Costco Wholesale Corporation — Q2 FY2011 Form 10-Q
Business context and reporting period. Costco operates membership warehouses selling a limited range of branded and private-label merchandise. This filing covers the 12 weeks ended February 13, 2011, and the first 24 weeks of fiscal 2011; comparisons are with the corresponding periods ended February 14, 2010. Amounts are in millions of dollars except per-share data.
Financial performance
| Metric | 12 weeks | 24 weeks |
|---|---|---|
| Total revenue | $20,875; up 11.4% | $40,114; up 11.3% |
| Net sales | $20,449; up 11.4% | $39,272; up 11.3% |
| Membership fees | $426; up 10.4% | $842; up 10.3% |
| Operating income | $596 vs. $470 | $1,121 vs. $898 |
| Net income attributable to Costco | $348 vs. $299 | $660 vs. $565 |
| Diluted earnings per share | $0.79 vs. $0.67 | $1.49 vs. $1.27 |
| Gross margin as % of net sales | 10.83% vs. 10.68% | 10.90% vs. 10.77% |
| SG&A as % of net sales | 9.96% vs. 10.20% | 10.13% vs. 10.35% |
Comparable sales rose 7% in both periods. The company reported that stronger foreign currencies and higher gasoline prices boosted Q2 net sales by approximately $237 and $244, respectively; comparable sales were also positively affected by currency and gasoline. Excluding Costco Mexico, net-sales growth would have been 8% for both periods. U.S. and Canada membership renewal was 89%; worldwide renewal was approximately 86%.
Cash flow, liquidity and debt
- First-half operating cash flow was $1,446, compared with $1,360 a year earlier. Investing activities used $861, principally reflecting capital spending and purchases of short-term investments; financing activities used $503, including $239 of share repurchases.
- Cash and cash equivalents were $3,355 and short-term investments were $2,024 at February 13, 2011, totaling $5,379. Cash increased $141 from fiscal year-end.
- Long-term debt was $2,144; short-term borrowings were $1. Current assets were $13,138 and current liabilities were $10,746.
- First-half capital expenditures were $540. The quarterly dividend was $0.205 per share. The company repurchased 3.751 million shares in the first half for approximately $245; $894 remained under the repurchase authorization.
Material changes and unusual items
- Beginning August 30, 2010, Costco consolidated its 50%-owned Mexico joint venture following adoption of new accounting guidance. This increased reported revenue, assets and liabilities by approximately 3%; management said it did not affect net income attributable to Costco. Prior-year Mexico results were accounted for under the equity method, limiting comparability.
- Reported gross margin improved, while increased gasoline sales mix, a $6 LIFO inflation charge and higher Executive Member rewards partly offset core merchandise margin gains. The Q2 SG&A ratio benefited from gasoline-driven sales growth, a prior-year employee-benefit charge and Mexico consolidation; excluding identified effects, management said SG&A comparisons were higher, mainly due to healthcare and other employee costs.
- Q2 interest income and other, net fell to $4 from $30, partly because Mexico moved from equity-method accounting; Costco also recorded foreign-currency transaction losses of $9 for the quarter.
- A proposed settlement of stock-option derivative litigation resulted in a $4.85 million Q2 SG&A charge. The settlement remained subject to final court approval.
Outlook, risks and contingencies
No earnings or revenue forecast is provided. Costco expected to spend approximately $1.5 billion on real estate, construction, remodeling and equipment in fiscal 2011, funded from operations and existing liquid resources. It planned up to 15 additional warehouse openings for the remainder of the year. Management cited economic conditions, competition, exchange rates, gasoline and commodity costs, healthcare and other employee costs, and real-estate availability as important risks; it warned that economic weakness could continue to pressure member spending and that modest margin or expense changes can significantly affect earnings.
Contingencies include wage-and-hour class actions, an organic-milk matter remanded for further proceedings, fuel-temperature litigation subject to a revised settlement proposal, and environmental inquiries concerning refrigerant compliance for which potential losses could not be estimated. Washington issued an unclaimed-property assessment, which Costco said it was contesting. Management stated that pending matters were not expected to have a material adverse effect on financial position, while acknowledging an adverse outcome could materially affect an individual quarter.
Important facts for investors to verify
- How much of comparable-sales and reported revenue growth came from underlying volume and spending versus gasoline prices, foreign exchange and Mexico consolidation.
- Whether core merchandise margin gains persist after accounting for gasoline mix, LIFO effects and Executive Member rewards.
- Whether healthcare and employee-benefit costs continue to outpace sales growth and pressure SG&A.
- Progress against the $1.5 billion fiscal-year capital-spending plan and the remaining warehouse-opening plans.
- Final court outcomes and any eventual exposure from the stock-option settlement, labor, environmental and unclaimed-property matters.