Costco Wholesale Corporation — Q3 FY2020 Form 10-Q
Reporting period: 12 weeks ended May 10, 2020; year-to-date figures cover 36 weeks. Comparatives are the corresponding periods ended May 12, 2019. Amounts are in millions except per-share data.
Business context
Costco operates membership warehouses and e-commerce sites, emphasizing high-volume sales at low prices and membership-fee revenue. It operated 787 warehouses worldwide at quarter-end. COVID-19 affected operations across segments, including reduced hours, capacity limits, department and service restrictions, and temporary employee compensation increases.
Key financial metrics
| Metric | 12 weeks ended May 10, 2020 | 12 weeks ended May 12, 2019 | Change |
|---|---|---|---|
| Net sales | $36,451 | $33,964 | +7% |
| Membership fees | $815 | $776 | +5% |
| Total revenue | $37,266 | $34,740 | +7% |
| Operating income | $1,179 | $1,122 | +5% |
| Net income attributable to Costco | $838 | $906 | -7% |
| Diluted EPS | $1.89 | $2.05 | -8% |
| Gross margin as % of net sales | 11.53% | 10.99% | +54 bps |
| SG&A as % of net sales | 10.51% | 9.92% | +59 bps |
For the first 36 weeks, revenue was $113,378 (+8%), operating income $3,506 (+7%), net income attributable to Costco $2,613 (+2%), and diluted EPS $5.89 versus $5.79. Gross margin was 11.18% versus 11.01%; SG&A was 10.19% versus 10.02% of net sales.
Cash flow and liquidity: Year-to-date operating cash flow was $4,619, versus $4,063; capital expenditures were $1,958. Cash and cash equivalents were $10,826 and short-term investments $948 at May 10, 2020. Current assets were $25,254 and current liabilities $22,779.
Debt: Reported long-term debt was $9,149 before discounts and current maturities ($7,598 excluding the current portion). Costco issued $4,000 of senior notes in April, with maturities from 2027 to 2032. After quarter-end, it used part of the proceeds to redeem $1.5 billion of notes early; the filing says a $36 charge will be recorded in Q4.
Material changes and drivers
- Q3 comparable sales increased 5%; excluding currency and gasoline-price changes, they increased 8%. E-commerce comparable sales rose 65%. Comparable-sales growth was supported by higher average tickets, while traffic was affected by restrictions and stay-at-home orders.
- Sales shifted from ancillary businesses to food and sundries and fresh foods. Gasoline sales volume fell about 20%, and the average price per gallon declined 21%, reducing reported net sales by $671. Currency movements reduced sales by approximately $407.
- Gross margin percentage increased 54 basis points, but core merchandise margin as a percentage of core sales declined 17 basis points. COVID-related wage and sanitation costs reduced gross margin by $44 and increased SG&A by $239 in Q3.
- Management attributed the Q3 net income decline partly to $283 of pretax incremental COVID-related wage and sanitation costs, or $0.47 per diluted share. The prior-year quarter included a nonrecurring $73 tax benefit, or $0.16 per share.
- Membership-fee revenue rose 5%; paid members were 55.8 million and cardholders 101.8 million. Renewal rates were 91% in the U.S. and Canada and 88% worldwide.
- Investing cash use rose to $2,950 year to date, including the $998 Innovel acquisition and a minority investment in Navitus. Innovel’s initial purchase-price allocation was provisional, including $935 of goodwill.
Outlook, risks and contingencies
Management said the pandemic’s effects on results, financial position and liquidity could not be reasonably estimated because the duration and consequences were uncertain. The filing cites risks including supply-chain disruption, product availability and delivery delays, labor shortages and higher costs, changing demand, reduced traffic, facility closures, and volatility in capital markets. Management stated that available cash and operating cash flows should meet liquidity and capital requirements for the foreseeable future.
For the remainder of FY2020, Costco expected to open 10 additional warehouses, including two relocations, and intended to spend $2.7–$2.9 billion on capital expenditures for the fiscal year; construction projects had been delayed by COVID-19. These were plans, not guarantees. The quarterly dividend was increased 8% to $0.70 per share, paid May 15, 2020.
Other items to monitor include ongoing wage-and-hour and other legal matters, opioid-related litigation, shareholder securities and derivative actions concerning internal-control disclosures, and tax examinations. Costco said it did not expect pending litigation, individually or in aggregate, to materially adversely affect its financial position, results or cash flows, while acknowledging an unfavorable outcome could materially affect an individual quarter or year.
Important facts for investors to verify
- Whether COVID-related wage, sanitation, supply-chain and labor costs persist, and how they affect margins and earnings.
- Whether strong e-commerce and comparable-sales trends continue as store restrictions and consumer behavior change.
- Actual FY2020 capital spending and warehouse openings versus management’s plans.
- The final Innovel purchase-price allocation, including goodwill and assumed obligations, and the acquisition’s contribution to results.
- The post-quarter debt redemption, its $36 charge, and resulting debt and interest expense.
- Developments in material legal matters and tax assessments, for which possible losses may not be estimable.