Costco Wholesale Corporation — Q3 FY2017 Form 10-Q
Reporting period: 12 weeks ended May 7, 2017; year-to-date figures cover 36 weeks. Fiscal 2017 is a 53-week year. Amounts are in millions except per-share data.
Business context
Costco operates membership warehouses and online businesses, with 729 warehouses worldwide at quarter-end. Management describes sales growth—particularly comparable sales—and membership as central to profitability, which is supported by high-volume, low-margin operations.
Financial performance
| Metric | 12 weeks ended May 7, 2017 | 12 weeks ended May 8, 2016 | 36 weeks ended May 7, 2017 | 36 weeks ended May 8, 2016 |
|---|---|---|---|---|
| Net sales | $28,216 | $26,151 | $84,815 | $80,345 |
| Membership fees | $644 | $618 | $1,910 | $1,814 |
| Operating income | $968 | $858 | $2,661 | $2,481 |
| Net income attributable to Costco | $700 | $545 | $1,760 | $1,571 |
| Diluted EPS | $1.59 | $1.24 | $3.99 | $3.56 |
| Gross margin % of net sales | 11.51% | 11.43% | 11.35% | 11.32% |
| SG&A % of net sales | 10.30% | 10.44% | 10.41% | 10.42% |
Quarterly net sales rose 8%, including 5% comparable-sales growth; year-to-date sales rose 6%, with 3% comparable-sales growth. Quarterly gasoline-price increases added approximately $381 to sales, while currency movements reduced sales by approximately $165. Management attributed comparable-sales gains to increased shopping frequency and, in the quarter, higher average ticket; new openings also contributed. Membership fee revenue rose 4% for the quarter and 5% year to date.
Quarterly gross margin percentage improved 8 basis points and SG&A as a percentage of sales declined 14 basis points. Excluding gasoline-price effects, management reported a 23-basis-point quarterly increase in gross margin on adjusted net sales, reflecting ancillary businesses and co-branded credit-card income, partly offset by prior-year legal and LIFO benefits and the Executive membership reward program. The quarterly effective tax rate was 26.8%, versus 34.2%; an $82 discrete tax benefit related primarily to the special dividend’s deductibility for employee 401(k) plan shares contributed about $0.19 to diluted EPS.
Cash, liquidity and debt
- For the first 36 weeks, operating cash flow was $4,892, investing cash flow was negative $1,550, and financing cash flow was negative $2,141. Operating cash flow increased from $3,461 a year earlier, primarily because approximately $1,700 of vendor payments had been accelerated into the final week of FY2016.
- Cash and cash equivalents were $4,538 and short-term investments $1,187 at May 7, 2017, totaling $5,725. Management said cash and operating cash flows should meet foreseeable liquidity and capital needs. About $1,564 of cash and short-term investments at foreign subsidiaries was considered indefinitely reinvested.
- Total debt carrying value was $3,979, including $1,158 current and $2,821 long-term, versus $5,161 at August 28, 2016. Costco repaid $1,100 of 5.5% notes in March.
- After quarter-end, Costco issued $3,800 of senior notes with maturities from 2021 to 2027 and called $1,100 of 1.125% notes for redemption. Proceeds were used to fund the special dividend, with the remainder intended for the note redemption.
- Capital expenditures were $1,723 year to date; FY2017 spending was estimated at approximately $2,500–$2,700. Costco declared a $7.00 special and $0.50 regular dividend per share, paid May 26; the approximately $3,290 obligation was recorded in current liabilities at quarter-end.
Balance-sheet changes and other material items
Compared with August 28, 2016, total assets increased to $35,631 from $33,163, while total liabilities rose to $25,446 from $20,831. Current liabilities increased to $21,394 from $15,575, including the $3,290 dividend payable. Equity declined to $10,185 from $12,332, chiefly reflecting dividends declared. Inventory increased to $9,736 from $8,969; accounts payable rose to $9,425 from $7,612.
Costco had 48.6 million paid members and 88.9 million cardholders. Renewal rates were 90% in the U.S. and Canada and 88% worldwide. U.S. and Canadian membership fees increased effective June 1, 2017; management did not expect a material impact for the remainder of FY2017. The company opened 16 warehouses, including two relocations, in the first 36 weeks and expected up to 12 more openings for the remainder of the year, including Iceland and France.
Outlook, risks and contingencies
Management provided no earnings or sales forecast in this filing. It cited plans for capital spending and warehouse openings above. Business risks include competition, economic and consumer-spending conditions, foreign exchange and fuel-price volatility, employee and healthcare costs, energy and commodity costs, cybersecurity and privacy, and real-estate matters. Costco noted that modest changes in costs can materially affect earnings given its low margins.
Legal and regulatory matters include fuel-temperature sales litigation, a California employee seating class action, state unclaimed-property examinations, an Ontario pharmacy-related information request, and Connecticut hazardous-waste notices. The company recorded an immaterial accrual for two matters, stated that possible losses in other matters could not be reasonably estimated, and said an unfavorable outcome could materially affect an individual quarter, though it did not expect pending matters to materially affect financial position. Management reported no material changes to previously disclosed risk factors or market risks.
Upcoming accounting standards include revenue recognition, leases, and stock compensation. Costco expected lease adoption to materially affect its balance sheet, but not results or cash flows; it expected stock-compensation adoption to potentially materially affect tax provision and EPS.
Investor verification priorities
- Assess how much reported sales growth came from comparable sales, new warehouses, gasoline prices, and foreign exchange.
- Separate recurring earnings growth from the $82 tax benefit and other margin comparisons affected by prior-year legal and LIFO items.
- Review the impact of the $3.29 billion special dividend, subsequent $3.8 billion debt issuance, and planned note redemption on liquidity and leverage.
- Monitor inventory and accounts-payable movements, including the prior-year vendor-payment timing effect on operating cash flow.
- Track membership fee increases, renewal rates, planned openings and capital spending, and developments in disclosed legal and regulatory matters.