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| COST > SEC Filings for COST > Form 10-Q on 18-Mar-2009 | All Recent SEC Filings |
18-Mar-2009
Quarterly Report
Forward-looking Statements
Certain statements contained in this document constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For these purposes, forward-looking statements are statements that address activities, events, conditions or developments that the Company expects or anticipates may occur in the future. Such forward-looking statements involve risks and uncertainties that may cause actual events, results or performance to differ materially from those indicated by such statements. These risks and uncertainties include, but are not limited to, domestic and international economic conditions, including exchange rates, the effects of competition and regulation, uncertainties in the financial markets, consumer and small business spending patterns and debt levels, conditions affecting the acquisition, development, ownership or use of real estate, actions of vendors, rising costs associated with employees (including health care and workers' compensation costs), rising costs associated with the acquisition of merchandise (including the direct and indirect effects of the changing cost of petroleum-based products and fuel and energy costs), geopolitical conditions and other risks identified from time to time in the Company's public statements and reports filed with the Securities and Exchange Commission (SEC).
This management discussion should be read in conjunction with the management discussion included in our fiscal 2008 annual report on Form 10-K, as amended, previously filed with the SEC.
Overview
We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and selected private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. This rapid inventory turnover, when combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, enables us to operate profitably at significantly lower gross margins than traditional wholesalers, mass merchandisers, supermarkets and supercenters. Certain percentages presented are calculated using actual results prior to rounding.
Key items for the second quarter of fiscal 2009 as compared to the second quarter of fiscal 2008 included:
• Net sales decreased 0.8% over the prior year to $16,488, attributable to a 3% decrease in comparable sales (sales in warehouses open for at least one year, including relocated warehouses), offset by the opening of 18 new warehouses (25 opened and 7 closed due to relocations) since the end of the second quarter of fiscal year 2008. Net sales were significantly impacted by the negative change, quarter over quarter, in the price of gasoline and by certain foreign currency exchange rates;
• Membership fees increased 3.7% to $355, primarily due to new membership sign-ups at warehouses opened since the end of the second quarter of fiscal 2008 and increased penetration of our higher-fee Executive Membership program;
• Gross margin (net sales less merchandise costs) as a percentage of net sales decreased 31 basis points;
• Selling, general and administrative (SG&A) expenses as a percentage of net sales increased 39 basis points;
• Net income decreased to $239 from $328; and
• Net income per diluted share decreased to $0.55 from $0.74.
In addition, the Board of Directors declared a quarterly cash dividend in the amount of $0.16 per share.
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
Results of Operations (dollars in millions, except earnings per share and warehouse number data)
Our fiscal year ends on the Sunday closest to August 31. References to the second quarters of 2009 and 2008 relate to the 12-week fiscal quarters ended February 15, 2009 and February 17, 2008, respectively. References to the first half of 2009 and 2008 relate to the 24-weeks ended February 15, 2009 and February 17, 2008, respectively.
Net Sales
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Net sales $ 16,488 $ 16,616 $ 32,524 $ 32,088
Increase (decrease) in
comparable warehouse sales (3 )% 7 % (1 )% 7 %
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Net sales decreased 0.8% during the second quarter of 2009 compared to the second quarter of 2008. The $128 decrease in net sales is comprised of $467 from the decrease in comparable warehouse sales, offset by a $339 increase from sales at 18 new warehouses opened (25 opened and 7 closed due to relocations) since the end of the second quarter of 2008.
Foreign currencies, particularly in Canada, the United Kingdom and Korea, weakened against the U.S. dollar, which negatively impacted net sales by approximately $704, or 425 basis points. In addition, net sales were negatively impacted by gasoline price deflation of approximately $571, or 344 basis points, which resulted from a 41% decline in the average sales price per gallon quarter-over-quarter.
Weakening foreign currencies negatively impacted comparable sales by approximately $689, or 415 basis points. Gasoline price deflation negatively impacted comparable warehouse sales growth by approximately $558, or 336 basis points. Comparable sales were positively impacted by an increase in shopping frequency, the effect of which was partially offset by a small decline in the average amount spent (after adjustment for gasoline price deflation and measured in local currency).
