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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED AUGUST 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-20355
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COSTCO COMPANIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0572969
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
999 LAKE DRIVE, ISSAQUAH, WA 98027
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (425) 313-8100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $.01 Par Value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant at October 31, 1997, was $7,992,988,812.
The number of shares outstanding of the registrant's common stock as of
October 31, 1997 was 213,867,058.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on January 21, 1998 are incorporated by reference into
Part III of this Form 10-K.
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COSTCO COMPANIES, INC.
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED AUGUST 31, 1997
PAGE
----
PART I
Item 1. Business.......................................................... 3
Item 2. Properties........................................................ 7
Item 3. Legal Proceedings................................................. 8
Item 4. Submission of Matters to a Vote of Security Holders............... 8
Item 4A. Executive Officers of the Registrant.............................. 8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.......................................................... 10
Item 6. Selected Financial Data........................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 13
Item 8. Financial Statements.............................................. 18
Item 9. Change in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................. 18
PART III
Item 10. Directors and Executive Officers of the Registrant................ 19
Item 11. Executive Compensation............................................ 19
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 19
Item 13. Certain Relationships and Related Transactions.................... 19
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K.............................................................. 19
2
PART I
ITEM 1--BUSINESS
Costco Companies, Inc. ("Costco" or the "Company") began operations in 1976
in San Diego, California as The Price Company, pioneering the membership
warehouse concept. Costco Wholesale Corporation began operations in 1983 in
Seattle, Washington with a similar membership warehouse concept. Costco
Companies, Inc. (formerly Price/Costco, Inc. prior to a name change approved by
the shareholders in January 1997), a Delaware corporation, publicly traded under
the NASDAQ ticker symbol "COST", was formed in October 1993 as a result of a
merger of Costco Wholesale Corporation and The Price Company. Costco Companies,
Inc. is the parent company of Costco Wholesale Corporation and The Price Company
which operate membership warehouses primarily under the Costco Wholesale name.
In the second quarter of fiscal 1995, the Company completed a spin-off of
Price Enterprises, Inc. ("Price Enterprises"), consisting of Costco's
discontinued non-club commercial real estate operations and certain other
assets. (See "Note 2--Spin-off of Price Enterprises, Inc. and Discontinued
Operations").
GENERAL
Costco operates membership warehouses based on the concept that offering
members very 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 Costco to operate
profitably at significantly lower gross margins than traditional wholesalers,
discount retailers and supermarkets.
Costco buys nearly all of its merchandise directly from manufacturers for
shipment either directly to Costco's selling warehouses or to a consolidation
point ("depot") where various shipments are combined so as to minimize freight
and handling costs. As a result, Costco eliminates many of the costs associated
with multiple step distribution channels, which include purchasing from
distributors as opposed to manufacturers, use of central receiving, storing and
distributing warehouses, and storage of merchandise in locations off the sales
floor. By providing this more cost effective means of distributing goods, Costco
meets the needs of business customers who otherwise would pay a premium for
small purchases and for the distribution services of traditional wholesalers,
and who cannot otherwise obtain the full range of their product requirements
from any single source. In addition, these business members will often combine
personal shopping with their business purchases. Individuals shopping for their
personal needs are primarily motivated by the cost savings on brand name
merchandise. Costco's merchandise selection is designed to appeal to both the
business and consumer requirements of its members by offering a wide range of
nationally-branded and selected private label products, often in case, carton or
multiple-pack quantities, at attractively low prices.
Because of its high sales volume and rapid inventory turnover, Costco
generally has the opportunity to receive cash from the sale of a substantial
portion of its inventory at mature warehouse operations before it is required to
pay all its merchandise vendors, even though Costco takes advantage of early
payment terms to obtain payment discounts. As sales in a given warehouse
increase and inventory turnover becomes more rapid, a greater percentage of the
inventory is financed through payment terms provided by vendors rather than by
working capital.
Costco's typical warehouse format averages approximately 129,000 square
feet. Floor plans are designed for economy and efficiency in the use of selling
space, in the handling of merchandise and in the control of inventory. Because
shoppers are attracted principally by the availability of low prices on brand
name and selected private label goods, Costco's warehouses need not be located
on prime commercial real estate sites or have elaborate facilities.
3
By strictly controlling the entrances and exits of its warehouses and by
limiting membership to selected groups and businesses, Costco has been able to
limit inventory losses to less than one-half of one percent of net sales--well
below those of typical discount retail operations. Losses associated with
dishonored checks have also been minimal, since individual memberships are
limited primarily to members of qualifying groups, and bank information from
business members is verified prior to establishing a check purchase limit.
Memberships are invalidated at the point of sale for those members who have
issued dishonored checks to Costco.
Costco's policy is generally to limit advertising and promotional expenses
to new warehouse openings and occasional direct mail advertisements to
prospective new members. These practices result in lower marketing expenses as
compared to typical discount retailers and supermarkets. In connection with new
warehouse openings, Costco's marketing teams personally contact businesses in
the area who are potential wholesale members. These contacts are supported by
direct mailings during the period immediately prior to opening. Potential Gold
Star (individual) members are contacted by direct mail generally distributed
through credit unions, employee associations and other entities representing
individuals who are eligible for Gold Star membership. After a membership base
is established in an area, most new memberships result from word of mouth
advertising, follow-up contact by direct mail distributed through regular
payroll or other organizational communications to employee groups, and ongoing
direct solicitations to prospective wholesale members.
Costco's warehouses generally operate on a seven-day, 68-hour week, and are
open somewhat longer during the holiday season. Generally, warehouses are open
weekdays between 10:00 a.m. and 8:30 p.m., with earlier closing hours on the
weekend. Because these hours of operation are shorter than those of traditional
discount grocery retailers and supermarkets, labor costs are lower relative to
the volume of sales. Merchandise is generally stored on racks above the sales
floor and displayed on pallets containing large quantities of each item, thereby
reducing labor required for handling and stocking. In addition, sales are
processed through centralized, automated check-out stands. Items are not
individually price marked; rather, each item is bar-coded so it can be scanned
into electronic cash registers. This allows price changes without remarking
merchandise. Substantially all manufacturers provide merchandise pre-marked with
the item numbers and bar codes and many provide special, larger package sizes.
Costco's merchandising strategy is to provide the customer with a broad
range of high quality merchandise at prices consistently lower than could be
obtained through traditional wholesalers, discount retailers or supermarkets. An
important element of this strategy is to carry only those products on which
Costco can provide its members significant cost savings. Items which members may
request but which cannot be purchased at prices low enough to pass along
meaningful cost savings are usually not carried. Costco seeks to limit specific
items in each product line to fast selling models, sizes and colors and
therefore carries only an average of approximately 3,600 to 4,000 active
stockkeeping units ("SKU's") per warehouse as opposed to discount retailers and
supermarkets which normally stock 40,000 to 60,000 SKU's or more. These
practices are consistent with Costco's membership policies of satisfying both
the business and personal shopping needs of its wholesale members, thereby
encouraging high volume shopping. Many consumable products are offered for sale
in case, carton or multiple-pack quantities only. Appliances, equipment and
tools often feature commercial and professional models. Costco's policy is to
accept returns of merchandise within a reasonable time after purchase.
4
The following table indicates the approximate percentage of net sales
accounted for by each major category of items sold by Costco during fiscal 1997,
1996 and 1995:
1997 1996 1995
----------- ----------- -----------
SUNDRIES (including candy, snack foods, health and
beauty aids, tobacco, alcoholic beverages, soft
drinks and cleaning and institutional
supplies)........................................ 31% 32% 32%
FOOD (including dry and fresh foods and
institutionally packaged foods).................. 32% 32% 32%
HARDLINES (including major appliances, video and
audio tape, electronics, tools, office supplies,
furniture and automotive supplies)............... 20% 21% 22%
SOFTLINES (including apparel, domestics, cameras,
jewelry, housewares, books and small
appliances)...................................... 12% 11% 11%
OTHER (including pharmacy, optical, one-hour
photo, print shop, hearing aid and gas
stations)........................................ 5% 4% 3%
--- --- ---
100% 100% 100%
--- --- ---
--- --- ---
Costco has direct buying relationships with many producers of national brand
name merchandise. No significant portion of merchandise is obtained by Costco
from any one of these or any other single supplier. Costco has not experienced
any difficulty in obtaining sufficient quantities of merchandise, and believes
that if one or more of its current sources of supply became unavailable, it
would be able to obtain alternative sources without experiencing a substantial
disruption of its business. Costco also purchases different national brand name
or selected private label merchandise of the same product, as long as cost,
quality and customer demand are comparable.
Costco reports on a 52/53 week fiscal year, consisting of 13 four-week
periods and ending on the Sunday nearest the end of August. The first, second
and third quarters consist of three periods each, and the fourth quarter
consists of four periods (five weeks in the thirteenth period in a 53-week
year). There is no material seasonal impact on Costco's operations, except an
increased level of sales and earnings during the Christmas holiday season.
MEMBERSHIP POLICY
Costco's membership format is designed to reinforce customer loyalty and
provide a continuing source of membership fee revenue. Costco has two primary
types of members: Business and Gold Star (individual members).
Businesses, including individuals with a business license, retail sales
license or other evidence of business existence, may become Business members.
Costco promotes Business membership through its merchandise selection and its
membership marketing programs. Business members generally pay an annual
membership fee of $30 for the primary membership card with additional membership
cards available for an annual fee of $20.
Individual memberships are available to employees of federal, state and
local governments, financial institutions, corporations, utility and
transportation companies, public and private educational institutions, and other
selected organizations. Individual members generally pay an annual membership
fee of $35, which includes a spouse card.
As of August 31, 1997, Costco had approximately 4.0 million Business
memberships and approximately 7.7 million Gold Star memberships. Members can
utilize their memberships at any wholesale location.
LABOR
As of August 31, 1997, Costco had approximately 57,000 employees, about 50%
of which were part time. Approximately 12,500 hourly employees in California,
Maryland, New Jersey, New York and one
5
warehouse in Virginia are represented by the International Brotherhood of
Teamsters. All remaining hourly employees are non-union. Costco considers its
employee relations to be good.
COMPETITION
The Company operates in the rapidly changing and highly competitive
merchandising industry. When The Price Company pioneered the membership
warehouse club concept in 1976, the dominant companies selling comparable lines
of merchandise were department stores, grocery stores and traditional
wholesalers. Since then, new merchandising concepts and aggressive marketing
techniques have led to a more intense and focused competitive environment.
Wal-Mart has become the largest retailer in the United States and has expanded
into food merchandising. Target has also emerged as a significant retail
competitor. Approximately 750 warehouse clubs exist across the U.S. and Canada,
including the 254 warehouses operated by the Company in North America; and every
major metropolitan area has some, if not several, club operations. Low cost
operators selling a single category or narrow range of merchandise, such as Home
Depot, Office Depot, PetSmart, Toys-R-Us, Circuit City and Barnes & Noble, have
significant market share in their respective categories. New forms of retailing
involving modern technology are boosting sales in stores such as The Sharper
Image, while home shopping and electronic commerce over the Internet is becoming
increasingly popular. Likewise, in the institutional food business, companies
such as Smart & Final, which operates in Arizona, California and Florida, are
capturing an increasingly greater share of the institutional food business from
wholesale operators and others; and many supermarkets now offer food lines in
bulk sizes and at prices comparable to those offered by the Company. (See
"Item--7 Management's Discussion and Analysis of Financial Condition and Results
of Operations")
REGULATION
Certain state laws require that the Company apply minimum markups to its
selling prices for specific goods, such as tobacco products and alcoholic
beverages. While compliance with such laws may cause the Company to charge
somewhat higher prices than it otherwise would charge, other retailers are also
typically governed by the same restrictions, and the Company believes that
compliance with such laws does not have a material adverse effect on its
operations.
It is the policy of the Company to sell at lower than manufacturers'
suggested retail prices. Some manufacturers attempt to maintain the resale price
of their products by refusing to sell to the Company or to other purchasers that
do not adhere to suggested retail prices. To date, the Company believes that it
has not been materially affected by its inability to purchase directly from such
manufacturers. Both federal and state legislation is proposed from time to time
which, if enacted, would restrict the Company's ability to purchase goods or
extend the application of laws enabling the establishment of minimum prices. The
Company cannot predict the effect on its business of the enactment of such
federal or state legislation.
6
ITEM 2--PROPERTIES
WAREHOUSE PROPERTIES
At August 31, 1997, Costco operated 261 warehouse clubs: 200 in the United
States (in 23 states); 54 in Canada (in 9 Canadian provinces); six in the United
Kingdom; and one in Taiwan--mainly under the "Costco Wholesale" name. The
following is a summary of owned and leased warehouses by region:
NUMBER OF WAREHOUSES
OWN LAND AND LEASE LAND AND/OR
BUILDING BUILDING TOTAL
----------------- --------------------- -----
UNITED STATES..................................... 160 40 200
CANADA............................................ 43 11 54
UNITED KINGDOM.................................... 6 -- 6
TAIWAN............................................ -- 1 1
--- --- ---
Total......................................... 209 52 261
--- --- ---
--- --- ---
The following schedule shows warehouse openings (net of warehouse closings)
by region for the past five fiscal years and expected openings (net of closings)
through December 31, 1997:
TOTAL
OTHER WAREHOUSES IN
OPENINGS BY FISCAL YEAR UNITED STATES CANADA INTERNATIONAL TOTAL OPERATION
- ---------------------------------------- ----------------- ----------- --------------- ----- ---------------
1992 and prior.......................... 147 23 -- 170 170
1993.................................... 23 7 -- 30 200
1994.................................... 12 7 2 21 221
1995.................................... 9 8 2 19 240
1996.................................... 1 10 1 12 252
1997.................................... 8 (1) 2 9 261
1998 (through 12/31/97)................. 4 2 1 7 268
--- --- --- ---
Total............................... 204 56 8(a) 268
--- --- --- ---
--- --- --- ---
- ------------------------
(a) As of August 31, 1997, the Company operated (through a 50%-owned joint
venture) thirteen warehouses in Mexico (one opened in fiscal 1992, two
opened in fiscal 1993, five opened in fiscal 1994, and five opened in fiscal
1995). An additional warehouse was opened in Monterrey, Mexico in September,
1997. These warehouses are not included in the number of warehouses open in
any period because the joint venture is accounted for on the equity basis
and therefore their operations are not consolidated in the Company's
financial statements. Additionally, the Company operates two warehouses in
Korea under a licensing agreement. These warehouses are not included in the
number of warehouses open in any period because the arrangement is accounted
for as a licensing agreement.
