Costco Wholesale Corporation — Q2 FY2013 Form 10-Q
Reporting period: 12 weeks ended February 17, 2013; first-half comparisons cover 24 weeks ended the same date. Financial amounts are in millions of dollars except per-share data. Costco operated 622 warehouses and online businesses in the U.S., Canada and U.K.
Financial performance
| Metric | Q2 FY2013 | Q2 FY2012 | First half FY2013 | First half FY2012 |
|---|---|---|---|---|
| Net sales | $24,343 | $22,508 | $47,547 | $43,689 |
| Membership fees | $528 | $459 | $1,039 | $906 |
| Operating income | $738 | $644 | $1,377 | $1,187 |
| Net income attributable to Costco | $547 | $394 | $963 | $714 |
| Diluted EPS | $1.24 | $0.90 | $2.19 | $1.62 |
- Q2 net sales rose 8%; comparable sales increased 5%. First-half net sales rose 9%, with comparable sales up 6% (5% excluding gasoline price and foreign-currency effects).
- Q2 gross margin was 10.59% of net sales, up 6 basis points year over year; SG&A was 9.70%, up 2 basis points. Operating income increased 15% in Q2 and 16% in the first half.
- Net income increased 39% in Q2 and 35% in the first half. Q2 results included a $62 tax benefit, or $0.14 per diluted share, related to the special dividend paid to employee stock-plan participants.
- First-half operating cash flow was $1,525, versus $1,244; capital expenditures were $943, versus $632. Investing cash outflow was $855. Cash and cash equivalents were $4,413 and short-term investments $1,238 at February 17.
- Long-term debt, excluding current portion, was $4,806, compared with $1,381 at fiscal year-end; total liabilities were $18,806. Costco issued $3,500 of senior notes in December 2012, with maturities in 2015, 2017 and 2019 and coupons of 0.65%, 1.125% and 1.7%.
Material changes and capital allocation
- Revenue growth reflected comparable sales, 24 net new warehouses opened since the prior-year Q2, higher membership fees, and favorable currency movements. Membership-fee revenue rose 15%; renewal rates were approximately 89.8% in the U.S. and Canada and 86.5% worldwide.
- Gross-margin improvement included a $9 million LIFO benefit in Q2, compared with a $3 million charge a year earlier. The quarter’s gross-margin rate also benefited from ancillary businesses; increased Executive Member rewards partly offset gains.
- On December 18, 2012, Costco paid a $7.00-per-share special dividend totaling approximately $3,049, alongside its regular quarterly dividend. First-half cash dividend payments were $3,169. The special dividend was primarily financed with proceeds from the new notes.
- Stockholders’ equity attributable to Costco fell to $10,112 from $12,361 at September 2, 2012, principally reflecting dividends declared. First-half share repurchases totaled $34; none occurred in Q2.
Outlook, risks and contingencies
- Management expected fiscal 2013 spending of approximately $2,000 for real estate, construction, remodeling, equipment and information-system modernization; $943 had been spent through the first half. Plans called for up to 14 additional warehouse openings in the remainder of the fiscal year after 14 opened in the first half.
- Management stated that cash and operating cash flows should be sufficient for foreseeable capital requirements. Approximately $2,013 of cash, cash equivalents and short-term investments were held by non-U.S. subsidiaries; Costco said it had no current plans to repatriate those funds.
- Management emphasized that the low-margin model is sensitive to modest changes in merchandise margins and SG&A. Risks cited include economic and consumer-spending conditions, competition, currency and commodity movements, employee benefit costs, regulation and real estate availability. Forward-looking statements are subject to these and other uncertainties.
- Costco reported several legal matters, including a gender-promotion class action, fuel-temperature litigation and environmental and unclaimed-property inquiries. No accrual was recorded for the matters discussed; the company said a loss was reasonably possible but could not be reasonably estimated. An unfavorable outcome could materially affect an individual quarter, though management did not expect pending matters to materially affect financial position.
Important facts for investors to verify
- How much earnings growth reflected the $62 million discrete tax benefit and the post-acquisition inclusion of 100% of Costco Mexico’s results.
- Whether comparable-sales growth and membership renewals persist, particularly after excluding currency and gasoline effects.
- Whether gross-margin improvements are sustainable given Costco’s pricing strategy, LIFO benefits and category-level margin trends.
- How the debt-funded special dividend affects future interest costs, liquidity and capital allocation.
- Developments in the disclosed legal matters and the timing and returns of planned capital spending and warehouse openings.