For the first half of 2009, net sales increased 1.4% compared to the first half of 2008. The $436 increase in net sales is comprised of a $737 increase from sales at 18 new warehouses opened (25 opened and 7 closed due to relocations) since the end of the second quarter of 2008, partially offset by a $301 decrease in comparable warehouse sales.
Foreign currencies, particularly in Canada, the United Kingdom and Korea, weakened against the U.S. dollar, which negatively impacted net sales by approximately $1,220, or 380 basis points. In addition, net sales were negatively impacted by gasoline price deflation of approximately $521, or 162 basis points, related primarily to a 19% decline in the average sales price per gallon of gasoline year-over-year.
Weakening foreign currencies negatively impacted comparable sales by approximately $1,178, or 370 basis points. Gasoline price deflation negatively impacted comparable warehouse sales growth by approximately $508, or 158 basis points. Comparable sales were positively impacted by an increase in shopping frequency, the effect of which was partially offset by a small decline in the average amount spent (after adjustment for gasoline price deflation and measured in local currency).
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
Net sales in the second quarter and first half of 2009, particularly in hardlines and softlines, were negatively impacted by general economic conditions, and we believe that those conditions will continue to have a significant adverse impact on spending by our members. We believe, however, that due to the nature of our business model, we are better positioned than many retailers to compete in such an environment.
Membership Fees
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Membership fees $ 355 $ 343 $ 714 $ 681
Membership fees as a
percent of net sales 2.16 % 2.06 % 2.20 % 2.12 %
Total cardholders (000's) 54,500 51,800 54,500 51,800
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Membership fees increased 3.7% in the second quarter of 2009 compared to the second quarter of 2008 and 4.9% in the first half of 2009 compared to the first half of 2008. These increases were primarily due to the additional membership sign-ups at the 25 new warehouses opened since the second quarter of 2008 and increased penetration of our higher-fee Executive Membership program. Our member renewal rate, currently at 87.5%, is consistent with recent years.
Effective for renewals occurring on and after March 1, 2009, we changed an element of our membership renewal policy. Memberships renewed within two months after expiration of the current membership year are extended for twelve months from the expiration date. (Under the previous policy renewals within six months of expiration were extended for twelve months from expiration date.) Memberships renewed more than two months after such expiration are extended for twelve months from the renewal date. Although this change will have the effect of deferring recognition of certain membership fees paid by late-renewing members, the effect is not expected to be material.
Gross Margin
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Gross margin $ 1,717 $ 1,783 $ 3,477 $ 3,431
Gross margin as a percent of
net sales 10.42 % 10.73 % 10.69 % 10.69 %
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Gross margin, as a percent of net sales, decreased 31 basis points compared to the second quarter of 2008. This decrease was primarily related to a decrease of 19 basis points in our warehouse ancillary businesses, primarily in our gasoline business, and a net seven basis point decrease in our core merchandise categories, particularly softlines. This seven basis point decrease in our core merchandise categories was favorably impacted due to our lower margin gas business having a lower sales penetration quarter over quarter. The core merchandise categories gross margin, as a percent of their own sales, were lower quarter over quarter by 57 basis points. This decrease is largely attributable to price reductions designed to drive sales on certain items and higher seasonal markdowns. In addition, increased penetration of the Executive Membership two-percent reward program and increased spending by Executive members negatively affected gross margin by nine basis points. These items were offset by a favorable LIFO adjustment of four basis points.
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
Gross margin, as a percent of net sales, was flat compared to the first half of 2008. Our ancillary businesses experienced a 13 basis point increase, primarily in our gasoline business; and we recorded a favorable LIFO adjustment of three basis points. These increases were offset by a net ten basis point decrease in our core merchandise categories, particularly related to lower sales penetration of hardlines and softlines, offset by an increase in food and sundries. In addition, increased penetration of the Executive Membership two-percent reward program and increased spending by Executive members negatively affected gross margin by six basis points.
Selling, General and Administrative Expenses
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Selling, general and
administrative (SG&A)
expenses $ 1,666 $ 1,615 $ 3,343 $ 3,185
SG&A expenses as a percent of
net sales 10.11 % 9.72 % 10.28 % 9.93 %
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SG&A expenses, as a percent of net sales, increased 39 basis points compared to the second quarter of 2008. Warehouse operating and central administrative costs negatively impacted SG&A expense comparisons, as a percent of net sales, by approximately 38 basis points, resulting primarily from lower sales levels and increased employee benefit costs. Slightly higher stock-based compensation expense negatively impacted SG&A expense comparisons, as a percent of net sales, by one basis point.
