Costco Wholesale Corporation — Q3 FY2011 Form 10-Q
Reporting period: Third quarter was the 12 weeks ended May 8, 2011; year-to-date (YTD) was the 36 weeks ended May 8, 2011. Dollar amounts are in millions unless stated otherwise. Costco operated 580 warehouses worldwide.
Financial performance
| Metric | Q3 FY2011 | Q3 FY2010 | YTD FY2011 | YTD FY2010 |
|---|---|---|---|---|
| Total revenue | $20,623 | $17,780 | $60,737 | $53,821 |
| Net sales | $20,188 | $17,385 | $59,460 | $52,663 |
| Membership fees | $435 | $395 | $1,277 | $1,158 |
| Operating income | $556 | $491 | $1,677 | $1,389 |
| Net income attributable to Costco | $324 | $306 | $984 | $871 |
| Diluted EPS | $0.73 | $0.68 | $2.22 | $1.95 |
| Gross margin as % of net sales | 10.50% | 10.88% | 10.77% | 10.81% |
| SG&A as % of net sales | 9.86% | 10.29% | 10.04% | 10.33% |
- Q3 revenue rose 16.0% and net income attributable to Costco rose 6.1%; diluted EPS increased to $0.73 from $0.68. YTD revenue rose 12.9% and Costco net income rose 13.0%.
- Comparable sales increased 12% in Q3 and 9% YTD. Management attributed reported sales growth partly to gasoline price increases and stronger foreign currencies: gasoline added about 335 basis points and currency about 165 basis points to Q3 comparable sales. Sales also benefited from 13 net new warehouses since the prior-year quarter.
- Q3 gross margin rate fell 38 basis points. A $49 pre-tax LIFO inventory charge reduced Q3 gross margin by about 24 basis points; higher gasoline sales also weighed on the rate. Core merchandise margin improved, while lower SG&A as a share of sales helped offset gross-margin pressure.
- Membership-fee growth reflected greater Executive Membership penetration and new sign-ups. Renewal rates were 89% in the U.S. and Canada and approximately 86% worldwide.
Cash flow, balance sheet and capital allocation
- YTD operating cash flow was $2,257, versus $2,169 a year earlier. Capital expenditures were $818, making operating cash flow less capital expenditures approximately $1,439, compared with $1,525 in the prior-year period.
- YTD investing cash use was $1,238, including $818 of capital expenditures and net purchases of short-term investments. Financing cash use was $262, including $347 of share repurchases and $179 of dividend payments.
- At May 8, cash and cash equivalents were $4,082 and short-term investments were $2,133, totaling $6,215. Current assets were $14,069 and current liabilities $12,494.
- Total debt was $2,147: $900 was classified as current, principally the 5.3% senior notes due March 2012, and $1,247 was long-term. Management stated it intended to repay the maturing notes using existing cash, cash equivalents and short-term investments.
- The Board raised the quarterly dividend from $0.205 to $0.24 per share ($0.96 annualized) and authorized a new $4,000 share-repurchase program expiring April 2015. YTD repurchases totaled $347.
Outlook, commentary and notable matters
- Management planned approximately $1,400 of FY2011 spending on real estate, construction, remodeling and equipment, funded with operating cash flow and existing liquidity. After eight net new warehouses in the first 36 weeks, the company expected to open up to 12 more in the rest of the fiscal year, including a Japan reopening; another earthquake-damaged Japan warehouse was expected to reopen in 2012.
- Management emphasized sales growth and comparable sales as key profit drivers, while noting that the low-margin model makes results sensitive to modest changes in gross margin and SG&A. It may absorb merchandise-cost increases rather than immediately pass them to members.
- Effective August 30, 2010, Costco began consolidating its 50%-owned Mexico joint venture following an accounting-standard adoption and subsequent governance changes. This increased reported assets, liabilities and revenue by approximately 3%, but management said it did not affect net income attributable to Costco.
- Risks cited include economic conditions and consumer spending, competition, currency movements, employee and health-care costs, energy and commodity prices, vendors, regulation and real-estate availability. Forward foreign-exchange contracts were used for economic hedging; fixed-price energy contracts covered approximately 38% of warehouses and other facilities.
- Legal matters include employment class actions, an unresolved EPA inquiry concerning refrigeration and air-conditioning compliance, unclaimed-property disputes and other claims. The company said it could not reasonably estimate possible losses for most matters; it did not expect pending matters, individually or collectively, to materially affect financial position, but an unfavorable outcome could materially affect an individual quarter.
Important facts for investors to verify
- How much of comparable-sales and revenue growth persists after removing gasoline-price and foreign-exchange effects.
- Whether gross-margin pressure, including inventory inflation and the LIFO charge, continues, and whether SG&A leverage is sustainable.
- Execution of the FY2011 capital-spending and warehouse-opening plans, including Japan repair and reopening timing.
- Repayment of the $900 senior notes due March 2012 and the company’s cash and investment position after repayment and planned capital returns.
- Developments and potential financial exposure from the disclosed litigation, regulatory inquiries and unclaimed-property assessments.