The Company's headquarters are located in Issaquah, Washington.
Additionally, the Company maintains regional buying and administrative offices,
operates regional cross-docking facilities (depots) for the consolidation and
distribution of certain shipments to the warehouses and operates various
processing and packaging facilities to support ancillary businesses.
DISCONTINUED OPERATIONS--NON-CLUB REAL ESTATE SEGMENT
As a result of the 1995 spin-off of Price Enterprises, the Company's
business now consists primarily of its warehouse club operations in the United
States, Canada and the United Kingdom; and the Company has ceased to have any
significant real estate activities that are not directly related to its
warehouse club business.
7
ITEM 3--LEGAL PROCEEDINGS
On April 6, 1992, The Price Company was served with a Complaint in an action
entitled FECHT ET AL. v. THE PRICE COMPANY ET AL., Case No. 92-497, United
States District Court, Southern District of California (the "Court").
Subsequently, on April 22, 1992, The Price Company was served with a First
Amended Complaint in the action. The case was dismissed without prejudice by the
Court on September 21, 1992, on the grounds the plaintiffs had failed to state a
sufficient claim against defendants. Subsequently, plaintiffs filed a Second
Amended Complaint which, in the opinion of The Price Company's counsel, alleged
substantially the same facts as the prior complaint. The Complaint alleged
violation of certain state and federal laws during the time period prior to The
Price Company's earnings release for the second quarter of fiscal year 1992. The
case was dismissed with prejudice by the Court on March 9, 1993, on grounds the
plaintiffs had failed to state a sufficient claim against defendants. Plaintiffs
filed an Appeal in the Ninth Circuit Court of Appeals. In an opinion dated
November 20, 1995, the Ninth Circuit reversed and remanded the lawsuit. In
February 1997, the Court granted the plaintiffs' motion for certification of a
class consisting of all purchasers of the common stock of The Price Company from
April 3, 1991 through April 2, 1992. The Company believes that this lawsuit is
without merit and is vigorously defending the lawsuit. The Company does not
believe that the ultimate outcome of such litigation will have a material
adverse effect on the Company's financial position or results of operations.
The Company is involved from time to time in claims, proceedings and
litigation arising from its business and property ownership. The Company does
not believe that any such claim, proceeding or litigation, either alone or in
the aggregate, will have a material adverse effect on the Company's financial
position or results of operations.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting is scheduled for 10:00 a.m. on January 21,
1998, at the Meydenbauer Center Hall in Bellevue, Washington. Matters to be
voted on will be included in the Company's proxy statement to be filed with the
Securities and Exchange Commission and distributed to stockholders prior to the
meeting.
ITEM 4A--EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a list of the names, ages and positions of the executive
officers of the registrant.
NAME AGE POSITION WITH COMPANY
- ------------------------------ --- --------------------------------------------------
James D. Sinegal 61 President and Chief Executive Officer
Jeffrey H. Brotman 55 Chairman of the Board
Richard D. DiCerchio 54 Sr. Executive Vice President, Chief Operating
Officer-- Merchandising, Distribution,
Construction and Marketing
Richard A. Galanti 41 Executive Vice President and Chief Financial
Officer
Franz E. Lazarus 50 Executive Vice President--International Operations
David B. Loge 55 Executive Vice President--Manufacturing and
Ancillary Businesses
Walter C. Jelinek 45 Executive Vice President, Chief Operating
Officer--Northern Division
Edward B. Maron 70 Executive Vice President, Chief Operating
Officer--Canadian Division
Joseph P. Portera 44 Executive Vice President, Chief Operating
Officer--Eastern Division
Dennis R. Zook 48 Executive Vice President, Chief Operating
Officer--Southern Division
James D. Sinegal has been President, Chief Executive Officer and a director
of the Company since October 1993 upon consummation of the Merger of Costco
Wholesale Corporation and The Price Company. From its inception until 1993, he
was President and Chief Operating Officer of Costco Wholesale Corporation and
served as Chief Executive Officer from August 1988 until October 1993. Mr.
Sinegal was a co-founder of Costco Wholesale Corporation and has been a director
since its inception.
8
Jeffrey H. Brotman is a native of the Pacific Northwest and is a 1967
graduate of the University of Washington Law School. Mr. Brotman was a founder
and Chairman of the Board of Costco Wholesale Corporation from its inception.
Upon the consummation of the Merger, Mr. Brotman became the Vice Chairman of the
Company, and has served as Chairman since December, 1994. Mr. Brotman is a
founder of a number of other specialty retail chains. He is a director of
Starbucks Corp., the Sweet Factory and Garden Botanika, and serves as an
Advisory Board Member of Seafirst Bank.
Richard D. DiCerchio was named Senior Executive Vice President of the
Company in 1997. He has been Executive Vice President and Chief Operating
Officer--Merchandising, Distribution, Construction and Marketing and a director
of the Company since October 1993. Until mid-August 1994, he also served as
Executive Vice President, Chief Operating Officer--Northern Division. He was
appointed Chief Operating Officer--Western Region of Costco Wholesale
Corporation in August 1992 and was appointed Executive Vice President and
director of Costco Wholesale Corporation in April 1986. From June 1985 to April
1986, he was Senior Vice President, Merchandising of Costco Wholesale
Corporation. He joined Costco Wholesale Corporation as Vice President,
Operations in May 1983.
Richard A. Galanti has been Executive Vice President and Chief Financial
Officer of the Company since the Merger and has been a director of the Company
since January 1995. He was Senior Vice President, Chief Financial Officer and
Treasurer of Costco Wholesale Corporation since January 1985, having joined
Costco Wholesale Corporation as Vice President--Finance in March 1984. From 1978
to February 1984, Mr. Galanti was an Associate with Donaldson, Lufkin & Jenrette
Securities Corporation. Mr. Galanti also currently serves as a director of
Hollywood Entertainment Corporation.
Franz E. Lazarus was named Executive Vice President--International
Operations in September 1995, prior to which he had served as Executive Vice
President, Chief Operating Officer--Northern Division of the Company since
August 1994 and Executive Vice President, Chief Operating Officer--Eastern
Division since the Merger. He was named Executive Vice President, Chief
Operating Officer--East Coast Operations of Costco Wholesale Corporation in
August 1992. Mr. Lazarus joined Costco Wholesale Corporation in November 1983
and has held various management positions prior to his current position.
David B. Loge has been Executive Vice President--Manufacturing and Ancillary
Businesses since August 1994. Mr. Loge joined The Price Company as a Director of
Price Club Industries in March 1989 and became a Vice President of The Price
Company and President of Price Club Industries in December 1990. Prior to
joining The Price Company, he served as Vice President of Operations of Sundale
Beverage in Belmont, California.
Walter C. ("Craig") Jelinek has been Executive Vice President, Chief
Operating Officer--Northern Division since September 1995. He had been Senior
Vice President, Operations--Northwest Region since September 1992. From May 1986
to September 1994 he was Vice President, Regional Operations Manager--Los
Angeles Region and has held various management positions since joining Costco
Wholesale Corporation in April 1984.
Edward B. Maron has been Executive Vice President, Chief Operating
Officer--Canadian Division of the Company since the Merger. He had been Senior
Vice President--Canadian Division of Costco Wholesale Corporation since April
1990. He has held various management positions since joining Costco Wholesale
Corporation in June 1985.
Joseph P. Portera has been Executive Vice President, Chief Operating
Officer--Eastern Division of the Company since August 1994. He was Senior Vice
President, Operations--Northern California Region from October 1993 to August
1994. From August 1991 to October 1993 he was Senior Vice President,
Merchandising--Non Foods of Costco Wholesale Corporation, and has held various
management positions since joining Costco Wholesale Corporation in April 1984.
Dennis R. Zook has been Executive Vice President, Chief Operating
Officer--Southern Division of the Company since the Merger. He was Executive
Vice President of The Price Company since February 1989. Mr. Zook became Vice
President of West Coast Operations of The Price Company in
9
October 1988 and has held various management positions since joining The Price
Company in October 1981.
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Trading in Costco Common Stock commenced on October 22, 1993, as
Price/Costco, Inc. quoted on The Nasdaq Stock Market's National Market under the
symbol "PCCW". On January 29, 1997, the shareholders of the Company approved a
name change to Costco Companies, Inc. The stock is now quoted on The Nasdaq
Stock Market's National Market under the symbol "COST."
The following table sets forth the closing high and low sales prices of
Costco Common Stock for the period January 1, 1995 through October 31, 1997. The
quotations are as reported in published financial sources.
COSTCO COMMON STOCK
-------------------
HIGH LOW
-------- ---
Calendar Quarters--1995
First Quarter................................... 15 1/8 12
Second Quarter.................................. 16 5/8 13 5/16
Third Quarter................................... 19 1/2 16 1/4
Fourth Quarter.................................. 17 3/4 14 3/8
Calendar Quarters--1996
First Quarter................................... 19 1/2 14 3/4
Second Quarter.................................. 21 5/8 17 1/2
Third Quarter................................... 22 1/8 19 3/4
Fourth Quarter.................................. 25 5/8 19 1/8
Calendar Quarters--1997
First Quarter................................... 30 24 1/8
Second Quarter.................................. 35 3/16 26 7/8
Third Quarter................................... 39 1/8 31 7/16
Fourth Quarter (through October 31, 1997)....... 39 5/8 35 1/8
On October 31, 1997, the Company had 7,611 stockholders of record.
DIVIDEND POLICY
Costco does not pay regular dividends and presently has no plans to declare
a cash dividend. Under its two revolving credit agreements, Costco is generally
permitted to pay dividends in any fiscal year up to an amount equal to 50% of
its consolidated net income for that fiscal year.
ITEM 6--SELECTED FINANCIAL DATA
SELECTED FINANCIAL AND OPERATING DATA
The following tables set forth selected financial and operating data for
Costco for the ten fiscal years in the period ended August 31, 1997, giving
effect to the merger of Costco Wholesale Corporation and The Price Company using
the pooling-of-interests method of accounting and treating the non-club real
estate segment as a discontinued operation prior to its spin-off in 1994. This
selected financial and operating data should be read in conjunction with "Item
7--Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the consolidated financial statements of Costco for fiscal
1997.