SG&A expenses, as a percent of net sales, increased 35 basis points compared to the first half of 2008. Warehouse operating and central administrative costs negatively impacted SG&A expense comparisons, as a percent of net sales, by approximately 29 basis points, the largest single factor being increased employee benefit costs. SG&A expenses also included a $29 charge for a mark-to-market write-down of the cash surrender value of employee life insurance contracts in the first half of 2009, which negatively impacted SG&A expenses as a percent of net sales by seven basis points.
SG&A expenses, as a percent of net sales, for both the second quarter and first half of 2009, were significantly adversely impacted by the negative change in the price of gasoline and certain foreign currency exchange rates.
Preopening Expenses
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Preopening expenses $ 7 $ 10 $ 20 $ 31
Warehouse openings - 7 8 17
Relocations - - (1 ) (4 )
Warehouse openings, net of
relocations - 7 7 13
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Preopening expenses include costs incurred for startup operations related to new warehouses, warehouse remodel projects and the expansion of ancillary operations at existing warehouses. Preopening expenses per warehouse opening can vary due to the timing of the opening relative to our
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
fiscal quarter end, whether the warehouse is owned or leased, whether the opening is in an existing, new or international market, and the number and magnitude of warehouse remodel projects.
Provision for Impaired Assets and Closing Costs, Net
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Warehouse closing expenses $ 1 $ - $ 6 $ 3
Impairment of long-lived
assets - - 2 -
Net (gains)/losses on sale
of real property - (3 ) - (6 )
Provision for impaired
assets & closing costs, net $ 1 $ (3 ) $ 8 $ (3 )
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This provision primarily includes costs related to impairment of long-lived assets, future lease obligations of warehouses that have been relocated to new facilities, accelerated depreciation on buildings to be demolished or sold and that are not otherwise impaired, and losses or gains resulting from the sale of real property, largely comprised of former warehouse locations.
Interest Expense
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Interest expense $ 25 $ 23 $ 50 $ 46
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Interest expense incurred primarily relates to our $900 of 5.3% and $1,100 of 5.5% Senior Notes issued in fiscal 2007. The increase in interest expense for the second quarter and first half of 2009 over the previous year is primarily due to a decrease in capitalized interest related to our new warehouse and remodel construction activity.
Interest Income and Other
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Interest income $ 8 $ 26 $ 14 $ 52
Earnings of affiliates 7 14 14 21
Minority interest and other (7 ) 1 (2 ) 1
Interest income and other $ 8 $ 41 $ 26 $ 74
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The decrease in interest income in the second quarter of 2009 compared to second quarter of 2008 is largely due to lower interest rates on our cash and cash equivalents and short-term investment balances and a change in policy to invest primarily in U. S. government and agency securities. In addition, we recognized $1 and $3 of other-than-temporary impairment losses on certain securities within our investment portfolio in the second quarter of 2009 and 2008, respectively. See further discussion in Liquidity and Capital Resources. The decrease in earnings of affiliates is due to a decrease in earnings
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
from our 50% owned joint-venture in Mexico. Costco Mexico's earnings were lower quarter over quarter due to the peso weakening against the U.S. dollar. The decrease in minority interest and other is primarily due to a negative $5 compared to a favorable $2 mark-to-market adjustment in the second quarter of 2009 and 2008, respectively, related to our forward foreign exchange contracts, which are used primarily to hedge the impact of fluctuations of foreign exchange on merchandise inventory purchases. See the Derivatives section for more information.
The decrease in interest income in the first half of 2009 compared to first half of 2008 is largely due to lower interest rates on our cash and cash equivalents and short-term investment balances. In addition, we recognized $7 and $3 of other-than-temporary impairment losses on certain securities within our investment portfolio in the first half of 2009 and 2008, respectively. See further discussion in Liquidity and Capital Resources. The decrease in earnings of affiliates is due to a decrease in earnings from our 50% owned joint-venture in Mexico. Costco Mexico's earnings were lower in the first half of 2009 due to the peso weakening against the U.S. dollar.
