Costco Wholesale Corporation — Q3 FY2015 Form 10-Q
Reporting period: 12 weeks ended May 10, 2015; year-to-date figures cover the 36 weeks ended May 10, 2015. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. Costco operated 673 warehouses worldwide.
Financial performance
| Metric | Q3 FY2015 | Q3 FY2014 | 36 weeks FY2015 | 36 weeks FY2014 |
|---|---|---|---|---|
| Total revenue | $26,101 | $25,794 | $80,421 | $77,117 |
| Net sales | $25,517 | $25,233 | $78,673 | $75,457 |
| Operating income | $821 | $737 | $2,468 | $2,129 |
| Net income attributable to Costco | $516 | $473 | $1,610 | $1,361 |
| Diluted EPS | $1.17 | $1.07 | $3.64 | $3.07 |
| Gross margin as % of net sales | 11.09% | 10.62% | 11.06% | 10.65% |
| SG&A as % of net sales | 10.11% | 9.86% | 10.10% | 9.96% |
Q3 revenue rose about 1% and net income rose 9%; membership fees increased 4% to $584. Comparable sales fell 1%, but increased 6% excluding gasoline-price and foreign-currency effects. For the first 36 weeks, revenue rose about 4%, net income about 18%, and comparable sales rose 2% (7% excluding those effects). Management cited new warehouse sales and increased shopping frequency as contributors.
Cash flow, 36 weeks: Operating cash flow was $3,257 versus $3,142 a year earlier; investing cash outflow was $1,775 versus $1,487; financing cash outflow was $1,843 versus $542. Capital expenditures were $1,588. Cash and cash equivalents ended at $5,063, down from $5,738 at fiscal year-end. Cash plus short-term investments totaled $6,805, compared with $7,315 at August 31, 2014.
Debt and liquidity: Total debt carrying value was $6,026, including $1,200 classified as current and $4,826 long-term. Costco issued $1,000 of notes in February, with maturities in 2020 and 2022; proceeds funded part of the special dividend. The filing states management expects cash and operating cash flows to meet capital requirements for the foreseeable future. It also reports $50 of short-term borrowings outstanding under bank facilities.
Material changes and notable items
- Lower gasoline prices reduced Q3 net sales by about $904; currency movements reduced sales by about $807. The average gasoline selling price per gallon fell 28% year over year. Currency changes reduced Q3 diluted EPS by $0.06, primarily reflecting the Canadian dollar.
- Q3 reported gross-margin percentage increased 47 basis points, while SG&A percentage increased 25 basis points. Excluding gasoline-price deflation’s effect on the sales denominator, gross margin improved 9 basis points and SG&A improved 10 basis points, according to management.
- Costco paid $2,514 in cash dividends during the first 36 weeks, including a $5.00-per-share special dividend; the current quarterly dividend was raised to $0.40 per share. Financing cash outflow increased substantially year over year, partly offset by the February notes issuance.
- Foreign-currency translation and other items reduced year-to-date comprehensive income by $656. The company recorded a $45 net discrete tax benefit for the 36 weeks, primarily related to the employee 401(k) special-dividend payment, partly offset by a $14 tax charge related to an ongoing tax matter.
- Costco authorized a new $4 billion share-repurchase program, expiring in April 2019; $3.959 billion remained available at May 10. It repurchased 1.62 million shares for approximately $234 during the first 36 weeks.
Outlook, risks and contingencies
- Management expected to open up to 15 additional warehouses in the remainder of fiscal 2015, including one relocation, and planned fiscal-year capital spending of approximately $2.4–$2.5 billion. These are expectations, not guarantees.
- The filing does not provide formal earnings or revenue guidance. Management emphasizes comparable-sales growth, membership growth and renewal rates, cost control, and the effects of gasoline prices and foreign exchange. Member renewal rates were 91% in the U.S. and Canada and 88% worldwide.
- Risks identified include economic and consumer-spending conditions, competition, currency movements, gasoline and other commodity costs, employee health-care and utility expenses, real-estate availability, information-security and privacy breaches, and regulation. The company notes that low operating margins make results sensitive to modest changes in gross margin and expenses.
- Legal matters include fuel-temperature sales-practice litigation and investigations or examinations concerning unclaimed property and controlled-substance prescription practices. No accrual was recorded for the described matters; possible losses could not be reasonably estimated. Management did not believe pending matters would have a material adverse effect on financial position, but an unfavorable outcome could materially affect an individual quarter.
- A February 2015 agreement makes Citibank the exclusive issuer of Costco co-branded U.S. credit cards to members, with Visa replacing American Express as the U.S. network beginning April 1, 2016. The initial agreement term is 10 years.
Key facts for investors to verify
- Whether comparable-sales trends excluding gasoline and currency effects persist, and how reported sales respond as those effects change.
- The sustainability of margin improvement, particularly core merchandise margins, and the effect of ongoing information-systems investment and employee costs.
- Cash and liquidity after the special dividend, planned capital expenditures, warehouse expansion and debt maturities.
- Membership growth, Executive Membership penetration and renewal rates, including the effects of currency movements.
- Developments, potential financial exposure and timing in the legal and regulatory matters for which losses were not estimable.
- Implementation and financial effects of the 2016 credit-card network transition; the filing does not quantify the agreement’s expected financial impact.