10
COSTCO COMPANIES, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
52 WEEKS 52 WEEKS 53 WEEKS 52 WEEKS 52 WEEKS 52 WEEKS 52 WEEKS
ENDED ENDED ENDED ENDED ENDED ENDED ENDED
AUGUST 31, SEPTEMBER 1, SEPTEMBER 3, AUGUST 28, AUGUST 29, AUGUST 30, SEPTEMBER 1,
1997 1996 1995 1994 1993 1992 1991
---------- ------------ ------------ ---------- ---------- ---------- ------------
OPERATING DATA
Revenue
Net sales.......................... $21,484,118 $19,213,866 $17,905,926 $16,160,911 $15,154,685 $13,820,380 $11,813,509
Membership fees and other.......... 390,286 352,590 341,360 319,732 309,129 276,998 228,742
---------- ------------ ------------ ---------- ---------- ---------- ------------
Total revenue...................... 21,874,404 19,566,456 18,247,286 16,480,643 15,463,814 14,097,378 12,042,251
Operating expenses
Merchandise costs.................. 19,314,485 17,345,315 16,225,848 14,662,891 13,751,153 12,565,463 10,755,823
Selling, General &
Administrative................... 1,876,759 1,691,187 1,555,588 1,425,549 1,314,660 1,128,898 934,120
Preopening expenses................ 27,448 29,231 25,018 24,564 28,172 25,595 16,289
Provision for impaired assets and
warehouse closing costs.......... 75,000(a) 10,000 7,500 7,500 5,000 2,000 1,850
---------- ------------ ------------ ---------- ---------- ---------- ------------
Operating income................... 580,712 490,723 433,332 360,139 364,829 375,422 334,169
Other income (expense)
Interest expense................... (76,281) (78,078) (67,911) (50,472) (46,116) (35,525) (26,041)
Interest income and other.......... 15,898 10,832 2,783 13,888 17,750 28,958 33,913
Provision for merger and
restructuring expenses........... -- -- -- (120,000) -- -- --
---------- ------------ ------------ ---------- ---------- ---------- ------------
Income from continuing operations
before provision for income
taxes.............................. 520,329 423,477 368,204 203,555 336,463 368,855 342,041
Provision for income taxes........... 208,132 174,684 150,963 92,657 133,620 145,833 134,748
---------- ------------ ------------ ---------- ---------- ---------- ------------
Income from continuing operations.... 312,197 248,793 217,241 110,898 202,843 223,022 207,293
Discontinued operations:
Income (loss), net of tax........ -- -- -- (40,766) 20,404 19,385 11,566
Loss on disposal................. -- -- (83,363) (182,500) -- -- --
Extraordinary items................ -- -- -- -- -- -- --
---------- ------------ ------------ ---------- ---------- ---------- ------------
Net income (loss).................. $ 312,197 $ 248,793 $ 133,878 $ (112,368) $ 223,247 $ 242,407 $ 218,859
---------- ------------ ------------ ---------- ---------- ---------- ------------
---------- ------------ ------------ ---------- ---------- ---------- ------------
Per Share Data--Fully Diluted
Income from continuing
operations....................... $ 1.46 $ 1.22 $ 1.05 $ 0.51 $ 0.92 $ 0.98 $ 0.93
Discontinued Operations:
Income (loss), net of tax.......... -- -- -- (0.19) 0.08 0.08 0.05
Loss on Disposal................... -- -- (0.37) (0.83) -- -- --
Extraordinary items.................. -- -- -- -- -- -- --
---------- ------------ ------------ ---------- ---------- ---------- ------------
Net income (loss).................. $ 1.46 $ 1.22 $ 0.68 $ (0.51) $ 1.00 $ 1.06 $ 0.98
---------- ------------ ------------ ---------- ---------- ---------- ------------
---------- ------------ ------------ ---------- ---------- ---------- ------------
Shares used in calculation......... 226,195 218,363 224,079 219,334 240,162 245,090 234,202
52 WEEKS 53 WEEKS 52 WEEKS
ENDED ENDED ENDED
SEPTEMBER 2, SEPTEMBER 3, AUGUST 28,
1990 1989 1988
------------ ------------ -----------
OPERATING DATA
Revenue
Net sales.......................... $9,346,099 $7,844,539 $6,042,159
Membership fees and other.......... 185,144 157,621 125,985
------------ ------------ -----------
Total revenue...................... 9,531,243 8,002,160 6,168,144
Operating expenses
Merchandise costs.................. 8,518,951 7,168,907 5,531,626
Selling, General &
Administrative................... 719,446 590,465 458,013
Preopening expenses................ 11,691 11,685 6,509
Provision for impaired assets and
warehouse closing costs.......... 6,000 1,609 4,000
------------ ------------ -----------
Operating income................... 275,155 229,494 167,996
Other income (expense)
Interest expense................... (18,769) (24,583) (20,949)
Interest income and other.......... 19,239 24,275 22,341
Provision for merger and
restructuring expenses........... -- -- --
------------ ------------ -----------
Income from continuing operations
before provision for income
taxes.............................. 275,625 229,186 169,388
Provision for income taxes........... 107,899 88,742 67,533
------------ ------------ -----------
Income from continuing operations.... 167,726 140,444 101,855
Discontinued operations:
Income (loss), net of tax........ 6,854 3,600 --
Loss on disposal................. -- -- --
Extraordinary items................ -- -- 2,856
------------ ------------ -----------
Net income (loss).................. $ 174,580 $ 144,044 $ 104,711
------------ ------------ -----------
------------ ------------ -----------
Per Share Data--Fully Diluted
Income from continuing
operations....................... $ 0.79 $ 0.69 $ 0.56
Discontinued Operations:
Income (loss), net of tax.......... 0.03 0.02 --
Loss on Disposal................... -- -- --
Extraordinary items.................. -- -- 0.02
------------ ------------ -----------
Net income (loss).................. $ 0.82 $ 0.71 $ 0.58
------------ ------------ -----------
------------ ------------ -----------
Shares used in calculation......... 219,532 212,772 181,336
- ------------------------------
(a) Includes the effect of adopting SFAS 121, a $65,000 pre-tax ($38,675
after-tax or $0.17 per share) charge for asset impairment.
11
COSTCO COMPANIES, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT WAREHOUSE DATA)
AUGUST 31, SEPTEMBER 1, SEPTEMBER 3, AUGUST 28, AUGUST 29, AUGUST 30,
1997 1996 1995 1994 1993 1992
------------ ------------ ------------ ------------ ------------ ------------
BALANCE SHEET DATA
Working capital (deficit)......... $ 145,903 $ 56,710 $ 9,381 $ (113,009) $ 127,312 $ 281,592
Property and equipment, net....... 3,154,634 2,888,310 2,535,593 2,146,396 1,966,601 1,704,052
Total assets...................... 5,476,314 4,911,861 4,437,419 4,235,659 3,930,799 3,576,543
Short-term debt................... 25,460 59,928 75,725 149,340 23,093 --
Long-term debt and capital lease
obligations, net................ 917,001 1,229,221 1,094,615 795,492 812,576 813,976
Stockholders' equity(a)(b)........ $ 2,468,116 $ 1,777,798 $ 1,530,744 $ 1,684,960 $ 1,796,728 $ 1,593,943
WAREHOUSES IN OPERATION
Beginning of year................. 252 240 221 200 170 140
Opened(c)......................... 17 20 24 29 37 31
Closed(d)......................... (8) (8) (5) (8) (7) (1)
------------ ------------ ------------ ------------ ------------ ------------
End of Year....................... 261 252 240 221 200 170
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
SEPTEMBER 1, SEPTEMBER 2, SEPTEMBER 3, AUGUST 28,
1991 1990 1989 1988
------------ ------------ ------------ ------------
BALANCE SHEET DATA
Working capital (deficit)......... $ 304,703 $ 14,342 $ 103,252 $ 208,569
Property and equipment, net....... 1,183,432 935,767 752,912 511,784
Total assets...................... 2,986,094 2,029,931 1,740,332 1,445,814
Short-term debt................... -- 139,414 114,000 --
Long-term debt and capital lease
obligations, net................ 500,440 199,506 234,017 327,760
Stockholders' equity(a)(b)........ $ 1,429,703 $ 988,458 $ 777,730 $ 585,598
WAREHOUSES IN OPERATION
Beginning of year................. 119 104 84 77
Opened(c)......................... 23 19 20 10
Closed(d)......................... (2) (4) -- (3)
------------ ------------ ------------ ------------
End of Year....................... 140 119 104 84
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
- --------------------------
(a) In 1989 The Price Company paid to its shareholders a one-time special cash
dividend of $74,621 or $1.50 per share of The Price Company Common Stock.
(b) In 1989 stockholders' equity reflects a $20,100 reduction of retained
earnings related to conforming The Price Company's accounting for income tax
method to Costco Wholesale Corporation's accounting for income tax method as
of fiscal 1989.
(c) Includes relocations as well as new warehouse openings.
(d) Includes relocations as well as outright closings.
12
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPARISON OF FISCAL 1997 (52 WEEKS) AND FISCAL 1996 (52 WEEKS):
(DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
Net operating results for fiscal 1997 reflect net income of $312,197 or
$1.46 per share (fully diluted), compared to a fiscal 1996 net income of
$248,793, or $1.22 per share (fully diluted). The net income for fiscal 1997
includes a non-cash, pre-tax charge of $65,000 ($38,675 after-tax, or $.17 per
share) reflecting a provision for the impairment of long-lived assets as
required by the Company's adoption of the Financial Accounting Standards Board
Statement No. 121. In addition, net income was impacted by one-time, pre-tax
charges of approximately $13,000 ($7,800 after-tax, or $.03 per share) related
to the call and majority redemption of $764,000 of convertible subordinated
debentures.
Net sales increased 12% to $21,484,118 in fiscal 1997 from $19,213,866 in
fiscal 1996. This increase was due to: (i) first year sales at the 17 new
warehouses opened during fiscal 1997, which increase was partially offset by
eight warehouses closed during fiscal 1997 that were in operation during fiscal
1996; (ii) increased sales at 20 warehouses that were opened in fiscal 1996 and
that were in operation for the entire 1997 fiscal year; and (iii) higher sales
at existing locations opened prior to fiscal 1996. Changes in prices did not
materially impact sales levels.
Comparable sales, that is sales in warehouses open for at least a year,
increased at a 9% annual rate in fiscal 1997 compared to a 5% annual rate during
fiscal 1996. The improvement in comparable sales levels in fiscal 1997, as
compared to fiscal 1996, reflected continued marketing and merchandising
efforts, including the expansion of various ancillary businesses at certain
existing locations.
Membership fees and other revenue increased 11% to $390,286, or 1.82% of net
sales, in fiscal 1997 from $352,590, or 1.84% of net sales, in fiscal 1996. This
increase is primarily due to membership sign-ups at the 17 new warehouses opened
in fiscal 1997. The decrease as percent of sales is due to increasing sales
volumes.
Gross margin (defined as net sales minus merchandise costs) increased 16% to
$2,169,633, or 10.10% of net sales, in fiscal 1997 from $1,868,551, or 9.73% of
net sales, in fiscal 1996. Gross margin as a percentage of net sales increased
due to greater purchasing power, favorable inventory shrink results, the
expanded use of the Company's depot facilities, and improved performance of the
Company's international operations. The gross margin figures reflect accounting
for most U.S. merchandise inventories on the last-in, first-out (LIFO) method.
For both fiscal 1997 and 1996 there was no LIFO charge due to the use of the
LIFO method compared to the first-in, first-out (FIFO) method.
Selling, general and administrative expenses as a percent of net sales
decreased to 8.74% during fiscal 1997 from 8.80% during fiscal 1996, primarily
reflecting the increase in comparable warehouse sales noted above; and a
year-over-year improvement at the Company's core warehouse operations and
Central and Regional administrative offices, which was partially offset by
higher expenses associated with international expansion and certain ancillary
businesses.
Preopening expenses totaled $27,448, or 0.13% of net sales, during fiscal
1997 and $29,231, or 0.15% of net sales, during fiscal 1996. During fiscal 1997,
the Company opened 17 new warehouses compared to 20 new warehouses during fiscal
1996.
The provision for impaired assets and warehouse closing costs includes the
non-cash, pre-tax charge of $65,000 ($38,675 after-tax, or $.17 per share) for
the impairment of long-lived assets, discussed above, and a pre-tax provision
for warehouse closing costs of $10,000, or $.03 per share, during fiscal 1997.
The provision for warehouse closing costs includes estimated closing costs for
certain warehouses, which were or will be replaced by new warehouses. Warehouse
closing costs were $10,000 (pre-tax), or $.03 per share, in fiscal 1996.
13
Interest expense totaled $76,281 in fiscal 1997, and $78,078 in fiscal 1996.
The decrease in interest expense is primarily related to the call for redemption
of three convertible subordinated debenture issues during fiscal 1997. Both the
Company's 6 3/4% ($285,100 principal amount), and 5 1/2% ($179,300 principal
amount) debentures were called for redemption in the second quarter of fiscal
1997. Approximately $302,000 of these two series of debentures were converted
into common stock, thereby eliminating future interest payments associated
therewith. The 5 3/4% ($300,000 principal amount) debentures were called for
redemption in the fourth quarter of fiscal 1997. The reduction in interest
expense related to the three redemptions was partially offset by the one-time
costs of the redemption call premiums and write-offs of unamortized issuance
costs associated with the redemptions of these convertible subordinated
debentures. Also, in the fourth quarter of fiscal 1997, the Company issued
$900,000 (principal amount at maturity) of Zero Coupon Convertible Subordinated
Notes, priced with a yield to maturity of 3 1/2%, resulting in gross proceeds to
the Company of $449,600, approximately $312,000 of which was used to redeem the
5 3/4% convertible subordinated debentures referred to above.
Interest income and other totaled $15,898 in fiscal 1997 compared to $10,832
in fiscal 1996. The increase was primarily due to the Company terminating
certain unconsolidated joint ventures which had been incurring losses and
improved earnings in its Mexico joint venture operation.
The effective income tax rate on earnings in fiscal 1997 was 40.0% compared
to a 41.25% effective tax rate in fiscal 1996. The decrease in the effective tax
rate was related primarily to decreases in foreign taxes.
COMPARISON OF FISCAL 1996 (52 WEEKS) AND FISCAL 1995 (53 WEEKS):
(DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
Net operating results for fiscal 1996 reflect net income of $248,793, or
$1.22 per share (fully diluted), as compared to a fiscal 1995 net income of
$133,878, or $.68 per share (fully diluted). The fiscal 1995 results include a
non-cash charge of $83,363, or $.37 per share, reflecting the final calculation
for the loss on the disposal of the discontinued real estate operations
following the completion of the spin-off of Price Enterprises.
CONTINUING OPERATIONS
Income from continuing operations for fiscal 1996 was $248,793, or $1.22 per
share (fully diluted), compared to income from continuing operations for fiscal
1995 of $217,241, or $1.05 per share.
Net sales increased 7% to $19,213,866 in fiscal 1996 (a 52-week year) from
$17,905,926 in fiscal 1995 (a 53-week year). This increase was due to: (i) first
year sales at the 20 new warehouses opened during fiscal 1996, which increase
was partially offset by eight warehouses closed during fiscal 1996 that were in
operation during fiscal 1995; (ii) increased sales at 24 warehouses that were
opened in fiscal 1995 and that were in operation for the entire 1996 fiscal
year; and (iii) higher sales at existing locations opened prior to fiscal 1995.
Changes in prices did not materially impact sales levels.
Comparable sales, that is sales in warehouses open for at least a year,
increased at a 5% annual rate in fiscal 1996, compared to a 2% annual rate
during fiscal 1995. The improvement in comparable sales levels in fiscal 1996,
as compared to fiscal 1995, reflects new marketing and merchandising efforts,
including the rollout of fresh foods and various ancillary businesses to certain
existing locations.
Membership fees and other revenue increased 3% to $352,590, or 1.84% of net
sales, in fiscal 1996 from $341,360, or 1.91% of net sales, in fiscal 1995. This
increase was primarily due to membership sign-ups at the 20 new warehouses
opened in fiscal 1996. Effective with renewals in the United States, subsequent
to April 1, 1996, the Company increased the annual membership fee for its
Business "Add-on" members from $15 to $20. There were approximately 3.4 million
"Add-on" members as of fiscal 1996 year-end.
