Business Context and Reporting Period
Company: Costco Wholesale Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: November 25, 2007 (12 weeks)
Operations: Membership warehouse retailer operating 494 warehouses globally (384 in the U.S., 71 in Canada, and others in the U.K., Japan, Korea, Taiwan, and Mexico).
Key Financial Metrics
| Metric | Q1 2008 (Nov 25, 2007) | Q1 2007 (Nov 26, 2006) |
|---|---|---|
| Total Revenue | $15,809,530 | $14,151,624 |
| Net Sales | $15,471,500 | $13,852,321 |
| Membership Fees | $338,030 | $299,303 |
| Operating Income | $394,854 | $353,140 |
| Net Income | $261,981 | $236,886 |
| Diluted EPS | $0.59 | $0.51 |
| Gross Margin % | 10.65% | 10.56% |
| Cash & Equivalents | $2,742,354 | $2,779,733 |
| Total Debt (Current + Long-term) | $2,219,106 | $2,221,715 |
| Operating Cash Flow | $270,883 | $407,490 |
Note: All dollar figures in thousands except per share data.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 11.7% year-over-year. Net sales grew 11.7% driven by an 8% increase in comparable warehouse sales and the opening of 24 net new warehouses. Membership fees rose 12.9% due to a $5 fee increase implemented in the prior year and higher Executive membership penetration.
- Profitability: Net income increased 10.6% to $262.0 million. Diluted EPS grew 15.7% to $0.59, aided by share repurchases reducing the share count.
- Margins: Gross margin percentage improved by 9 basis points to 10.65%. SG&A expenses as a percentage of net sales increased 17 basis points to 10.15%, impacted by payroll costs and a $9 million accrual for health plan savings sharing.
- Cash Flow: Net cash provided by operating activities decreased $136.6 million to $270.9 million, primarily due to a $200 million prepayment for employee health care costs. Investing cash outflows increased due to capital expenditures and changes in short-term investment portfolios.
- Debt: Interest expense surged to $23.0 million from $2.1 million due to the issuance of $2 billion in Senior Notes in the prior fiscal year.
Guidance, Outlook, and Risks
- Expansion Plans: Management intends to spend approximately $1.6 billion to $1.8 billion in fiscal 2008 on real estate, construction, and equipment. Plans include opening 24 to 26 additional warehouses for the remainder of the fiscal year.
- Capital Allocation: The Board approved an additional $1.3 billion in stock repurchase authorizations in late 2007. Approximately $1.68 billion remained available for repurchases as of November 25, 2007. A quarterly dividend of $0.145 per share was declared.
- Liquidity: Total liquid assets (cash, equivalents, and short-term investments) stood at $3.21 billion. Management noted uncertainty in money fund markets but assessed no material loss exposure.
- Legal and Regulatory Risks:
- Class Actions: Multiple pending class actions regarding overtime compensation, meal/rest breaks, membership fee practices, and gasoline temperature sales practices.
- Government Investigations: Ongoing inquiries by the U.S. Attorney's Office regarding stock option granting practices and hazardous merchandise handling. An EPA information request regarding air-conditioning and refrigeration compliance is also pending.
- Tax Matters: Adoption of FIN 48 resulted in a $6.0 million increase to liabilities for uncertain tax positions. Approximately $16.0 million of unrecognized tax benefits may decrease in the next 12 months.
Investor Verification Checklist
- Verify the impact of the $200 million prepaid insurance payment on future operating cash flow comparisons.
- Monitor the status of the U.S. Attorney's Office investigation into stock option practices and potential financial impact.
- Track the resolution of pending class action lawsuits, particularly those regarding overtime and membership fees, for potential liability exposure.
- Assess the sustainability of the 8% comparable sales growth given rising fuel costs and economic conditions.
- Review the execution of the $1.6 billion to $1.8 billion capital expenditure plan for fiscal 2008.