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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

 

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended August 31, 2003

 

OR

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 0-20355


Costco Wholesale Corporation

(Exact name of registrant as specified in its charter)

 

Washington   91-1223280

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer 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:

 

Title of Each Class


  

Name of Each Exchange on

Which Registered


Common Stock, $.005 Par Value    The NASDAQ National Market

 

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), (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. ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x    No ¨

 

The aggregate market value of the voting stock held by nonaffiliates of the registrant at February 16, 2003 was $12,969,669,226.

 

The number of shares outstanding of the registrant’s common stock as of November 1, 2003 was 457,753,001.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s Proxy Statement for the Annual Meeting of Stockholders to be held on January 29, 2004 are incorporated by reference into Part III of this Form 10-K.

 



Table of Contents

COSTCO WHOLESALE CORPORATION

ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED AUGUST 31, 2003

 

          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

PART II

         

Item 5.

  

Market for Registrant’s Common Equity and Related Stockholder Matters

   9

Item 6.

  

Selected Financial Data

   9

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   12

Item 7A.

  

Quantitative and Qualitative Disclosure of Market Risk

   20

Item 8.

  

Financial Statements and Supplementary Data

   21

Item 9.

  

Change in and Disagreements with Accountants on Accounting and Financial Disclosure

   21

Item 9A.

  

Controls and Procedures

   21

PART III

         

Item 10.

  

Directors and Executive Officers of the Registrant

   22

Item 11.

  

Executive Compensation

   23

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management

   23

Item 13.

  

Certain Relationships and Related Transactions

   23

PART IV

         

Item 15.

  

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

   24

 

2


Table of Contents

PART I

 

Item 1—Business

 

Costco Wholesale Corporation (“Costco” or the “Company”) began operations in 1983 in Seattle, Washington. In October 1993, Costco merged with The Price Company, which had pioneered the membership warehouse concept in 1976, to form Price/Costco, Inc., a Delaware corporation. In January 1997, after the spin-off of most of its non-warehouse assets to Price Enterprises, Inc., the Company changed its name to Costco Companies, Inc. On August 30, 1999, the Company reincorporated from Delaware to Washington and changed its name to Costco Wholesale Corporation, which trades on the NASDAQ under the symbol “COST”.

 

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. The cost savings on brand name and selected private label merchandise are the primary motivation for individuals shopping for their personal needs. 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 139,000 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.

 

By strictly controlling the entrances and exits of its warehouses and using a membership format, Costco has been able to limit inventory losses to approximately two-tenths of one percent of net sales—well below those of typical discount retail operations. Losses associated with dishonored checks have also been minimal and bank information from business members is verified prior to establishing a check purchase limit. Members are identified and prevented from cashing checks at the point of sale when they have presented dishonored checks to Costco.

 

3


Table of Contents

Item 1—Business (Continued)

 

Costco’s policy is generally to limit marketing and promotional expenses to new warehouse openings, occasional direct mail marketing to prospective new members and annual direct mail marketing programs to existing members promoting selected merchandise. 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 that 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 or by providing such mailings to be distributed through employee associations and other entities. 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. Gasoline operations generally have extended hours. Because the 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. Most 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 that members may request but that cannot be purchased at prices low enough to pass along meaningful cost savings are often not carried. Costco seeks to limit specific items in each product line to fast selling models, sizes and colors. Therefore, the Company carries an average of only 3,700 to 4,500 active stockkeeping units (“SKU’s”) per warehouse in its core warehouse business, as opposed to discount retailers and supermarkets that 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 generally to accept returns of merchandise within a reasonable time after purchase.

 

The following table indicates the approximate percentage of net sales accounted for by each major category of items sold by Costco during fiscal 2003, 2002 and 2001:

 

     2003

    2002

    2001

 

Sundries (including candy, snack foods, health and beauty aids, tobacco, alcoholic beverages, soft drinks and cleaning and institutional supplies)

   30 %   31 %   31 %

Food (including dry and fresh foods and institutionally packaged foods)

   30 %   30 %   30 %

Hardlines (including major appliances, video and audio tape, electronics, hardware, office supplies, furniture and automotive supplies)

   16 %   16 %   16 %

Softlines (including apparel, domestics, cameras, jewelry, housewares, media and small appliances)

   14 %   14 %   14 %

Other (including pharmacy, optical, one-hour photo, print shop, food court, hearing aid and gas stations)

   10 %   9 %   9 %
    

 

 

     100 %   100 %   100 %
    

 

 

 

4


Table of Contents

Item 1—Business (Continued)

 

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 may also purchase selected private label merchandise of the same product, as long as quality and customer demand are comparable and the savings to its members are greater.

 

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. Fiscal years 2003, 2002 and 2001 all consisted of 52 weeks.

 

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. In addition, the Company offers an Executive Membership program to both Business and Gold Star 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 $45 for the primary and spouse membership card with add-on membership cards available for an annual fee of $35 (including a free spouse card).

 

Individual memberships are available to employees of federal, state and local governments, financial institutions, corporations, utility and transportation companies, public and private educational institutions, other organizations and to other persons. Individual members generally pay an annual membership fee of $45, which includes a spouse card.

 

Executive Memberships are available to all members for an annual fee of $100. The Executive Membership program offers members additional savings and benefits on various business and consumer services offered by Costco, such as merchant credit card processing, small business loans, auto and home insurance, long-distance telephone service, check printing, and real estate and mortgage services. The services offered are generally provided by third-party providers and vary by state. In addition, Executive members qualify for a 2% reward (which can be redeemed at Costco warehouses), up to a maximum of $500 per year, on all qualified purchases made at Costco.

 

As of August 31, 2003, Costco had approximately 4.6 million primary Business memberships and approximately 15.0 million Gold Star memberships. Members can utilize their memberships at any Costco warehouse location.

 

Labor

 

As of August 31, 2003, Costco had approximately 103,000 employees, with about forty percent of those being employed part-time. Approximately 13,000 hourly employees in California, Maryland, New Jersey, New York and one warehouse in Virginia are represented by the International Brotherhood of Teamsters. All remaining 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

 

5


Table of Contents

Item 1—Business (Continued)

 

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 the world) and has expanded further into various food merchandising formats. Target has also emerged as a significant retail competitor. Approximately 1,050 warehouse club locations exist across the U.S. and Canada, including the 370 warehouses operated by the Company in North America; and every major metropolitan area has one, 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 certain stores, 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 predominately in California, Washington, Oregon, Florida and Arizona, are capturing an increasingly greater share of the institutional food business from wholesale operators and others.

 

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 or that otherwise sell at discounted 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.

 

Certain states, counties and municipalities have enacted or proposed laws and regulations that would prevent or restrict the operations or expansion plans of certain large retailers and warehouse clubs, including the Company, within their jurisdictions. The Company believes that, if enacted, such laws and regulations could have a material adverse effect on the Company’s operations.

 

6


Table of Contents

Item 2—Properties

 

Warehouse Properties

 

At August 31, 2003, Costco operated 397 warehouse clubs: 309 in the United States (in 36 states and Puerto Rico); 61 in Canada (in 9 Canadian provinces); 15 in the United Kingdom (12 in England; 3 in Scotland); five in Korea; three in Taiwan; and four in Japan. The following is a summary of owned and leased warehouses by region:

 

NUMBER OF WAREHOUSES

 

     Own Land
and Building


   Lease Land
and/or
Building


   Total

UNITED STATES

   243    66    309

CANADA

   54    7    61

UNITED KINGDOM

   13    2    15

KOREA

   2    3    5

TAIWAN

      3    3

JAPAN

      4    4
    
  
  

Total

   312    85    397
    
  
  

 

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, 2003:

 

Openings by Fiscal Year


   United States

   Canada

   Other
International


   Total

  

Total Warehouses

in Operation


1999 and prior

   221    58    13    292    292

2000

   16    1    4    21    313

2001

   27    1    4    32    345

2002

   26       3    29    374

2003

   19    1    3    23    397

2004 (through 12/31/03)

   9    1       10    407
    
  
  
  
    

Total

   318    62    27    407     
    
  
  
  
    

 

As of August 31, 2003, the Company operated (through a 50%-owned joint venture) 21 warehouses in Mexico. These warehouses are not included in the number of warehouses open in any period because the joint venture is accounted for using the equity method and therefore its operations are not consolidated in the Company’s financial statements.

 

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, packaging, and other facilities to support ancillary and other businesses.

 

7


Table of Contents

Item 3—Legal Proceedings

 

The Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company is a defendant in two actions purportedly brought as class actions on behalf of certain present and former Costco managers in California, in which plaintiffs allege that they have not been properly compensated for overtime work. Scott M. Williams v. Costco Wholesale Corporation, United States District Court (San Diego), Case No. 02-CV-2003 NAJ (JFS); Superior Court for the County of San Diego, Case No. GIC 792559; Greg Randall v. Costco Wholesale Corporation, Superior Court for the County of Los Angeles, Case No. BC 296369. Presently, claims are made under various provisions of the California Labor Code and the California Business and Professions Code. Plaintiffs seek restitution/disgorgement, compensatory damages, various statutory penalties, liquidated damages, punitive, treble and exemplary damages, and attorneys’ fees. In neither case has the Court been asked yet to determine whether the action should proceed as a class action or, if so, the definition of the class. The Company expects to vigorously defend these actions. The Company does not believe that any 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 its 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 29, 2004, at the Meydenbauer Center 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.