14
Gross margin (defined as net sales minus merchandise costs) increased 11% to
$1,868,551, or 9.73% of net sales, in fiscal 1996 from $1,680,078, or 9.38% of
net sales, in fiscal 1995. Gross margin as a percentage of net sales increased
due to greater purchasing power realized since the merger of Costco Wholesale
Corporation and The Price Company, favorable inventory shrink results, the
expanded use of the Company's depot facilities and increased sales penetration
of certain ancillary businesses. The gross margin figures reflect accounting for
most U.S. merchandise inventories on the last-in, first-out (LIFO) method. For
fiscal 1996 there was no LIFO charge due to the use of the LIFO method compared
to the first-in, first-out (FIFO) method. This compares to a $9,500 LIFO charge,
or $.03 per share (fully diluted), in fiscal 1995.
Selling, general and administrative expenses as a percent of net sales
increased to 8.80% during fiscal 1996 from 8.69% during fiscal 1995, primarily
reflecting higher expenses associated with international expansion and certain
ancillary operations. In addition, as a result of a strong second half
performance, the Company achieved its annual profit goals for the 1996 fiscal
year, resulting in a year-over-year increase of $11,200 in the employee bonus
accrual, which covers bonuses payable to more than seven hundred management
employees participating in the Company's Annual Bonus Plan.
Preopening expenses totaled $29,231, or 0.15% of net sales, during fiscal
1996 and $25,018, or 0.14% of net sales, during fiscal 1995. During fiscal 1996,
the Company opened 20 new warehouses compared to 24 new warehouses opened during
fiscal 1995. Fiscal 1996 preopening expenses also included an increased level of
costs associated with remodeling and expanding fresh foods and ancillary
operations at existing warehouses.
The Company recorded a pre-tax provision for warehouse closing costs of
$10,000, or $.03 per share, on an after-tax basis (fully diluted) in fiscal
1996. The provision included estimated closing costs for certain warehouses,
which were or will be replaced by new warehouses, the closing of a regional
office and additional costs related to warehouse clubs closed in prior years.
Warehouse closing costs were $7,500 (pre-tax), or $.02 per share, in fiscal
1995.
Interest expense totaled $78,078 in fiscal 1996, and $67,911 in fiscal 1995.
In both fiscal years, interest expense was incurred as a result of the interest
on the convertible subordinated debentures and interest on borrowings on the
Company's bank lines and commercial paper programs. The increase in interest
expense is primarily related to higher borrowings and interest rates under the
Company's bank lines and commercial paper programs and the issuance of $300,000
in Senior Notes in June 1995.
Interest income and other totaled $10,832 in fiscal 1996, and $2,783 in
fiscal 1995. This increase was primarily due to the Company reflecting a
reduction in its share of losses in certain unconsolidated joint ventures,
(primarily PriceQuest) and an increase in income from its joint venture with
Price Club Mexico.
In fiscal 1996 and 1995, the effective income tax rate on income from
continuing operations before provision for income taxes was 41.25% and 41.00%
respectively.
Discontinued operations in fiscal 1995 included a non-cash charge of
$83,363, or $.37 per share, reflecting the final calculation for the loss on
disposal of the discontinued real estate operations. These charges related to
the transfer of the Company's commercial real estate operations, together with
certain other assets, to Price Enterprises as part of the Exchange Transaction.
The Exchange Transaction was completed on December 20, 1994, and the estimated
loss on disposal was adjusted to actual. For a more detailed discussion of the
Exchange Transaction, see "Note 2--Spin-off of Price Enterprises, Inc. and
Discontinued Operations."
RECENT SALES RESULTS
(DOLLARS IN THOUSANDS)
Costco's net sales for the nine-week period ended November 2, 1997 were
approximately $3,860,000, an increase of 11% from approximately $3,470,000 for
the same nine-week period of the prior fiscal year.
15
Comparable warehouse sales (sales in warehouses open for at least a year)
increased by eight percent during the nine-week period.
LIQUIDITY AND CAPITAL RESOURCES
(DOLLARS IN THOUSANDS)
The discussion below contains forward-looking statements that involve risks
and uncertainties, and should be read in conjunction with the Company's reports
filed previously with the Securities and Exchange Commission. Actual results may
differ materially.
EXPANSION PLANS
Costco's primary requirement for capital is the financing of the land,
building and equipment costs for new warehouses plus the costs of initial
warehouse operations and working capital requirements, as well as additional
capital for international expansion through investments in foreign subsidiaries
and joint ventures.
While there can be no assurance that current expectations will be realized,
and plans are subject to change upon further review, it is management's current
intention to spend an aggregate of approximately $400,000 to $450,000 during
fiscal 1998 in the United States and Canada for real estate, construction,
remodeling and equipment for warehouse clubs and related operations; and
approximately $80,000 to $100,000 for international expansion, including Mexico,
the United Kingdom, Asia and other potential ventures. These expenditures will
be financed with a combination of cash provided from operations, the use of cash
and cash equivalents (which totaled $175,508 at August 31, 1997); if necessary,
short-term borrowings under revolving credit facilities and/or commercial paper
facilities; and other financing sources as required.
Expansion plans for the United States and Canada during fiscal 1998 are to
open approximately 20 new warehouse clubs, including one or two relocations. The
Company expects to continue expansion of its international operations and plans
to open one or two additional units in the United Kingdom through its 60%-owned
subsidiary during fiscal 1998. Additionally the Company expects to open one
warehouse in Taiwan through a joint venture. Other international markets are
being assessed, particularly in the Pacific Rim.
The Company has entered into a purchase agreement with Hechinger Company to
acquire seven of Hechinger's locations in Michigan. The acquisition is subject
to certain conditions including third party approvals and permits. The Company
intends to invest approximately $80,000 in these facilities, including the
initial warehouse purchase and remodeling costs and working capital
requirements.
Costco and its Mexico-based joint venture partner, Controladora Comercial
Mexicana, each own a 50% interest in Price Club Mexico following the Company's
acquisition of Price Enterprises' interest in Price Club Mexico in April 1995.
As of August 31, 1997, Price Club Mexico operated 13 Price Club warehouses in
Mexico and one additional warehouse was opened in September 1997.
COMMERCIAL PAPER PROGRAMS AND BANK CREDIT FACILITIES (ALL AMOUNTS STATED IN US
DOLLARS)
The Company has in place a $500,000 commercial paper program supported by a
$500,000 bank credit facility with a group of 12 banks, of which $250,000
expires on January 26, 1998, and $250,000 expires on January 30, 2001. At August
31, 1997, no amount was outstanding under the loan facility or the commercial
paper program.
In addition, a wholly-owned Canadian subsidiary has a $144,000 commercial
paper program supported by a $101,000 bank credit facility with three Canadian
banks, of which $61,000 expires in March 1998 and $40,000 expires in March 1999.
At August 31, 1997, no amount was outstanding under the bank credit facility and
$25,460 was outstanding under the Canadian commercial paper program.
16
The Company has agreed to limit the combined amount outstanding under the
U.S. and Canadian commercial paper programs to the $601,000 combined amounts of
the respective supporting bank credit facilities.
LETTERS OF CREDIT
The Company has separate letter of credit facilities (for commercial and
standby letters of credit), totaling approximately $254,000. The outstanding
commitments under these facilities at August 31, 1997 totaled approximately
$184,000, including approximately $42,000 in standby letters of credit for
workers' compensation requirements.
REDEMPTION/CONVERSION OF CONVERTIBLE SUBORDINATED DEBENTURES
On November 19, 1996, The Price Company, a wholly-owned subsidiary of the
Company, called for redemption all $285,100 of its 6 3/4% Convertible
Subordinated Debentures due 2001. On the redemption date, December 4, 1996,
approximately $159,400 principal amount of the Debentures were converted into
approximately 7.1 million shares of Costco Common Stock and the remaining
$125,700 of Debentures were redeemed at a total cost of $130,300 (including
accrued interest and redemption premium). The redemption portion of the
transaction was initially financed with short-term bank borrowings.
On December 16, 1996, The Price Company called for redemption all $179,300
of its 5 1/2% Convertible Subordinated Debentures due 2012. On the redemption
date, January 6, 1997, approximately $142,700 principal amount of the Debentures
were converted into approximately 6.0 million shares of Costco Common Stock and
the remaining $36,600 of Debentures were redeemed at a total cost of $37,500
(including accrued interest and redemption premium). The redemption portion of
the transaction was paid with cash on hand.
On August 4, 1997, Costco Wholesale Corporation, a wholly-owned subsidiary
of the Company, called for redemption all $300,000 of its 5 3/4% Convertible
Subordinated Debentures due 2002. On the redemption date, August 21, 1997,
virtually all of the Debentures were redeemed at a total cost of $312,000
(including accrued interest and redemption premium). The transaction was
financed with proceeds from the issuance of 3 1/2% Zero Coupon Convertible
Subordinated Notes (see below).
On August 19, 1997, the Company completed the sale of $900,000 principal
amount at maturity of Zero Coupon Subordinated Notes (the "Notes") due August
19, 2017. The Notes were priced with a yield to maturity of 3 1/2%, resulting in
gross proceeds to the Company of $449,640. The Notes are convertible into a
maximum of 10,219,090 shares of Costco Common Stock at an initial conversion
price of $44.00 per share. Holders of the notes may require the Company to
purchase the Notes (at the discounted issue price plus accrued interest to date
of purchase) on August 19, 2002, 2007, or 2012. The Company, at its option, may
redeem the Notes (at the discounted issue price plus accrued interest to date of
redemption) any time on or after August 19, 2002. Approximately $312,000 of the
proceeds from the offering were used to redeem Costco Wholesale Corporation's
$300,000 principal amount of 5 3/4% Convertible Subordinated Debentures due
2002, including the redemption premium and accrued interest. The remaining
proceeds will be used for general corporate purposes.
The Company has limited involvement with derivative financial instruments
and uses them only to manage well-defined interest rate and foreign exchange
risks. Forward foreign exchange contracts are used to hedge the impact of
fluctuations of foreign exchange on inventory purchases. The amount of interest
rate and foreign exchange contracts outstanding at year-end or in place during
1997 was immaterial to the Company's results of operations or its financial
position.
17
FINANCIAL POSITION AND CASH FLOWS
Due to rapid inventory turnover, the Company's operations provide a higher
level of supplier trade payables in relation to inventory than generally
encountered in other forms of retailing. When combined with other current
liabilities, the resulting amount typically approaches or exceeds the current
assets needed to operate the business (e.g., merchandise inventories, accounts
receivable and other current assets). Working capital totaled approximately
$146,000 at August 31, 1997, compared to working capital of $57,000 at September
1, 1996. The increase in net working capital was primarily due to an increase in
cash and cash equivalents of approximately $74,000, an increase in owned
inventories (inventories less accounts payable) of approximately $27,000,
increases in receivables and other current assets of approximately $22,000,
reductions in short-term borrowings of approximately $34,000, offset by
increases in accrued salaries and benefits of approximately $46,000 and
increases in other current liabilities of approximately $23,000.
Net cash provided by operating activities totaled $590,249 in fiscal 1997
compared to $426,359 in fiscal 1996. The increase in net cash from operating
activities is primarily a result of increased net income, adjusted for the
non-cash provision for asset impairments, and decreased owned inventory during
fiscal 1997 compared to fiscal 1996.
Net cash used in investing activities totaled $543,173 in fiscal 1997
compared to $543,249 in fiscal 1996. The investing activities primarily relate
to additions to property and equipment for new and remodeled warehouses of
$553,374 and $506,782 in fiscal 1997 and 1996, respectively. Additionally, the
Company received proceeds from the sale of property and equipment of $40,946 in
fiscal 1997 compared to $4,665 in fiscal 1996.
Net cash provided by financing activities totaled $25,144 in fiscal 1997
compared to $173,749 in fiscal 1996. This decrease is due to the redemption of
the convertible debentures in fiscal 1997, partially offset by utilizing
short-term borrowings and issuing the Zero Coupon Subordinated Notes.
The Company's balance sheet as of August 31, 1997 reflects a $564,453 or 11%
increase in total assets since September 1, 1996. The increase is primarily due
to a net increase in property and equipment and merchandise inventory related to
the Company's expansion program.
ITEM 8--FINANCIAL STATEMENTS
Financial statements of Costco are as follows:
PAGE
----
Report of Independent Public Accountants.................................. 22
Consolidated Balance Sheets, as of August 31, 1997 and September 1,
1996..................................................................... 23
Consolidated Statements of Operations, for the 52 weeks ended August 31,
1997 and
September 1, 1996, and the 53 weeks ended September 3, 1995.............. 24
Consolidated Statements of Stockholders' Equity, for the 52 weeks ended
August 31, 1997 and
September 1, 1996, and the 53 weeks ended September 3, 1995.............. 25
Consolidated Statements of Cash Flows, for the 52 weeks ended August 31,
1997 and
September 1, 1996, and the 53 weeks ended September 3, 1995.............. 26
Notes to Consolidated Financial Statements................................ 27
ITEM 9--CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
18
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information with respect to the executive officers of the Registrant,
see Item--4A "Executive Officers of the Registrant" at the end of Part I of this
report. The information required by this Item concerning the Directors and
nominees for Director of the Company is incorporated herein by reference to
Costco's Proxy Statement for its Annual Meeting of Stockholders, to be held on
January 21, 1998, to be filed with the Securities and Exchange Commission within
120 days of the end of the Company's fiscal year.
ITEM 11--EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to
Costco's Proxy Statement for its Annual Meeting of Stockholders, to be held on
January 21, 1998, to be filed with the Securities and Exchange Commission within
120 days of the end of the Company's fiscal year.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to
Costco's Proxy Statement for its Annual Meeting of Stockholders to be held on
January 21, 1998 to be filed with the Securities and Exchange Commission within
120 days of the end of the Company's fiscal year.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference to
Costco's Proxy Statement for its Annual Meeting of Stockholders, to be held on
January 21, 1998 to be filed with the Securities and Exchange Commission within
120 days of the end of the Company's fiscal year.
