Costco Wholesale Corporation — Q2 FY2020 Form 10-Q
Reporting period: 12 weeks ended February 16, 2020; year-to-date figures cover 24 weeks. Amounts are in millions, except per-share data. Costco operated 785 warehouses and e-commerce sites in eight countries.
Financial performance
- Quarter revenue: $39,072, up 10.4% year over year; net sales were $38,256, up 10%, and membership fees were $816, up 6%.
- Quarter comparable sales: up 9% overall and 8% excluding foreign exchange and gasoline prices. Growth reflected higher shopping frequency and average ticket, plus a favorable Thanksgiving timing shift; new warehouses also contributed to total sales.
- Quarter earnings: operating income was $1,266 versus $1,203; net income attributable to Costco was $931 versus $889; diluted EPS was $2.10 versus $2.01.
- Margins: gross margin was $4,200, or 10.98% of net sales, down 31 basis points. SG&A was 9.78% of net sales, down 22 basis points. Operating margin was approximately 3.24% of total revenue versus 3.40% a year earlier.
- First-half results: revenue was $76,112, up 8%; operating income was $2,327 versus $2,152; net income attributable to Costco was $1,775 versus $1,656; diluted EPS was $4.00 versus $3.74. Gross margin percentage was 11.01%, down one basis point.
- Cash flow, first half: operating cash flow was $2,721 versus $1,958; capital expenditures were $1,260. Investing cash outflow was $1,100 and financing cash outflow was $2,228, including $1,200 of debt repayment.
- Liquidity and debt: cash and cash equivalents were $7,786 and short-term investments were $929 at February 16. Debt carrying value was $5,624, including $500 current. The company subsequently repaid that $500 note on February 18 using cash and investments. Management said available cash and operating cash flows should meet foreseeable liquidity and capital needs.
Material changes and management commentary
- Sales growth was supported by 9% comparable-sales growth and 16 net warehouse openings since the prior-year quarter. Gasoline price increases added about $320 to quarterly sales; foreign currency added about $85.
- Quarter gross-margin pressure reflected a shift toward lower-margin ancillary businesses and initial operating losses at a new poultry processing plant. Core merchandise margin as a percentage of core sales fell 15 basis points in the quarter.
- SG&A leverage from higher sales and business mix more than offset some pressure from wage increases and bonding-leave benefits. The company describes its model as relying on high sales volumes and rapid inventory turnover while accepting lower gross margins.
- Paid members reached 55.3 million, and cardholders totaled 100.9 million. Renewal rates were 91% in the U.S. and Canada and 88% worldwide.
- The company adopted the new lease accounting standard in fiscal Q1. Adoption added $2,632 to assets and liabilities at September 2, 2019; management said it did not materially affect income or cash flows.
Outlook, risks, and contingencies
- No earnings or sales guidance was provided. Management planned approximately $3,000 of fiscal 2020 capital expenditures and 15 additional warehouse openings, including two relocations, for the remainder of the year; plans could change.
- Principal risks cited include economic conditions, competition, consumer spending, currency and interest-rate movements, tariffs, rising employee and commodity costs, real estate and capital needs, data security, internal controls, and global disease threats. The filing does not quantify any disease-related business impact for this reporting period.
- Legal matters include California employment class actions, opioid-related litigation, shareholder securities and derivative actions related to internal-control disclosures, and environmental notices. Certain matters could produce a material charge in an individual quarter or year, although the company did not expect pending matters, individually or in aggregate, to materially affect its financial position, results, or cash flows. Potential losses for some matters could not be reasonably estimated.
- Tax authorities are examining non-income taxes in several jurisdictions. An assessment related to a product tax audit was recorded in fiscal 2019 and is being protested; the company reported no change to that estimate in the first half of 2020.
Most important facts for investors to verify
- Whether comparable-sales growth and membership renewal rates remain strong, and how much growth reflects traffic, average ticket, new locations, gasoline, currency, or calendar effects.
- Whether poultry-plant startup losses and the sales mix continue to pressure gross margins.
- Actual fiscal 2020 capital spending and warehouse openings versus the stated plans, and the subsequent effect of global disease risks on sales, costs, and operations.
- Subsequent cash, debt, and liquidity levels after the February 18 note repayment, alongside ongoing capital expenditures and shareholder distributions.
- Developments in employment, opioid, shareholder, and tax matters, including any settlement, assessment, or loss that becomes estimable.