 

8


Table of Contents

PART II

 

Item 5—Market for Registrant’s Common Equity and Related Stockholder Matters

 

Costco Common Stock is 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, 2001 through November 1, 2003. The quotations are as reported in published financial sources.

 

     Costco Common
Stock


     High

   Low

Calendar Quarters—2001

             

First Quarter

   $ 46.250    $ 36.500

Second Quarter

     43.620      34.063

Third Quarter

     44.500      31.220

Fourth Quarter

     45.190      33.540

Calendar Quarters—2002

             

First Quarter

     46.320      38.920

Second Quarter

     43.000      37.590

Third Quarter

     39.300      31.850

Fourth Quarter

     36.210      27.240

Calendar Quarters—2003

             

First Quarter

     31.230      28.080

Second Quarter

     37.430      30.410

Third Quarter

     37.150      28.890

Fourth Quarter (through November 1, 2003)

     35.450      31.940

 

On November 1, 2003 the Company had 7,805 stockholders of record.

 

DIVIDEND POLICY

 

Costco has never paid 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, 2003, 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 2003.

 

9


Table of Contents

Item 6—Selected Financial Data (Continued)

 

COSTCO WHOLESALE CORPORATION

 

SELECTED CONSOLIDATED FINANCIAL DATA

(dollars in thousands, except per share data)

 

    52 Weeks
Ended
August 31,
2003


    52 Weeks
Ended
September 1,
2002


    52 Weeks
Ended
September 2,
2001


    53 Weeks
Ended
September 3,
2000


    52 Weeks
Ended
August 29,
1999


    52 Weeks
Ended
August 30,
1998


    52 Weeks
Ended
August 31,
1997


    52 Weeks
Ended
September 1,
1996


    53 Weeks
Ended
September 3,
1995


    52 Weeks
Ended
August 28,
1994


 

OPERATING DATA

                                                                               

Revenue

                                                                               

Net sales

  $ 41,692,699     $ 37,993,093     $ 34,137,021     $ 31,620,723     $ 26,976,453     $ 23,830,380     $ 21,484,118     $ 19,213,866     $ 17,905,926     $ 16,160,911  

Membership fees and other

    852,853       769,406       660,016       543,573       479,578       439,497       390,286       352,590       341,360       319,732  
   


 


 


 


 


 


 


 


 


 


Total revenue

    42,545,552       38,762,499       34,797,037       32,164,296       27,456,031       24,269,877       21,874,404       19,566,456       18,247,286       16,480,643  

Operating expenses

                                                                               

Merchandise costs

    37,235,383       33,983,121       30,598,140       28,322,170       24,170,199       21,379,691       19,314,485       17,345,315       16,225,848       14,662,891  

Selling, general & administrative

    4,097,398       3,575,536       3,129,059       2,755,355       2,338,198       2,069,900       1,876,759       1,691,187       1,555,588       1,425,549  

Preopening expenses

    36,643       51,257       59,571       42,321       31,007       27,010       27,448       29,231       25,018       24,564  

Provision for impaired assets and closing costs

    19,500       21,050       18,000       7,000       56,500       6,000       75,000 (a)     10,000       7,500       7,500  
   


 


 


 


 


 


 


 


 


 


Operating income

    1,156,628       1,131,535       992,267       1,037,450       860,127       787,276       580,712       490,723       433,332       360,139  

Other income (expense)

                                                                               

Interest expense

    (36,920 )     (29,096 )     (32,024 )     (39,281 )     (45,527 )     (47,535 )     (76,281 )     (78,078 )     (67,911 )     (50,472 )

Interest income and other

    38,525       35,745       43,238       54,226       44,266       26,662       15,898       10,832       2,783       13,888  

Provision for merger and restructuring expenses

                                                          (120,000 )
   


 


 


 


 


 


 


 


 


 


Income from continuing operations before income taxes and cumulative effect of accounting change

    1,158,233       1,138,184       1,003,481       1,052,395       858,866       766,403       520,329       423,477       368,204       203,555  

Provision for income taxes

    437,233       438,201       401,392       420,958       343,545       306,561       208,132       174,684       150,963       92,657  
   


 


 


 


 


 


 


 


 


 


Income from continuing operations before cumulative effect of accounting change

    721,000       699,983       602,089       631,437       515,321       459,842       312,197       248,793       217,241       110,898  

Cumulative effect of accounting change, net of tax

                            (118,023 )(b)                              
   


 


 


 


 


 


 


 


 


 


Income from continuing operations

    721,000       699,983       602,089       631,437       397,298       459,842       312,197       248,793       217,241       110,898  

Discontinued operations:

                                                                               

Loss, net of tax

                                                          (40,766 )

Loss on disposal

                                                    (83,363 )     (182,500 )
   


 


 


 


 


 


 


 


 


 


Net income (loss)

  $ 721,000     $ 699,983     $ 602,089     $ 631,437     $ 397,298     $ 459,842     $ 312,197     $ 248,793     $ 133,878     $ (112,368 )
   


 


 


 


 


 


 


 


 


 


Per Share Data—Diluted

                                                                               

Income from continuing operations before cumulative effect of accounting change

  $ 1.53     $ 1.48     $ 1.29     $ 1.35     $ 1.11     $ 1.01     $ 0.73     $ 0.61     $ 0.53     $ 0.25  

Cumulative effect of accounting change, net of tax

                            (0.25 )                              
   


 


 


 


 


 


 


 


 


 


Income from continuing operations

    1.53       1.48       1.29       1.35       0.86       1.01       0.73       0.61       0.53       0.25  

Discontinued Operations:

                                                                               

Loss, net of tax

                                                          (0.09 )

Loss on disposal

                                                    (0.19 )     (0.42 )
   


 


 


 


 


 


 


 


 


 


Net income (loss)

  $ 1.53     $ 1.48     $ 1.29     $ 1.35     $ 0.86     $ 1.01     $ 0.73     $ 0.61     $ 0.34     $ (0.26 )
   


 


 


 


 


 


 


 


 


 


Shares used in calculation

    479,326       479,262       475,827       475,737       471,120       463,371       449,336       435,781       447,219       438,664  

(a)   Includes the effect of adopting SFAS 121, a $65,000 pre-tax ($38,675 after-tax or $0.09 per diluted share) provision for asset impairment.
(b)   Represents a one-time non-cash charge reflecting the cumulative effect of the Company’s change in accounting for membership fees from a cash to a deferred method.

 

10


Table of Contents

Item 6—Selected Financial Data (Continued)

 

COSTCO WHOLESALE CORPORATION

 

SELECTED CONSOLIDATED FINANCIAL DATA

(dollars in thousands, except warehouse data)

 

    August 31,
2003


    September 1,
2002


    September 2,
2001


    September 3,
2000


    August 29,
1999


    August 30,
1998


    August 31,
1997


    September 1,
1996


    September 3,
1995


    August 28,
1994


 

BALANCE SHEET DATA

                                                                               

Working capital (deficit)

  $ 700,431     $ 180,806     $ (229,732 )   $ 65,759     $ 449,680     $ 431,288     $ 145,903     $ 56,710     $ 9,381     $ (113,009 )

Property and equipment, net

    6,960,008       6,523,619       5,826,585       4,834,116       3,906,888       3,395,372       3,154,634       2,888,310       2,535,593       2,146,396  

Total assets

    13,191,688       11,620,263       10,089,786       8,633,940       7,505,001       6,259,820       5,476,314       4,911,861       4,437,419       4,235,659  

Short-term borrowings

    47,421       103,774       194,552       9,500                   25,460       59,928       75,725       149,340  

Long-term debt

    1,289,649       1,210,638       859,393       790,053       918,888       930,035       917,001       1,229,221       1,094,615       795,492  

Stockholders’ equity

  $ 6,554,980     $ 5,694,237     $ 4,882,940     $ 4,240,280     $ 3,532,110     $ 2,965,886     $ 2,468,116     $ 1,777,798     $ 1,530,744     $ 1,684,960  

WAREHOUSES IN OPERATION(d)

                                                                               

Beginning of year

    374       345       313       292       278       261       252       240       221       200  

Opened(a)

    29       35       39       25       21       18 (c)     17       20       24       29  

Closed(b)

    (6 )     (6 )     (7 )     (4 )     (7 )     (1 )     (8 )     (8 )     (5 )     (8 )
   


 


 


 


 


 


 


 


 


 


End of Year

    397       374       345       313       292       278       261       252       240       221  
   


 


 


 


 


 


 


 


 


 



(a)   Includes relocations, as well as new warehouse openings.
(b)   Includes relocations, as well as outright closings.
(c)   Includes the acquisition of two warehouses in Korea formerly operated under a license agreement.
(d)   Excludes warehouses operated in Mexico through a 50% owned joint venture.