PART IV
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report are as follows:
1. Financial Statements:
See listing of Financial Statements included as a part of this Form
10-K on Item 8 of Part II.
2. Financial Statement Schedules--None.
3. Exhibits:
The required exhibits are included at the end of the Form 10-K Annual
Report and are described in the Exhibit Index immediately preceding
the first exhibit.
(b) Current Report on Form 8-K was filed on August 18, 1997, reporting Item
5.
19
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
November 7, 1997
COSTCO COMPANIES, INC.
(Registrant)
By /s/ RICHARD A. GALANTI
--------------------------------------
Richard A. Galanti
EXECUTIVE VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By /s/ JAMES D. SINEGAL November 7, 1997
---------------------------------------------
James D. Sinegal
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND DIRECTOR
By /s/ JEFFREY H. BROTMAN November 7, 1997
---------------------------------------------
Jeffrey H. Brotman
CHAIRMAN OF THE BOARD
By /s/ RICHARD D. DICERCHIO November 7, 1997
---------------------------------------------
Richard D. DiCerchio
SR. EXECUTIVE VICE PRESIDENT, CHIEF OPERATING
OFFICER-MERCHANDISING, DISTRIBUTION,
CONSTRUCTION AND MARKETING AND DIRECTOR
By /s/ RICHARD A. GALANTI November 7, 1997
---------------------------------------------
Richard A. Galanti
EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL
OFFICER AND DIRECTOR (PRINCIPAL FINANCIAL
OFFICER)
By /s/ DAVID S. PETTERSON November 7, 1997
---------------------------------------------
David S. Petterson
SENIOR VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
By /s/ HAMILTON E. JAMES November 7, 1997
---------------------------------------------
Hamilton E. James
DIRECTOR
20
By /s/ RICHARD M. LIBENSON November 7, 1997
---------------------------------------------
Richard M. Libenson
DIRECTOR
By /s/ JOHN W. MEISENBACH November 7, 1997
---------------------------------------------
John W. Meisenbach
DIRECTOR
By /s/ CHARLES T. MUNGER November 7, 1997
---------------------------------------------
Charles T. Munger
DIRECTOR
By /s/ FREDERICK O. PAULSELL November 7, 1997
---------------------------------------------
Frederick O. Paulsell
DIRECTOR
By /s/ JILL S. RUCKELSHAUS November 7, 1997
---------------------------------------------
Jill S. Ruckelshaus
DIRECTOR
21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Costco Companies, Inc.:
We have audited the accompanying consolidated balance sheets of Costco
Companies, Inc. (a Delaware corporation) and subsidiaries (Costco) as of August
31, 1997 and September 1, 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for the 52 weeks ended August
31, 1997 and September 1, 1996, and the 53 weeks ended September 3, 1995. These
financial statements are the responsibility of Costco's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Costco as of August 31, 1997
and September 1, 1996, and the results of its operations and its cash flows for
the 52 weeks ended August 31, 1997 and September 1, 1996, and the 53 weeks ended
September 3, 1995 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Seattle, Washington
October 13, 1997
22
COSTCO COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS EXCEPT PAR VALUE)
ASSETS
AUGUST 31, SEPTEMBER 1,
1997 1996
----------- ------------
CURRENT ASSETS
Cash and cash equivalents........................................................... $ 175,508 $ 101,955
Receivables, net.................................................................... 147,133 137,467
Merchandise inventories, net........................................................ 1,686,525 1,500,842
Other current assets................................................................ 100,784 88,040
----------- ------------
Total current assets.............................................................. 2,109,950 1,828,304
----------- ------------
PROPERTY AND EQUIPMENT
Land and land rights................................................................ 1,094,607 1,055,208
Buildings and leasehold and land improvements....................................... 1,933,740 1,667,697
Equipment and fixtures.............................................................. 840,578 716,448
Construction in progress............................................................ 81,417 104,183
----------- ------------
3,950,342 3,543,536
Less-accumulated depreciation and amortization...................................... (795,708) (655,226)
----------- ------------
Net property and equipment........................................................ 3,154,634 2,888,310
----------- ------------
OTHER ASSETS.......................................................................... 211,730 195,247
----------- ------------
$ 5,476,314 $4,911,861
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Bank checks outstanding............................................................. $ 14,930 $ 22,330
Short-term borrowings............................................................... 25,460 59,928
Accounts payable.................................................................... 1,379,379 1,220,426
Accrued salaries and benefits....................................................... 302,681 256,951
Accrued sales and other taxes....................................................... 90,774 84,545
Other current liabilities........................................................... 150,823 127,414
----------- ------------
Total current liabilities......................................................... 1,964,047 1,771,594
LONG-TERM DEBT........................................................................ 917,001 1,229,221
DEFERRED INCOME TAXES................................................................. 33,544 56,734
OTHER LIABILITIES..................................................................... 5,423 4,168
----------- ------------
Total liabilities................................................................. 2,920,015 3,061,717
----------- ------------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST..................................................................... 88,183 72,346
----------- ------------
STOCKHOLDERS' EQUITY
Preferred stock $.01 par value; 100,000,000 shares authorized; no shares issued and
outstanding....................................................................... -- --
Common stock $.01 par value; 900,000,000 shares authorized; 213,593,000 and
196,436,000 shares issued and outstanding......................................... 2,136 1,964
Additional paid-in capital.......................................................... 706,324 321,832
Accumulated foreign currency translation............................................ (78,426) (71,883)
Retained earnings................................................................... 1,838,082 1,525,885
----------- ------------
Total stockholders' equity........................................................ 2,468,116 1,777,798
----------- ------------
$ 5,476,314 $4,911,861
----------- ------------
----------- ------------
The accompanying notes are an integral part of these balance sheets.
23
COSTCO COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
52 WEEKS 52 WEEKS 53 WEEKS
ENDED ENDED ENDED
AUGUST 31, SEPTEMBER 1, SEPTEMBER 3,
1997 1996 1995
------------- ------------- -------------
REVENUE
Net sales....................................................... $ 21,484,118 $ 19,213,866 $ 17,905,926
Membership fees and other....................................... 390,286 352,590 341,360
------------- ------------- -------------
Total revenue................................................. 21,874,404 19,566,456 18,247,286
OPERATING EXPENSES
Merchandise costs............................................... 19,314,485 17,345,315 16,225,848
Selling, general and administrative............................. 1,876,759 1,691,187 1,555,588
Preopening expenses............................................. 27,448 29,231 25,018
Provision for impaired assets and warehouse
closing costs................................................. 75,000 10,000 7,500
------------- ------------- -------------
Operating income.............................................. 580,712 490,723 433,332
OTHER INCOME (EXPENSE)
Interest expense................................................ (76,281) (78,078) (67,911)
Interest income and other....................................... 15,898 10,832 2,783
------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS BEFORE PROVISION FOR INCOME
TAXES........................................................... 520,329 423,477 368,204
Provision for income taxes...................................... 208,132 174,684 150,963
------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS................................. 312,197 248,793 217,241
DISCONTINUED OPERATIONS:
Loss on disposal................................................ -- -- (83,363)
------------- ------------- -------------
NET INCOME........................................................ $ 312,197(a) $ 248,793 $ 133,878
------------- ------------- -------------
------------- ------------- -------------
NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE--
PRIMARY:
Continuing operations:.......................................... $ 1.47 $ 1.24 $ 1.06
------------- ------------- -------------
------------- ------------- -------------
FULLY DILUTED:
Continuing operations:.......................................... $ 1.46 $ 1.22 $ 1.05
Discontinued operations:
Loss on disposal.............................................. -- -- (0.37)
------------- ------------- -------------
Net income...................................................... $ 1.46(a) $ 1.22 $ 0.68
------------- ------------- -------------
------------- ------------- -------------
- ------------------------
(a) Net income and net income per common and common equivalent share would have
been $350,872 and $1.63, respectively, without the effect of adopting SFAS
No. 121, using 226,195 fully-diluted shares.
The accompanying notes are an integral part of these financial statements.
24
COSTCO COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE 52 WEEKS ENDED AUGUST 31, 1997 AND SEPTEMBER 1, 1996,
AND THE 53 WEEKS ENDED SEPTEMBER 3, 1995
(IN THOUSANDS)
ACCUMULATED
COMMON STOCK ADDITIONAL FOREIGN
-------------------- PAID-IN CURRENCY RETAINED
SHARES AMOUNT CAPITAL TRANSLATION EARNINGS TOTAL
--------- --------- ----------- ------------ ------------ ------------
BALANCE AT AUGUST 28, 1994...................... 217,795 $ 2,178 $ 582,148 $ (42,580) $ 1,143,214 $ 1,684,960
Stock options exercised including income tax
benefits.................................... 593 6 4,071 -- -- 4,077
Shares exchanged.............................. (23,224) (232) (282,230) -- -- (282,462)
Net income.................................... -- -- -- -- 133,878 133,878
Foreign currency translation adjustment....... -- -- -- (9,709) -- (9,709)
--------- --------- ----------- ------------ ------------ ------------
BALANCE AT SEPTEMBER 3, 1995.................... 195,164 1,952 303,989 (52,289) 1,277,092 1,530,744
Stock options exercised including income tax
benefits.................................... 1,272 12 17,843 -- -- 17,855
Net income.................................... -- -- -- -- 248,793 248,793
Foreign currency translation adjustment....... -- -- -- (19,594) -- (19,594)
--------- --------- ----------- ------------ ------------ ------------
BALANCE AT SEPTEMBER 1, 1996.................... 196,436 1,964 321,832 (71,883) 1,525,885 1,777,798
Stock options exercised including income tax
benefits.................................... 4,077 41 78,186 -- -- 78,227
Conversion of convertible debentures.......... 13,080 131 306,306 -- -- 306,437
Net income.................................... -- -- -- -- 312,197 312,197
Foreign currency translation adjustment....... -- -- -- (6,543) -- (6,543)
--------- --------- ----------- ------------ ------------ ------------
BALANCE AT AUGUST 31, 1997...................... 213,593 $ 2,136 $ 706,324 $ (78,426) $ 1,838,082 $ 2,468,116
--------- --------- ----------- ------------ ------------ ------------
--------- --------- ----------- ------------ ------------ ------------
The accompanying notes are an integral part of these financial statements.
25
COSTCO COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
52 WEEKS 52 WEEKS 53 WEEKS
ENDED ENDED ENDED
AUGUST 31, SEPTEMBER 1, SEPTEMBER 3,
1997 1996 1995
----------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................................ $ 312,197 $ 248,793 $ 133,878
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization......................................... 182,326 161,632 142,022
Net (gain) loss on sale of property and equipment and other........... (602) 3,494 (384)
Provision for asset impairments....................................... 65,000 -- --
Loss on disposal of discontinued operations........................... -- -- 83,363
Decrease in deferred income taxes..................................... (4,322) (4,520) (3,559)
Change in receivables, other current assets, accrued and other current
liabilities......................................................... 66,303 105,156 (81,729)
Increase in merchandise inventories................................... (189,323) (82,411) (160,114)
Increase (decrease) in accounts payable............................... 162,628 (8,345) 155,851
Other................................................................. (3,958) 2,560 9,054
----------- ------------ ------------
Total adjustments................................................... 278,052 177,566 144,504
----------- ------------ ------------
Net cash provided by operating activities........................... 590,249 426,359 278,382
----------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property and equipment................................... (553,374) (506,782) (530,638)
Proceeds from the sale of property and equipment...................... 40,946 4,665 7,337
Investment in unconsolidated joint ventures........................... (4,750) (5,312) (11,487)
Decrease in short-term investments and restricted cash................ -- -- 9,268
Increase in other assets and other, net............................... (25,995) (35,820) (10,932)
----------- ------------ ------------
Net cash used in investing activities................................. (543,173) (543,249) (536,452)
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments under short-term credit facilities, net.................... (33,990) (14,354) (73,194)
Net proceeds from issuance of long-term debt.......................... 461,035 141,851 299,026
Repayments of long-term debt.......................................... (471,791) (3,270) (3,194)
Changes in bank overdraft............................................. (7,244) 9,835 5,668
Proceeds from minority interests...................................... 15,119 21,832 16,603
Exercise of stock options............................................. 62,015 17,855 4,077
----------- ------------ ------------
Net cash provided by financing activities............................. 25,144 173,749 248,986
----------- ------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH................................. 1,333 (592) 1,134
----------- ------------ ------------
Net increase (decrease) in cash and cash equivalents.................. 73,553 56,267 (7,950)
CASH AND CASH EQUIVALENTS BEGINNING OF YEAR............................. 101,955 45,688 53,638
----------- ------------ ------------
CASH AND CASH EQUIVALENTS END OF YEAR................................... $ 175,508 $ 101,955 $ 45,688
----------- ------------ ------------
----------- ------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest (excludes amounts capitalized and paid for redemption
premiums)........................................................... $ 76,233 $ 65,752 $ 75,583
Income taxes.......................................................... $ 195,241 $ 163,004 $ 165,269
The accompanying notes are an integral part of these financial statements.
26
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Costco
Companies, Inc., a Delaware corporation, and its subsidiaries ("Costco" or the
"Company"). On January 29, 1997, the shareholders of the Company approved a name
change from Price/Costco, Inc. to Costco Companies, Inc. Costco is a holding
company which operates primarily through its major subsidiaries, The Price
Company and subsidiaries, and Costco Wholesale Corporation and subsidiaries. All
intercompany transactions between the Company and its subsidiaries have been
eliminated in consolidation. The Price Company and Costco Wholesale Corporation
primarily operate membership warehouses under the Costco Wholesale name.
