Costco Wholesale Corporation — Q1 FY2013 Form 10-Q
Reporting period: 12 weeks ended November 25, 2012; comparative period was the 12 weeks ended November 20, 2011. Unless otherwise noted, dollar amounts are in millions.
Business context and results
Costco operated 617 membership warehouses worldwide and online businesses in the U.S., Canada and U.K. Its low-price, high-volume model relies on rapid inventory turnover and thin merchandise margins. In July 2012, Costco acquired its former partner’s remaining 50% interest in Costco Mexico; the current quarter includes all Mexico earnings attributable to Costco, unlike the comparable period.
- Revenue: Total revenue rose 9.6% to $23,715, including net sales of $23,204, up 9.6%, and membership fees of $511, up 14.4%. Net sales growth reflected 7% comparable-sales growth and sales from 25 net new warehouses opened since the start of Q1 FY2012. Gasoline-price inflation added about $138 and foreign exchange added about $116 to net sales.
- Profit and margins: Operating income increased to $639 from $543. Net income attributable to Costco rose 30% to $416 from $320; diluted EPS was $0.95 versus $0.73. Gross margin was 10.68% of net sales, up six basis points; SG&A was 10.05%, improving seven basis points.
- Cash flow: Operating cash flow was $1,102 versus $664. Investing cash outflow was $855 versus $352, including $488 of property-and-equipment additions. Financing cash inflow was $121 versus $67. Cash and cash equivalents ended the quarter at $3,897, compared with $3,528 at FY2012 year-end.
- Liquidity and debt: Cash and short-term investments totaled $5,576, up from $4,854 at September 2, 2012. Long-term debt was $1,367 carrying value, including $1 of current maturities; short-term borrowings were $12. After quarter-end, Costco issued $3,500 of senior notes.
- Other: The quarterly dividend declared was $0.275 per share, compared with $0.24 in the prior-year quarter. The effective tax rate was 34.8%, down from 40.8%; the prior-year rate included a $29 net discrete tax expense, primarily related to a Mexico tax audit and nondeductible expenses.
Material changes and management commentary
- Comparable sales increased 7% versus 10% in the prior-year quarter. Excluding gasoline-price inflation and foreign exchange, comparable sales rose 6% versus 7%; management attributed the increase to higher shopping frequency and average spending.
- Membership-fee growth reflected the prior fee increase, new sign-ups and improved renewal rates. Renewal rates were approximately 89.7% in the U.S. and Canada and 86.4% worldwide.
- Core merchandise gross margin, measured against core merchandise sales, declined one basis point, with U.S. fresh-food and softlines pricing investments partly offset by international improvement. Higher gasoline margins helped consolidated gross margin. SG&A leverage from sales and lower prior-year alcohol-law reform contributions was partly offset by higher stock compensation and IT modernization costs.
- Management said current cash and operating cash flow should meet foreseeable capital requirements. It planned approximately $2,000 of FY2013 spending on real estate, construction, remodeling, equipment and information systems; $488 had been spent through Q1. Plans called for up to 21 additional warehouse openings during the remainder of FY2013.
Outlook, risks and unusual items
- On November 28, 2012, after quarter-end, the board declared a $7.00-per-share special dividend. Costco paid approximately $3,049 on December 18. On December 7, it issued $3,500 of notes at coupons of 0.650%, 1.125% and 1.700%, due in 2015, 2017 and 2019, primarily to fund the dividend; approximately $450 was designated for general corporate purposes. The filing expects interest expense to increase as a result of the issuance.
- Management identified risks including economic conditions, competition, consumer spending, foreign exchange, regulation, real estate, vendor actions, employee and healthcare costs, energy and commodity prices, and geopolitical conditions. Costco noted that modest changes in gross margin or SG&A can materially affect results given its low-margin model. No specific earnings or comparable-sales guidance was provided.
- Legal matters include a gender-promotion class action, fuel-temperature litigation and settlement-related proceedings, environmental inquiries, and other claims. A Washington unclaimed-property assessment was settled in November 2012 for less than the $3.3 assessment. Costco said pending matters were not expected to materially affect financial position, but an unfavorable outcome could cause a material charge in an individual quarter; possible losses for certain matters could not be reasonably estimated.
- Other notable items: deflation produced a $2 benefit to merchandise costs from the LIFO adjustment. Management reported effective disclosure controls and no material change in internal control over financial reporting; it also reported no material change in risk factors from the FY2012 10-K.
Important facts for investors to verify
- How much of sales and comparable-sales growth was driven by gasoline prices, foreign exchange, new warehouses and underlying member demand.
- Whether membership renewal rates and fee revenue growth persist after the earlier fee increase’s effects roll off.
- Funding and balance-sheet effects of the $7 special dividend and $3.5 billion note issuance, including future interest expense.
- Execution of the planned FY2013 capital spending and warehouse openings, and the returns from that investment.
- Developments in the disclosed legal and regulatory matters, including potential timing and magnitude of losses that the filing could not estimate.