Costco Wholesale Corporation — FY2013 Form 10-K
Reporting period: Fiscal year ended September 1, 2013 (52 weeks). Fiscal 2012 had 53 weeks, which affects year-over-year comparisons. Fiscal Q4 was 16 weeks; Q4 FY2012 was 17 weeks.
Business context
Costco operates membership warehouses and online businesses, emphasizing low prices, high sales volume, and rapid inventory turnover. At year-end it operated 634 warehouses across the U.S. and Puerto Rico, Canada, Mexico, the U.K., Japan, Taiwan, Korea, and Australia. U.S. and Canadian operations generated 88% of net sales and 84% of operating income.
Key financial results
| Metric | FY2013 | FY2012 |
|---|---|---|
| Net sales | $102.870 billion | $97.062 billion |
| Total revenue, including membership fees | $105.156 billion | $99.137 billion |
| Membership fees | $2.286 billion | $2.075 billion |
| Gross margin | $10.922 billion; 10.62% of sales | $10.239 billion; 10.55% of sales |
| Operating income | $3.053 billion | $2.759 billion |
| Net income attributable to Costco | $2.039 billion | $1.709 billion |
| Diluted EPS | $4.63 | $3.89 |
| Net cash from operating activities | $3.437 billion | $3.057 billion |
| Capital expenditures | $2.083 billion | $1.480 billion |
Net sales and comparable sales each grew 6%. Net income rose 19%; diluted EPS rose 19%. The prior year’s extra week and changes in foreign exchange affected comparisons. FY2013 net sales were reduced by approximately $208 million from currency movements. Gross margin percentage improved seven basis points; SG&A rose one basis point to 9.82% of sales. Operating income was 2.90% of total revenue.
Cash and short-term investments totaled $6.124 billion at year-end, versus $4.854 billion a year earlier. Long-term debt was $4.998 billion, up from $1.381 billion; short-term borrowings were $36 million. Total current assets were $15.840 billion and current liabilities $13.257 billion. Management said cash and operating cash flows should meet foreseeable capital requirements. Approximately $2.320 billion of cash and short-term investments was held by non-U.S. subsidiaries and was considered indefinitely reinvested.
Material changes and capital allocation
- Costco issued $3.5 billion of Senior Notes in December 2012, primarily to finance a $7.00-per-share special dividend totaling approximately $3.049 billion.
- Quarterly dividends increased from $0.275 to $0.31 per share in April 2013. Total dividends declared were $8.17 per share for FY2013, including the special dividend.
- Membership fees grew 10%, reflecting the earlier U.S. and Canada fee increases and membership sign-ups. Renewal rates were approximately 90% in the U.S. and Canada and 86% worldwide.
- Costco opened 26 warehouses, compared with 17 in FY2012. Paid cardholders increased to 39.0 million from 36.9 million.
- FY2013 net income included a $62 million tax benefit related to the special dividend paid to employee 401(k) plan participants; the filing reports $77 million of net nonrecurring tax benefits overall.
Outlook, risks, and contingencies
Management planned to open 30–36 warehouses in FY2014 and expected capital spending of approximately $2.3–$2.5 billion for real estate, construction, remodels, equipment, and information-system modernization. These are plans, not guarantees. The company expected no material effect from the accounting pronouncement discussed as not yet adopted.
Management describes comparable-sales growth as a key profitability driver and emphasizes maintaining competitive pricing, which can mean absorbing merchandise-cost increases and pressuring gross margin. Principal risks include dependence on U.S. and Canadian operations (especially California), intense retail competition, economic and commodity-price volatility, currency exposure, growth execution and cannibalization, supply and distribution disruptions, technology and cybersecurity risks, product safety, labor and benefit costs, and legal, tax, and regulatory matters.
The company disclosed ongoing litigation and government inquiries. It had not accrued amounts for the matters described in the legal proceedings note; possible losses could not be reasonably estimated. A gender-promotion class action settlement was reached in principle after year-end, subject to definitive documents and court approval; the company stated potential payments would be immaterial. Other disclosed matters include motor-fuel temperature litigation and environmental and prescription-related inquiries. The company said an unfavorable outcome could materially affect an individual quarter, though it did not expect pending matters, individually or in aggregate, to materially affect financial position.
A Section 13(r) disclosure reported that an Iranian Embassy business membership at the Japan subsidiary was canceled in June 2013, but purchases inadvertently continued until August. The company reported $1,032 in Q4 revenue and estimated $13 in net profit from the membership.
Most important facts for investors to verify
- How much of reported earnings growth reflects recurring operations versus the $77 million of net nonrecurring tax benefits, including the $62 million 401(k)-related benefit.
- Whether comparable-sales growth, membership renewals, and new-warehouse openings support continued growth, accounting for the 52-week versus 53-week comparison.
- Whether the $3.5 billion debt-funded special dividend and planned FY2014 capital spending leave adequate liquidity and returns on invested capital.
- Developments in the disclosed litigation, tax audits, and regulatory inquiries, including any change to potential exposure or accruals.
- Execution and costs of information-system modernization, and the company’s management of cybersecurity, foreign-exchange, commodity, and supply-chain risks.