Costco operates membership warehouses that offer very low prices on a
limited selection of nationally-branded and selected private label products in a
wide range of merchandise categories in no-frills, self-service warehouse
facilities. At August 31, 1997, Costco operated 261 warehouse clubs: 200 in the
United States (in 23 states); 54 in Canada (in nine Canadian provinces); six in
the United Kingdom; and one in Taiwan--primarily under the "Costco Wholesale"
name. As of August 31, 1997, the Company also operated (through a 50%-owned
joint venture) 13 warehouses in Mexico, and had a license agreement for the
operation of two membership warehouses in Korea.
The Company's investment in the Price Club Mexico joint venture and in other
unconsolidated joint ventures that are less than majority owned are accounted
for under the equity method.
FISCAL YEARS
The Company reports on a 52/53 week fiscal year basis which ends on the
Sunday nearest August 31st. Fiscal years 1997 and 1996 were 52 weeks, and fiscal
year 1995 was 53 weeks.
CASH AND CASH EQUIVALENTS
The Company considers all investments in highly liquid debt instruments
maturing within 90 days after purchase as cash equivalents unless amounts are
held in escrow for future property purchases or restricted by agreements.
SHORT-TERM INVESTMENTS AND RESTRICTED CASH
Short-term investments include highly liquid investments in United States
and Canadian government obligations, along with other investment vehicles, some
of which have maturities of three months or less at the time of purchase. The
Company's policy is to classify these investments as short-term investments
rather than cash equivalents if they are acquired and disposed of through its
investment trading account, held for future property purchases, or restricted by
agreement. Unrealized holding gains and losses were not significant.
RECEIVABLES
Receivables consist primarily of vendor rebates and promotional allowances
and other miscellaneous amounts due to the Company, and are net of allowance for
doubtful accounts of $4,360 at August 31, 1997 and $3,498 at September 1, 1996.
27
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MERCHANDISE INVENTORIES
Merchandise inventories are valued at the lower of cost or market as
determined primarily by the retail inventory method, and are stated using the
last-in, first-out (LIFO) method for substantially all U.S. merchandise
inventories. The Company believes the LIFO method more fairly presents the
results of operations by more closely matching current costs with current
revenues. If all merchandise inventories had been valued using the first-in,
first-out (FIFO) method, inventories would have been higher by $16,150 at both
August 31, 1997 and September 1, 1996.
AUGUST 31, SEPTEMBER 1,
1997 1996
------------ ------------
Merchandise inventories consist of:
United States (primarily LIFO).................................. $ 1,358,917 $1,216,131
Foreign (FIFO).................................................. 327,608 284,711
------------ ------------
Total......................................................... $ 1,686,525 $1,500,842
------------ ------------
------------ ------------
The Company provides for estimated inventory losses between physical
inventory counts on the basis of a standard percentage of sales. This provision
is adjusted periodically to reflect the actual shrinkage results of the physical
inventory counts which generally occur in the second and fourth quarters of the
Company's fiscal year.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
expenses are computed using the straight-line method for financial reporting
purposes and by accelerated methods for tax purposes. Buildings are depreciated
over twenty-five to thirty-five years; equipment and fixtures are depreciated
over three to ten years; and land rights and leasehold improvements are
amortized over the initial term of the lease.
Interest costs incurred on property and equipment during the construction
period are capitalized. The amount of interest costs capitalized related to
continuing operations was approximately $4,097 in fiscal 1997, $5,612 in fiscal
1996, and $3,275 in fiscal 1995.
GOODWILL
Goodwill, included in other assets, totaled $48,136 at August 31, 1997 and
$50,746 at September 1, 1996, resulting from certain previous business
combinations and the purchase of Price Enterprises' interest in Price Club
Mexico in March 1995. Goodwill is being amortized over 5 to 40 years using the
straight-line method. Accumulated amortization was $11,574 at August 31, 1997,
and $8,815 at September 1, 1996.
NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
The calculation of net income per common and common equivalent share for
each period eliminates interest expense, net of income taxes, on the 5 1/2%
convertible subordinated debentures (primary and fully diluted), the 6 3/4%
convertible subordinated debentures (fully diluted only), and includes the
additional shares issuable upon conversion of these instruments for the portion
of the year they were outstanding. In
28
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
fiscal year 1997, the calculation also eliminates the 5 3/4% convertible
subordinated debentures (fully diluted only), and the 3 1/2% zero coupon
subordinated notes and includes the additional shares issuable upon conversion
of these instruments for the portion of the year they were outstanding. The
weighted average number of common and common equivalent shares outstanding for
primary and fully diluted share calculations for fiscal 1997, 1996, and 1995
were as follows (in thousands):
1997 1996 1995
--------- --------- ---------
Primary...................................................... 214,349 205,242 210,962
Fully diluted................................................ 226,195 218,363 224,079
PREOPENING EXPENSES
Preopening expenses related to new warehouses, major remodels/expansions,
regional offices and other startup operations are expensed as incurred.
MEMBERSHIP FEES
Membership fee revenue represents annual membership fees paid by
substantially all of the Company's members. In accordance with historical and
industry practice, annual membership fees are recognized as income when
received.
FOREIGN CURRENCY TRANSLATION
The accumulated foreign currency translation relates to the Company's
consolidated foreign operations as well as its investment in the Price Club
Mexico joint venture (prior to the 1997 calendar year). Foreign currency
translation is determined by application of the current rate method and included
in the determination of consolidated stockholders' equity at the respective
balance sheet dates.
Because cumulative inflation in Mexico exceeded 100% in the three-year
calendar period 1994-1996, a hyper-inflation accounting treatment is required in
calendar 1997, whereby foreign currency translation gains or losses are
reflected in the Statement of Operations rather than as an adjustment to
stockholders' equity. For the first nine months of calendar year 1997,
translation gains and losses were not material.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes."
That standard requires companies to account for deferred income taxes using the
asset and liability method.
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
FISCAL 1997 NON-CASH ACTIVITIES
- In December 1996, approximately $159,400 principal amount of the $285,100,
6 3/4% Convertible Subordinated Debentures were converted into
approximately 7.1 million shares of Costco Common Stock as a result of a
call for redemption of the $285,100 Convertible Subordinated Debentures.
29
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
- In January 1997, approximately $142,700 principal amount of the $179,300,
5 1/2% Convertible Subordinated Debentures were converted into
approximately 6.0 million shares of Costco Common Stock as a result of the
call for redemption of the Convertible Subordinated Debentures.
- In fiscal 1997, the Company recorded a pre-tax, non-cash charge of $65,000
reflecting its estimate of impairment relating principally to excess
property and closed warehouses in connection with the adoption of the
Financial Accounting Standards Board Statement No. 121.
FISCAL 1996 NON-CASH ACTIVITIES
- None.
FISCAL 1995 NON-CASH ACTIVITIES
- During December 1994, the Company exchanged approximately 23.2 million
shares of Price Enterprises common stock valued at $282,462 for an equal
number of shares of Price Costco common stock.
- In February 1995, the Company exchanged approximately 3.8 million shares
of Price Enterprises common stock valued at $45,925 for an
interest-bearing note receivable from Price Enterprises.
- As of August 28, 1994, the net assets of Price Enterprises consisted
primarily of the discontinued operations net assets of $377,085 and
certain other assets. In connection with the spin-off of Price
Enterprises, all of these assets were eliminated from the Company's
consolidated balance sheet during fiscal 1995. For additional information
see "Note 2--Spin-off of Price Enterprises, Inc. and Discontinued
Operations."
- In April 1995, the Company purchased Price Enterprises' 25.5% interest in
Price Club Mexico for $30,500 by a partial offset to the $45,925 note
receivable due from Price Enterprises.
- During fiscal 1995, the Company increased its investment in certain
unconsolidated joint ventures by $23,100 through reductions of accounts
receivable due from those joint ventures.
DERIVATIVES
The Company has limited involvement with derivative financial instruments
and only uses them to manage well-defined interest rate and foreign exchange
risks. Forward foreign exchange contracts are used to hedge the impact of
fluctuations of foreign exchange on inventory purchases. The amount of interest
rate and foreign exchange contracts outstanding at year-end or in place during
fiscal 1997 was immaterial to the Company's results of operations or its
financial position.
ADOPTION OF FINANCIAL ACCOUNTING STANDARDS BOARD STATEMENT NO. 121
The Company adopted the Financial Accounting Standards Board Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" (SFAS No. 121), as of the first quarter of fiscal
1997. In accordance with SFAS No. 121, the Company recorded a pretax, non-cash
charge of $65,000 reflecting its estimate of impairment relating principally to
excess property and
30
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
closed warehouses. The charge reflects the difference between carrying value and
fair value, which was based on market valuations for those assets whose carrying
value was not recoverable through future cash flows.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings per Share" (SFAS No. 128). SFAS No. 128 establishes new
standards for computing and presenting earnings per share (EPS) for entities
with publicly-held common stock. The Company is required to adopt SFAS No. 128
at the beginning of fiscal 1998. If the provisions of SFAS No. 128 had been used
to calculate EPS for the 1997 and 1996 fiscal years, proforma EPS would have
been:
52 WEEKS ENDED
------------------------------
SEPTEMBER 1,
AUGUST 31, 1997 1996
--------------- -------------
Basic........................................................... $ 1.51 $ 1.27
Diluted......................................................... $ 1.47 $ 1.22
Excluding the non-cash, pre-tax charge of $65,000 ($38,675 after-tax) for
asset impairment, basic and diluted earnings per share for the 52 weeks ended
August 31, 1997 would have been $1.69 and $1.64, respectively.
RECLASSIFICATIONS
Certain reclassifications have been reflected in the financial statements in
order to conform prior years to the current year presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
NOTE 2--SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS
On July 28, 1994, the Company entered into an Agreement of Transfer and Plan
of Exchange (as amended and restated, the "Transfer and Exchange Agreement")
with Price Enterprises, Inc. ("Price Enterprises"). Price Enterprises was an
indirect, wholly-owned subsidiary of Costco, formed in July 1994. The
transactions contemplated by the Transfer and Exchange Agreement are referred to
herein as the "Exchange Transaction."
The Exchange Transaction was completed on December 20, 1994, with 23,224,028
shares of Costco Common Stock tendered and exchanged for an equal number of
shares of Price Enterprises Common Stock. On February 9, 1995, Price Enterprises
purchased from Costco 3,775,972 shares of Price Enterprises Common Stock,
constituting all of the remaining shares of Price Enterprises Common Stock held
by Costco. Based on the aggregate number of shares of Price Enterprises Common
Stock (27 million shares)
31
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 2--SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS
(CONTINUED)
exchanged for Costco Common Stock and sold to Price Enterprises for a secured
promissory note and an average closing sales price of $12.1625 per share for
Price Enterprises Common Stock, the loss on disposal of the discontinued real
estate operations increased by $83,363 from the estimated loss recorded in
fiscal 1994 (27 million shares multiplied by $3.0875 per share representing the
difference between the estimated and actual price per share). This non-cash
charge was reflected as an additional loss on disposal of discontinued
operations in 1995.
Costco transferred to Price Enterprises substantially all of the real estate
properties which historically formed the non-club real estate segment of Costco,
four warehouse facilities, notes receivable from various municipalities and
agencies and a note receivable from Atlas Hotels, Inc. In addition, Costco
transferred to Price Enterprises 51% of the outstanding capital stock of Price
Quest, Inc. ("Price Quest") and Price Global Trading, Inc. ("Price Global").
Price Quest operated the Quest interactive electronic shopping business and
provided other services to members. Price Global had the rights to develop
membership warehouse club businesses in certain geographical areas specified in
the Transfer and Exchange Agreement.
Costco also transferred to Price Enterprises a 25.5% interest in the Price
Club Mexico joint venture. This interest was subsequently acquired from Price
Enterprises in fiscal 1995. Price Club Mexico is a joint venture with
Controladora Comercial Mexicana, S.A. de CV. operating Price Clubs in Mexico.
On or about September 1, 1996, Price Quest discontinued the Quest
interactive electronic shopping business in the Company's warehouses, but
continues to provide other services to members, including auto referral and
travel related services.
As part of the resolution of a shareholder lawsuit arising from the spin-off
and Exchange Transaction, Costco and Price Enterprises amended the Transfer and
Exchange Agreement, effective May 28, 1997. Under the amendment to the Transfer
and Exchange Agreement, Costco retained no ownership interest in Price Quest or
Price Global.
NOTE 3--DEBT
SHORT-TERM BORROWINGS
The Company has in place a $500,000 commercial paper program supported by a
$500,000 bank credit facility with a group of 12 banks, of which $250,000
expires on January 26, 1998, and $250,000 expires on January 30, 2001. At August
31, 1997, no amount was outstanding under the loan facility or the commercial
paper program.
In addition, a wholly-owned Canadian subsidiary has a $144,000 commercial
paper program supported by a $101,000 bank credit facility with three Canadian
banks, of which $61,000 expires in March 1998 and $40,000 expires in March 1999.
At August 31, 1997, no amount was outstanding under the bank credit facility and
$25,460 was outstanding under the Canadian commercial paper program.
The Company has agreed to limit the combined amount outstanding under the
U.S. and Canadian commercial paper programs to the $601,000 combined amounts of
the respective supporting bank credit facilities.
