were $490 million or 2.24% of sales. That’s up a little under 4% and a little over — about 15 basis points higher from the $473 million or 2.09% from a year ago. So about a $17 million reported increase. Of course, these numbers are impacted by FX.
Again, with the strengthening dollar, membership fees in international currencies, when converted to US dollars were lower than they would have been if the FX rates had stayed constant. So that $490.5 million reported, if we’d had constant FX in 2009 as compared to 2008, the $490.5 million would be $500.5 million or 2.29%, so a little under 6% increase, or 20 basis points up. Either way, good showing in our view.
Strong renewal rates still in the mid 87% plus range. Continuing increasing penetration of the executive membership. And the third factor impacting Q4 membership in the current results, three very strong Asia openings this past July. Now, that’s impacting sign-ups, recognizing we account for membership fee income on a going forward basis, if you will, and so even if we got them all in August, we had a very little bit of that income in August, it will be stretched out over the next 12 months.
Very large new member sign-ups in the three openings in July that we did in Taiwan, Korea, and Japan. We also had a great opening both in sales and membership sign-ups in the new country, in the City of Melbourne in Australia in August. Our new membership sign-ups in Q4 were down 3% year-over-year in the fiscal quarter.
Recall that they were down 7% in Q2 year-over-year and down 5% in Q3 year-over-year. Pretty much the same reason why. We don’t feel this is a big issue. We’re still feeling the impact of fewer year-over-year openings.
In Q4 2008, we opened a net of six openings but we actually opened 13 openings including [relos] compared to six which include two relos this year. So if you recall back even in Q2, in 2008 in Q2 we opened seven openings compared to zero. So, again, you’ve got a lot of new sign-ups and new buildings with fewer openings this year versus last. Overall fewer openings are impacting the new sign-ups, so, again, we believe that’s the biggest factor for that.
In terms of number of members at Q4 end, we ended Q4 2009 with 21.4 million members, up from 20.9 million at the end of Q3. Primary business remained at 5.7 million. Business add-on remained at 3.4 million. So all told, 30.6 million compared to 30.0 million at Q3 end. Including spouse cards, we went from 54.9 million at the end of Q3 to just 8,000 shy of 56 million at the end of Q4.
At fiscal year end, paid executive memberships totaled [8,936 million], an increase of 408,000 or 5% since Q3 3 end, that’s just under 26,000 a week increase. That’s new as well as conversions to the executive membership. I might point out that we did introduce the executive membership program in the UK this past fiscal quarter. That would make it the third quarter that we now have the executive membership.
Of the 408,000 executive members that became executive members during Q4, 62,000 came from the introduction of this program in the UK. So, again, taking that out, the 5% increase in that 16-week quarter would have been a 4% increase for the rest of the existing Company.
In terms of renewal rates, remained a shade under 87.5% coming in rounding to 87.3%, 92.2% on the business which is actually a slight improvement from Q3 end, and 86.0% which is one-tenth down from Q3 end, but averaging 87.3% overall. Going down the gross margin line, in the fourth quarter year-over-year the gross margin was up 56 basis points at a 10.85% compared to 10.29% last year.
This is where I ask you — one of the two times I ask you on the call to jot down a few numbers to help you understand our numbers. We’ll have three columns. Q2 2009, Q3 2009 and Q4 2009, and about six line items, core merchandise, second line is ancillary, third line is 2% reward, fourth line is LIFO, and last line is total.
Going across, core merchandising in Q2, year-over-year, core merchandising was down seven basis points. In Q3 up 42 basis points. In Q4 up 48 basis points. Ancillary businesses, and how it contributed or opposite to the quarter.
Q2 minus 19, Q3 plus eight basis points, and Q4 minus three basis points. The 2% reward all three quarters was minus nine basis points. LIFO, plus four, plus four, and in Q4 plus 22. That relates, of course, to the $16 million LIFO credit I talked about. In total, minus 31 in Q2, plus 45 in Q3, and plus 56 in Q4.
Recall, of course, in that Q2 we were very aggressive on pricing, and I talked about that back in Q2, leading up to the Christmas Day. As you can see our overall gross margin was higher by 56, and our core merchandise gross margin was up 48 basis points.
But as was in the case of both Q2 and Q3, the 48 basis points year-over-year core merchandise result is good but like in the past two quarters a large component of this increase reflects reduced gasoline sales penetration which is a much lower gross margin business. Our lower margin gas business represented 12% of Q4 2008 sales and only 8% of Q4 2009 sales as the average price per gallon dropped precipitously.
Thus, sales penetration of our core merchandise business was up year-over-year. So while gross margins of these areas were higher year-over-year by six basis points, its aggregate higher sales penetration caused it to be up significantly more in the matrix of the 48. But, again, if you look at like sales in those four categories to gross margin on those four categories divided by sales of those four categories it showed improvement of six basis points.
Of the four major departments, food and sundries and hard lines were up year-over-year in Q4 as they were in Q3. Soft lines was down ever so slightly and fresh foods was down somewhere in the mid 40, 50 basis points, similar as they were in Q3. That, again, we’re doing a lot more volume but with lower price points. We felt we did okay there.
The impact from increasing executive membership — executive member business continued in Q4 at a minus nine-basis-point impact. Again, the same nine-basis-point impact that occurred in both Q2 and Q3. The implication that means that about 4.5% of our sales penetration is increased executive membership, to executive member sales. We view this as a positive and it reflects increasing sales penetration to our most loyal members.
