Costco Wholesale Corporation — Q1 FY2017 Form 10-Q
Reporting period: 12 weeks ended November 20, 2016; comparable quarter ended November 22, 2015. Costco operated 723 warehouses and online businesses in six countries. Amounts below are in millions of dollars except per-share data.
Financial results
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $27,469 | $26,627 | +3% |
| Membership-fee revenue | $630 | $593 | +6% |
| Total revenue | $28,099 | $27,220 | +3% |
| Gross margin | $3,181; 11.58% | $3,006; 11.29% | +29 basis points |
| Operating income | $849; approximately 3.0% of revenue | $767; approximately 2.8% | +11% |
| Net income attributable to Costco | $545 | $480 | +14% |
| Diluted earnings per share | $1.24 | $1.09 | Up $0.15 |
| Operating cash flow | $2,793 | $811 | + $1,982 |
| Capital expenditures | $667 | $715 | Down $48 |
SG&A was $2,940, or 10.70% of net sales, versus $2,806, or 10.54%; the rate rose 16 basis points. Net income margin was approximately 1.9%, versus 1.8%. Comprehensive income attributable to Costco fell to $205 from $496, principally reflecting a $345 foreign-currency translation and other loss, compared with a $15 gain.
Sales, operations, and changes from the prior year
- Comparable sales rose 1% overall, compared with a 1% decline a year earlier. Excluding currency and gasoline-price effects, comparable sales rose 2%, versus 6%. Growth was affected by price deflation, lower gasoline prices, foreign exchange, and cannibalization from new warehouses; shopping frequency increased.
- Net sales growth reflected new warehouses and comparable-sales growth, partly offset by deflation in foods and hardlines. Currency changes reduced reported sales by about $100 and lower gasoline prices by about $77.
- Paid members increased to 47.9 million from 45.4 million; cardholders rose to 87.3 million from 82.7 million. Renewal rates were 90% in the U.S. and Canada and 88% worldwide.
- Gross-margin percentage benefited from a non-recurring legal settlement (19 basis points) and the U.S. co-branded credit-card arrangement (13 basis points); core merchandise categories added 3 basis points. These benefits were partly offset by ancillary-business declines, mainly gasoline.
- Net income also benefited from a lower effective tax rate, 34.4% versus 36.1%. Management said both periods’ rates included immaterial net discrete items.
Cash, debt, and liquidity
- Cash and cash equivalents were $4,805 and short-term investments $1,311 at November 20, for combined balances of $6,116. Management cited cash, investments, and operating cash flow as primary liquidity sources and said they should meet foreseeable liquidity and capital needs.
- Operating cash flow included a significant timing benefit: approximately $1,700 of vendor payments were accelerated into the final week of FY2016 ahead of the new accounting system implementation. Inventory growth used $1,983 of cash, while accounts payable provided $3,707.
- Cash used in investing activities was $655; cash used in financing activities was $660. Financing included $198 of cash dividends, $122 of share repurchases, and stock-award tax withholding.
- Long-term debt had a carrying value of $5,092, including $1,159 current and $3,933 long-term. Cash and short-term investments exceeded debt, but current liabilities of $19,161 exceeded current assets of $18,570.
- The quarterly dividend was increased to $0.45 per share from $0.40. The company repurchased 809,000 shares for $122 at an average $151 per share; $3,100 remained under the $4,000 authorization.
Outlook, risks, and other notable items
- No specific earnings or sales guidance was provided. Costco planned to open up to 23 additional warehouses and relocate two during the remainder of FY2017, and expected FY2017 capital expenditures of approximately $2,600–$2,800.
- Management highlighted competition, economic and consumer-spending conditions, currency and gasoline-price changes, employee and health-care costs, energy and commodity costs, real estate, regulation, and data-security risks. It emphasized that sales growth and expense control are important given the company’s low-margin model.
- Legal and regulatory matters include fuel-temperature class actions, a California employee-seating class action, state unclaimed-property examinations, federal inquiries concerning controlled-substance prescription practices, an Ontario inspection request, and Connecticut hazardous-waste notices. The company recorded an immaterial accrual for two matters; it said potential losses on other matters could not be reasonably estimated and that an adverse quarterly charge could be material.
- Costco implemented a new U.S. and Canada accounting system in Q1. Management reported disclosure controls were effective and said system-related internal-control processes would be updated as needed.
Important facts for investors to verify
- How much of the unusually high operating cash flow reflects vendor-payment timing, and how cash generation trends in subsequent quarters.
- Whether comparable-sales growth improves, particularly after adjusting for currency, gasoline prices, deflation, and new-store cannibalization.
- Whether gross-margin gains persist after the non-recurring legal-settlement benefit and the new credit-card arrangement’s contribution.
- Progress against the warehouse-opening and capital-spending plans, and the resulting effect on liquidity and operating returns.
- Developments in the disclosed legal and regulatory matters, including any material change in estimated exposure or accruals.