32
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--DEBT (CONTINUED)
The weighted average borrowings, highest borrowings and interest rate under
all short-term borrowing arrangements were as follows for fiscal 1997, 1996, and
1995:
MAXIMUM AMOUNT AVERAGE AMOUNT WEIGHTED AVERAGE
OUTSTANDING OUTSTANDING INTEREST RATE
CATEGORY OF AGGREGATE DURING THE DURING THE DURING THE
SHORT-TERM BORROWINGS PERIOD PERIOD PERIOD
- --------------------------------------- ----------------- --------------- -----------------
PERIOD ENDED AUGUST 31, 1997
Bank borrowings:
U.S.................................. $ -- $ -- --%
Canadian............................. 10,169 732 5.74
Commercial Paper:
U.S.................................. 279,000 85,140 5.54
Canadian............................. 100,716 52,486 3.43
PERIOD ENDED SEPTEMBER 1, 1996
Bank borrowings:
U.S.................................. $ -- $ -- --%
Canadian............................. 32,904 6,795 5.99
Commercial Paper:
U.S.................................. 198,000 55,239 5.71
Canadian............................. 102,368 69,775 5.40
PERIOD ENDED SEPTEMBER 3, 1995
Bank borrowings:
U.S.................................. $ -- $ -- --%
Canadian............................. 9,374 1,776 8.04
Commercial Paper:
U.S.................................. 468,000 215,683 5.75
Canadian............................. 23,760 3,912 5.56
The Company has separate letter of credit facilities (for commercial and
standby letters of credit) totaling approximately $254,000. The outstanding
commitments under these facilities at August 31, 1997 totaled approximately
$184,000, including approximately $42,000 in standby letters for workers'
compensation requirements.
33
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--DEBT (CONTINUED)
LONG-TERM DEBT
Long-term debt at August 31, 1997 and September 1, 1996 consists of:
1997 1996
---------- ------------
5 3/4% Convertible subordinated debentures due May 2002............. $ -- $ 300,000
6 3/4% Convertible subordinated debentures due March 2001........... -- 285,079
5 1/2% Convertible subordinated debentures due February 2012........ -- 179,338
7 1/8% Senior Notes due June 2005................................... 300,000 300,000
3 1/2% Zero Coupon convertible subordinated notes due August 2017... 450,207 --
Unsecured note payable to banks due April 2001...................... 140,000 140,000
Notes payable secured by trust deeds on real estate................. 16,327 21,956
Capital lease obligations and other................................. 19,426 12,247
---------- ------------
925,960 1,238,620
Less current portion (included in other current liabilities)........ 8,959 9,399
---------- ------------
Total long-term debt................................................ $ 917,001 $ 1,229,221
---------- ------------
---------- ------------
On August 4, 1997, Costco Wholesale Corporation, a wholly-owned subsidiary
of the Company, called for redemption all $300,000 of its 5 3/4% Convertible
Subordinated Debentures due 2002. On the redemption date, August 21, 1997,
virtually all of the Debentures were redeemed at a total cost of $312,000
(including accrued interest and redemption premium). The transaction was
financed with proceeds from the issuance of 3 1/2% Zero Coupon Convertible
Subordinated Notes (see below).
On November 19, 1996, The Price Company, a wholly-owned subsidiary of the
Company, called for redemption all $285,100 of its 6 3/4% Convertible
Subordinated Debentures due 2001. On the redemption date, December 4, 1996,
approximately $159,400 principal amount of the Debentures were converted into
approximately 7.1 million shares of Costco Common Stock and the remaining
$125,700 of Debentures were redeemed at a total cost of $130,300 (including
accrued interest and redemption premium). The redemption portion of the
transaction was financed with short-term bank borrowings.
On December 16, 1996, The Price Company called for redemption all $179,300
of its 5 1/2% Convertible Subordinated Debentures due 2012. On the redemption
date, January 6, 1997, approximately $142,700 principal amount of the Debentures
were converted into approximately 6.0 million shares of Costco Common Stock and
the remaining $36,600 of Debentures were redeemed at a total cost of $37,500
(including accrued interest and redemption premium). The redemption portion of
the transaction was paid with cash on hand.
The 7 1/8% Senior Notes were issued on June 7, 1995. Interest on the notes
is payable semiannually on June 15 and December 15. The indentures contain
certain limitations on the Company's and certain subsidiaries' ability to create
liens securing indebtedness and to enter into certain sale leaseback
transactions.
34
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--DEBT (CONTINUED)
On August 19, 1997, the Company completed the sale of $900,000 principal
amount at maturity of Zero Coupon Subordinated Notes (the "Notes") due August
19, 2017. The Notes were priced with a yield to maturity of 3 1/2%, resulting in
gross proceeds to the Company of $449,640. The Notes are convertible into a
maximum of 10,219,090 shares of Costco Common Stock at an initial conversion
price of $44.00. Holders of the notes may require the Company to purchase the
Notes (at the discounted issue price plus accrued interest to date of purchase)
on August 19, 2002, 2007, or 2012. The Company, at its option, may redeem the
Notes (at the discounted issue price plus accrued interest to date of
redemption) any time on or after August 19, 2002.
In April 1996, the Company borrowed $140,000 from a group of banks under a
five-year unsecured term loan. Interest only is payable quarterly at rates based
on LIBOR. Proceeds of the loan were used to retire $40,000 outstanding under the
Canadian commercial paper program and $100,000 outstanding under the U.S.
commercial paper program.
In February, 1996, the Company filed with the Securities and Exchange
Commission a shelf registration statement for $500,000 of senior debt
securities. Although the registration statement was declared effective, no
securities have been issued under this filing.
At August 31, 1997, the fair value of the 7 1/8% Senior Notes, based on
market quotes on August 31, 1997, was approximately $305,000. The Senior Notes
are not redeemable prior to maturity. The fair value of the 3 1/2% Zero Coupon
Subordinated Notes at August 31, 1997 was approximately $450,000.
Maturities of long-term debt during the next five fiscal years and
thereafter are as follows:
1998.......................... $ 8,959
1999.......................... 6,390
2000.......................... 3,676
2001.......................... 142,109
2002.......................... 1,275
Thereafter.................... 763,551
-------------
Total....................... $ 925,960
-------------
-------------
NOTE 4--LEASES
The Company leases land and/or warehouse buildings at 52 of the 261
warehouses open at August 31, 1997 and certain other office and distribution
facilities under operating leases with remaining terms ranging from 2 to 30
years. These leases generally contain one or more of the following options which
the Company can exercise at the end of the initial lease term: (a) renewal of
the lease for a defined number of years at the then fair market rental rate; (b)
purchase of the property at the then fair market value; (c) right of first
refusal in the event of a third party purchase offer. Certain leases provide for
periodic rental increases based on the price indices and some of the leases
provide for rents based on the greater of minimum guaranteed amounts or sales
volume. Contingent rents have not been material. Additionally, the Company
leases certain equipment and fixtures under short-term operating leases which
permit the Company to either renew for a series of one-year terms or to purchase
the equipment at the then fair market value.
35
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 4--LEASES (CONTINUED)
Aggregate rental expense for fiscal 1997, 1996, and 1995, was $54,019,
$55,686, and $53,600, respectively. Future minimum payments during the next five
fiscal years and thereafter under noncancelable leases with terms in excess of
one year, at August 31, 1997, were as follows:
1998.......................... $ 57,490
1999.......................... 54,513
2000.......................... 53,596
2001.......................... 51,905
2002.......................... 51,730
Thereafter.................... 499,452
-------------
Total minimum payments.... $ 768,686
-------------
-------------
NOTE 5--STOCK OPTIONS
Prior to the Merger, The Price Company and Costco Wholesale Corporation
adopted various incentive and non-qualified stock option plans which allowed
certain key employees and directors to purchase or be granted common stock of
The Price Company and Costco Wholesale Corporation (collectively the Old Stock
Option Plans). Options were granted for a maximum term of ten years, and were
exercisable upon vesting. Options granted under these plans generally vest
ratably over five to nine years. Subsequent to the Merger, new grants of options
are not being made under the Old Stock Option Plans.
The Costco Companies, Inc. 1993 Combined Stock Grant and Stock Option Plan
(the New Stock Option Plan) provides for the issuance of up to 20 million shares
of the Company's common stock pursuant to the exercise of stock options or up to
1,666,666 shares through stock grants.
The Company applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for stock options. Accordingly, no compensation
cost has been recognized for the plans. In fiscal year 1997, the Company adopted
the disclosure requirements of Statement of Financial Accounting Standards No.
123 (SFAS No.123), "Accounting for Stock-Based Compensation." Had compensation
cost for the Company's stock-based compensation plans been determined based on
the fair value at the grant dates for awards under those plans consistent with
SFAS No. 123, the Company's net income and net income per share would have been
reduced to the pro forma amounts indicated below:
1997 1996
------------- -------------
Net income:
As reported................. $ 312,197 $ 248,793
Pro forma................... $ 301,947 $ 246,208
Net income per share (fully
diluted):
As reported................. $ 1.46 $ 1.22
Pro forma................... $ 1.41 $ 1.21
36
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--STOCK OPTIONS (CONTINUED)
The effects of applying SFAS No. 123 on pro forma disclosures of net income
and earnings per share for fiscal 1997 and 1996 are not likely to be
representative of the pro forma effects on net income and earnings per share in
future years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1997 and 1996:
1997 1996
------------- -------------
Risk free interest rate....... 6.40% 6.15%
Expected life................. 7 years 7 years
Expected volatility........... 34% 32%
Expected dividend yield....... 0% 0%
Stock option transactions relating to the Old and New Stock Option Plans are
summarized below (shares in thousands):
1997 1996 1995
---------------------- ---------------------- ----------------------
SHARES PRICE(1) SHARES PRICE(1) SHARES PRICE(1)
--------- ----------- --------- ----------- --------- -----------
Under option at beginning of
year.......................... 16,972 $ 17.14 15,963 $ 16.71 14,691 $ 17.07
Granted(2)...................... 4,610 26.13 2,645 17.35 3,516 13.76
Exercised....................... (4,077) 15.24 (1,272) 10.60 (593) 5.72
Cancelled....................... (184) 18.37 (364) 18.26 (1,651) 17.59
--------- ----------- --------- ----------- --------- -----------
Under option at end of year..... 17,321 $ 19.96 16,972 $ 17.14 15,963 $ 16.71
--------- ----------- --------- ----------- --------- -----------
--------- ----------- --------- ----------- --------- -----------
- ------------------------
(1) Weighted-average exercise price
(2) The weighted-average fair value of options granted during fiscal 1997 and
1996 was $11.47 and $7.46, respectively.
The following table summarizes information regarding stock options
outstanding at August 31, 1997:
OPTIONS OUTSTANDING
----------------------------------------- OPTIONS EXERCISABLE
REMAINING
CONTRACTUAL ------------------------
RANGE OF PRICES NUMBER LIFE PRICE(1) NUMBER PRICE(1)
- ----------------------------------------- ----------- --------------- ----------- ----------- -----------
$2.75 - $17.13.......................... 5,832 5.3 $ 13.08 2,852 $ 11.89
$17.25 - $24.00.......................... 5,977 5.7 19.32 2,891 19.69
$24.53 - $40.17.......................... 5,512 8.2 27.99 1,375 31.50
--
----------- ----------- ----- -----------
$2.75 - $40.17.......................... 17,321 6.4 $ 19.96 7,118 $ 18.85
- ------------------------
(1) Weighted-average exercise price
37
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--RETIREMENT PLANS
The Company has a 401(k) Retirement Plan which is available to all U.S.
employees who have one year or more of service, except California union
employees. The plan allows pre-tax deferral against which the Company matches
50% of the first one thousand dollars of employee contributions. In addition,
the Company will provide each eligible participant a contribution based on
salary and years of service. The Company has a defined contribution plan for
Canadian and United Kingdom employees and contributes a percentage of each
employee's salary.
California union employees participate in a defined benefit plan sponsored
by its union. The Company makes contributions based upon its union agreement. In
June 1995, the Company also established a 401(k) plan for the California union
employees. The plan allows pre-tax deferral against which the Company matches
50% of the first two hundred fifty dollars of employee contributions.
Amounts expensed under these plans were $59,960, $51,996, and $37,298 for
fiscal 1997, 1996, and 1995, respectively. The Company has defined contribution
401(k) and retirement plans only and thus has no liability for postretirement
benefit obligations under the Financial Accounting Standards Board Statement No.
106 "Employer's Accounting for Postretirement Benefits Other than Pensions."
NOTE 7--INCOME TAXES
The provisions for income taxes from continuing operations for fiscal 1997,
1996, and 1995 are as follows:
1997 1996 1995
------------- ------------- --------------
Federal:
Current......................................... $ 151,433 $ 131,978 $ 102,481
Deferred........................................ (13,249) (4,515) (4,445)
------------- ------------- --------------
Total federal................................. 138,184 127,463 98,036
------------- ------------- --------------
State:
Current......................................... 34,666 27,926 23,009
Deferred........................................ (3,178) (976) 51
------------- ------------- --------------
Total state................................... 31,488 26,950 23,060
------------- ------------- --------------
Foreign:
Current......................................... 40,192 20,882 29,051
Deferred........................................ (1,732) (611) 816
------------- ------------- --------------
Total foreign................................. 38,460 20,271 29,867
------------- ------------- --------------
Total provision for income taxes.................. $ 208,132 $ 174,684 $ 150,963
------------- ------------- --------------
------------- ------------- --------------
38
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (CONTINUED)
NOTE 7--INCOME TAXES (CONTINUED)
A reconciliation between the statutory tax rate and the effective rate from
continuing operations for fiscal 1997, 1996, and 1995 is as follows:
1997 1996 1995
-------------------- -------------------- --------------------
Federal taxes at statutory rate................... $ 182,115 35.00% $ 148,217 35.00% $ 128,871 35.00%
State taxes, net.................................. 22,374 4.30 17,786 4.20 15,465 4.20
Foreign taxes, net................................ 5,452 1.05 4,658 1.10 4,471 1.21
Other............................................. (1,809) (.35) 4,023 .95 2,156 0.59
--------- -------- --------- -------- --------- --------
Provision at effective tax rate................... $ 208,132 40.00% $ 174,684 41.25% $ 150,963 41.00%
--------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- --------
The components of the deferred tax assets and liabilities related to
continuing operations are as follows:
AUGUST 31, SEPTEMBER 1,
1997 1996
------------- -------------
Accrued liabilities.......................... $ 79,663 $ 64,809
Other........................................ 15,735 12,402
------------- -------------
Total deferred tax assets.................. 95,398 77,211
------------- -------------
Property and equipment....................... 45,647 53,590
Merchandise inventories...................... 22,765 21,683
Other........................................ 1,208 3,220
------------- -------------
Total deferred tax liabilities............. 69,620 78,493
------------- -------------
Net deferred tax assets (liabilities)...... $ 25,778 $ (1,282)
------------- -------------
------------- -------------
The deferred tax accounts at August 31, 1997 and September 1, 1996 include
current deferred income tax assets of $59,322 and $55,452, respectively, and
non-current deferred income tax liabilities of $33,544 and $56,734,
respectively.
