Costco Wholesale Corporation — Q3 FY2010 Form 10-Q
Reporting period: 12 weeks ended May 9, 2010; year-to-date figures cover 36 weeks. Financial amounts are in millions of dollars, except per-share data. Costco operated 535 warehouses across the U.S. and several international markets, plus locations in Mexico through a 50%-owned joint venture.
Financial performance
| Metric | Q3 FY2010 | Q3 FY2009 | 36 weeks FY2010 | 36 weeks FY2009 |
|---|---|---|---|---|
| Net sales | $17,385 | $15,477 | $52,663 | $48,001 |
| Membership fees | $395 | $329 | $1,158 | $1,043 |
| Total revenue | $17,780 | $15,806 | $53,821 | $49,044 |
| Operating income | $491 | $359 | $1,389 | $1,179 |
| Net income attributable to Costco | $306 | $210 | $871 | $712 |
| Diluted EPS | $0.68 | $0.48 | $1.95 | $1.62 |
| Operating cash flow | — | $2,169 | $1,543 |
- Q3 net sales grew 12.3%; comparable sales rose 10%. The company attributed about 380 basis points of sales growth to foreign exchange and 273 basis points to gasoline price inflation. It opened 12 net new warehouses since the prior-year quarter.
- Q3 gross margin was 10.88% of net sales, down 11 basis points year over year. SG&A was 10.29% of net sales, down 40 basis points. Q3 operating income increased 36.8%; diluted EPS rose 41.7%.
- Membership fees increased 20.1% in Q3, partly because the prior-year quarter included a $27 litigation-settlement charge. Excluding that comparison, fees increased 11%, supported by new sign-ups and greater Executive Membership penetration. U.S. and Canada renewal rate was 87%.
- For the first 36 weeks, net sales increased 9.7%, operating income 17.8%, and Costco-attributable net income 22.3%. Comparable sales increased 7%.
Liquidity, debt and capital
- At May 9, cash and cash equivalents were $4,413 and short-term investments were $854, totaling $5,267; the filing notes approximately $983 of these balances represented debit- and credit-card receivables, primarily from the final week of the quarter.
- Long-term debt was $2,132, with no current portion reported; short-term borrowings were $30. Costco said it was in compliance with debt covenants. Cash and short-term investments exceeded reported long-term debt.
- Operating cash flow of $2,169 funded $644 of capital expenditures. Investing activities used $912; financing activities used $12. Cash rose to $4,413 from $3,157 at fiscal year-end.
- The board raised the quarterly dividend from $0.18 to $0.205 per share, equivalent to $0.82 annualized. The company said it presently expects quarterly dividends to continue, subject to board declaration.
- Costco expected approximately $1,000 of FY2010 spending on real estate, construction, remodeling and equipment; $644 had been spent through Q3. It planned up to six additional warehouse openings for the remainder of the fiscal year.
Management commentary, outlook and risks
- Management identified sales growth, particularly comparable sales, as a key profitability driver. It cautioned that economic weakness may continue to pressure member spending and that competition, pricing decisions and cost inflation can affect sales and margins.
- Gasoline inflation and stronger foreign currencies materially boosted reported sales and comparable sales; management also noted that gasoline mix can dilute reported gross margin. Healthcare costs, workers’ compensation and bonuses pressured operating costs.
- Unusual items included a $14 Q3 SG&A benefit from recovery of amounts previously paid for certain Canadian employees’ tax consequences; a $22 employee-benefit charge in Q2 for annual payment of certain unused time off; and a $7 prior-year Q3 membership-litigation charge. The prior-year 36-week period also included a $26 employee life-insurance valuation charge.
- Legal matters include employment class actions, consumer claims, environmental and regulatory inquiries, and shareholder derivative litigation related to historical stock-option grants. Management said it could not reasonably estimate possible losses for several matters and did not expect pending matters, individually or in aggregate, to materially affect financial position; an unfavorable outcome could nevertheless materially affect an individual quarter.
- Other disclosed risks include currency and interest-rate movements, energy prices, vendor actions, regulation, real estate conditions, and employee costs. Management reported no material changes to previously disclosed risk factors or market risks and concluded disclosure controls were effective.
Important facts for investors to verify
- How much comparable-sales growth persists after adjusting for gasoline prices and foreign exchange, and whether member spending remains resilient.
- Whether gross-margin trends, especially food and fresh-food margins, and elevated employee costs affect earnings as sales growth normalizes.
- Execution of the FY2010 capital-spending and warehouse-opening plans, alongside the company’s dividend and repurchase activity.
- Developments in legal and regulatory matters, for which several potential losses were not estimable in the filing.
- Effects of the $14 tax-related benefit and other unusual items when assessing recurring operating performance.