Costco Wholesale Corporation — Q1 FY2014 Form 10-Q
Business and period: Costco operates membership warehouses and online businesses. This 12-week quarter ended November 24, 2013; comparisons are with the 12 weeks ended November 25, 2012. Unless noted, amounts are USD millions.
Financial performance
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Net sales | $24,468 | $23,204 | +5% |
| Membership fees | $549 | $511 | +7% |
| Total revenue | $25,017 | $23,715 | +5% |
| Operating income | $668 | $639 | +5% |
| Net income attributable to Costco | $425 | $416 | +2% |
| Diluted EPS | $0.96 | $0.95 | +1% |
| Operating cash flow | $939 | $1,102 | −15% |
| Capital expenditures | $574 | $488 | +18% |
Sales and margins: Comparable sales grew 3% overall (U.S. 3%; international 1%). Excluding gasoline price and currency effects, comparable sales grew 5%. Currency movements reduced sales by about $355 and lower gasoline prices by about $245. Gross margin was $2,644, or 10.81% of net sales, up 13 basis points; excluding gasoline-price deflation, it rose 2 basis points. SG&A was $2,501, or 10.22% of net sales, up 17 basis points (7 basis points excluding gasoline effects). Operating income margin was approximately 2.67%, versus 2.69% a year earlier.
Cash, liquidity, and debt: Cash and cash equivalents were $4,699 and short-term investments $1,740 at quarter-end, totaling $6,439. Long-term debt was $4,987, excluding $54 of short-term borrowings. Operating cash flow declined, principally reflecting a larger inventory investment associated with the Thanksgiving timing shift. Investing cash outflow was $826; financing cash outflow was $71. Current assets were $17,473 and current liabilities $14,933. Management said cash, investments, and operating cash flow should meet foreseeable capital needs. $2,484 of cash and short-term investments was held by non-U.S. subsidiaries and was considered indefinitely reinvested.
Other measures: Membership fees increased partly due to sign-ups, greater Executive Membership penetration, and prior fee increases. Cardholders totaled 72.5 million; renewal rates were 90% in the U.S. and Canada and 87% worldwide. The quarterly dividend was $0.31 per share, up from $0.275.
Changes and management commentary
- Costco opened 13 warehouses in the quarter, compared with 9 a year earlier; it operated 646 warehouses at November 24, 2013.
- U.S. segment revenue was $17,724 and operating income $364; Canadian revenue was $4,124 and operating income $189; other international revenue was $3,169 and operating income $115.
- Interest expense increased to $27 from $13, primarily reflecting senior notes issued in fiscal 2007 and December 2012. SG&A pressure included higher stock-based compensation and information-systems investment.
- Management emphasizes sales growth and value pricing, and notes that absorbing merchandise-cost increases can pressure gross margin. It also identifies competition, economic conditions, foreign exchange, gasoline prices, employee-benefit costs, and energy and commodity costs as risks.
Outlook, risks, and contingencies
- No earnings or sales guidance is provided. For the remainder of FY2014, Costco planned up to 18 additional warehouse openings and approximately $2.4 billion of full-year capital spending, funded with operating cash flow and existing cash and investments.
- Management reported no material changes to previously disclosed risk factors or contractual obligations. It stated that disclosure controls were effective and that internal control over financial reporting had not materially changed.
- Legal matters include a proposed settlement, subject to court approval, in a gender-promotion class action; fuel-temperature class actions, including a pending attorneys’ fee request; an EPA/Department of Justice inquiry involving refrigeration compliance and potential penalties; state unclaimed-property examinations; and DEA inquiries concerning controlled-substance prescriptions. No accrual was recorded for the described matters; possible losses were not reasonably estimable. Management did not expect pending matters to materially affect financial position, but noted an unfavorable outcome could materially affect an individual quarter.
Key facts for investors to verify
- Whether comparable-sales momentum and membership growth continue, particularly excluding currency and gasoline effects.
- Whether margin pressure from SG&A, gasoline, merchandise costs, and Executive Member rewards changes in subsequent quarters.
- How inventory timing and planned capital spending affect cash generation and liquidity.
- Progress on warehouse openings and the planned approximately $2.4 billion FY2014 capital program.
- Developments in the disclosed legal and regulatory matters, especially the EPA inquiry and pending litigation-related requests.