Costco Wholesale Corporation — FY2018 Form 10-K
Reporting period: Fiscal year ended September 2, 2018 (52 weeks). The filing also reports unaudited fourth-quarter results; FY2018 Q4 was 16 weeks, versus 17 weeks in FY2017 Q4, so quarter-over-quarter-year comparisons are affected by the extra prior-year week.
Business context
Costco operates membership warehouses and e-commerce businesses, emphasizing limited product selection, high sales volumes, rapid inventory turnover, and low prices. It ended FY2018 with 762 warehouses, up from 741, and 51.6 million paid members. U.S. and Canadian operations accounted for 87% of net sales. E-commerce represented approximately 4% of net sales.
Financial and operating metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $138.434 billion | $126.172 billion |
| Membership fees | $3.142 billion | $2.853 billion |
| Gross margin | $15.282 billion; 11.04% of net sales | $14.290 billion; 11.33% |
| Operating income | $4.480 billion | $4.111 billion |
| Net income attributable to Costco | $3.134 billion | $2.679 billion |
| Diluted EPS | $7.09 | $6.08 |
| Operating cash flow | $5.774 billion | $6.726 billion |
| Capital expenditures | $2.969 billion | $2.502 billion |
| Cash and short-term investments at year-end | $7.259 billion | $5.779 billion |
| Long-term debt, including current portion | $6.577 billion | $6.659 billion |
Comparable sales increased 9% overall (7% excluding currency and gasoline-price effects). Net sales rose 10%, reflecting comparable sales growth and new warehouses, partly offset by FY2017’s extra week. Higher gasoline prices contributed approximately $2.267 billion, or 180 basis points, to reported net sales growth; favorable currency movements added approximately $1.156 billion, or 92 basis points.
Gross margin percentage fell 29 basis points, mainly from gasoline-price inflation’s effect on the sales mix and greater penetration of lower-margin ancillary businesses. SG&A as a percentage of sales improved 24 basis points, helped by sales leverage and gasoline-price inflation. Cash from operations declined year over year, primarily because approximately $1.7 billion of accelerated vendor payments in FY2016 had benefited FY2017 cash flow. Year-end current assets were $20.289 billion and current liabilities were $19.926 billion.
FY2018 Q4: Net sales were $43.414 billion, membership fees $997 million, operating income $1.446 billion, net income attributable to Costco $1.043 billion, and diluted EPS $2.36. FY2017 Q4 reported $41.357 billion, $943 million, $1.450 billion, $919 million, and $2.08, respectively. The prior quarter included one additional week.
Changes, outlook, and notable matters
- Membership fee revenue grew 10%, primarily reflecting the U.S. and Canada fee increase implemented in June 2017 and member sign-ups. Renewal rates were 90% in the U.S. and Canada and 88% worldwide.
- The effective tax rate declined to 28.4% from 32.8%, favorably affected by the 2017 Tax Act and $76 million of net tax benefits. The filing records a $142 million estimated transition-tax charge on deemed repatriation; tax-accounting estimates remained subject to possible adjustment through FY2019 Q2.
- Management expected FY2019 capital expenditures of approximately $2.8–$3.1 billion, funded from cash and operating cash flow, and planned approximately 20 net new warehouses and up to four relocations. The filing does not provide formal earnings or sales guidance.
- The Board increased the quarterly dividend from $0.50 to $0.57 per share in April 2018. FY2018 dividends declared were $2.14 per share; FY2017’s $8.90 included a $7.00 special dividend.
- Costco identified a material weakness in IT general controls over user access and program change management affecting certain systems supporting financial reporting. Management and the auditor concluded internal control over financial reporting was ineffective at year-end; the auditor issued an adverse ICFR opinion but an unqualified opinion on the financial statements. No financial-statement misstatements were identified. Management planned remediation before the end of FY2019.
- Disclosed risks include dependence on U.S. and Canadian performance, intense retail and e-commerce competition, labor and healthcare costs, currency and commodity volatility, cybersecurity and privacy exposure, and self-insured claims. The company described several legal and regulatory matters; it said no pending matter was expected to materially adversely affect overall financial position, results, or cash flows, while noting an unfavorable outcome could materially affect an individual quarter.
Important facts for investors to verify
- Whether the IT-control remediation was completed and independently tested as effective, and whether related costs or reporting issues emerged.
- Underlying comparable-sales trends after separating gasoline prices and foreign exchange, and the effect of the 16-week versus 17-week Q4 periods.
- Whether gross-margin pressure, including sales-mix shifts and return-center costs, persists as sales grow.
- Actual FY2019 capital spending, warehouse openings, and membership renewal and fee-revenue trends against management’s stated plans.
- Final tax effects of the 2017 Tax Act and developments in the disclosed legal, regulatory, and self-insurance exposures.