Costco Wholesale Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter ended May 11, 2014 (12 weeks), and first 36 weeks of fiscal 2014, compared with the periods ended May 12, 2013. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise.
Business context and results
Costco operated 653 membership warehouses worldwide and online businesses in the U.S., Canada, U.K. and Mexico. Its model relies on high sales volumes, rapid inventory turnover, low prices and membership-fee income.
| Metric | Third quarter | First 36 weeks |
|---|---|---|
| Net sales | $25,233; up 7% | $75,457; up 6% |
| Total revenue, including membership fees | $25,794; up 7% | $77,117; up 6% |
| Membership fees | $561; up 6% | $1,660; up 6% |
| Operating income | $737; up 2% | $2,129; up 1% |
| Net income attributable to Costco | $473; up 3% | $1,361; down 4% |
| Diluted EPS | $1.07 vs. $1.04 | $3.07 vs. $3.23 |
| Gross margin as % of net sales | 10.62% vs. 10.67% | 10.65% vs. 10.65% |
| SG&A as % of net sales | 9.86% vs. 9.82% | 9.96% vs. 9.85% |
Third-quarter comparable sales rose 4% overall (6% excluding gasoline-price and foreign-currency effects); first-36-week comparable sales rose 3% (5% excluding those effects). Renewal rates were 91% in the U.S. and Canada and 87% worldwide. Paid cardholders totaled 40.9 million.
Cash flow, balance sheet and liquidity
- Operating cash flow for the first 36 weeks was $3,142, versus $2,874 a year earlier. Investing cash outflow was $1,487, mainly reflecting capital spending; financing cash outflow was $542.
- Cash and cash equivalents were $5,736 and short-term investments $1,539 at May 11, 2014, totaling $7,275. Cash increased by $1,092 from fiscal year-end.
- Total assets were $32,701; current assets $17,533 and current liabilities $14,687. Long-term debt, excluding current portion, was $4,985, compared with $4,998 at fiscal year-end.
- Management said cash and operating cash flows should be sufficient for foreseeable capital requirements. The company planned approximately $2,200 of fiscal-2014 capital expenditures; $1,426 had been spent through the first 36 weeks.
- Cash dividends paid during the first 36 weeks were $273; the current quarterly dividend was raised 14.5% to $0.355 per share. The filing reports $0.975 per share declared year to date in 2014 versus $7.86 in 2013, reflecting the prior-year special dividend.
Material changes and management commentary
- Third-quarter net sales growth reflected comparable-sales gains and newer warehouses, but was reduced by approximately $343 from currency movements and $55 from lower gasoline prices. Currency and gasoline effects reduced first-36-week sales by approximately $1,200 and $363, respectively.
- Management attributed comparable-sales improvement chiefly to increased shopping frequency. For the first 36 weeks, that was partly offset by lower average spending per visit. New locations also created some cannibalization, particularly internationally.
- Third-quarter gross margin declined five basis points. Management cited a $12 LIFO charge (versus an $8 benefit in the prior-year quarter) and a prior-year non-recurring legal settlement; core merchandise margin excluding gasoline deflation improved. First-36-week gross margin percentage was flat, with an $18 LIFO charge versus a $19 benefit in the prior-year period.
- SG&A rate increased four basis points in the quarter and eleven basis points year to date. Higher stock-based compensation and information-system investment were partly offset by warehouse payroll leverage.
- First-36-week net income and diluted EPS were lower year over year, partly reflecting a $72 discrete tax benefit in the prior-year period. Third-quarter foreign-exchange movements reduced diluted EPS by $0.03, primarily due to the Canadian dollar.
Outlook, risks and contingencies
No specific earnings or sales forecast was provided. Costco planned up to 10 additional warehouse openings for the remainder of fiscal 2014 and opened its first warehouse in Spain after quarter-end. Management’s stated capital-spending plan was approximately $2,200 for fiscal 2014.
Risks identified include economic conditions, currency and gasoline-price movements, competition, consumer spending, employee and benefit costs, energy and commodity costs, regulation, real estate, and data-security or privacy breaches. Forward-looking statements are subject to uncertainty.
Legal matters include employment-promotion litigation, fuel-temperature class actions, environmental inquiries, unclaimed-property examinations and controlled-substance prescription inquiries. The company recorded an immaterial accrual for one matter; it said potential losses in matters without accruals could not be reasonably estimated. An unfavorable outcome could cause a material charge in an individual quarter, although management did not believe pending matters would materially adversely affect financial position. The proposed employment settlement received final court approval on May 27, 2014; payments were expected to be immaterial.
Important facts for investors to verify
- Whether comparable-sales growth and membership-fee gains continue, especially excluding currency and gasoline effects.
- Whether margin pressure from LIFO costs, foreign exchange, membership rewards and operating expenses persists.
- Progress against the fiscal-2014 capital-spending and warehouse-opening plans, and the effect of new-store cannibalization.
- Cash availability and debt obligations, including the $2,708 held by non-U.S. subsidiaries that management considered indefinitely reinvested.
- Developments in the disclosed legal and regulatory matters, including any material change in estimated exposure.