Business context and reporting period
Costco Wholesale Corporation operates membership warehouses and online businesses. This Form 10-K covers the 53-week fiscal year ended September 2, 2012; the prior year had 52 weeks. The filing’s fiscal fourth quarter was 17 weeks, versus 16 weeks in 2011, so quarterly comparisons include an extra week. Costco operated 608 warehouses at year-end. In July 2012, it acquired the remaining 50% of Costco Mexico for $789 million.
Financial performance and condition
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Net sales | $97.062 billion | $87.048 billion |
| Total revenue, including membership fees | $99.137 billion | $88.915 billion |
| Membership fees | $2.075 billion | $1.867 billion |
| Gross margin | $10.239 billion; 10.55% of net sales | $9.309 billion; 10.69% |
| Operating income | $2.759 billion | $2.439 billion |
| Net income attributable to Costco | $1.709 billion | $1.462 billion |
| Diluted EPS | $3.89 | $3.30 |
| Operating cash flow | $3.057 billion | $3.198 billion |
| Capital expenditures | $1.480 billion | $1.290 billion |
FY 2012 net sales grew 11.5%; comparable sales increased 7% (6% excluding gasoline price inflation and foreign currencies). Net income rose 16.9%. The 53rd week and gasoline price inflation contributed to sales growth; gasoline inflation added about $801 million to sales, while currency movements reduced sales by about $597 million. Gross margin declined 14 basis points, reflecting pricing investment in core merchandise, partly offset by a lower LIFO charge. SG&A improved 17 basis points as a share of sales.
Fourth-quarter net sales were $31.524 billion and net income attributable to Costco was $609 million, compared with $27.588 billion and $478 million, respectively, in the prior-year quarter. Diluted EPS was $1.39 versus $1.08. These comparisons are affected by the extra week in FY 2012’s quarter.
Cash and short-term investments totaled $4.854 billion at year-end, down from $5.613 billion. Current assets were $13.526 billion and current liabilities $12.260 billion. Long-term debt was $1.381 billion, with $1 million current; total debt was approximately $1.382 billion versus $2.153 billion a year earlier. Costco repaid $900 million of 5.3% notes in March. Operating cash flow less capital expenditures was approximately $1.577 billion. Operating cash flow declined $141 million, primarily due to increased investment in inventory net of payables. The company reported no year-end short-term bank borrowings and $438 million of credit-facility capacity.
Material changes, outlook, risks and unusual items
- Membership fees rose 11.1%, supported by membership growth, fee increases and greater Executive Membership penetration. Renewal rates were 89.7% in the U.S. and Canada and 86.4% worldwide. Management expected the 2011-12 fee increases to add approximately $121 million to FY 2013 membership-fee revenue.
- Management planned FY 2013 capital spending of approximately $1.8-$2.0 billion and 27-30 net new warehouse openings. It stated existing cash and operating cash flow should meet foreseeable capital needs; no earnings guidance was provided.
- The FY 2012 effective tax rate was 36.1%, versus 35.3%. Tax expense included $25 million of nonrecurring net charges, primarily related to a Mexico tax audit and dividend, and nondeductible expenses associated with a Washington State alcohol-law initiative.
- Costco purchased Mexico’s remaining interest for $789 million and completed the repayment of its $900 million 5.3% notes. It increased the quarterly dividend from $0.24 to $0.275 per share and repurchased 7.272 million shares for approximately $617 million.
- Key risks include intense retail competition; dependence on U.S. and Canadian operations (88% of sales and 83% of operating income); commodity and currency volatility; execution and cannibalization risks from expansion; supplier, labor, technology, cybersecurity, product-safety and regulatory risks; and exposure to legal proceedings and tax audits.
- Management described several ongoing legal matters, including a gender-promotion class action, environmental and gasoline-related matters, and state unclaimed-property examinations. One matter had a recorded accrual that was not material; possible losses for several matters could not be reasonably estimated. Management said an unfavorable outcome could materially affect an individual quarter, while it did not expect pending matters in aggregate to materially affect financial position.
- CEO W. Craig Jelinek assumed the role in January 2012; co-founder James Sinegal retired as CEO and continued in an advisory role and on the Board.
Investor verification priorities
- Separate underlying sales and earnings growth from the extra fiscal week, gasoline inflation, currency effects and Mexico’s changing consolidation and ownership.
- Review the basis for margin trends, including pricing investments, LIFO charges, gasoline mix and Executive Member rewards.
- Assess inventory and working-capital movements, cash conversion, planned capital spending and the pace and returns of warehouse expansion.
- Monitor renewal rates, Executive Membership penetration and realization of the expected FY 2013 membership-fee benefit.
- Track developments in the disclosed litigation, environmental matters, unclaimed-property examinations and Mexico tax issues, including any changes in loss estimates.