Costco Wholesale Corporation — Q2 FY2014 Form 10-Q
Reporting period: Twelve and 24 weeks ended February 16, 2014; comparisons are with periods ended February 17, 2013. Amounts below are in millions of dollars except per-share data and percentages. Costco operated 649 warehouses worldwide at quarter-end.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | First half FY2014 | First half FY2013 |
|---|---|---|---|---|
| Total revenue | $26,306 | $24,871 | $51,323 | $48,586 |
| Net sales | $25,756 | $24,343 | $50,224 | $47,547 |
| Operating income | $724 | $738 | $1,392 | $1,377 |
| Net income attributable to Costco | $463 | $547 | $888 | $963 |
| Diluted EPS | $1.05 | $1.24 | $2.01 | $2.19 |
| Gross margin as % of net sales | 10.53% | 10.59% | 10.67% | 10.63% |
| SG&A as % of net sales | 9.83% | 9.70% | 10.02% | 9.87% |
- Q2 revenue grew 6%; comparable sales rose 3% (5% excluding gasoline-price and foreign-currency effects). First-half revenue also grew 6%; comparable sales rose 3% (5% excluding those effects).
- Q2 Costco-attributable net income fell 15% and diluted EPS fell 15%. First-half net income fell 8% and diluted EPS fell 8%, despite slightly higher operating income.
- Q2 gross margin rate declined 6 basis points and SG&A rate increased 13 basis points. First-half gross margin rate improved 4 basis points, while SG&A rate increased 15 basis points.
- Q2 income tax provision was $255, with a 35.0% effective tax rate, versus $185 and 25.1% a year earlier. Prior-year results included a $62 tax benefit tied to the special dividend paid to 401(k) plan participants; prior-year discrete tax benefits totaled $72 for Q2 and $73 for the first half.
Cash flow, balance sheet and capital
- First-half operating cash flow was $1,652, up from $1,525. Investing cash use was $891 versus $855; financing cash use was $224 versus $235 of financing cash provided a year earlier. The prior-year financing period included $3,500 of senior-note proceeds, primarily used to fund a one-time special dividend.
- Cash and cash equivalents were $5,130 at February 16, 2014; short-term investments were $1,352. Together, these totaled $6,482, versus $6,124 at fiscal year-end. About $2,323 was held by non-U.S. subsidiaries and was considered indefinitely reinvested.
- Long-term debt, excluding current portion, was $4,985, compared with $4,998 at fiscal year-end. Short-term borrowings under bank credit facilities were $74. Total liabilities were $19,857 and total equity was $11,709.
- First-half capital expenditures were $1,021. Management expected fiscal-2014 spending of approximately $2,300 and planned up to 14 additional warehouse openings during the remainder of the year, after opening 16 in the first half.
- The quarterly dividend was $0.31 per share, versus $0.275 in Q2 FY2013; the prior-year reported dividend per share included a special dividend. No shares were repurchased in the first half of FY2014.
Material changes and management commentary
- Foreign exchange reduced Q2 net sales by approximately $503 and first-half net sales by approximately $857; gasoline-price declines reduced sales by approximately $70 and $310, respectively. Currency effects also adversely affected Q2 diluted EPS by $0.03.
- Management attributed comparable-sales growth to more frequent shopping, partly offset by lower average spend per visit. Q2 sales were also affected by cannibalization from new locations, particularly internationally.
- Membership fees rose 4% in Q2 and 6% in the first half, supported by sign-ups and greater Executive Membership penetration. Renewal rates were 90% in the U.S. and Canada and 87% worldwide.
- Management cited higher employee benefit costs and payroll as pressures on warehouse operating expenses, alongside continued investment in information systems. It stated that cash and operating cash flow should be sufficient for capital requirements for the foreseeable future.
Outlook, risks and unusual items
- No specific earnings or revenue forecast was provided. The filing gives a capital-spending estimate of approximately $2,300 for FY2014 and a plan for up to 14 further warehouse openings, subject to change.
- Key stated business risks include economic and consumer-spending conditions, competition, foreign exchange, gasoline and commodity costs, employee and health-care costs, real-estate matters, and security or privacy breaches. Costco noted that its low-margin model makes modest changes in gross margin and SG&A meaningful to earnings.
- Legal matters include a proposed settlement in a gender-promotion class action, motor-fuel temperature sales litigation, environmental and hazardous-merchandise inquiries, state unclaimed-property examinations, and DEA inquiries regarding controlled-substance prescriptions. No accrual had been recorded for the matters described; possible losses were not reasonably estimable. Management did not expect pending matters to materially affect financial position, but said an unfavorable outcome could materially affect an individual quarter.
- Q2 included a $5 LIFO charge, compared with a $9 benefit in the prior-year quarter; first-half LIFO charge was $6 versus an $11 benefit. Foreign-currency translation reduced first-half comprehensive income by $36.
Important facts for investors to verify
- Whether comparable-sales growth and membership-fee growth continue, particularly as currency and fuel-price effects change.
- Whether gross-margin pressure and higher SG&A costs persist, including employee-benefit costs and Executive Membership rewards.
- Progress against the approximately $2,300 FY2014 capital-spending plan and remaining warehouse-opening intentions.
- Tax-rate comparability after the prior-year 401(k)-related special-dividend tax benefit.
- Developments in the disclosed legal and regulatory matters and any resulting accruals, penalties, or quarter-specific charges.