Costco Wholesale Corporation — Form 10-Q Summary
Reporting period: Second quarter and first half of fiscal 2012, ended February 12, 2012. The quarter covered 12 weeks and the first half 24 weeks; fiscal 2012 is a 53-week year ending September 2, 2012. Amounts are in millions of dollars except per-share data.
Business context and operating results
Costco operates membership warehouses selling a limited selection of branded and private-label merchandise at low prices. At quarter-end it operated 598 warehouses worldwide. Management describes sales growth and cost control as central to profitability, noting that the business operates with low margins.
| Metric | Q2 FY2012 | Q2 FY2011 | First half FY2012 | First half FY2011 |
|---|---|---|---|---|
| Total revenue | $22,967 | $20,875 | $44,595 | $40,114 |
| Net sales | $22,508 | $20,449 | $43,689 | $39,272 |
| Operating income | $644 | $596 | $1,187 | $1,121 |
| Net income attributable to Costco | $394 | $348 | $714 | $660 |
| Diluted earnings per share | $0.90 | $0.79 | $1.62 | $1.49 |
| Gross margin as % of net sales | 10.53% | 10.83% | 10.57% | 10.90% |
| SG&A as % of net sales | 9.67% | 9.96% | 9.89% | 10.13% |
Financial position, cash flow and capital
- For the first half, net cash from operating activities was $1,244, down from $1,446 a year earlier. Management attributed the decline principally to a $351 greater net investment in inventory (inventory less accounts payable).
- First-half investing cash outflow was $452, including $632 of property and equipment additions. Financing cash outflow was $392, including $312 of common-stock repurchases and $105 of cash dividends paid. Cash and cash equivalents increased $380 to $4,389.
- At February 12, cash and cash equivalents plus short-term investments totaled $5,785, compared with $5,613 at fiscal year-end. Current assets were $14,360 and current liabilities $12,409.
- Total debt carrying value was $2,280, including $900 of current debt. The $900 of 5.3% senior notes was due March 15, 2012; the company said it intended to repay principal and interest from cash, cash equivalents and short-term investments. A Japanese subsidiary issued $129 of 1.18% notes due October 2018 during the half.
- Management said current liquidity and operating cash flows should meet capital requirements for the foreseeable future. About $1,874 of cash and short-term investments was held by non-U.S. subsidiaries and other entities and was expected to remain invested internationally.
Changes versus the comparable periods
- Q2 net sales rose 10.1%; comparable sales increased 8%, supported by shopping frequency and average spend, and sales from 17 net new warehouses opened since the prior-year quarter. Gasoline price inflation added about $200 to Q2 net sales, while foreign-currency movements reduced them by about $99. For the first half, net sales rose 11.2% and comparable sales increased 9%.
- Membership-fee revenue rose 7.8% in Q2 to $459, primarily from new sign-ups and greater Executive Membership penetration. Total cardholders were 65.7 million, versus 62.0 million. Renewal rates were 89% in the U.S. and Canada and 86% worldwide.
- Q2 gross margin declined 30 basis points, primarily reflecting lower core merchandise margins and investment in pricing; the Executive Member reward program also weighed on margin. SG&A improved 29 basis points as a share of net sales, largely from lower warehouse and central operating costs.
- First-half net income increased to $714 from $660, while the effective tax rate rose to 37.3% from 34.9%. A $26 net discrete tax expense, primarily related to a Mexican tax audit and nondeductible costs associated with a Washington State alcohol-law initiative, adversely affected the current-period tax provision.
Outlook, commentary, risks and unusual items
- No specific earnings or sales guidance was provided. For fiscal 2012, management intended to spend approximately $1,400 on real estate, construction, remodeling and equipment; $632 had been spent in the first half. It planned up to 11 additional warehouse openings in the remainder of the year, including a relocation and the reopening of a Japan warehouse closed for earthquake repairs.
- Membership fees were increased effective November 1, 2011 for new members and January 1, 2012 for renewals. Management said the deferred recognition of fees meant the increases had not materially affected first-half membership revenue but would contribute increasingly in later quarters.
- The quarterly dividend was raised to $0.24 per share from $0.205. The board declared the $0.24 dividend during the quarter; it was paid February 24, 2012. The company repurchased 3.881 million shares for $318 in the first half; $3,388 remained available under the repurchase authorization.
- Management cited economic conditions, currency movements, competition, consumer spending, real-estate availability, supplier actions, and rising employee, health-care, energy and commodity costs as risks. It also cautioned that new warehouses can initially have lower profitability and may cannibalize existing locations.
- The company reported several ongoing legal and regulatory matters, including employment, motor-fuel temperature, hazardous-product handling, refrigeration compliance, gasoline-station cleanup materials and unclaimed-property proceedings. It recorded no accrual for the matters described, stating that a material loss was not considered probable; possible losses could not be reasonably estimated. An unfavorable outcome could still materially affect an individual quarter.
- The company was evaluating options to seek a refund of some or all taxes assessed in the Mexican tax audit, but said the likelihood of success was significantly uncertain. It also used foreign-exchange contracts to economically hedge certain exposures and fixed-price energy contracts to partially mitigate energy-price risk.
Important facts for investors to verify
- Whether comparable-sales growth persists after separating gasoline price effects, foreign exchange and new-warehouse contributions.
- Whether merchandise pricing investments and Executive Membership rewards continue to pressure gross margin, and whether SG&A leverage offsets that pressure.
- The repayment of the $900 million notes due March 15, 2012, and subsequent liquidity and capital-spending levels.
- Developments in the Mexican tax audit and the outstanding legal and regulatory matters, for which the filing provides no reasonably estimable aggregate loss range.
- Execution of the fiscal-year capital plan and planned warehouse openings, including the Japan reopening.