 

11


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Certain statements contained in this document constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For these purposes, forward-looking statements are statements that address activities, events, conditions or developments that the Company expects or anticipates may occur in the future. Such forward-looking statements involve risks and uncertainties that may cause actual events, results or performance to differ materially from those indicated by such statements. These risks and uncertainties include, but are not limited to, domestic and international economic conditions including exchange rates, the effects of competition and regulation, conditions affecting the acquisition, development, ownership or use of real estate, actions of vendors, rising costs associated with employees (including health care and workers’ compensation costs), consumer and small business debt levels and spending patterns, and other risks identified from time to time in the Company’s public statements and reports filed with the Securities and Exchange Commission.

 

Comparison of Fiscal 2003 (52 weeks) and Fiscal 2002 (52 weeks):

    (dollars in thousands, except earnings per share)

 

Net income for fiscal 2003 increased 3% to $721,000, or $1.53 per diluted share, from $699,983, or $1.48 per diluted share during fiscal year 2002.

 

Net sales increased 10% to $41,692,699 in fiscal 2003 from $37,993,093 in fiscal 2002. Approximately 55% of the increase was due to an increase in comparable warehouse sales, that is sales in warehouses open for at least a year, and approximately 45% of the increase was due to opening a net of 23 new warehouses (29 opened, 6 closed) during fiscal 2003 and a net of 29 new warehouses (35 opened, 6 closed) during fiscal 2002, a portion of which is not included in comparable warehouse sales. With the exception of gasoline, which accounted for a comparable sales increase of approximately 70 basis points, changes in prices of merchandise did not materially contribute to sales increases. In addition, due to the weaker US dollar, translation of foreign sales into US dollars contributed to the increase in sales, accounting for a comparable sales increase of approximately one percent year-over-year. Comparable sales increased at a 5% annual rate in fiscal 2003 compared to a 6% annual rate during fiscal 2002.

 

Membership fees and other revenue increased 11% to $852,853, or 2.05% of net sales, in fiscal 2003 from $769,406, or 2.03% of net sales, in fiscal 2002. This increase was primarily due to additional membership sign-ups at the 23 new warehouses opened in fiscal 2003, and increased penetration of the Company’s Executive Membership. Overall, member renewal rates remained consistent with the prior year, currently at 86%.

 

Gross margin (defined as net sales minus merchandise costs) increased 11% to $4,457,316, or 10.69% of net sales, in fiscal 2003 from $4,009,972, or 10.55% of net sales, in fiscal 2002. The increase in gross margin as a percentage of net sales reflects merchandise gross margin improvement within the Company’s ancillary warehouse businesses and international operations accounting for increases of 15 and 8 basis points, respectively. Additionally, increased rewards related to the Executive Membership Two-Percent Reward Program reduced gross margin by 7 basis points. The gross margin figures reflect accounting for most U.S. merchandise inventories on the last-in, first-out (LIFO) method. The effect of the LIFO adjustment for fiscal 2003 was to increase gross margin by $19,650, compared to a gross margin increase of $13,500 in fiscal 2002. If all inventories had been valued using the first-in, first-out (FIFO) method, inventories would have been lower by $19,500 at August 31, 2003 and higher by $150 at September 1, 2002.

 

Selling, general and administrative expenses as a percent of net sales increased to 9.83% during fiscal 2003 from 9.41% during fiscal 2002. The increase in selling, general and administrative expenses as a percent of net sales was primarily due to increases in healthcare, workers’ compensation (primarily in the state of California) and salary costs within the Company’s domestic operations. International expenses also increased, accounting for approximately 7 basis points of the 42 basis points year-over-year increase.

 

Preopening expenses totaled $36,643, or 0.09% of net sales, during fiscal 2003 and $51,257, or 0.13% of net sales, during fiscal 2002. During fiscal 2003, the Company opened 29 new warehouses (including 5 relocations) compared to 35 new warehouses (including 6 relocations) during fiscal 2002. Pre-opening expenses also include

 

12


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

costs related to remodels and expanded ancillary operations at existing warehouses, as well as expanded international operations.

 

The provision for impaired assets and closing costs was $19,500 in fiscal 2003 compared to $21,050 in fiscal 2002. The provision includes costs related to impairment of long-lived assets, future lease obligations of warehouses that have been relocated to new facilities and any losses or gains resulting from the sale of real property. The provision for fiscal 2003 included charges of $11,836 for warehouse closing expenses, $4,697 for impairment of long-lived assets and $2,967 for net losses on the sale of real property. The fiscal 2002 provision included charges of $13,683 for warehouse closing expenses and $7,765 for Canadian administrative reorganization, which were offset by $398 of net gains on the sale of real property. At August 31, 2003 the reserve for warehouse closing costs was $8,609, of which $7,833 related to lease obligations. This compares to a reserve for warehouse closing costs of $11,845 at September 1, 2002, of which $10,395 related to lease obligations.

 

Interest expense totaled $36,920 in fiscal 2003, and $29,096 in fiscal 2002. Interest expense in fiscal 2003 includes interest on the 3 1/2% Zero Coupon Notes, 7 1/8% and 5 1/2% Senior Notes and on balances outstanding under the Company’s bank credit facilities and promissory notes. The increase is primarily related to the reduction in interest capitalized related to warehouse construction, as the overall cost of projects under construction was lower than in fiscal 2002. The increase was also attributed to the Company’s issuance of $300,000 5 1/2% Senior Notes in March 2002, which were simultaneously swapped to a floating interest rate. This increase was partially offset by an interest rate reduction in the Company’s $300,000 7 1/8% Senior Notes, resulting from interest rate swap agreements entered into effective November 13, 2001, converting the interest rate from fixed to floating, and to the fact that the Company had little interest expense related to borrowings under its commercial paper program in fiscal 2003.

 

Interest income and other totaled $38,525 in fiscal 2003, compared to $35,745 in fiscal 2002. The increase primarily reflects greater interest earned on higher cash and cash equivalents balances on hand throughout fiscal 2003, as compared to fiscal 2002, which was partially offset by an increase in the expense to record the minority interest in earnings of foreign subsidiaries.

 

The effective income tax rate on earnings was 37.75% in fiscal 2003 and 38.50% in fiscal 2002. The decrease in the effective income tax rate, year-over-year, is primarily attributable to lower statutory income tax rates for foreign operations.

 

Comparison of Fiscal 2002 (52 weeks) and Fiscal 2001 (52 weeks):

    (dollars in thousands, except earnings per share)

 

Net income for fiscal 2002 increased 16% to $699,983, or $1.48 per diluted share, from $602,089, or $1.29 per diluted share during fiscal year 2001.

 

Net sales increased 11% to $37,993,093 in fiscal 2002 from $34,137,021 in fiscal 2001. This increase was due to higher sales at existing locations opened prior to fiscal 2001; increased sales at the 32 new warehouses opened (39 opened, 7 closed) during fiscal 2001; and first year sales at the 29 new warehouses opened (35 opened, 6 closed) during fiscal 2002. 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 6% annual rate in fiscal 2002 compared to a 4% annual rate during fiscal 2001.

 

Membership fees and other revenue increased 17% to $769,406, or 2.03% of net sales, in fiscal 2002 from $660,016, or 1.93% of net sales, in fiscal 2001. This increase was primarily due to the increase in membership fees across all member categories – beginning with renewals on October 1, 2000, averaging approximately five dollars per member; additional membership sign-ups at the 29 new warehouses opened in fiscal 2002; and increased penetration of the Company’s Executive Membership. Overall, member renewal rates remained consistent with the prior year, currently at 86%.

 

13


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

Gross margin (defined as net sales minus merchandise costs) increased 13% to $4,009,972, or 10.55% of net sales, in fiscal 2002 from $3,538,881, or 10.37% of net sales, in fiscal 2001. The increase in gross margin as a percentage of net sales reflects merchandise gross margin improvement within the Company’s core merchandising business, with fresh foods and foods and sundries categories being the primary contributors. Additionally, a reduction in the LIFO reserve, improved purchasing resulting from expanded depot operations and improved international operations had a positive effect on margins, while increased costs related to the Executive Membership Two-Percent Reward Program had a negative impact. The gross margin figures reflect accounting for most U.S. merchandise inventories on the last-in, first-out (LIFO) method. The effect of the LIFO adjustment for fiscal 2002 was to increase gross margin by $13,500, compared to a gross margin decrease of $5,500 in fiscal 2001. If all inventories had been valued using the first-in, first-out (FIFO) method, inventories would have been higher by $150 at September 1, 2002 and $13,650 at September 2, 2001.

