Costco Wholesale Corporation — Q1 FY2016 Form 10-Q
Reporting period: 12 weeks ended November 22, 2015; comparisons are with the 12 weeks ended November 23, 2014. Amounts are in U.S. dollars; financial figures are in millions unless noted.
Business context and results
Costco operates membership warehouses and online businesses. At quarter-end, it operated 697 warehouses worldwide. Management describes comparable-sales growth as a key driver of profitability, with a low-margin model focused on value, sales volume, and rapid inventory turnover.
- Net sales were $26,627, up 1%; total revenue was $27,220, up 1%. Membership fees were $593, up 2%.
- Comparable sales declined 1% overall, but rose 6% excluding foreign-exchange and gasoline-price effects. Reported sales were affected by an estimated $1,113 adverse currency impact and $776 adverse gasoline-price impact.
- Net income attributable to Costco was $480, down 3%; diluted EPS was $1.09 versus $1.12. Operating income was $767 versus $770.
- Gross margin was 11.29% of net sales versus 11.03%; SG&A was 10.54% versus 10.26%. The reported margin changes were largely affected by gasoline-price deflation. Excluding that effect, gross margin declined six basis points and SG&A improved two basis points.
- Paid members increased to 45.4 million from 42.5 million; cardholders increased to 82.7 million from 77.5 million. Renewal rates were 91% in the U.S. and Canada and 88% worldwide.
Cash flow, liquidity, and debt
- Operating cash flow was $811, down from $1,128; management attributed the decline primarily to the timing of tax payments. Investing cash flow was $(332), including $715 of property-and-equipment additions. Financing cash flow was $(224).
- Operating cash flow less capital additions was approximately $96, compared with approximately $573 in the prior-year quarter.
- Cash and cash equivalents were $5,054 and short-term investments were $1,229, totaling $6,283. Current assets were $18,858 and current liabilities $18,293.
- Total debt carrying value was $6,126, including $1,281 current and $4,845 long-term. On December 7, 2015, Costco repaid approximately $1,204, including principal and interest, on its 0.65% notes due December 2015 using existing liquidity.
- Costco repurchased 898,000 shares for approximately $130, versus 139,000 shares for $18 in the prior-year quarter. The quarterly dividend was raised to $0.40 per share from $0.355.
Material changes and segment results
Currency translation and lower gasoline prices weighed on reported sales; comparable sales excluding those factors increased 6%. Foreign-exchange changes reduced diluted EPS by an estimated $0.10, primarily reflecting the Canadian dollar. Membership-fee growth benefited from sign-ups and Executive membership upgrades, partly offset by currency effects.
| Segment | Revenue, Q1 FY2016 | Operating income, Q1 FY2016 | Prior-year comparison |
|---|---|---|---|
| U.S. | $19,846 | $451 | Revenue $19,181; operating income $433 |
| Canada | $3,882 | $183 | Revenue $4,231; operating income $196 |
| Other International | $3,492 | $133 | Revenue $3,454; operating income $141 |
Reported gross margin benefited from gasoline-price deflation, while the comparable prior-year period included a non-recurring legal-settlement benefit. Costco also cited lower U.S. co-branded-card sign-up bounty revenue, expected to remain a headwind until the planned card transition. Stock-based compensation expense rose to $186 from $150; interest expense increased to $33 from $26, primarily due to 2015 note issuance.
Outlook, risks, and contingencies
- For the remainder of FY2016, Costco expected to open up to 21 new warehouses and relocate up to two, following 11 net new openings and two relocations in the first quarter. Planned FY2016 capital spending was approximately $2,800–$3,000; $715 had been spent in the quarter.
- Management said cash and operating cash flow should meet liquidity and capital needs for the foreseeable future. It identified no specific earnings or sales guidance in the filing.
- Costco expected Citi to purchase the existing co-branded card portfolio from American Express and begin issuing Visa cards in mid-calendar 2016. The transition timing and reduced card-related bounty revenue are relevant to monitor.
- Risks discussed include economic and consumer-spending conditions, currency and gasoline-price movements, competition, employee and benefit costs, energy and commodity costs, data security, and real-estate conditions. Management reported no material change in risk factors from its FY2015 Form 10-K.
- Legal matters include motor-fuel temperature-sales litigation, state unclaimed-property examinations, and DEA inquiries concerning controlled-substance prescription fulfillment. Costco recorded an immaterial accrual for one matter; it said loss estimates for other matters could not be reasonably determined and that an unfavorable outcome could materially affect an individual quarter.
Key facts for investors to verify
- Whether comparable-sales momentum excluding currency and gasoline effects is sustained, and how reported sales respond to those factors.
- Progress on warehouse openings, the $2.8–$3.0 billion capital-spending plan, and resulting cash flow and returns.
- The timing and financial effects of the Citi/Visa transition, including card-related revenue and membership impacts.
- Repayment of the December 2015 notes, subsequent liquidity and debt levels, and developments in the disclosed legal and regulatory matters.