Costco Wholesale Corporation — Q2 FY2010 Form 10-Q
Business context and reporting period. Costco operates membership warehouses offering a limited selection of products at low prices. This filing covers the 12 weeks ended February 14, 2010, and the first 24 weeks of fiscal 2010; comparisons are with the corresponding periods ended February 15, 2009. At quarter-end, Costco operated 534 warehouses, including 32 in Mexico through a 50%-owned joint venture.
Financial performance and position
| Metric | Q2 FY2010 | Q2 FY2009 | First half FY2010 | First half FY2009 |
|---|---|---|---|---|
| Net sales | $18.356 billion | $16.488 billion | $35.278 billion | $32.524 billion |
| Membership fees | $386 million | $355 million | $763 million | $714 million |
| Operating income | $470 million | $398 million | $898 million | $820 million |
| Net income attributable to Costco | $299 million | $239 million | $565 million | $502 million |
| Diluted EPS | $0.67 | $0.55 | $1.27 | $1.14 |
| Gross margin as % of net sales | 10.68% | 10.42% | 10.77% | 10.69% |
| SG&A as % of net sales | 10.20% | 10.11% | 10.35% | 10.28% |
Q2 net sales rose 11.3%, with comparable sales up 9%; first-half sales rose 8.5%, with comparable sales up 6%. Management attributed growth to stronger shopping frequency and spending, new warehouses, and higher sales from gasoline-price inflation and stronger foreign currencies. Those two factors contributed approximately $973 million to Q2 sales and $1.011 billion to first-half sales, so reported growth includes substantial fuel-price and currency effects.
Q2 net income attributable to Costco increased 24.9%; diluted EPS increased 21.8%. First-half net income increased 12.5% and diluted EPS increased 11.4%. Q2 gross margin improved 26 basis points, while SG&A as a share of sales increased 9 basis points. A $22 million employee-benefit change charge reduced Q2 and first-half earnings by approximately $0.03 per diluted share. First-half operating cash flow was $1.360 billion, versus $850 million; capital expenditures were $506 million, versus $671 million. Cash and cash equivalents were $4.134 billion at February 14, and short-term investments were $585 million, for combined liquidity of $4.719 billion.
At February 14, total assets were $23.366 billion, total liabilities $12.623 billion, and total equity $10.743 billion. Current assets were $11.501 billion against current liabilities of $9.865 billion. Debt included $46 million of short-term borrowings, $45 million of current long-term debt, and $2.134 billion of long-term debt. Long-term debt carrying value was $2.179 billion; the filing reports estimated fair value of $2.396 billion. The company said it was in compliance with borrowing covenants.
Material changes, outlook and management commentary
- Sales growth and membership fees benefited from 15 net new warehouses opened since the prior-year comparable quarter and greater penetration of Executive Memberships. Cardholders totaled 56.9 million, up from 54.5 million; the renewal rate was 87%.
- Management cited a continuing adverse effect from general economic conditions on member spending. It emphasized maintaining competitive prices, even where this means absorbing cost increases, and noted that low margins make results sensitive to modest changes in gross margin and expenses.
- Management planned approximately $1.2 billion in FY2010 capital spending, funded by operating cash flow and existing liquidity. Costco had spent $506 million and opened eight warehouses, including relocations, in the first half; it planned up to seven additional openings for the rest of the year. This is a stated plan, not earnings guidance.
- The current quarterly dividend was $0.18 per share ($0.72 annualized); the company said it presently expected to continue quarterly dividends, subject to Board approval. The Board appointed W. Craig Jelinek President and COO and elected him a director; Jim Sinegal remained CEO.
- Legal matters include employment and other putative class actions, a proposed membership-renewal settlement, a proposed motor-fuel temperature settlement, and environmental and regulatory inquiries. The company said it could not reasonably estimate possible losses for several matters and did not believe pending matters would materially affect its financial position, while acknowledging an unfavorable outcome could materially affect an individual quarter.
Most important facts for investors to verify
- How much of comparable-sales and earnings growth reflects underlying customer demand versus gasoline prices and foreign-exchange movements.
- Whether gross-margin improvement and expense control persist, particularly given the $22 million employee-benefit charge and higher healthcare and workers’ compensation costs.
- Execution of the approximately $1.2 billion capital-spending plan, planned warehouse openings, and the resulting cash and debt position.
- Developments, potential costs, and court approval status for the disclosed class actions, settlements, and environmental matters; several potential losses were not estimable.
- Membership growth, Executive Membership penetration, and renewal rates, which support recurring fee revenue.