 

Selling, general and administrative expenses as a percent of net sales increased to 9.41% during fiscal 2002 from 9.17% during fiscal 2001. The increase in selling, general and administrative expenses as a percent of net sales was primarily due to higher expense ratios at new warehouses, where such expense ratios to sales are typically higher than at more mature warehouses; and also due to increases in salary, healthcare and workers’ compensation costs.

 

Preopening expenses totaled $51,257, or 0.13% of net sales, during fiscal 2002 and $59,571, or 0.17% of net sales, during fiscal 2001. During fiscal 2002, the Company opened 35 new warehouses (including relocations) compared to 39 new warehouses (including relocations) during fiscal 2001. Pre-opening expenses also include costs related to remodels and expanded ancillary operations at existing warehouses, as well as expanded international operations.

 

The provision for impaired assets and closing costs was $21,050 in fiscal 2002 compared to $18,000 in fiscal 2001. The fiscal 2002 provision included charges of $7,765 for the Canadian administrative reorganization (See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” —Liquidity and Capital Resources) and $13,683 for warehouse closing expenses which were offset by net gains on the sale of real property totaling $398. The fiscal 2001 provision included charges of $19,000 for the Canadian administrative reorganization, $15,231 for the impairment of long-lived assets and $2,412 for warehouse closing expense, which were offset by $18,643 of gains on the sale of real property. At September 1, 2002, the reserve for warehouse closing costs was $11,845, of which $10,395 related to future lease obligations. This compares to a reserve for warehouse closing costs of $15,434 at September 1, 2001, of which $6,538 related to future lease obligations. The increase in future lease obligations is attributable to leased warehouses constituting a larger percentage of the closed locations. (See Part II, “Item 8—Financial Statements”—Notes to Consolidated Financial Statements—Note 1).

 

Interest expense totaled $29,096 in fiscal 2002, and $32,024 in fiscal 2001. The decrease is primarily attributable to the retirement in April 2001 of a $140,000 unsecured note payable to banks and to the interest rate reduction on the Company’s $300,000 7 1/8% Senior Notes, resulting from interest rate swap agreements entered into effective November 13, 2001, converting the interest rate from fixed to floating. This decrease in interest expense was partially offset by a reduction in interest capitalized related to warehouse construction, as the Company had fewer construction projects in progress during the fiscal 2002 period, and the weighted average capitalized interest rate was lower than in fiscal 2001. The decrease in interest expense was also offset by the issuance of the $300,000 5 1/2% Senior Notes issued in March, 2002, and simultaneously swapped to floating, and increased interest expense related to the Zero Coupon subordinated notes as accrued interest is accreted into principal.

 

Interest income and other totaled $35,745 in fiscal 2002, compared to $43,238 in fiscal 2001. The decrease primarily reflects lower interest income due to lower interest rates and lower daily cash and short-term investment balances on hand throughout fiscal 2002, as compared to fiscal 2001. This was partially offset by increased year-over-year earnings in Costco Mexico, the Company’s 50%-owned joint venture.

 

14


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

The effective income tax rate on earnings was 38.5% in fiscal 2002 and 40% in fiscal 2001. The decrease in the effective income tax rate, year-over-year, is primarily attributable to lower statutory rates for foreign operations, the effect of which is expected, substantially, to continue to impact the effective tax rate on a prospective basis.

 

Liquidity and Capital Resources (dollars in thousands)

 

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 $900,000 to $1,000,000 during fiscal 2004 in the United States and Canada for real estate, construction, remodeling and equipment for warehouse clubs and related operations; and approximately $75,000 to $125,000 for international expansion, including the United Kingdom, Asia, Mexico and other potential ventures. These expenditures will be financed with a combination of cash provided from operations, the use of cash and cash equivalents and short-term investments, short-term borrowings under the Company’s commercial paper program and other financing sources as required.

 

Expansion plans for the United States and Canada during fiscal 2004 are to open approximately 25 new warehouse clubs, including two relocations to larger and better-located warehouses. The Company expects to continue its review of expansion plans in its international operations in existing markets including the United Kingdom and in Asia along with other international markets. Costco and its Mexico-based joint venture partner, Controladora Comercial Mexicana, each own a 50% interest in Costco Mexico. As of August 31, 2003, Costco Mexico operated 21 warehouses in Mexico and planned to open two new warehouse clubs during fiscal 2004.

 

Reorganization of Canadian Administrative Operations

 

On January 17, 2001, the Company announced plans to reorganize and consolidate the administration of its operations in Canada. Total costs related to the reorganization were $26,765 pre-tax, of which $7,765 pre-tax ($4,775 after-tax, or $.01 per diluted share) was expensed in fiscal 2002 and $19,000 pre-tax ($11,400 after-tax, or $.02 per diluted share) was expensed in fiscal 2001 and reported as part of the provision for impaired assets and closing costs. These costs consisted primarily of employee severance, implementation and consolidation of support systems and employee relocation. The reorganization was completed in the first quarter of fiscal 2002.

 

Bank Credit Facilities and Commercial Paper Programs (all amounts stated in thousands of US dollars)

 

The Company has in place a $500,000 commercial paper program supported by a $300,000 bank credit facility with a group of ten banks, of which $150,000 expires on November 9, 2004 and $150,000 expires on November 15, 2005. At August 31, 2003, no amounts were outstanding under the commercial paper program and no amounts were outstanding under the credit facility.

 

A wholly owned Canadian subsidiary has a $144,000 commercial paper program supported by a $43,000 bank credit facility with a Canadian bank, which expires in March 2004. At August 31, 2003, no amounts were outstanding under the Canadian commercial paper program or the bank credit facility.

 

The Company has agreed to limit the combined amount outstanding under the U.S. and Canadian commercial paper programs to the $343,000 combined amounts of the supporting bank credit facilities.

 

The Company’s wholly-owned Japanese subsidiary has a short-term ¥3 billion ($25,782) bank line of credit, which expires in November 2004. At August 31, 2003, no amounts were outstanding under the line of credit.

 

15


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

The Company’s UK subsidiary has a £60 million ($94,842) bank revolving credit facility and a £20 million ($31,614) bank overdraft facility, both expiring in February 2007. At August 31, 2003, $47,421 was outstanding under the revolving credit facility with an applicable interest rate of 4.413% and no amounts were outstanding under the bank overdraft facility.

 

Letters of Credit

 

The Company has letter of credit facilities (for commercial and standby letters of credit), totaling approximately $369,000. The outstanding commitments under these facilities at August 31, 2003 totaled approximately $125,000, including approximately $44,000 in standby letters of credit.

 

Contractual Obligations

 

The Company’s commitment to make future payments under long-term contractual obligations was as follows, as of August 31, 2003.

 

     Payments Due by Period

 

Contractual obligations


   Total

    Less than
1 year


   1 to 3
years


   4 to 5
years


  

After

5 years


 

Long-term debt(1)

   $ 1,702,618 (2)   $ 44,368    $ 361,542    $ 379,528    $ 917,180 (2)

Capital lease obligations

     12,116       6,427      2,250      1,115      2,324  

Operating leases

     1,405,262 (3)     85,862      173,996      162,101      983,303  
    


 

  

  

  


Total

   $ 3,119,996     $ 136,657    $ 537,788    $ 542,744    $ 1,902,807  
    


 

  

  

  



(1)   Amounts include contractual interest payments.

 

(2)   The amount includes interest accreted to maturity for the Company’s Zero Coupon 3 1/2% Convertible Subordinated Notes due August 2017, totaling $851,860. The consolidated balance sheet as of August 31, 2003 reflects the current balance outstanding of $524,735.

 

(3)   Operating lease obligations have been reduced by $142,975 to reflect sub-lease income.

 

Financing Activities

 

In April 2003, the Company’s wholly-owned Japanese subsidiary issued promissory notes bearing interest at 0.92% in the aggregate amount of approximately $34,376, through a private placement. Interest is payable semi-annually and principal is due on April 26, 2010.

 

In November 2002, the Company’s wholly-owned Japanese subsidiary issued promissory notes bearing interest at 0.88% in the aggregate amount of approximately $25,782, through a private placement. Interest is payable semi-annually and principal is due on November 7, 2009.

 

In March 2002, the Company issued $300,000 of 5 1/2% Senior Notes due March 15, 2007. Interest is payable semi-annually. Simultaneous with the issuance of the Senior Notes, the Company entered into interest rate swap agreements converting the interest from fixed to floating.

 

In February 1996, the Company filed with the Securities and Exchange Commission a shelf registration statement for $500,000 of senior debt securities. On October 23, 2001, additional debt securities of $100,000 were registered, bringing the total amount of debt registered under the shelf registration to $600,000. The $300,000 of 5 1/2% Senior Notes issued in March 2002 reduced the amount of registered securities available for future issuance to $300,000.

