Costco Wholesale Corporation — FY2019 Form 10-K
Business context and reporting period. Costco operates membership warehouses and related e-commerce and ancillary businesses. This 10-K covers the 52 weeks ended September 1, 2019; the fourth quarter was 16 weeks. Fiscal 2018 was also 52 weeks. Unless noted, amounts below are in U.S. dollars and millions.
Financial and operating performance
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Net sales | $149,351 | $138,434 | +8% |
| Membership fees | $3,352 | $3,142 | +7% |
| Operating income | $4,737 | $4,480 | +6% |
| Net income attributable to Costco | $3,659 | $3,134 | +17% |
| Diluted EPS | $8.26 | $7.09 | +16% |
| Operating cash flow | $6,356 | $5,774 | +10% |
| Capital expenditures | $2,998 | $2,969 | +1% |
- Total-company comparable sales rose 6% versus 9% in FY2018; excluding currency, gasoline-price and revenue-recognition effects, comparable sales rose 6% versus 7%.
- Gross margin was $16,465; gross margin rate was 11.02%, down 2 basis points from 11.04%. Excluding the new revenue-recognition standard’s effect on sales, the rate was 11.12%, up 8 basis points.
- SG&A was $14,994, or 10.04% of sales, up 2 basis points. Operating income margin was approximately 3.2% of net sales; net income margin was approximately 2.5%.
- Net income benefited from a lower effective tax rate: 22.3% versus 28.4%. The filing reports $221 of net discrete tax benefits; excluding those benefits, the FY2019 tax rate was 26.9%.
- At year-end, cash and cash equivalents were $8,384 and short-term investments were $1,060, totaling $9,444. Total debt was $6,852, including $1,699 current; long-term debt excluding the current portion was $5,124. No short-term bank borrowings were outstanding.
- Current assets were $23,485 and current liabilities $23,237. Operating cash flow less capital expenditures was approximately $3,358.
- Costco paid $1,038 in dividends and declared $2.44 per share for FY2019. The quarterly dividend was raised to $0.65 per share. It repurchased $247 of stock during the year; $3,943 remained under the $4,000 authorization.
Fourth-quarter results
In the 16-week fourth quarter, net sales were $46,448 and membership fees were $1,050, compared with $43,414 and $997, respectively, in the prior-year quarter. Operating income was $1,463 versus $1,446; net income attributable to Costco was $1,097 versus $1,043; diluted EPS was $2.47 versus $2.36.
Material changes and management commentary
- Net sales growth reflected 6% comparable-sales growth and sales from new warehouses. Foreign exchange reduced sales by approximately $1,463; adoption of the new revenue-recognition standard increased reported sales by $1,332. Gasoline-price changes had no material sales impact.
- The revenue standard was adopted in FY2019 and affected the presentation and timing of certain transactions. Excluding its effect, net sales were $148,019 and gross margin was $16,457.
- Gross-margin performance reflected stronger ancillary businesses, particularly gasoline, partly offset by lower core-category margins and higher Executive-member rewards. The filing cites a $123 product-tax-assessment charge as a significant factor in higher SG&A as a percentage of adjusted sales.
- Costco opened 25 warehouses, including five relocations, and ended the year with 782 locations. This included its first warehouse in China. Paid members reached 53.9 million; renewal rates were 91% in the U.S. and Canada and 88% worldwide.
- Management expects FY2020 capital expenditures of approximately $3,000–$3,200 and plans approximately 22 warehouse openings, including three relocations. No earnings or sales guidance is provided.
- Management stated that cash, investments and operating cash flows should meet liquidity and capital needs for the foreseeable future. The company expects to continue quarterly dividends, subject to Board approval.
Risks, contingencies and unusual items
- Key risks include dependence on U.S. and Canadian operations, intense retail competition, membership retention, labor and benefit costs, foreign exchange, tariffs, volatile commodities, supply disruptions, cybersecurity and privacy, and execution of international and digital growth.
- The company recorded a $123 product-tax-assessment charge in FY2019 and plans to protest the assessment received after year-end. Other tax examinations and legal matters could result in material charges, though outcomes and possible losses are not generally estimable from the filing.
- Costco disclosed multiple employment-related class actions, opioid-related litigation, shareholder suits concerning prior internal-control disclosures, and environmental matters. It did not believe pending matters would have a material adverse effect on its overall financial position, results or cash flows, while noting an adverse outcome could materially affect an individual quarter or year.
- Self-insurance liabilities were $1,222, up from $1,148. Estimation of these liabilities was a critical audit matter.
- A material weakness in IT general controls identified in FY2018 was reported as remediated by September 1, 2019, and management and the auditor concluded internal control over financial reporting was effective at year-end. The auditor nevertheless performed additional procedures because controls were ineffective for part of FY2019.
- Adoption of the new lease accounting standard was expected in FY2020 to increase reported assets and liabilities by approximately $2,400, with no material impact expected on income or cash flows.
Important facts for investors to verify
- Separate underlying sales and margin trends from the $1,332 revenue-recognition uplift and foreign-exchange effects.
- Assess the sustainability of earnings growth given the lower tax rate and $221 of discrete tax benefits.
- Track resolution of the $123 product-tax assessment, related audits and other legal contingencies.
- Review whether warehouse expansion and planned capital spending generate returns without materially cannibalizing existing locations.
- Monitor renewal rates, comparable sales, wage and benefit costs, self-insurance claims, and progress in maintaining effective IT controls.