Costco Wholesale Corporation — Q3 FY2019 Form 10-Q
Reporting period: 12 weeks ended May 12, 2019; year-to-date figures cover 36 weeks. Unless noted, dollar amounts are in millions. Costco operated 772 warehouses and e-commerce sites in six countries.
Financial results and liquidity
| Metric | Q3 FY2019 | Q3 FY2018 | 36 weeks FY2019 | 36 weeks FY2018 |
|---|---|---|---|---|
| Net sales | $33,964 | $31,624 | $102,903 | $95,020 |
| Total revenue | $34,740 | $32,361 | $105,205 | $97,165 |
| Operating income | $1,122 | $1,067 | $3,274 | $3,034 |
| Net income attributable to Costco | $906 | $750 | $2,562 | $2,091 |
| Diluted EPS | $2.05 | $1.70 | $5.79 | $4.74 |
- Q3 net sales rose 7%; comparable sales rose 6% (also 6% excluding currency and gasoline effects). Membership-fee revenue increased 5% to $776. U.S./Canada renewal rates were 91%; worldwide renewal was 88%.
- Gross margin was $3,731, or 10.99% of net sales, versus 11.05% a year earlier. Excluding the revenue-recognition standard and gasoline effects, Q3 adjusted gross margin percentage was 11.10%, up 5 basis points. SG&A was $3,371, or 9.92% of sales, versus 9.98%.
- Operating cash flow was $4,063 for the first 36 weeks, down from $4,220. Capital expenditures were $1,989; investing cash use was $1,945. Cash dividends paid were $752 and share repurchases were $195.
- At May 12, cash and cash equivalents were $7,013 and short-term investments were $1,154. Total debt carrying value was $6,529, including $1,699 classified as current. Current liabilities were $22,832 and total liabilities $28,932.
- Cash and short-term investments totaled $8,167, including about $1,460 of unsettled card receivables that generally settle within four days. Management said cash and operating cash flows should meet liquidity and capital needs for the foreseeable future. No short-term bank borrowings were outstanding; available bank-facility capacity was $880.
Changes and notable items
- Q3 net sales increased $2,340, reflecting comparable-sales growth and sales from 23 net new warehouses opened since the prior-year quarter. Currency movements reduced sales by about $427 (135 basis points); the new revenue standard added $346 (110 basis points). Gasoline prices had a slight positive effect.
- For the first 36 weeks, net sales increased 8%; currency reduced sales by about $1,199, while the accounting-standard change added $865 and gasoline prices added about $240.
- Net income growth benefited from lower effective tax rates: 18.5% in Q3 versus 28.8% and 20.7% year to date versus 29.0%. Q3 included a nonrecurring $73 tax benefit, or $0.16 per diluted share, related to U.S. taxation of deemed foreign dividends. Year-to-date tax results included $165 of discrete net tax benefits; excluding these, the reported tax rate was 26.8%.
- Costco adopted the new revenue-recognition standard in Q1 using the modified retrospective method. Reported Q3 net sales were increased by $346 and gross margin by $4; year-to-date increases were $865 and $9, respectively. The standard also changed the presentation of returns and the timing of certain sales.
- Long-term debt excluding the current portion fell to $4,799 from $6,487 at fiscal year-end, while the current portion rose to $1,699 from $90, largely reflecting debt maturity classification. Senior Notes include $1,200 due December 2019 and $500 due February 2020.
Outlook, risks and contingencies
- Management planned fiscal 2019 capital spending of approximately $2,800–$3,100 and expected 13 additional warehouse openings, including two relocations, during the remainder of the year. It provided no specific earnings or sales forecast in this filing.
- The quarterly dividend rate increased to $0.65 per share from $0.57; the declared Q3 dividend was paid May 24, 2019. A new $4,000 share-repurchase authorization, expiring April 2023, left $3,995 available at quarter-end.
- Costco estimated adoption of the lease standard in fiscal 2020 would increase assets and liabilities by approximately $2,500–$3,000; management did not expect a material income-statement or cash-flow effect.
- Management cited competition, consumer spending, foreign exchange, tariffs, employee and other operating costs, gasoline prices, security/privacy breaches, and real-estate and regulatory conditions as risks. Tariff effects were uncertain and could adversely affect sales and margins.
- Disclosure controls were not effective at May 12 because of a previously disclosed material weakness in internal control over financial reporting. Management expected remediation before fiscal year-end, subject to controls operating effectively and testing.
- Legal matters include employment-related claims, opioid litigation, shareholder securities and derivative actions concerning internal-control disclosures, and regulatory notices. Accruals for described matters were immaterial; the company said adverse outcomes could nevertheless cause a material charge in an individual quarter or year. Possible losses for certain tax and legal matters could not be reasonably estimated.
Important facts for investors to verify
- How much of reported earnings growth reflects the lower tax rate and the nonrecurring $73 Q3 benefit, rather than operating performance.
- Comparable-sales trends and margin performance after separating currency, gasoline, new-accounting-standard, and new-warehouse effects.
- The timing and funding of the December 2019 and February 2020 debt maturities, and the eventual effect of lease-standard adoption.
- Progress and testing of the internal-control remediation plan, plus developments in securities litigation and other contingencies.
- Whether planned fiscal 2019 capital spending and warehouse openings proceed as expected, and how tariffs or other cost pressures affect pricing and margins.