 

16


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

Derivatives

 

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 and typically have very short terms. The aggregate amount of foreign exchange contracts outstanding at August 31, 2003 was not material. The only significant derivative instruments the Company holds are interest rate swaps, which the Company uses to manage the interest rate risk associated with its borrowings and to manage the Company’s mix of fixed and variable-rate debt. As of August 31, 2003, the Company had “fixed-to-floating” interest rate swaps with an aggregate notional amount of $600,000 and an aggregate fair value of $34,204, which is recorded in other assets. These swaps were entered into effective November 13, 2001, and March 25, 2002, and are designated and qualify as fair value hedges of the Company’s $300,000 7 1/8% Senior Notes and the Company’s $300,000 5 1/2% Senior Notes, respectively. As the terms of the swaps match those of the underlying hedged debt, the changes in the fair value of these swaps are offset by corresponding changes in the carrying amount of the hedged debt, and result in no net earnings impact.

 

Financial Position and Cash Flows

 

Working capital totaled $700,431 at August 31, 2003, compared to $180,806 at September 1, 2002. The increase of $519,625 was primarily due to an increase in cash and cash equivalents of $739,921, an increase in receivables of $81,229 and a reduction in short-term borrowing of $56,353, which was offset by increases in accrued salaries and benefits and in other current liabilities of $144,334 and $141,381, respectively, and a decrease in net inventory levels (inventories less accounts payable) of $34,844.

 

Net cash provided by operating activities totaled $1,507,208 in fiscal 2003, compared to $1,018,243 in fiscal 2002. The increase of $488,965 is primarily a result of a decrease in the change in net inventories (inventories less accounts payable) of $256,288; an increase in the change in the aggregation of receivables, other current assets, deferred income and accrued and other current liabilities of $102,284, an increase in the change in deferred income taxes of $56,514 and an increase in depreciation and amortization of $49,521 between fiscal 2003 and fiscal 2002.

 

Net cash used in investing activities totaled $790,588 in fiscal 2003, compared to $1,033,815 in fiscal 2002, a decrease of $243,227. This decrease is primarily a result of a reduction in the acquisition of property and equipment and the construction of facilities for new and remodeled warehouses of $227,940 and an increase in the proceeds received from the sale of property and equipment between fiscal 2003 and fiscal 2002 of $18,980.

 

Net cash used in financing activities totaled $1,428 in fiscal 2003 compared to cash provided by financing activities of $217,828 in fiscal 2002, a decrease of $219,256. The decrease in cash provided by financing activities primarily resulted from a decrease in net proceeds from the issuance of long-term debt of $240,576 and a reduction in proceeds from the exercise of stock options of $32,104 offset by a decrease in repayments of short-term borrowings of $41,031 between fiscal 2003 and fiscal 2002.

 

Stock Repurchase Program

 

On November 30, 2001, the Company’s Board of Directors approved a stock repurchase program, authorizing the repurchase of up to $500,000 of Costco Common Stock through November 30, 2004. Under the program, the Company can repurchase shares at any time in the open market or in private transactions as market conditions warrant. The repurchased shares would constitute authorized, but non-issued shares and would be used for general corporate purposes, including stock option grants under stock option programs. To date, no shares have been repurchased under this program.

 

17


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

Additional Equity Investments in Subsidiary Subsequent to Year-End

 

Subsequent to the Company’s fiscal year end, the Company, on October 3, 2003 acquired from Carrefour Nederland B.V. its 20% equity interest in Costco Wholesale UK Limited for cash of approximately $95,000, bringing Costco’s ownership in Costco Wholesale UK Limited to 100%.

 

Critical Accounting Policies

 

The preparation of the Company’s financial statements requires that management make estimates and judgments that affect the financial position and results of operations. Management continues to review its accounting policies and evaluate its estimates, including those related to merchandise inventory, impairment of long-lived assets and warehouse closing costs and insurance/self-insurance liabilities. The Company bases its estimates on historical experience and on other assumptions that management believes to be reasonable under the present circumstances.

 

Merchandise Inventories

 

Merchandise inventories are valued at the lower of cost or market as determined primarily by the retail method of accounting and are stated using the last-in, first-out (LIFO) method for substantially all U.S. merchandise inventories. Merchandise inventories for all foreign operations are primarily valued by the retail method of accounting, and are stated using the first-in, first-out (FIFO) method. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter for the expected annual effect of inflation, and these estimates are adjusted to actual results determined at year-end. The Company considers in its calculation of the LIFO cost the estimated net realizable value of inventory in those inventory pools where deflation exists and records a write down of inventory where estimated net realizable value is less than LIFO inventory.

 

The Company provides for estimated inventory losses between physical inventory counts on the basis of a percentage of sales. The provision is adjusted periodically to reflect the trend of the actual physical inventory count results, which generally occur in the second and fourth fiscal quarters.

 

Inventory cost, where appropriate, is reduced by estimates of vendor rebates earned when those rebates are deemed to be probable and reasonably estimable. Other consideration received from vendors is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of agreement, or other systematic and rational approach.

 

Impairment of long-lived assets and warehouse closing costs

 

The Company periodically evaluates its long-lived assets for indicators of impairment. Management’s judgments are based on market and operational conditions at the present time. Future events could cause management to conclude that impairment factors exist, requiring an adjustment of these assets to their then-current fair market value.

 

The Company provides estimates for warehouse closing costs when it is appropriate to do so based on accounting principles generally accepted in the United States. Future circumstances may result in the Company’s actual future closing costs or the amount recognized upon the sale of the property to differ substantially from the original estimates.

 

Insurance/Self Insurance Liabilities

 

The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability, property insurance, director and officers’ liability, vehicle liability and employee health care benefits. Liabilities associated with the risks that are retained by the Company

 

18


Table of Contents

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

are estimated, in part, by considering historical claims experience and outside expertise, demographic factors, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

 

Recent Accounting Pronouncements

 

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 143 (SFAS No. 143), “Accounting for Asset Retirement Obligations,” which provides the accounting requirements for retirement obligations associated with tangible long-lived assets. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. SFAS No. 143 was effective for the Company’s 2003 fiscal year. The adoption of SFAS No. 143 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” effective for the Company’s 2003 fiscal year. This Statement supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” and other related accounting guidance. The adoption of SFAS No. 144 did not have a material impact on the Company’s consolidated results of operations, financial position, or cash flows.

 

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement addresses financial accounting and reporting of costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” This statement requires that a liability for a cost associated with an exit or disposal activity should be recognized at fair value when the liability is incurred. SFAS No. 146 was effective for the Company’s 2003 fiscal year. The adoption of SFAS No. 146 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows, other than to impact the timing of charges related to future warehouse relocations.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” which provides guidance for transition to the fair value based method of accounting for stock-based employee compensation and the required financial statement disclosure. Effective September 3, 2002 the Company adopted the fair value based method of accounting for stock-based compensation. See Note (1) and Note (5) of the Company’s consolidated financial statements.

 

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This interpretation established financial statement disclosure requirements for companies that enter into or modify certain types of guarantees subsequent to December 31, 2002. Beginning in calendar 2003, the standard requires that companies record the fair value of certain types of guarantees as a liability in the financial statements. The adoption of this interpretation did not have a material impact on the Company’s results of operations, consolidated financial position or cash flows.

 

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities.” In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of Interpretation No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption

 

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Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

 

of this interpretation did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In November 2002, the EITF reached a consensus on EITF 00-21, “Revenue Arrangements with Multiple Deliverables,” with respect to determining when and how to allocate revenue from sales with multiple deliverables. The EITF 00-21 consensus provides a framework for determining when and how to allocate revenue from sales with multiple deliverables based on a determination of whether the multiple deliverables qualify to be accounted for as separate units of accounting. The consensus is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this consensus did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In November 2002, the EITF reached consensus on certain issues discussed in EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” with respect to determining how a reseller should characterize consideration received from a vendor and when to recognize and how to measure that consideration in its income statement. Requirements for recognizing volume-based rebates are effective for arrangements entered into or modified after November 21, 2002, and resellers with other supplier payments should generally apply the new rules prospectively for agreements entered into or modified after December 31, 2002. The adoption of this consensus did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows in fiscal 2003. However, the Company does expect the adoption of this consensus to impact interim quarterly financial information, commencing with the first quarter of fiscal 2004, as the application of the consensus will result in a change in the timing for the recognition of some vendor allowances for certain agreements entered into subsequent to December 31, 2002.

 

Item 7A—Quantitative and Qualitative Disclosure of Market Risk

 

The Company is exposed to financial market risk resulting from changes in interest and currency rates. As a policy, the Company does not engage in speculative or leveraged transactions, nor hold or issue financial instruments for trading purposes.

 

The nature and amount of the Company’s long and short-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. As of August 31, 2003, the Company’s fixed rate long-term debt includes its $851,860 principal amount at maturity Zero Coupon Subordinated Notes and additional notes and capital lease obligations totaling $137,761. The Company’s debt also includes $300,000 7 1/8% Senior Notes and $300,000 5 1/2% Senior Notes. The Company has entered into “fixed-to-floating” interest rate swaps on the Senior Notes, effectively converting these fixed interest rate securities to variable rate securities. Fluctuations in interest rates may affect the fair value of the fixed rate debt and may affect the interest expense related to the variable rate debt.