As mentioned in our press release, LIFO represent a large credit in Q4, $16.6 million pretax compared to the $32.3 million LIFO charge in Q4 last year. The deflationary trends, of course, began back in Q2 and continued throughout this past fiscal year.
Moving on to SG&A, our SG&A percentage Q4-over-Q4 were higher by 63 basis points, coming in at 10.29% of sales this year compared to 9.66% last year. Again, I’ll ask to you jot a few numbers down. We’ll use the same three columns, Q2 2009, Q3 2009, and Q4 2009.
The line items are operations, second line item is central, third line item is stock compensation, or equity compensation. Fourth line item, quarterly adjustments, and then total. And I will actually have a memo line item below the total called gas mix effect.
Going across, operations in Q2 2009 year-over-year compared to Q2 2008, it was minus 34 or higher by 34 basis points. Q3, minus 67 basis points, and Q4, minus 61. Central, minus four, minus 15, and minus eight. Equity, minus one, minus five, and minus one.
Quarterly adjustments, zero, minus nine, and plus seven. And total, minus 39, minus 96, and minus 63. Now, the memo item, the gas mix effect, and basically this is the number that when you look at the operations line, the 34, 67 and 61, of that these three numbers relate to the lower gas penetration which, while it boosted reported margins, it also boosts the percentages of reported SG&A.
Of that minus 34, minus 28 was gas mix effect. of the minus 67, 38, and of the minus 61, minus 40. So, again, a big chunks of those numbers relate to that. And, again, hopefully gasoline deflation, or these giant swings is getting ready to anniversary.
In terms of a little editorial on these SG&A issues, I will point out the following. Again, operations was higher by 61. But again, as I mentioned, the gross margin percentage is where it helped us. It correspondingly hurt is here in SG&A.
Our central expense was higher year-over-year in Q4 by minus eight basis points. About three basis points of gas mix and most of the other five basis points was higher payroll and benefits as a percent. Health benefits is a big chunk of that, within that number, but certainly payroll was up small single-digits on essentially flat sales.
Our stock compensation expense was almost flat in dollars year-over-year in Q4. Down about 3% on slightly lower sales but up one basis point in terms of percentages. Benefits, I mentioned Q4 year-over-year percentage was higher by [16] basis points. This includes a sizable year-over-year spike in healthcare utilization. For the quarter, the amount we spent on US healthcare was up over 25%.
Three factors fueled this large rate of increase. Normal healthcare inflation that we all hear and read about, increased utilization per person, some would argue that’s related to everything going on in the economy and stress and what have you, but we don’t know. And greatly reduced — and the last one is greatly reduced employee turnover.
With regard to the reduced employee turnover, there is — there’s a smaller percentage of our employee base who are not yet eligible for benefits. Over 90% of our new hires tend to be entry level part-time hourly employees. Our part-time hourly employees become benefits eligible on average around six and a half months after they begin. It’s the first of the month after they start plus six months.
As we have opened fewer units, as well as existing employees aren’t turning over as fast in this tiffany bracelet, you’ve got more people that are benefits eligible. For the last several years, the percentage of our employees that are benefits eligible was right around 80%, 82%. In the last year, it has gone to 92%, the low 90s.
So again, that’s not going to go away, and that’s economy related. My guess is as the economy improves slowly you will see a reduction in that, but it will be probably minor levels of reductions over a few years, assuming that people’s expectations out there, that it’s going to take that long for the economy to improve. But nonetheless, that’s also exacerbating it a little bit.
In terms of quarterly adjustments, the plus seven simply relates to the fact that in Q4 last year we that had $15.9 million pretax charge for a litigation settlement versus nothing this quarter. Overall, not a bad SG&A performance given sales levels, the huge gasoline deflation and increased benefits costs.
I don’t see benefits costs changing dramatically. I think it’s going to continue to be relatively high, but we’ve worked that into our numbers this coming year. In terms of factors that will impact our outlook, 2010, probably the single biggest question is sales trends, and where that goes, and, of course, the anniversarying of gas deflation that will help a little bit.
Next on the income statement is pre-opening expense, $5.8 million higher this year, coming in in the fourth quarter at $17.8 million. I’m sorry, lower this year, coming in at $12 million this year in the fourth quarter versus $17.8 million last year. No real surprise. Last year in the fourth quarter including relos we opened a total of 13 units. This year in the fourth quarter, including the two relos, we opened six new openings.
In terms of provision for impaired assets and closing costs, in Q4 2008 last year we had a net credit of $6.2 million for the quarter. That was comprised of about a $12 million in real estate gains offset by about $6 million in actual closing costs. In the fourth quarter this year, we didn’t have any real estate gains but we did after net charge of $2.7 million in closing costs.
So there you have almost a $9 million pretax year-over-year negative swing in Q4. All told, operating income in Q4 2009 was down about 1% year-over-year, from $604 million last year to $597.8 million this year, or a decrease of about $6 million.
Below the operating income line, reported interest expense was slightly higher year-over-year with the fourth quarter coming in at $33.3 million versus $32.1 million last year, so a little over $1 million. These amounts mainly reflect the interest expense on our $2 billion debt offering that we did in February 2007. Interest income, however, interest income and other was lower year-over-year by $20 million in the quarter, reported at $15 million this year versus $35 million last year.
As I mentioned earlier, of that $20 million swing, about $15 million of it was lower interest income. The other $5 million is basically the weak peso. We account for Mexico on an equity method which means we simply add — since we own half of it we add half of their earnings into this interest income and other line. The peso in 2008 was around 10 to the dollar. The peso in 2009 was closer to 13. So, again, about $5 million of that number there is the weakness when expressed in US dollars.