Costco Wholesale Corporation — Q1 FY2011 Form 10-Q
Reporting period: 12 weeks ended November 21, 2010; comparable period ended November 22, 2009. Amounts are in millions of dollars unless otherwise noted.
Business context
Costco operates membership warehouses selling a limited selection of merchandise at low prices. At quarter-end it operated 580 warehouses in 40 U.S. states and Puerto Rico, Canada, Mexico, the U.K., Japan, Korea, Taiwan and Australia. The company began consolidating its 50%-owned Costco Mexico joint venture at the start of FY2011; prior-period results were accounted for under the equity method.
Financial performance and liquidity
| Metric | Q1 FY2011 | Q1 FY2010 | Change / context |
|---|---|---|---|
| Net sales | $18,823 | $16,922 | Up 11.2%; excluding Costco Mexico, up 8.1% |
| Membership fees | $416 | $377 | Up 10.2%; excluding Mexico, up 8.1% |
| Total revenue | $19,239 | $17,299 | Up approximately 11.2% |
| Operating income | $525 | $428 | Up 22.7% |
| Net income attributable to Costco | $312 | $266 | Up 17.4% |
| Diluted earnings per share | $0.71 | $0.60 | Up $0.11 |
| Gross margin as % of net sales | 10.97% | 10.88% | Up 9 basis points |
| SG&A as % of net sales | 10.31% | 10.50% | Improved 19 basis points |
| Cash from operations | $720 | $751 | Down $31 |
| Capital expenditures | $306 | $313 | Net additions to property and equipment |
Comparable sales increased 7%, versus 3% a year earlier. Growth reflected higher shopping frequency and spending, 21 net new warehouses, stronger foreign currencies and higher gasoline prices. Currency and gasoline effects contributed approximately 110 and 69 basis points, respectively, to comparable-sales growth.
At November 21, 2010, cash and cash equivalents were $3,739 and short-term investments were $1,545, totaling $5,284. Current assets were $13,558 and current liabilities $11,502. Short-term borrowings were $24; long-term debt was $2,143. Total liabilities were $14,336 and total equity $11,707. Cash increased $525 during the quarter. Operating cash flow was lower mainly due to increased net investment in inventory and changes in other operating assets and liabilities.
Net cash used in investing activities was $137, including $306 of capital expenditures; the reported amount also reflected $165 of cash included with the initial consolidation of Costco Mexico. Net cash used in financing was $87, including $89 of dividends and approximately $150 of share repurchases. The quarterly dividend was $0.205 per share.
Material changes and unusual items
- Consolidation of Costco Mexico increased reported assets, liabilities and revenue by approximately 3%, but had no impact on net income attributable to Costco. Mexico’s partner share is now reported as noncontrolling interest.
- Reported operating results benefited from 7% comparable-sales growth and improved gross-margin and SG&A rates. Gasoline price increases contributed to sales growth but also affected the sales mix and margins.
- The effective tax rate declined to 34.2% from 36.1%, primarily because of resolution of an uncertain tax position and a tax refund received by Costco Mexico.
- The company repurchased 2.436 million shares for approximately $150 at an average $61.71 per share; $989 remained available under authorized programs.
Outlook, risks and contingencies
Management planned approximately $1.6 billion of FY2011 spending on real estate, construction, remodeling and equipment, expected to be funded from operating cash flow and existing cash and investments. After opening eight warehouses in Q1, the company planned up to 21 additional openings for the balance of the fiscal year, including two relocations. No earnings or sales guidance was provided.
Management emphasized comparable-sales growth, cost control and maintaining competitive pricing. It cautioned that weak economic conditions may continue to weigh on member spending; competition, currency movements, gasoline prices, healthcare costs and other employee costs may affect results. Because the business operates on low margins, relatively small changes in gross margin or SG&A can materially affect net income.
Contingencies include employment class actions, consumer product and fuel-related claims, environmental and regulatory inquiries, unclaimed-property examinations and shareholder derivative litigation. The company stated it could not reasonably estimate possible losses for most matters and did not believe pending matters would materially affect financial position, though an unfavorable outcome could materially affect an individual quarter. A proposed settlement of the consolidated stock-option derivative litigation included up to $4.85 million in plaintiffs’ legal fees and governance changes, subject to court approval.
Forward-looking statements are subject to risks including economic conditions, competition, regulation, consumer spending, real estate matters, vendor actions, employee costs and geopolitical conditions. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether sales and comparable-sales growth persist after adjusting for gasoline prices, foreign exchange and Costco Mexico consolidation.
- Whether margin gains continue, given the low-margin model, gasoline mix, pricing choices and rising employee-benefit costs.
- Cash conversion and inventory investment, alongside the planned $1.6 billion FY2011 capital program and warehouse openings.
- Developments and potential financial exposure in employment, environmental, consumer and shareholder litigation matters.
- Execution and accounting effects of consolidating Costco Mexico, including the partner’s noncontrolling interest.