 

The Company holds interest-bearing instruments that are classified as cash and cash equivalents. As these investments are of a short-term nature, if interest rates were to increase or decrease immediately, there is no material risk of a valuation adjustment related to these instruments. In addition, changes in interest rates would not likely have a material impact on interest income.

 

Most foreign currency transactions have been conducted in local currencies, limiting the Company’s exposure to changes in currency rates. The Company periodically enters into forward foreign exchange contracts to hedge the impact of fluctuations in foreign currency rates on inventory purchases. The fair value of foreign exchange contracts outstanding at August 31, 2003 was not material to the Company’s results of operations or its financial position.

 

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Table of Contents

Item 8—Financial Statements and Supplementary Data

 

Financial statements of Costco are as follows:

 

     Page

Independent Auditors’ Report

   27

Consolidated Balance Sheets, as of August 31, 2003 and September 1, 2002

   29

Consolidated Statements of Income, for the 52 weeks ended August 31, 2003, September 1, 2002 and September 2, 2001

   30

Consolidated Statements of Stockholders’ Equity, for the 52 weeks ended August 31, 2003, September 1, 2002 and September 2, 2001

   31

Consolidated Statements of Cash Flows, for the 52 weeks ended August 31, 2003, September 1, 2002 and September 2, 2001

   32

Notes to Consolidated Financial Statements

   33

 

Item 9—Change in and Disagreements with Accountants on Accounting and Financial Disclosure

 

On May 13, 2002, the Audit Committee of Costco Wholesale Corporation’s Board of Directors engaged KPMG LLP as the Company’s independent auditors for 2002. The information required by this item is incorporated herein by reference to Costco’s Form 8-K filed on May 17, 2002 and the related Form 8-K/A filed on May 30, 2002.

 

Item 9A—Controls and Procedures

 

We carried out an evaluation as of August 31, 2003, under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14 and 15d-14. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures are effective to timely alert them to any material information relating to the Company (including its consolidated subsidiaries) that must be included in our periodic Securities and Exchange Commission filings. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

 

The Company intends to review and evaluate the design and effectiveness of its disclosure controls and procedures on an ongoing basis and to improve its controls and procedures over time and to correct any deficiencies that may be discovered in the future in order to ensure that senior management has timely access to all material financial and non-financial information concerning the Company’s business. While management believes that the present design of the Company’s disclosure controls and procedures is effective to achieve these results, future events affecting the Company’s business may cause management to modify its disclosure controls and  procedures.

 

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Table of Contents

PART III

 

Item 10—Directors and Executive Officers of the Registrant

 

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 29, 2004 (“Proxy Statement”). The Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of the end of the Company’s fiscal year.

 

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

   67   

President and Chief Executive Officer

Jeffrey H. Brotman

   61   

Chairman of the Board

Richard D. DiCerchio

   60   

Sr. Executive Vice President, Chief Operating Officer, Merchandising, Distribution and Construction

Richard A. Galanti

   47   

Executive Vice President and Chief Financial Officer

W. Craig Jelinek

   51   

Executive Vice President, Chief Operating Officer, Northern Division

Franz E. Lazarus

   56   

Executive Vice President, Chief Operating Officer, International Operations, Manufacturing and Ancillary Businesses

Paul G. Moulton

   52   

Executive Vice President, Real Estate Development

Joseph P. Portera

   50   

Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions

Dennis R. Zook

   54   

Executive Vice President, Chief Operating Officer, Southwest and Mexico Divisions

 

James D. Sinegal has been President and Chief Executive Officer of the Company since October 1993. From its inception until 1993, he was President and Chief Operating Officer of the Company and served as Chief Executive Officer from August 1988 until October 1993. Mr. Sinegal was a co-founder of the Company and has been a director since its inception.

 

Jeffrey H. Brotman was a founder and Chairman of the Board of the Company from its inception until October 1993. In October 1993, Mr. Brotman became the Vice Chairman of the Company, and has served as Chairman since December 1994.

 

Richard D. DiCerchio has been Senior Executive Vice President of the Company since 1997. He is Chief Operating Officer—Merchandising, Distribution and Construction. 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 the Company in August 1992 and was appointed Executive Vice President and director in April 1986. From June 1985 to April 1986, he was Senior Vice President, Merchandising of the Company. He joined the Company as Vice President, Operations in May 1983.

 

Richard A. Galanti has been a director of the Company since January 1995, and Executive Vice President and Chief Financial Officer of the Company since October 1993. He was Senior Vice President, Chief Financial Officer and Treasurer of the Company from January 1985 to October 1993, having joined as Vice President-Finance in March 1984. From 1978 to February 1984, Mr. Galanti was an associate with Donaldson, Lufkin & Jenrette Securities Corporation.

 

W. 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 1994. 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.

 

Franz E. Lazarus was named Executive Vice President, Chief Operating Officer—International Operations in September 1995 and assumed the additional responsibilities over Manufacturing and Ancillary Businesses in August 2000. From August 1994 to September 1995, Mr. Lazarus served as Executive Vice President, Chief

 

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Table of Contents

Item 10—Directors and Executive Officers of the Registrant (Continued)

 

Operating Officer—Northern Division of the Company. Subsequent to the merger in October 1993, he served as Executive Vice President, Chief Operating Officer—Eastern Division. 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.

 

Paul G. Moulton has been Executive Vice President, Real Estate Development since February 2001. He had been responsible for Marketing, E-commerce and Member Services since October 1999. He was Senior Vice President, Information Systems from November 1997 to August 1999. From 1995 to 1997, he was Senior Vice President, COO of Costco Asia; and from 1992 to 1995 he was Senior Vice President, COO of Costco Europe. From 1990 to 1992, Mr. Moulton was Vice President of Finance and Corporate Treasurer and has held various management positions since joining Costco Wholesale Corporation in July 1985.

 

Joseph P. Portera has been Executive Vice President, Chief Operating Officer—Eastern Division of the Company since August 1994 and assumed the additional responsibilities of Chief Operating Officer – Canadian Division in September 2000. 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 in October 1993. His management responsibilities also include the Company’s joint venture operation in Mexico. 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 October 1988 and has held various management positions since joining The Price Company in October 1981.

 

The Company has adopted a code of ethics for senior financial officers pursuant to section 406 of the Sarbanes Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027.

 

Item 11—Executive Compensation

 

The information required by this Item is incorporated herein by reference to the Proxy Statement. The Proxy Statement will 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 the Proxy Statement. The Proxy Statement will 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 the Proxy Statement. The Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of the end of the Company’s fiscal year.

 

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Table of Contents

PART IV

 

Item 15—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)   Two reports on Form 8-K were filed during the 16-week period ended August 31, 2003—on May 28, 2003, and August 5, 2003. On October 8, 2003, subsequent to the Company’s fiscal year end, the Company filed a Form 8-K, which contained its press release of the financial results of the fourth quarter and fiscal year 2003 and announced the acquisition of Carrefour Nederland B.V.’s 20% equity interest in Costco Wholesale UK Limited.

 

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Table of Contents

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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 20, 2003

 

COSTCO WHOLESALE CORPORATION

(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, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below.

 

By

 

/s/  JAMES D. SINEGAL


      November 20, 2003
    James D. Sinegal        
    President, Chief Executive Officer and Director        

By

 

/s/  JEFFREY H. BROTMAN


      November 20, 2003
    Jeffrey H. Brotman        
    Chairman of the Board        

By

 

/s/  RICHARD D. DICERCHIO


      November 20, 2003
    Richard D. DiCerchio        
    Sr. Executive Vice President, Chief Operating Officer        
    Merchandising, Distribution and Construction and Director        

By

 

/s/  RICHARD A. GALANTI


      November 20, 2003
    Richard A. Galanti        
    Executive Vice President, Chief Financial Officer and        
    Director (Principal Financial Officer)        

By

 

/s/  DAVID S. PETTERSON


      November 20, 2003
    David S. Petterson        
    Senior Vice President and Controller        
    (Principal Accounting Officer)        

By

 

/s/  DR. BENJAMIN S. CARSON, SR., M.D.


      November 20, 2003
    Dr. Benjamin S. Carson, Sr., M.D.        
    Director        

 

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Table of Contents

By

 

/s/  DANIEL J. EVANS


      November 20, 2003
    Daniel J. Evans        
    Director        

By

 

/s/  WILLIAM H. GATES, II


      November 20, 2003
    William H. Gates, II        
    Director        

By

 

/s/  HAMILTON E. JAMES


      November 20, 2003
    Hamilton E. James        
    Director        

By

 

/s/  RICHARD M. LIBENSON


      November 20, 2003
    Richard M. Libenson        
    Director        

By

 

/s/  JOHN W. MEISENBACH


      November 20, 2003
    John W. Meisenbach        
    Director        

By

 

/s/  CHARLES T. MUNGER


      November 20, 2003
    Charles T. Munger        
    Director        

By

 

/s/  JILL S. RUCKELSHAUS


      November 20, 2003
    Jill S. Ruckelshaus        
    Director        

 

26


Table of Contents

INDEPENDENT AUDITORS’ REPORT

 

To the Board of Directors and Shareholders:

 

We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries as of August 31, 2003 and September 1, 2002 and the related consolidated statements of income, stockholders’ equity and cash flows for the 52 weeks then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The accompanying consolidated financial statements of Costco Wholesale Corporation and subsidiaries as of September 2, 2001 were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements in their report dated October 8, 2001.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Costco Wholesale Corporation and subsidiaries as of August 31, 2003 and September 1, 2002, and the results of their operations and their cash flows for the 52 weeks then ended in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation effective September 3, 2002.

