Costco Wholesale Corporation — Q1 FY2019 Form 10-Q
Reporting period: 12 weeks ended November 25, 2018; comparable period ended November 26, 2017. Amounts are in millions of dollars unless noted. Costco operated 768 warehouses and e-commerce sites in six countries.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change / context |
|---|---|---|---|
| Net sales | $34,311 | $31,117 | Up 10%; comparable sales up 9% |
| Membership fees | $758 | $692 | Up 10% |
| Total revenue | $35,069 | $31,809 | Up about 10% |
| Gross margin | $3,688 | $3,500 | Gross margin rate 10.75%, down 50 basis points |
| SG&A | $3,475 | $3,224 | 10.13% of net sales, down 23 basis points |
| Operating income | $949 | $951 | Slightly lower |
| Net income attributable to Costco | $767 | $640 | Up 20% |
| Diluted EPS | $1.73 | $1.45 | Up from prior year |
| Operating cash flow | $2,177 | $2,006 | Up $171 |
| Capital expenditures | $730 | $820 | Lower year over year |
Liquidity, debt and cash flow
- At November 25, 2018, cash and cash equivalents were $6,778 and short-term investments were $1,175, totaling $7,953. The filing notes that approximately $1,611 of this balance represented unsettled card receivables, generally settled within four days.
- Current assets were $22,954 versus current liabilities of $22,473. Long-term debt, excluding current portion, was $6,480; total debt carrying value before discounts and issuance costs was $6,514. No short-term bank borrowings were outstanding.
- Operating cash flow was $2,177; investing cash outflow was $737, primarily for capital expenditures; financing cash outflow was $700, including $501 of dividends and $270 of tax withholdings on stock-based awards. Ending cash was $6,778.
- Management said cash and operating cash flows should meet liquidity and capital needs for the foreseeable future. Available borrowing capacity under bank facilities was $876.
Material changes and drivers
- Net sales growth reflected 9% comparable-sales growth and sales from 22 net new warehouses opened since the prior-year quarter. Higher gasoline prices added approximately $421, or 135 basis points, to sales; the new revenue standard added $340, or 109 basis points. Currency movements reduced sales by approximately $313, or 101 basis points.
- Reported gross margin rate fell 50 basis points. Excluding the effects of gasoline-price inflation and the new revenue standard on sales, adjusted gross margin rate was 10.99%, down 26 basis points. The company cited lower margins in core categories and a 13-basis-point negative effect from an adjustment to estimated co-branded card reward breakage.
- SG&A increased in dollars but declined as a share of sales; excluding gasoline and accounting-standard effects, the rate was flat year over year. Higher wage costs and stock compensation partly offset operating leverage.
- The effective tax rate was 16.9%, compared with 30.4%. Q1 FY2019 included $93 of discrete tax benefits, including $59 related to stock-based compensation and $27 related to implementation of the 2017 Tax Act. Excluding discrete benefits, the rate was 26.8%; lower tax expense was a major contributor to net income growth.
- Adoption of the new revenue recognition standard increased reported net sales by $340 and merchandise costs by $331, for a $9 gross-margin increase. It also changed presentation and timing for returns, cash-card breakage, certain online sales, and some vendor arrangements.
Outlook, risks and unusual items
- Costco planned to open 19 additional warehouses, including two relocations, during the remainder of FY2019. It expected fiscal-year capital expenditures of approximately $2.8–$3.1 billion; plans could change.
- The filing provides no specific earnings or revenue guidance. Management emphasized sales growth, especially comparable sales, membership growth and renewal rates, cost control, and low-price positioning. U.S. and Canada renewal rates were 91%; worldwide renewal was 88%. Paid members totaled 52.2 million, up from 49.9 million.
- The quarterly dividend rate was raised to $0.57 per share from $0.50 in the prior-year quarter. The October 2018 dividend was paid November 23, 2018.
- Disclosure controls were not effective at quarter end 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 California wage-and-hour litigation, an Ontario drug-benefit investigation, opioid-related cases, shareholder securities and derivative actions related to internal-control disclosures, and Connecticut hazardous-waste notices. The company recorded an immaterial accrual for one described matter; possible losses for other matters could not be reasonably estimated. Management did not expect pending matters, individually or in aggregate, to materially affect financial position, results or cash flows, but acknowledged an unfavorable outcome could materially affect an individual quarter.
- Risks discussed include currency and interest-rate movements, competition, consumer spending, employee and commodity costs, tariffs and geopolitical conditions, security and privacy breaches, real-estate constraints, and the ability to remediate the control weakness. The company said there were no material changes to risk factors or market risks previously disclosed.
Important facts for investors to verify
- Whether the sales and comparable-sales growth persists after adjusting for gasoline prices, currency, new warehouses and the revenue-accounting adoption.
- Whether core merchandise margins recover, given the quarter’s reported margin decline and reward-breakage adjustment.
- How much of the 20% net-income increase is repeatable, considering the lower tax rate and discrete tax benefits.
- Progress and testing results for remediation of the material weakness in internal controls, and developments in related shareholder litigation.
- Execution of the warehouse-opening and $2.8–$3.1 billion capital-spending plans, alongside dividend and liquidity needs.
- The expected balance-sheet effect of lease-accounting adoption in fiscal 2020; management expected a material balance-sheet impact but no material income-statement or cash-flow effect.