Provision for Income Taxes
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Provision for income taxes $ 142 $ 194 $ 294 $ 337
Effective tax rate 37.2 % 37.1 % 36.9 % 36.3 %
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Net Income
12 Weeks Ended 24 Weeks Ended
February 15, February 17, February 15, February 17,
2009 2008 2009 2008
Net income $ 239 $ 328 $ 502 $ 590
Diluted net income (per share) $ 0.55 $ 0.74 $ 1.14 $ 1.33
Shares used to calculate
diluted net income per common
share (000's) 439,688 444,925 440,095 445,148
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Net income for the second quarter of 2009 decreased to $239, or $0.55 per diluted share, from $328, or $0.74 per diluted share, during the second quarter of 2008, representing a 26% decrease in diluted net income per share. Net income for the first half 2009 decreased to $502, or $1.14 per diluted share, from $590, or $1.33 per diluted share, during the first half of 2008, representing a 14% decrease in diluted net income per share.
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
Liquidity and Capital Resources (dollars in thousands, except per share data)
Cash Flows
The following table itemizes components of our most liquid assets:
February 15, August 31,
2009 2008
Cash and cash equivalents $ 2,705 $ 2,619
Short-term investments 577 656
Total $ 3,282 $ 3,275
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Our primary sources of liquidity are cash flows generated from warehouse operations and existing cash and cash equivalents and short-term investments balances, which were $3,282 and $3,275 at February 15, 2009 and August 31, 2008, respectively. Of these balances, approximately $735 and $788 at February 15, 2009 and August 31, 2008, respectively, represented debit and credit card receivables, primarily related to sales in the week prior to the quarter-end close. Fluctuations in foreign currency had a material negative impact on our reported cash flows after amounts from our foreign subsidiaries were translated into U.S. dollars.
Net cash provided by operating activities totaled $822 in the first half of 2009, compared to $853 in the first half of 2008. This net decrease of $31 was primarily attributable to an increase in the funding of our prepaid health insurance, which is reflected in the change in operating assets and liabilities.
Net cash used in investing activities totaled $559 in the first half of 2009 compared to $1,198 in the first half of 2008, a decrease of $639. The decrease in net cash used in investing activities relates primarily to a $108 decrease in cash used for the purchase of property and equipment and a $151 increase in cash provided by the net investment in short-term investments. In addition, as discussed below, $371 formerly classified as cash and cash equivalents was reclassified to short-term investments and other assets in the first half of 2008.
In December 2007, one of our enhanced money fund investments, Columbia Strategic Cash Portfolio Fund (Columbia), ceased accepting cash redemption requests and changed to a floating net asset value. In light of the restricted liquidity, we elected to receive a pro-rata allocation of the underlying securities in a separately managed account. We assess the fair value of the underlying securities in this account through market quotations and review of current investment ratings, as available, coupled with an evaluation of the liquidation value of each investment and its current performance in meeting scheduled payments of principal and interest. During the second quarter of 2009 and 2008, we recognized $1 and $3, respectively, of other-than-temporary impairment losses related to these securities. During the first half of 2009 and 2008, we recognized $7 and $3, respectively, of other-than-temporary impairment losses related to these securities. The losses are included in interest income and other in the accompanying condensed consolidated statements of income. At February 15, 2009 and August 31, 2008, the balance of the Columbia fund was $65 and $104, respectively, on the condensed consolidated balance sheets.
Additionally, in December 2007, two other enhanced money fund investments, BlackRock Cash Strategies, LLC (BlackRock) and Merrill Lynch Capital Reserve Fund, LLC (Merrill Lynch), ceased accepting redemption requests. During the second quarter of 2009, BlackRock was liquidated and we received the remaining $21 balance of our investment. Merrill Lynch is still in the process of being liquidated with periodic distributions, and the expectation is that the fund will be substantially liquidated by 2010. To date, Merrill Lynch has maintained a $1.00 per unit net asset value. As of
Item 2-Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued) (dollars in millions, except per share data)
February 15, 2009 and August 31, 2008, the balance of the Merrill Lynch fund was $26 and $43, respectively, on the condensed consolidated balance sheets. As of . . .
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