 

/s/  KPMG LLP

 

Seattle, Washington

October 6, 2003

 

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Table of Contents

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

 

To Costco Wholesale Corporation:

 

We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation (a Washington corporation) and subsidiaries (“Costco”) as of September 2, 2001 and September 3, 2000, and the related consolidated statements of income, stockholders’ equity and cash flows for the 52 weeks ended September 2, 2001, the 53 weeks ended September 3, 2000 and the 52 weeks ended August 29, 1999. 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 auditing standards generally accepted in the United States. 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 September 2, 2001 and September 3, 2000, and the results of its operations and its cash flows for the 52 weeks ended September 2, 2001, the 53 weeks ended September 3, 2000 and the 52 weeks ended August 29, 1999, in conformity with accounting principles generally accepted in the United States.

 

As explained in Note 1 to the consolidated financial statements, during the year ended August 29, 1999, the Company changed its method of accounting for membership fee income from a cash basis to a deferred basis whereby membership fee income is recognized ratably over the one-year life of the membership.

 

/s/  ARTHUR ANDERSEN LLP

 

Seattle, Washington

October 8, 2001

 

This audit report of Arthur Andersen LLP, our former independent public accountants, is a copy of the original report dated October 8, 2001 rendered by Arthur Andersen LLP on our consolidated financial statements included in our Form 10-K filed on November 15, 2001, and has not been reissued by Arthur Andersen LLP since that date. We are including this copy of the Arthur Andersen LLP audit report pursuant to Rule 2-02 (e) of Regulation S-X under the Securities Act of 1933.

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

CONSOLIDATED BALANCE SHEETS

(dollars in thousands except par value)

 

     August 31,
2003


    September 1,
2002


 
ASSETS

CURRENT ASSETS

                

Cash and cash equivalents

   $ 1,545,439     $ 805,518  

Receivables, net

     556,090       474,861  

Merchandise inventories

     3,339,428       3,127,221  

Other current assets

     270,581       222,939  
    


 


Total current assets

     5,711,538       4,630,539  
    


 


PROPERTY AND EQUIPMENT

                

Land

     2,173,685       2,017,184  

Buildings, leaseholds and land improvements

     4,831,236       4,367,395  

Equipment and fixtures

     1,846,324       1,733,979  

Construction in progress

     154,181       198,744  
    


 


       9,005,426       8,317,302  

Less accumulated depreciation and amortization

     (2,045,418 )     (1,793,683 )
    


 


Net property and equipment

     6,960,008       6,523,619  
    


 


OTHER ASSETS

     520,142       466,105  
    


 


     $ 13,191,688     $ 11,620,263  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES

                

Short-term borrowings

   $ 47,421     $ 103,774  

Accounts payable

     3,131,320       2,884,269  

Accrued salaries and benefits

     734,261       589,927  

Accrued sales and other taxes

     207,392       163,273  

Deferred membership income

     401,357       360,515  

Other current liabilities

     489,356       347,975  
    


 


Total current liabilities

     5,011,107       4,449,733  

LONG-TERM DEBT

     1,289,649       1,210,638  

DEFERRED INCOME TAXES AND OTHER LIABILITIES

     209,835       145,925  
    


 


Total liabilities

     6,510,591       5,806,296  
    


 


COMMITMENTS AND CONTINGENCIES

                

MINORITY INTEREST

     126,117       119,730  
    


 


STOCKHOLDERS’ EQUITY

                

Preferred stock $.005 par value; 100,000,000 shares authorized; no shares issued and outstanding

     —         —    

Common stock $.005 par value; 900,000,000 shares authorized; 457,479,000 and 455,325,000 shares issued and outstanding

     2,287       2,277  

Additional paid-in capital

     1,280,942       1,220,954  

Other accumulated comprehensive loss

     (77,980 )     (157,725 )

Retained earnings

     5,349,731       4,628,731  
    


 


Total stockholders’ equity

     6,554,980       5,694,237  
    


 


     $ 13,191,688     $ 11,620,263  
    


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data)

 

     52 Weeks
Ended
August 31,
2003


    52 Weeks
Ended
September 1,
2002


    52 Weeks
Ended
September 2,
2001


 

REVENUE

                        

Net sales

   $ 41,692,699     $ 37,993,093     $ 34,137,021  

Membership fees and other

     852,853       769,406       660,016  
    


 


 


Total revenue

     42,545,552       38,762,499       34,797,037  

OPERATING EXPENSES

                        

Merchandise costs

     37,235,383       33,983,121       30,598,140  

Selling, general and administrative

     4,097,398       3,575,536       3,129,059  

Preopening expenses

     36,643       51,257       59,571  

Provision for impaired assets and closing costs

     19,500       21,050       18,000  
    


 


 


Operating income

     1,156,628       1,131,535       992,267  

OTHER INCOME (EXPENSE)

                        

Interest expense

     (36,920 )     (29,096 )     (32,024 )

Interest income and other

     38,525       35,745       43,238  
    


 


 


INCOME BEFORE INCOME TAXES

     1,158,233       1,138,184       1,003,481  

Provision for income taxes

     437,233       438,201       401,392  
    


 


 


NET INCOME

   $ 721,000     $ 699,983     $ 602,089  
    


 


 


NET INCOME PER COMMON SHARE:

                        

Basic

   $ 1.58     $ 1.54     $ 1.34  
    


 


 


Diluted

   $ 1.53     $ 1.48     $ 1.29  
    


 


 


Shares used in calculation (000’s)

                        

Basic

     456,335       453,650       449,631  

Diluted

     479,326       479,262       475,827  

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

For the 52 weeks ended August 31, 2003, the 52 weeks ended September 1, 2002  and the 52 weeks ended September 2, 2001

(in thousands)

 

     Common Stock

  

Additional
Paid-In
Capital


   Other
Accumulated
Comprehensive
Income/(Loss)


   

Retained
Earnings


  

Total


 
     Shares

   Amount

          

BALANCE AT SEPTEMBER 3, 2000

   447,297    $ 2,236    $ 1,028,414    $ (117,029 )   $ 3,326,659    $ 4,240,280  

Comprehensive Income

                                          

Net Income

                        602,089      602,089  

Other accumulated comprehensive loss Foreign currency translation adjustment

                  (56,581 )          (56,581 )
    
  

  

  


 

  


Total comprehensive income

                  (56,581 )     602,089      545,508  

Stock options exercised including income tax benefits and other

   4,457      23      97,129                 97,152  
    
  

  

  


 

  


BALANCE AT SEPTEMBER 2, 2001

   451,754      2,259      1,125,543      (173,610 )     3,928,748      4,882,940  

Comprehensive Income

                                          

Net Income

                        699,983      699,983  

Other accumulated comprehensive income Foreign currency translation adjustment

                  15,885            15,885  
    
  

  

  


 

  


Total comprehensive income

                  15,885       699,983      715,868  

Stock options exercised including income tax benefits and other

   3,571      18      95,402                 95,420  

Conversion of convertible debentures

             9                 9  
    
  

  

  


 

  


BALANCE AT SEPTEMBER 1, 2002

   455,325      2,277      1,220,954      (157,725 )     4,628,731      5,694,237  

Comprehensive Income

                                          

Net Income

                        721,000      721,000  

Other accumulated comprehensive income Foreign currency translation adjustment

                  79,745            79,745  
    
  

  

  


 

  


Total comprehensive income

                  79,745       721,000      800,745  

Stock options exercised including income tax benefits and other

   2,154      10      47,919                 47,929  

Stock-based compensation

             12,069                 12,069  
    
  

  

  


 

  


BALANCE AT AUGUST 31, 2003

   457,479    $ 2,287    $ 1,280,942    $ (77,980 )   $ 5,349,731    $ 6,554,980  
    
  

  

  


 

  


 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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COSTCO WHOLESALE CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

     52 Weeks
Ended
August 31,
2003


    52 Weeks
Ended
September 1,
2002


    52 Weeks
Ended
September 2,
2001


 

CASH FLOWS FROM OPERATING ACTIVITIES

                        

Net income

   $ 721,000     $ 699,983     $ 602,089  

Adjustments to reconcile net income to net cash provided by operating activities:

                        

