Costco Wholesale Corporation — FY2010 Form 10-K
Business context and reporting period. Costco operates membership warehouses offering a limited assortment of merchandise at low prices. This 10-K covers the 52-week fiscal year ended August 29, 2010; fiscal Q4 was 16 weeks. Costco ended the year with 540 warehouses, excluding 32 operated by its 50%-owned Mexico joint venture.
Financial performance and position
| Metric | FY2010 | FY2009 |
|---|---|---|
| Net sales | $76.255 billion | $69.889 billion |
| Membership fees | $1.691 billion | $1.533 billion |
| Total revenue | $77.946 billion | $71.422 billion |
| Gross margin | $8.260 billion; 10.83% of net sales | $7.554 billion; 10.81% |
| Operating income | $2.077 billion | $1.777 billion |
| Net income attributable to Costco | $1.303 billion | $1.086 billion |
| Diluted EPS | $2.92 | $2.47 |
| Operating cash flow | $2.780 billion | $2.092 billion |
- Net sales rose 9.1%; comparable sales increased 7% overall, comprising 4% in the U.S. and 19% internationally. International comparable sales rose 8% in local currency.
- SG&A was $7.840 billion, or 10.28% of net sales, versus $7.252 billion, or 10.38%, in FY2009. Gross margin expanded two basis points; operating income increased about 17% and net income about 20%.
- Cash and cash equivalents plus short-term investments totaled $4.749 billion, up from $3.727 billion. Current assets were $11.708 billion and current liabilities $10.063 billion.
- Short-term borrowings were $26 million; long-term debt was $2.141 billion, with no current portion at year-end. Interest expense was $111 million. The company reported $2.328 billion of operating lease obligations and $308 million of capital lease obligations.
- Capital expenditures were $1.055 billion. Cash used in investing was $2.015 billion, largely reflecting investment purchases; cash used in financing was $719 million, including share repurchases and dividends.
- At the fiscal fourth quarter, net sales were $23.592 billion versus $21.888 billion; net income attributable to Costco was $432 million versus $374 million, and diluted EPS was $0.97 versus $0.85.
Material changes versus FY2009
- Recovery followed FY2009’s 4% decline in comparable sales and 15% decline in diluted EPS. FY2010 growth included new-warehouse sales and favorable currency and gasoline effects.
- Stronger foreign currencies added approximately $1.570 billion to net sales and $61 million after tax to net income. Higher gasoline prices added approximately $895 million to net sales. These factors boosted reported growth and are not solely underlying volume gains.
- Membership fees rose 10.3%; excluding the $27 million FY2009 litigation-related charge, the increase was 8.4%. U.S. and Canada renewal rates were 88%, up from 87%; Executive members reached 36% of eligible primary members, versus 33%.
- Core merchandise gross margin improved, but increased gasoline sales mix limited the improvement in total gross margin. Higher employee benefit costs, particularly healthcare and workers’ compensation, pressured warehouse operating costs.
- Costco repurchased 9.943 million shares for approximately $568 million, compared with $57 million in FY2009. The quarterly dividend was raised from $0.18 to $0.205 per share; full-year dividends were $0.77 per share.
Outlook, commentary, risks and unusual items
- Management emphasized comparable-sales growth, member shopping frequency and spending, price competitiveness, cost control, and expansion. It noted that weak economic conditions could continue to weigh on member spending; no specific sales or earnings guidance was provided.
- For FY2011, Costco planned approximately $1.6 billion of spending on real estate, construction, remodeling and equipment, funded from operating cash and existing liquid resources. It planned up to 31 new warehouses, including one or two relocations.
- Management expects to consolidate Costco Mexico beginning in FY2011 under new accounting guidance. Consolidation is expected to increase reported assets, liabilities and revenue by about 3%, with no effect on net income attributable to Costco.
- Key risks include intense retail competition; economic and commodity-price volatility; dependence on U.S. and Canada operations, which generated 92% of FY2010 consolidated sales; foreign exchange exposure; site availability and new-store cannibalization; vendor, distribution and product-safety risks; labor and healthcare costs; cybersecurity; regulation; and litigation.
- Several employment, consumer, environmental and tax matters remained unresolved. The company said it could not reasonably estimate losses for certain matters; an unfavorable outcome could materially affect an individual quarter, though management did not expect pending claims collectively to materially affect financial position.
- Unusual items included a $24 million SG&A benefit from partially reversing a prior Canadian employee tax-related expense, a $22 million FY2010 second-quarter employee time-off benefit charge, and $8 million of asset impairment and warehouse closing costs for the year.
- Management expected healthcare reform to increase healthcare costs, but not materially. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Separate comparable-sales growth from the disclosed currency and gasoline price contributions, and assess underlying transaction volume and member spending.
- Review gross-margin and SG&A trends, particularly gasoline mix, employee healthcare costs, and the sustainability of the reported margin improvement.
- Assess the assumptions and execution risks behind the FY2011 capital-spending and warehouse-opening plans, including potential cannibalization.
- Review debt maturities, lease commitments, buyback pace and dividend policy against cash generation and planned investment needs.
- Track material legal proceedings, environmental inquiries, tax audits and the planned consolidation of Costco Mexico.