Costco Wholesale Corporation — Form 10-Q Summary
Reporting period: First fiscal quarter of 2012, the 12 weeks ended November 20, 2011; comparable period ended November 21, 2010. Fiscal 2012 is a 53-week year ending September 2, 2012. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Business context and performance
Costco operates membership warehouses selling a limited selection of branded and private-label merchandise at low prices. It had 596 warehouses worldwide at quarter-end. Management identifies comparable sales growth, membership, cost control and warehouse expansion as key business drivers, while emphasizing that the business operates on low margins.
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Net sales | $21,181 | $18,823 | +12.5% |
| Membership fees | $447 | $416 | +7.6% |
| Total revenue | $21,628 | $19,239 | +12.4% |
| Operating income | $543 | $525 | +3.4% |
| Net income attributable to Costco | $320 | $312 | +2.6% |
| Diluted EPS | $0.73 | $0.71 | +2.8% |
| Operating cash flow | $664 | $720 | −$56 |
| Capital expenditures | $343 | $306 | +$37 |
Financial condition and material changes
- Comparable sales increased 10%, versus 7% a year earlier. Gasoline price inflation contributed approximately $456 to comparable sales; foreign currency movements contributed approximately $51. The 26% increase in average gasoline selling price also added approximately $464 to reported net sales.
- Gross margin was $2,250, or 10.62% of net sales, down 35 basis points from 10.97%. Management attributed most of the percentage decline to higher gasoline sales mix; core merchandise margin as a percentage of core merchandise sales declined 5 basis points.
- SG&A was $2,145, or 10.13% of net sales, improving 18 basis points. Excluding gasoline price inflation’s effect on sales, the rate increased 4 basis points, including costs related to the Washington alcohol-law initiative contribution and higher stock-based compensation.
- Interest income and other, net rose to $37 from $5, primarily reflecting foreign-currency transaction gains. The quarter included a $20 foreign-currency transaction gain, compared with a $2 loss in the prior-year quarter.
- Cash and cash equivalents plus short-term investments totaled $5,915 at November 20, up from $5,613 at August 28, 2011. Operating cash flow fell mainly because the net investment in inventory increased by $120. Inventory was $7,618, versus $6,638 at fiscal year-end.
- Total debt was $2,264, including $34 of short-term borrowings; long-term debt was $2,230, of which $900 was current. The current portion is the 5.3% senior notes due March 15, 2012. Costco said it intended to repay them from existing liquidity. Japan’s subsidiary issued $78 of guaranteed notes at 1.18%, due October 2018, with another $52 funding scheduled for December 20, 2011.
- Current assets were $14,993 and current liabilities $13,311. Cash and short-term investments were substantial, though $1,836 of non-U.S. subsidiary and entity balances were described as indefinitely reinvested and potentially unavailable for certain financing uses.
- Segment revenue and operating income: U.S. operations $15,614 and $317; Canadian operations $3,441 and $135; other international operations $2,573 and $91.
Outlook, commentary and risks
- No specific earnings or comparable-sales guidance was provided. Management said cash and operating cash flow should meet capital requirements for the foreseeable future.
- Fiscal 2012 planned spending for real estate, construction, remodeling and equipment was approximately $1.4–$1.5 billion; $343 had been spent through Q1. Plans included up to 17 additional warehouse openings for the rest of the year, a relocation and reopening a Japan warehouse undergoing earthquake repairs.
- U.S. and Canada membership fees were increased effective November 1, 2011 for new members and January 1, 2012 for renewal members. Executive fees rose from $100 to $110, and the maximum annual 2% reward increased from $500 to $750. These changes did not affect Q1 membership-fee revenue. Renewal rates were approximately 89% in the U.S. and Canada and 85% worldwide.
- Q1 results included a $24 charge for a Costco Mexico tax audit and a $17 nondeductible contribution to the Yes on 1183 Coalition. Management reported a $29 net discrete tax expense overall; the reported effective tax rate was 40.8%, versus 34.2% a year earlier. Costco was evaluating whether to seek a Mexican tax refund, with significant uncertainty about recovery.
- Material risks cited include economic conditions, currency exchange rates, competition, consumer spending, supplier actions, employee and health-care costs, energy and commodity costs, and real estate conditions. Costco stated there had been no material changes to previously disclosed risk factors.
- Contingencies include employment class actions, motor-fuel temperature-sales litigation, organic-milk claims, hazardous-product and environmental inquiries, and state unclaimed-property examinations. The filing says a reasonable loss estimate generally could not be made; management did not expect pending matters, individually or in aggregate, to materially adversely affect financial position, but an unfavorable outcome could materially affect an individual quarter.
Important facts for investors to verify
- Whether comparable-sales momentum persists after separating gasoline-price and currency effects from underlying customer activity.
- Whether sales growth converts into earnings growth given lower reported gross margin and Costco’s low-margin operating model.
- The outcome and potential recovery relating to the Costco Mexico tax audit, and the impact of the Yes on 1183 contribution.
- Repayment or refinancing of the $900 senior notes due March 2012 and the use of cash held by non-U.S. entities.
- Execution of the $1.4–$1.5 billion capital-spending plan, planned warehouse openings and repair-related reopening in Japan.
- Developments in material litigation, environmental inquiries and unclaimed-property assessments, for which potential losses were generally not quantifiable.