NOTE 8--COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company has entered into a purchase agreement with Hechinger Company to
acquire seven of Hechinger's locations in Michigan. The acquisition is subject
to certain conditions including third party approvals and permits. The Company
intends to invest approximately $80,000 in these facilities, including the
initial warehouse purchase and remodeling costs and working capital
requirements.
LEGAL PROCEEDINGS
On April 6, 1992, The Price Company was served with a Complaint in an action
entitled FECHT ET AL. V. THE PRICE COMPANY ET AL., Case No. 92-497, United
States District Court, Southern District of California (the "Court").
Subsequently, on April 22, 1992, The Price Company was served with a First
Amended Complaint in the action. The case was dismissed without prejudice by the
Court on September 21, 1992, on the grounds the plaintiffs had failed to state a
sufficient claim against defendants. Subsequently, plaintiffs filed a Second
Amended Complaint which, in the opinion of The Price Company's counsel, alleged
substantially the same facts as the prior complaint. The Complaint alleged
violation of certain state and
39
COSTCO COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (CONTINUED)
NOTE 8--COMMITMENTS AND CONTINGENCIES (CONTINUED)
federal laws during the time period prior to The Price Company's earnings
release for the second quarter of fiscal year 1992. The case was dismissed with
prejudice by the Court on March 9, 1993, on grounds the plaintiffs had failed to
state a sufficient claim against defendants. Plaintiffs filed an Appeal in the
Ninth Circuit Court of Appeals. In an opinion dated November 20, 1995, the Ninth
Circuit reversed and remanded the lawsuit. In February 1997, the Court granted
the plaintiffs' motion for certification of a class consisting of all purchasers
of the Common Stock of The Price Company from April 3, 1991 through April 2,
1992. The Company believes that this lawsuit is without merit and is vigorously
defending the lawsuit. The Company does not believe that the ultimate outcome of
such litigation will have a material adverse effect on the Company's financial
position or results of operations.
The Company is involved from time to time in claims, proceedings and
litigation arising from its business and property ownership. The Company does
not believe that any such claim, proceeding or litigation, either alone or in
the aggregate, will have a material adverse effect on the Company's financial
position or results of operations.
NOTE 9--GEOGRAPHIC INFORMATION
The following table indicates the relative amounts of total revenue,
operating income and identifiable assets for the Company during fiscal 1997,
1996 and 1995:
1997 1996 1995
------------ ------------ -------------
Total revenue:
United States................................... $ 17,572,440 $ 15,709,258 $ 14,967,611
Foreign......................................... 4,301,964 3,857,198 3,279,675
------------ ------------ -------------
$ 21,874,404 $ 19,566,456 $ 18,247,286
------------ ------------ -------------
------------ ------------ -------------
Operating income:
United States................................... $ 459,339 $ 419,074 $ 357,463
Foreign......................................... 121,373 71,649 75,869
------------ ------------ -------------
$ 580,712 $ 490,723 $ 433,332
------------ ------------ -------------
------------ ------------ -------------
AUGUST 31, SEPTEMBER 1,
1997 1996
------------ ------------
Identifiable assets:
United States................................... $ 4,220,610 $ 3,885,726
Foreign......................................... 1,255,704 1,026,135
------------ ------------
$ 5,476,314 $ 4,911,861
------------ ------------
------------ ------------
NOTE 10--QUARTERLY FINANCIAL DATA (UNAUDITED)
The tables that follow on the next two pages reflect the unaudited quarterly
results of operations for fiscal 1997 and 1996.
Shares used in the earnings per share calculation fluctuate by quarter
depending primarily upon whether convertible subordinated debentures are
dilutive during the respective period.
40
COSTCO COMPANIES, INC.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
52 WEEKS ENDED AUGUST 31, 1997
---------------------------------------------------------------------------
FIRST SECOND FOURTH
QUARTER 12 QUARTER 12 THIRD QUARTER QUARTER 16 TOTAL
WEEKS WEEKS 12 WEEKS WEEKS 52 WEEKS
------------ ------------ ------------- ------------- -------------
REVENUE
Net sales....................................... $ 4,785,636 $ 5,147,425 $ 4,752,445 $ 6,798,612 $ 21,484,118
Membership fees and other....................... 97,772 91,468 83,784 117,262 390,286
------------ ------------ ------------- ------------- -------------
Total revenue................................. 4,883,408 5,238,893 4,836,229 6,915,874 21,874,404
OPERATING EXPENSES
Merchandise costs............................... 4,308,369 4,619,208 4,283,157 6,103,751 19,314,485
Selling, general and administrative............. 426,104 436,036 426,980 587,639 1,876,759
Preopening expenses............................. 10,197 6,087 2,458 8,706 27,448
Provision for impaired assets and warehouse
closing costs................................. 70,000 -- 3,500 1,500 75,000
------------ ------------ ------------- ------------- -------------
Operating income.............................. 68,738 177,562 120,134 214,278 580,712
OTHER INCOME (EXPENSE)
Interest expense................................ (18,933) (17,243) (14,662) (25,443) (76,281)
Interest income and other....................... 3,657 3,461 4,055 4,725 15,898
------------ ------------ ------------- ------------- -------------
INCOME BEFORE PROVISION FOR INCOME TAXES.......... 53,462 163,780 109,527 193,560 520,329
Provision for income taxes...................... 21,652 66,331 43,262 76,887 208,132
------------ ------------ ------------- ------------- -------------
NET INCOME........................................ $ 31,810(a) $ 97,449 $ 66,265 $ 116,673 $ 312,197(b)
------------ ------------ ------------- ------------- -------------
------------ ------------ ------------- ------------- -------------
NET INCOME PER COMMON AND
COMMON EQUIVALENT SHARE--
FULLY DILUTED:
Net income...................................... $ 0.16(a) $ 0.46 $ 0.31 $ 0.54 $ 1.46(b)
------------ ------------ ------------- ------------- -------------
------------ ------------ ------------- ------------- -------------
Shares used in calculation...................... 199,630 223,296 216,362 225,949 226,195
------------ ------------ ------------- ------------- -------------
------------ ------------ ------------- ------------- -------------
- ------------------------
(a) Net income and net income per common and common equivalent share would have
been $70,485 and $.34, respectively, without the effect of adopting SFAS No.
121, using 227,096 fully-diluted shares.
(b) Net income and net income per common and common equivalent share would have
been $350,872 and $1.63, respectively, without the effect of adopting SFAS
No. 121, using 226,195 fully-diluted shares.
41
COSTCO COMPANIES, INC.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
52 WEEKS ENDED SEPTEMBER 1, 1996
---------------------------------------------------------------------------
FIRST SECOND FOURTH
QUARTER 12 QUARTER 12 THIRD QUARTER QUARTER 16 TOTAL
WEEKS WEEKS 12 WEEKS WEEKS 52 WEEKS
------------ ------------ ------------- ------------- -------------
REVENUE
Net sales....................................... $ 4,295,862 $ 4,606,070 $ 4,236,207 $ 6,075,727 $ 19,213,866
Membership fees and other....................... 87,702 82,625 75,281 106,982 352,590
------------ ------------ ------------- ------------- -------------
Total revenue................................. 4,383,564 4,688,695 4,311,488 6,182,709 19,566,456
OPERATING EXPENSES
Merchandise costs............................... 3,887,116 4,153,992 3,829,923 5,474,284 17,345,315
Selling, general and administrative............. 385,973 391,943 383,387 529,884 1,691,187
Preopening expenses............................. 9,450 5,970 4,738 9,073 29,231
Provision for impaired assets and warehouse
closing costs................................. -- -- 6,000 4,000 10,000
------------ ------------ ------------- ------------- -------------
Operating income.............................. 101,025 136,790 87,440 165,468 490,723
OTHER INCOME (EXPENSE)
Interest expense................................ (17,771) (17,501) (19,194) (23,612) (78,078)
Interest income and other....................... 1,091 2,287 2,007 5,447 10,832
------------ ------------ ------------- ------------- -------------
INCOME BEFORE PROVISION FOR INCOME TAXES.......... 84,345 121,576 70,253 147,303 423,477
Provision for income taxes...................... 34,792 50,150 28,979 60,763 174,684
------------ ------------ ------------- ------------- -------------
NET INCOME........................................ $ 49,553 $ 71,426 $ 41,274 $ 86,540 $ 248,793
------------ ------------ ------------- ------------- -------------
------------ ------------ ------------- ------------- -------------
NET INCOME PER COMMON AND COMMON EQUIVALENT
SHARE-- FULLY DILUTED:
Net income...................................... $ 0.25 $ 0.35 $ 0.21 $ 0.42 $ 1.22
------------ ------------ ------------- ------------- -------------
------------ ------------ ------------- ------------- -------------
Shares used in calculation...................... 217,311 224,737 218,336 219,084 218,363
------------ ------------ ------------- ------------- -------------
------------ ------------ ------------- ------------- -------------
42
EXHIBIT INDEX
The following exhibits are filed as part of this Annual Report on Form 10-K
or are incorporated herein by reference. Where an exhibit is incorporated by
reference, the number which follows the description of the exhibit indicates the
document to which cross reference is made. See the end of this exhibit index for
a listing of cross reference documents.
EXHIBIT NO. DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
2.1.1 Amended and Restated Agreement of Transfer and Plan of Exchange dated as of November 14, 1994 by and
between Price/Costco, Inc. and Price Enterprises, Inc.(1)
2.1.2 Agreement Concerning Transfer of certain assets between and among Price/Costco, Inc., Price
Enterprises, Inc., The Price Company, Price Costco International, Inc., Costco Wholesale Corporation,
Price Global Trading, L.L.C., PGT, Inc., Price Quest, L.L.C., and PQI, Inc., dated as of November 21,
1996, with an effective date of May 28, 1997
2.1.3 Amendment No. 1 to Agreement Concerning Transfer of Certain Assets dated May 29, 1997
3.1 Restated Certificate of Incorporation of Costco Companies, Inc.(2)
3.2 Bylaws of Costco Companies, Inc.(3)
4.1.1 Form of 7 1/8% Senior Notes(4)
4.1.2 Indenture between Price/Costco, Inc. and American National Association, as Trustee(4)
4.2.1 Form of Zero Coupon Note due 2017
4.2.2 Indenture dated as of August 19, 1997 between Costco Companies, Inc. and Firstar Bank of Minnesota as
Trustee
4.2.3 Registration Rights Agreement dated August 19, 1997
4.3 Costco Companies, Inc. Stock Certificate
10.1.1 Costco Companies, Inc. 1993 Combined Stock Grant and Stock Option Plan(1)
10.1.2 Amendments to Stock Option Plan(8)
10.2 Form of Indemnification Agreement(5)
10.4 Restated Corporate Joint Venture Agreement between The Price Company, Price Venture Mexico and
Controladora Comercial Mexicana S.A. de C.V. dated March 1995(6)
10.5.1 A $250 million Short-Term Revolving Credit Agreement among Price/Costco, Inc. and a group of twelve
banks dated January 31, 1994(7)
10.5.2 A $250 million Extended Revolving Credit Agreement among Price/Costco, Inc. and a group of twelve
banks, dated January 31, 1994(7)
10.5 A $140 million Credit Agreement, dated as of April 11, 1996, among Price/Costco Nova Scotia Company,
certain financial institutions and Canadian Imperial Bank of Commerce(6)
12.1 Statements re computation of ratios
21.1 Subsidiaries of the Company
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule
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(1) Incorporated by reference to the exhibits filed as part of the Registration
Statement of Price/Costco, Inc. on Form S-4 (File No. 33-50359) dated
September 22, 1993
(2) Incorporated by reference to the exhibits filed as part of the Quarterly
Report on Form 10-Q of Costco Companies, Inc. for the quarterly period ended
February 16, 1997
(3) Incorporated by reference to the exhibits filed as part of the Annual Report
on Form 10-K/A of Price/Costco, Inc. for the fiscal year ended August 29,
1993
(4) Incorporated by reference to the exhibits filed as part of the Registration
Statement of Price/Costco, Inc. on Form S-3 (File No. 33-59403) dated May
17, 1995
(5) Incorporated by reference to the exhibits filed as part of the Annual Report
on Form 10-K of Price/Costco, Inc. for the fiscal year ended August 28, 1994
(6) Incorporated by reference to the exhibits filed as part of the Annual Report
on Form 10-K of Price/Costco, Inc. for the fiscal year ended September 1,
1996
(7) Incorporated by reference to the exhibits filed as part of the Quarterly
Report on Form 10-Q of Price/Costco, Inc. for the quarterly period ended
February 13, 1994
(8) Incorporated by reference to the exhibits filed as part of the Annual Report
on Form 10-K of Price/Costco, Inc. for the fiscal year ended September 3,
1995
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