Costco Wholesale Corporation — Q1 FY2020 Form 10-Q
Reporting period: 12 weeks ended November 24, 2019; comparable period ended November 25, 2018. Amounts are in millions except per-share data. Costco operated 785 warehouses worldwide and e-commerce sites in seven countries.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $36,236 | $34,311 | +6% |
| Membership fees | $804 | $758 | +6% |
| Total revenue | $37,040 | $35,069 | +6% |
| Gross margin | $4,003 | $3,688 | Gross margin rate 11.05%, up 30 basis points |
| Operating income | $1,061 | $949 | +12% |
| Net income attributable to Costco | $844 | $767 | +10% |
| Diluted EPS | $1.90 | $1.73 | +10% |
| Operating cash flow | $2,102 | $2,177 | Down $75 |
Comparable sales rose 4% overall; excluding currency and gasoline price changes, they rose 5%. Growth was supported by higher shopping frequency and average ticket, plus sales from 17 net new warehouses opened since the comparable quarter. Lower gasoline prices and foreign exchange reduced reported sales by approximately $122 and $103, respectively.
SG&A was $3,732, or 10.30% of net sales versus 10.13% a year earlier. Management attributed the rate increase principally to operating costs, employee wage and bonding-leave benefits, stock compensation, and technology spending. The effective tax rate was 19.1%, compared with 16.9%; Q1 FY2020 included a $77 stock-compensation tax benefit, while the prior-year quarter included $59 of such benefits and a $27 benefit related to the 2017 Tax Act.
Liquidity, debt and cash flows
- Cash and cash equivalents were $9,027 and short-term investments were $993 at November 24, 2019, totaling $10,020.
- Current assets were $26,643 and current liabilities were $26,265. Merchandise inventory increased to $13,818 from $11,395 at fiscal year-end.
- Balance-sheet debt was $6,807, comprising $1,700 current and $5,107 long-term. Costco repaid the $1,200 of 1.70% Senior Notes, plus interest, on December 16, 2019.
- Operating cash flow was $2,102; investing cash outflow was $630, including $715 of property and equipment additions; financing cash outflow was $836, including $573 of dividends paid.
Material changes, outlook and notable items
- Total gross margin rate increased 30 basis points. Management cited ancillary businesses and the prior-year adjustment to estimated co-branded-card reward breakage; core merchandise margin, measured on core sales, increased 4 basis points. New poultry-plant start-up losses weighed on fresh-food margins.
- Membership fees increased with sign-ups. Paid members reached 54.7 million, up from 52.2 million; renewal rates were 91% in the U.S. and Canada and 88% worldwide.
- Management expected approximately $3.0 billion of capital expenditures in FY2020 and 17 additional warehouse openings, including two relocations, for the remainder of the fiscal year. These are plans, not guaranteed results. No earnings or EPS guidance is provided in the filing.
- The quarterly dividend was raised to $0.65 per share from $0.57 a year earlier. The quarter’s dividend was paid November 15, 2019.
- Costco adopted ASC 842 lease accounting on September 2, 2019. Adoption initially added $2,632 of operating-lease assets and obligations; the company said income-statement and cash-flow effects were not material. At quarter-end, operating lease liabilities were $2,611 in present value.
- Management cited risks including competition, economic and consumer-spending conditions, foreign exchange, tariffs, employee and commodity costs, security/privacy incidents, and real-estate matters. It said risk factors were not materially changed from the FY2019 10-K.
Contingencies and unusual items
Costco is defending employment-related class and other actions, opioid-related litigation, and shareholder securities and derivative suits concerning internal-control disclosures. Certain California employment matters had proposed settlements subject to court approval; the consolidated securities complaint was dismissed with leave to amend. The filing reports immaterial legal accruals, but says an adverse outcome could produce a material charge in an individual quarter or year; potential losses generally could not be reasonably estimated. The company also faces tax and regulatory examinations, including a product-tax assessment recorded in FY2019 that it is contesting. Management did not believe pending litigation would materially affect financial position, results or cash flows.
Important facts for investors to verify
- Whether comparable-sales momentum, membership growth and renewal rates persist, and how the Thanksgiving timing shift and new-store cannibalization affect comparisons.
- Whether margin gains continue after considering gasoline mix, ancillary results, employee and technology costs, and poultry-plant start-up losses.
- Execution of the planned FY2020 capital spending and warehouse openings, and the resulting cash and working-capital needs.
- Post-quarter repayment of the $1.2 billion notes and the implications of lease obligations alongside reported debt.
- Developments in the disclosed litigation, tax assessments, tariff exposure and other contingencies; potential losses are not clearly quantified in the filing.