Costco Wholesale Corporation — Q3 FY2013 Form 10-Q
Reporting period: Third quarter ended May 12, 2013 (12 weeks), with year-to-date results for the 36 weeks ended May 12, 2013. Comparisons are against the periods ended May 6, 2012. Costco operated 627 warehouses worldwide.
Financial performance
| Metric | Q3 FY2013 | Q3 FY2012 | 36 weeks FY2013 | 36 weeks FY2012 |
|---|---|---|---|---|
| Net sales | $23.552bn | $21.849bn | $71.099bn | $65.538bn |
| Membership-fee revenue | $531m | $475m | $1.570bn | $1.381bn |
| Operating income | $722m | $623m | $2.099bn | $1.810bn |
| Net income attributable to Costco | $459m | $386m | $1.422bn | $1.100bn |
| Diluted EPS | $1.04 | $0.88 | $3.23 | $2.50 |
| Gross margin as % of net sales | 10.67% | 10.55% | 10.65% | 10.57% |
| SG&A as % of net sales | 9.82% | 9.85% | 9.85% | 9.88% |
Q3 net sales rose 8%; comparable sales increased 5%, or 7% excluding foreign-exchange and gasoline-price effects. Sales growth reflected higher comparable sales and 25 net new warehouses opened since the comparable prior-year quarter. Currency movements reduced Q3 sales by about $185m and gasoline-price deflation by about $141m. Membership fees rose 12%, supported by prior fee increases, new sign-ups, and improved renewals. Renewal rates were approximately 89.9% in the U.S. and Canada and 86.4% worldwide.
Q3 operating income increased about 16% and net income 19%. Gross margin expanded 12 basis points and SG&A leverage improved 3 basis points. However, core merchandise margin as a percentage of net sales declined 5 basis points; the reported gross-margin improvement included a 7-basis-point benefit from a non-recurring legal settlement and a 6-basis-point benefit from LIFO inventory accounting. The 36-week effective tax rate was 31.4%, versus 36.4% a year earlier, helped by $72m of discrete tax benefits, primarily related to the special dividend paid through the employee 401(k) plan.
Cash flow, liquidity and debt
- Operating cash flow for the first 36 weeks was $2.874bn, up from $2.327bn. Capital expenditures were $1.379bn, versus $900m; net cash used in investing was $1.116bn.
- Cash and cash equivalents were $5.448bn and short-term investments $1.062bn at May 12, 2013, totaling $6.510bn. Management stated that cash and operating cash flows should be sufficient for foreseeable capital requirements.
- Long-term debt, excluding current portion, was $4.887bn, versus $1.381bn at September 2, 2012. The increase primarily reflects $3.5bn of senior notes issued in December 2012 and approximately $98m of Japanese subsidiary notes issued in May 2013.
- Financing cash flow was $216m provided, compared with $1.011bn used in the prior-year period. The 2013 period included $3.610bn in long-term debt proceeds and $3.289bn in cash dividend payments.
- Costco paid a special dividend of $7.00 per share in December 2012, funded primarily with the December debt issuance. The current quarterly dividend was raised 13% to $0.31 per share.
Outlook, risks and unusual items
- No specific earnings or sales forecast was provided. Costco expected to spend approximately $2.0bn on real estate, construction, remodeling, warehouse equipment and information-system modernization in fiscal 2013; $1.379bn had been spent through the first 36 weeks. It planned up to nine additional warehouse openings for the remainder of the fiscal year.
- Management emphasized comparable-sales growth, competitive pricing, and cost control as key profitability drivers. It noted that price investments can pressure merchandise margins, and that low operating margins make results sensitive to modest changes in gross margin and SG&A.
- Risks identified include economic and consumer-spending conditions, competition, foreign-exchange movements, gasoline and commodity costs, employee health-care and utility costs, real-estate availability, and regulatory matters. Management reported no material change in risk factors from its latest Form 10-K.
- Several legal matters remain pending, including a gender-promotion class action, environmental and fuel-sales cases, and state unclaimed-property examinations. No accrual was recorded for the matters described; losses were considered reasonably possible but not reasonably estimable. An unfavorable outcome could materially affect an individual quarter.
- The filing disclosed small membership-related transactions involving the Iranian Embassy in Japan and Iran Air in the U.K.; the memberships were canceled, and Costco stated it did not intend to continue these activities.
Important facts for investors to verify
- How much of margin performance is sustainable apart from the one-time legal settlement and LIFO benefit, given lower core merchandise margins.
- Comparable-sales and membership-renewal trends, including the effects of gasoline prices, foreign exchange, and new warehouse cannibalization.
- Debt service and liquidity following the special dividend, including the planned use of cash for fiscal 2013 capital spending.
- Developments in the disclosed legal proceedings and any resulting accruals or financial exposure.