Costco Wholesale Corporation — FY2016 Form 10-K
Business context and reporting period. Costco operates membership warehouses and related businesses across the U.S. and international markets. This 10-K covers the 52 weeks ended August 28, 2016. The fourth quarter comprised 16 weeks; the filing’s fiscal-year comparisons are generally 52 weeks. Costco had 715 warehouses at year-end, including 29 net openings during the year.
Financial and operating performance
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $116.073 billion | $113.666 billion |
| Membership fees | $2.646 billion | $2.533 billion |
| Operating income | $3.672 billion | $3.624 billion |
| Net income attributable to Costco | $2.350 billion | $2.377 billion |
| Diluted EPS | $5.33 | $5.37 |
| Gross margin as a percentage of net sales | 11.35% | 11.09% |
| SG&A as a percentage of net sales | 10.40% | 10.07% |
| Operating cash flow | $3.292 billion | $4.285 billion |
| Capital expenditures | $2.649 billion | $2.393 billion |
- Sales and membership: Net sales rose 2%; comparable sales were flat overall, versus 1% growth in 2015. Excluding currency and gasoline-price effects, comparable sales rose 4% (versus 7%). Membership-fee revenue increased 4%. Renewal rates were 90% in the U.S. and Canada and 88% worldwide.
- Profitability: Gross margin percentage improved 26 basis points, largely because gasoline-price deflation reduced the sales denominator; excluding this effect, adjusted gross margin percentage rose five basis points. SG&A ratio increased 33 basis points, or 13 basis points excluding the gasoline-price effect. Net income declined 1%; the prior-year comparison benefited from a $57 million tax benefit related to the special dividend paid to 401(k) plan participants.
- Cash flow and liquidity: Operating cash flow fell $993 million. Costco attributed much of the decline to approximately $1.7 billion of accelerated vendor payments in the final week of FY2016, ahead of a modernized accounting-system implementation. Year-end cash and cash equivalents plus short-term investments were $4.729 billion, compared with $6.419 billion a year earlier; about $1.071 billion of the FY2016 balance was unsettled card receivables.
- Debt and equity: Total debt carrying value was $5.161 billion, including $1.100 billion current and $4.061 billion long-term; long-term debt excluding current maturities was down from $4.852 billion. Costco repaid $1.2 billion of 0.65% Senior Notes in December 2015. Stockholders’ equity was $12.079 billion. No short-term borrowings were outstanding at year-end; available bank-facility capacity was $429 million.
- Shareholder returns: FY2016 dividends declared were $1.70 per share, versus $6.51 in FY2015, which included a $5.00 special dividend. The quarterly dividend was raised from $0.40 to $0.45 in April 2016. Costco repurchased 3.184 million shares for about $477 million during FY2016.
- Q4 results: For the 16-week fourth quarter, net sales were $35.728 billion and net income attributable to Costco was $779 million; diluted EPS was $1.77. The comparable prior-year quarter reported sales of $34.993 billion, net income of $767 million and diluted EPS of $1.73.
Material changes versus the prior period
- Currency movements reduced FY2016 net sales by approximately $2.690 billion; lower gasoline prices reduced sales by approximately $2.194 billion, reflecting a 19% decline in average gasoline selling price.
- Reported comparable sales were flat, but grew 4% excluding foreign currency and gasoline-price changes. Canada and Other International comparable sales each declined 3% as reported.
- Operating income increased modestly despite higher expenses; net income and diluted EPS edged lower, partly reflecting the absence of the prior-year tax benefit.
- Cash and investments declined, including because of debt repayment, dividends, repurchases and accelerated vendor payments. Capital spending rose as Costco expanded its warehouse base and continued information-systems modernization.
Outlook, commentary, risks and unusual items
- Plans, not earnings guidance: Management expected to open up to 31 warehouses and relocate up to three in FY2017, and planned capital expenditures of approximately $2.6–$2.8 billion. It stated that cash and operating cash flows should meet foreseeable liquidity and capital needs. The filing provides no specific revenue or earnings forecast.
- Management emphasized comparable-sales growth, membership loyalty, competitive pricing and cost control as key profit drivers. It expects information-systems modernization to continue pressuring SG&A; FY2016 also included non-recurring legal and regulatory costs and higher health-care and employee-benefit costs.
- Costco shifted its U.S. co-branded card program from American Express to Citi/Visa in June 2016. The ten-year agreement includes external-spend royalties, Costco funding for part of cardholder rewards, and a lower base Visa acceptance discount than the former American Express arrangement.
- Key risks include reliance on U.S. and Canadian operations (87% of net sales), competitive and economic pressures, currency and commodity-price volatility, labor and health-care costs, new-warehouse execution and cannibalization, supply disruptions, cybersecurity and technology implementation, product safety, and regulatory or tax changes.
- Contingencies: Matters include gasoline-temperature class actions, state unclaimed-property examinations, and DEA inquiries and related U.S. Attorney communications concerning controlled-substance prescription fulfillment and practices. Costco recorded an immaterial accrual for two matters; for certain matters, possible losses could not be reasonably estimated. Management did not expect pending matters, individually or collectively, to materially affect financial position, while acknowledging an unfavorable outcome could materially affect an individual quarter.
- Financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting as of August 28, 2016.
Important facts for investors to verify
- Whether comparable-sales momentum improves, particularly in Canada and international markets, and how much reported growth remains affected by currency and gasoline prices.
- Whether higher SG&A, technology-modernization costs and employee costs are offset by sales growth and operating leverage.
- Whether operating cash flow normalizes after the unusually large year-end vendor payments, and how cash and investment balances evolve alongside capital spending and shareholder returns.
- Execution and returns from planned warehouse openings, including possible cannibalization and the use of the FY2017 capital-spending plan.
- Developments in the DEA matter, unclaimed-property examinations and gasoline litigation, including any change in accruals or estimability of potential losses.
- Effects of the Citi/Visa program on card acceptance costs, external-spend royalties, reward funding and member behavior.
- Potential U.S. tax consequences of repatriating foreign earnings; $3.280 billion of undistributed foreign earnings was treated as indefinitely reinvested or not subject to adverse tax consequences at year-end.