Business Context and Reporting Period
Company: Costco Wholesale Corporation
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: 12 weeks ended November 23, 2008 (First Quarter of Fiscal 2009)
Operations: Operates 519 membership warehouses globally (399 in the U.S., 76 in Canada, and others in the U.K., Japan, Korea, and Taiwan), plus a 50%-owned joint venture in Mexico with 31 warehouses.
Key Financial Metrics
| Metric | Q1 2009 | Q1 2008 |
|---|---|---|
| Total Revenue | $16,395 million | $15,810 million |
| Net Sales | $16,036 million | $15,472 million |
| Membership Fees | $359 million | $338 million |
| Gross Margin | $1,760 million (10.97% of net sales) | $1,648 million (10.65% of net sales) |
| Operating Income | $422 million | $395 million |
| Net Income | $263 million | $262 million |
| Diluted EPS | $0.60 | $0.59 |
| Cash and Cash Equivalents | $2,215 million | $2,619 million (Aug 31, 2008) |
| Short-term Investments | $602 million | $656 million (Aug 31, 2008) |
| Total Debt (Current + Long-term) | $2,365 million | $2,346 million (Aug 31, 2008) |
| Operating Cash Flow | ($39) million (Used) | $271 million (Provided) |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 3.7% year-over-year. Net sales grew 3.6%, driven by a 1% increase in comparable sales and the addition of 25 new warehouses. However, foreign currency weakness (Canada, U.K., Korea) negatively impacted net sales by approximately $516 million.
- Profitability: Net income increased slightly to $263 million. Gross margin percentage improved by 32 basis points, aided by a 46 basis point increase in ancillary businesses (primarily gasoline) and a favorable LIFO adjustment. This was partially offset by a 13 basis point decrease in core merchandise margins.
- Expenses: Selling, General, and Administrative (SG&A) expenses as a percentage of net sales increased 31 basis points. Key drivers included increased employee healthcare costs and a $28 million mark-to-market write-down on employee life insurance contracts.
- Cash Flow: Operating cash flow turned negative ($39 million used) compared to $271 million provided in the prior year. This was primarily due to a $268 million increase in net investment in merchandise inventories.
- Investments: The company recognized a $6 million other-than-temporary impairment loss on certain securities. Additionally, several money market funds (Columbia, BlackRock, Merrill Lynch, and The Reserve U.S. Government Fund) faced liquidity restrictions or redemption suspensions, though The Reserve fund is covered by a U.S. Treasury guarantee.
Guidance, Outlook, and Risks
- Expansion Plans: Management intends to spend approximately $1,500 million to $1,700 million in fiscal 2009 on real estate, construction, and equipment. Plans include opening 13 to 15 additional new warehouses and 1 to 2 relocations for the remainder of the fiscal year.
- Capital Allocation: The company repurchased 845,000 shares of common stock for $55 million. A quarterly dividend of $0.16 per share was declared and paid.
- Legal Proceedings: The company is involved in numerous class actions, including:
- California overtime and wage statement disputes (potential settlement of up to $16 million reserved).
- Shareholder derivative lawsuits alleging stock option backdating (1997–2006).
- Investigations by the U.S. Attorney's Office regarding stock option practices and hazardous merchandise handling.
- Consumer class actions regarding gasoline temperature sales practices and organic milk/salmon labeling.
- Market Risks: Significant exposure to foreign currency fluctuations and interest rate changes. The company notes that general economic conditions are negatively impacting member spending, particularly in hardlines and softlines.
Investor Verification Checklist
- Inventory Build: Verify the sustainability of the $1,096 million increase in merchandise inventories and its impact on future working capital needs.
- Investment Liquidity: Monitor the resolution of the restricted money market funds (Columbia, BlackRock, Merrill Lynch, The Reserve) and potential for further impairment losses.
- Legal Exposure: Track the status of the stock option backdating litigation and the California wage class actions, as outcomes could result in material charges.
- Foreign Currency Impact: Assess the ongoing effect of weakening foreign currencies (CAD, GBP, KRW) on reported revenue and earnings.
- Healthcare Costs: Evaluate the trajectory of rising employee healthcare costs, which significantly impacted SG&A margins in this quarter.