Costco Wholesale Corporation — FY2014 Form 10-K
Reporting period: Fiscal year ended August 31, 2014 (52 weeks). The filing also reports fourth-quarter results; FY2014 Q4 comprised 16 weeks. Dollar amounts are in millions unless otherwise indicated.
Business context
Costco operates membership warehouses and related businesses in the U.S., Canada and other international markets. At year-end it operated 663 warehouses, up from 634. Its low-price, high-volume model relies on rapid inventory turnover, membership fees and supplier payment terms. U.S. and Canadian operations generated 87% of consolidated net sales and 83% of operating income.
Financial results and liquidity
| Metric | FY2014 | FY2013 | Change |
|---|---|---|---|
| Net sales | $110,212 | $102,870 | +7% |
| Total revenue, including membership fees | $112,640 | $105,156 | +7% |
| Membership fees | $2,428 | $2,286 | +6% |
| Gross margin | $11,754; 10.66% of net sales | $10,922; 10.62% | Margin +4 bps |
| Operating income | $3,220; 2.92% of net sales | $3,053; 2.97% | +5% |
| Net income attributable to Costco | $2,058 | $2,039 | +1% |
| Diluted EPS | $4.65 | $4.63 | +0.4% |
| Cash provided by operating activities | $3,984 | $3,437 | +$547 |
| Capital expenditures | $1,993 | $2,083 | -$90 |
| Cash flow after capital expenditures | $1,991 | $1,354 | +$637 |
SG&A was $10,899, or 9.89% of net sales, compared with 9.82% in FY2013. The operating margin declined about 5 basis points despite a 4-basis-point improvement in gross margin. Net margin was approximately 1.87%.
At year-end, cash and cash equivalents were $5,738 and short-term investments were $1,577, totaling $7,315; the cash-equivalent balance included $1,383 of card receivables. Long-term debt was $5,093, with no short-term bank borrowings outstanding. Current assets were $17,588 and current liabilities $14,412. Management stated that cash and operating cash flows should cover foreseeable capital requirements.
FY2014 Q4: Net sales were $34,755, total revenue $35,523, operating income $1,091, net income attributable to Costco $697 and diluted EPS $1.58. The comparable FY2013 quarter reported net sales of $31,771, operating income of $954, net income of $617 and diluted EPS of $1.40.
Material changes and notable items
- Comparable sales increased 4% overall, versus 6% in FY2013; excluding gasoline-price and currency effects, comparable sales rose 6%. Currency changes reduced reported net sales by about $1,336 and diluted EPS by $0.10. Lower average gasoline prices also reduced reported sales.
- Membership renewal rates were approximately 91% in the U.S. and Canada and 87% worldwide. Paid cardholders increased to 42.0 million from 39.0 million.
- Net income growth was modest and included a difficult comparison: FY2013 benefited from a nonrecurring $62 tax benefit tied to the special dividend paid to employee 401(k) plan participants. FY2014’s effective tax rate was 34.7%, versus 32.4%.
- Gross margin benefited from merchandise mix and fresh-food sales penetration, but FY2014 included a $28 LIFO charge versus a $27 LIFO benefit in FY2013; FY2013 also included a nonrecurring legal-settlement benefit to gross margin.
- SG&A as a percentage of sales rose 7 basis points, principally reflecting information-systems modernization and higher stock-based compensation. Preopening expenses increased to $63 from $51 as Costco opened 30 warehouses, including its first in Spain.
- Cash and short-term investments increased to $7,315 from $6,124. Operating cash flow rose, while financing cash use was $786, primarily for dividends and share repurchases. FY2014 dividends declared were $1.33 per share; FY2013’s $8.17 included a $7.00 special dividend.
Outlook, risks and contingencies
Management planned up to 35 warehouse openings in FY2015, including four relocations, and estimated capital expenditures of approximately $2,500–$2,700, expected to be funded from operating cash flow and existing liquidity. The quarterly dividend was increased from $0.31 to $0.355 per share in April 2014. The filing does not provide earnings or comparable-sales guidance.
Key stated risks include intense retail competition; dependence on U.S. and Canadian performance, particularly California; currency, gasoline and commodity-price volatility; execution and cannibalization risks from expansion; member loyalty and Kirkland Signature acceptance; labor and health-care costs; supply disruptions and product safety; cybersecurity and technology implementation; and legal, tax, regulatory and environmental exposure. The company reported an EPA/Department of Justice settlement requiring an immaterial payment and refrigeration-system measures, subject to court approval. It also disclosed ongoing unclaimed-property examinations, DEA inquiries concerning controlled-substance prescriptions, and gasoline-related litigation. Management said pending matters were not expected to have a material adverse effect on financial position, while noting an unfavorable outcome could materially affect an individual quarter.
KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal controls were effective as of year-end.
Investor verification priorities
- Review comparable-sales trends and the effect of currency, gasoline prices and new-store cannibalization on reported growth.
- Assess whether membership growth and renewal rates sustain fee income and shopping activity.
- Track gross-margin and SG&A movements, including LIFO, merchandise mix, health-care costs, stock compensation and technology spending.
- Compare planned FY2015 warehouse openings and $2.5–$2.7 billion capital spending with actual execution and cash generation.
- Monitor debt maturities, international cash and repatriation tax assumptions, and the company’s substantial contractual commitments.
- Follow the status and potential financial impact of disclosed legal, regulatory, tax and DEA matters.