Costco Wholesale Corporation — Q3 FY2016 Form 10-Q
Reporting period: Twelve weeks ended May 8, 2016; year-to-date figures cover the 36 weeks ended May 8, 2016. Amounts are in millions of dollars, except per-share data. Costco operated 705 warehouses worldwide and online businesses in six markets.
Financial results
| Metric | Q3 FY2016 | Q3 FY2015 | 36 weeks FY2016 | 36 weeks FY2015 |
|---|---|---|---|---|
| Net sales | $26,151 | $25,517 | $80,345 | $78,673 |
| Membership fees | $618 | $584 | $1,814 | $1,748 |
| Operating income | $858 | $821 | $2,481 | $2,468 |
| Net income attributable to Costco | $545 | $516 | $1,571 | $1,610 |
| Diluted EPS | $1.24 | $1.17 | $3.56 | $3.64 |
| Gross margin percentage | 11.43% | 11.09% | 11.32% | 11.06% |
| SG&A as % of net sales | 10.44% | 10.11% | 10.42% | 10.10% |
Quarterly comparison: Revenue rose 3% (net sales rose 2%), and Costco-attributable net income increased 5%. Comparable sales were flat, but increased 3% excluding foreign exchange and gasoline-price effects. Membership fees increased 6%; paid members reached 46.9 million, and renewal rates were 90% in the U.S. and Canada and 88% worldwide.
Year-to-date comparison: Revenue rose 2%, while Costco-attributable net income fell 2% and diluted EPS fell from $3.64 to $3.56. Comparable sales were flat versus 2% growth a year earlier; excluding foreign exchange and gasoline-price effects, growth was 5% versus 7%.
Cash flow, liquidity and debt
- For the first 36 weeks, operating cash flow was $3,461, compared with $3,257 a year earlier; capital expenditures were $1,800. Investing activities used $1,320 and financing activities used $2,088.
- At May 8, 2016, cash and cash equivalents were $4,884 and short-term investments were $1,137, totaling $6,021. Total reported debt was $5,114, including $1,193 current and $3,921 long-term. Cash and short-term investments exceeded reported debt by approximately $907.
- Cash and short-term investments declined from $6,419 at August 30, 2015. Total liabilities were $22,125 and equity was $11,748. Current assets of $16,542 were below current liabilities of $16,999.
- Costco repaid $1,200 of senior notes during the period; its Japanese subsidiary issued approximately $103 of notes due in 2026. Management said cash and operating cash flows should meet foreseeable liquidity and capital needs. No short-term borrowings were outstanding at quarter-end.
Drivers, outlook and risks
- Net sales growth reflected 32 net new warehouses opened since the comparable prior-year quarter. In Q3, gasoline-price decreases reduced sales by approximately $483, while foreign currency changes reduced sales by approximately $372. Currency movements adversely affected diluted EPS by $0.03.
- Reported gross margin percentage improved 34 basis points in Q3, partly because gasoline-price deflation reduced the sales denominator. Excluding that effect, adjusted gross margin percentage increased 13 basis points; non-recurring legal settlements contributed seven basis points. SG&A as a percentage of adjusted net sales rose 14 basis points, with employee benefit costs, information-systems modernization and stock compensation among the pressures.
- Management expected to open up to 10 new warehouses and relocate one in the remainder of FY2016; it projected FY2016 capital spending of approximately $2,500–$2,700. No earnings or EPS guidance is provided in the filing.
- Management cited competition, economic and consumer-spending conditions, foreign exchange, gasoline and commodity prices, employee and healthcare costs, real-estate development, and security or privacy breaches as risks. It said no material changes had occurred in the risk factors disclosed in the prior annual report.
- Contingencies include gasoline-temperature class-action litigation, state unclaimed-property examinations, and inquiries by the Drug Enforcement Administration and U.S. Attorneys concerning controlled-substance prescriptions. Costco reported an immaterial accrual for one matter; it said an unfavorable outcome could cause a material charge in an individual quarter, though it did not expect pending matters to materially affect financial position.
- Other notable items: foreign-currency translation and other adjustments were a $224 million gain in Q3, while the year-to-date amount was a $5 million loss. Costco declared a $0.45-per-share quarterly dividend, paid May 13, 2016, and repurchased $346 million of shares year to date.
Important facts for investors to verify
- Whether comparable-sales momentum improves, particularly after adjusting for gasoline prices and foreign exchange.
- Whether membership growth, Executive-member penetration and renewal rates remain strong.
- Whether margin gains persist after accounting for legal settlements, LIFO benefits, gasoline effects and ongoing cost pressures.
- Execution of planned warehouse openings and the $2.5–$2.7 billion FY2016 capital-spending plan, and its effect on cash and returns.
- Developments in the prescription-related inquiries and other litigation or unclaimed-property matters; the filing does not provide a reasonably estimable total loss range.