Depreciation and amortization

     391,302       341,781       301,297  

Accretion of discount on zero coupon notes

     17,852       17,233       16,654  

Stock-based compensation

     12,069              

Undistributed equity earnings in affiliates

     (21,612 )     (21,485 )     (17,719 )

Net loss/(gain) on sale of property and equipment and other

     4,907       4,001       (15,934 )

Provision for impaired assets

     4,697             15,231  

Change in deferred income taxes

     68,693       12,179       40,797  

Tax benefit from exercise of stock options

     12,348       27,171       32,552  

Change in receivables, other current assets, deferred income, accrued and other current liabilities

     232,167       129,883       (6,159 )

Increase in merchandise inventories

     (162,759 )     (380,158 )     (271,355 )

Increase in accounts payable

     226,544       187,655       335,110  
    


 


 


Total adjustments

     786,208       318,260       430,474  
    


 


 


Net cash provided by operating activities

     1,507,208       1,018,243       1,032,563  
    


 


 


CASH FLOWS FROM INVESTING ACTIVITIES

                        

Additions to property and equipment

     (810,665 )     (1,038,605 )     (1,447,549 )

Proceeds from the sale of property and equipment

     51,829       32,849       110,002  

Investment in unconsolidated joint venture

           (1,000 )     (28,500 )

Decrease in short-term investments

           4,928       41,599  

Increase in other assets and other, net

     (31,752 )     (31,987 )     (15,395 )
    


 


 


Net cash used in investing activities

     (790,588 )     (1,033,815 )     (1,339,843 )
    


 


 


CASH FLOWS FROM FINANCING ACTIVITIES

                        

(Repayments)/proceeds from short-term borrowings, net

     (58,144 )     (99,175 )     185,942  

Net proceeds from issuance of long-term debt

     59,424       300,000       81,951  

Repayments of long-term debt

     (11,823 )     (18,540 )     (159,328 )

Changes in bank checks outstanding

     (31,639 )     (35,136 )     216,661  

Proceeds from minority interests

     6,087       3,908       7,119  

Exercise of stock options

     34,667       66,771       62,000  
    


 


 


Net cash (used in)/provided by financing activities

     (1,428 )     217,828       394,345  
    


 


 


EFFECT OF EXCHANGE RATE CHANGES ON CASH

     24,729       677       (8,985 )
    


 


 


Increase in cash and cash equivalents

     739,921       202,933       78,080  

CASH AND CASH EQUIVALENTS BEGINNING OF YEAR

     805,518       602,585       524,505  
    


 


 


CASH AND CASH EQUIVALENTS END OF YEAR

   $ 1,545,439     $ 805,518     $ 602,585  
    


 


 


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

                        

Cash paid during the year for:

                        

Interest (excludes amounts capitalized)

   $ 20,861     $ 9,511     $ 14,761  

Income taxes

   $ 320,546     $ 351,003     $ 363,649  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

32


Table of Contents

COSTCO WHOLESALE CORPORATION

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 Wholesale Corporation, a Washington corporation, and its subsidiaries (“Costco” or the “Company”). All material inter-company transactions between the Company and its subsidiaries have been eliminated in consolidation. Costco primarily operates membership warehouses under the Costco Wholesale name.

 

Costco operates membership warehouses that offer 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, 2003, Costco operated 418 warehouse clubs: 309 in the United States; 61 in Canada; 15 in the United Kingdom; five in Korea; three in Taiwan; four in Japan; and 21 warehouses in Mexico with a joint venture partner.

 

The Company’s investment in the Costco Mexico joint venture and in other unconsolidated joint ventures that are less than majority owned are accounted for under the equity method. The investment in Costco Mexico is included in other assets and was $167,293 at August 31, 2003 and $157,312 at September 1, 2002. The equity in earnings of Costco Mexico is included in interest income and other and for fiscal 2003, 2002 and 2001, was $21,400, $21,028 and $17,378, respectively. The amount of retained earnings that represents undistributed earnings of Costco Mexico was $86,074 and $64,674 at August 31, 2003 and September 1, 2002, respectively.

 

Fiscal Years

 

The Company reports on a 52/53-week fiscal year basis, which ends on the Sunday nearest August 31st. Fiscal years 2003, 2002 and 2001, were 52-week years.

 

Cash Equivalents

 

The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase and proceeds due from credit and debit card transactions with settlement terms of less than five days to be cash equivalents. Of the total cash and cash equivalents of $1,545,439 at August 31, 2003 and $805,518 at September 1, 2002, credit and debit card receivables were $412,861 and $351,788, respectively.

 

Receivables, net

 

Receivables consist primarily of vendor rebates and promotional allowances, receivables from government tax authorities and other miscellaneous amounts due to the Company, and are net of allowance for doubtful accounts of $1,529 at August 31, 2003 and $2,224 at September 1, 2002. Management determines the allowance for doubtful accounts based on known troubled accounts and historical experience applied to an aging of accounts.

 

Vendor Rebates and Allowances

 

Periodic payments from vendors in the form of buy downs, volume or other purchase discounts that are evidenced by signed agreements are reflected in the carrying value of the inventory when earned and as a component of cost of sales as the merchandise is sold. Other consideration received from vendors is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by other systematic and rational approach.

 

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

 

33


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

inventories. Merchandise inventories for all foreign operations are primarily valued by the retail method of accounting, and are stated using the first-in, first-out (FIFO) method. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter for the expected annual effect of inflation and these estimates are adjusted to actual results determined at year-end. The Company considers in its calculation of the LIFO cost the estimated net realizable value of inventory in those inventory pools where deflation exists and records a write down of inventory where estimated net realizable value is less than LIFO inventory. The LIFO inventory adjustment for the fourth quarter of fiscal 2003 increased gross margin by approximately $14,650 as compared to $21,000 in the fourth quarter of fiscal 2002. If all merchandise inventories had been valued using the first-in, first-out (FIFO) method, inventories would have been lower by $19,500 at August 31, 2003 and higher by $150 at September 1, 2002.

 

     August 31,
2003


  

September 1,

2002


Merchandise inventories consist of:

             

United States (primarily LIFO)

   $ 2,668,342    $ 2,552,820

Foreign (FIFO)

     671,086      574,401
    

  

Total

   $ 3,339,428    $ 3,127,221
    

  

 

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. Buildings are generally depreciated over twenty-five to thirty-five years; equipment and fixtures are depreciated over three to ten years; 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 was $3,272 in fiscal 2003, $13,480 in fiscal 2002, and $19,157 in fiscal 2001.

 

Impairment of Long-Lived Assets

 

The Company periodically evaluates the realizability of long-lived assets for impairment when events or changes in circumstances occur, which may indicate the carrying amount of the asset may not be recoverable. The Company evaluates the carrying value of the asset by comparing the estimated future undiscounted cash flows generated from the use of the asset and its eventual disposition with the asset’s reported net book value. In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, the Company recorded a pre-tax, non-cash charge of $4,697 in fiscal 2003 and $0 and $15,231 in fiscal 2002 and 2001, respectively, reflecting its estimate of impairment relating to scheduled warehouse closings. The charge reflects the difference between the carrying value and fair value, which was based on estimated market valuations for those assets whose carrying value is not currently anticipated to be recoverable through future cash flows.

 

34


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

Goodwill

 

Goodwill, net of accumulated amortization, resulting from certain business combinations is included in other assets, and totaled $46,549 at August 31, 2003 and $43,920 at September 1, 2002. On September 3, 2001, the Company adopted SFAS No. 142, “Accounting for Goodwill and Other Intangibles,” which specifies that goodwill and some intangible assets will no longer be amortized, but instead will be subject to periodic impairment testing. Accordingly, the Company reviews previously reported goodwill for impairment on an annual basis, or more frequently if circumstances dictate. In fiscal 2001 goodwill was amortized on a straight-line basis over lives ranging from two to forty years and was periodically evaluated for impairment as circumstances dictated. The effects on net income and net income per share data would not be significant if the Company had followed the provisions of SFAS No. 142 in the year ended September 2, 2001.

 

Accounts Payable

 

The Company’s banking system provides for the daily replenishment of major bank accounts as checks are presented. Accordingly, included in accounts payable at August 31, 2003 and September 1, 2002 are $216,980 and $235,458 respectively, representing the excess of outstanding checks over cash on deposit at the banks on which the checks were drawn.

 

Insurance/Self Insurance Liabilities

 

The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability, property insurance, director and officers’ liability, vehicle liability and employee health care benefits. Liabilities associated with the risks that are retained by the Company are estimated, in part, by considering historical claims experience and outside expertise, demographic factors, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

 

Derivatives

 

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 only significant derivative instruments the Company holds are interest rate swaps, which the Company uses to manage the interest rate risk associated with its borrowings and to manage the Company’s mix of fixed and variable-rate debt. As of August 31, 2003, the Company had “fixed-to-floating” interest rate swaps with an aggregate notional amount of $600,000 and an aggregate fair value of $34,204, which is recorded in other assets. These swaps were entered into effective November 13, 2001, and March 25, 2002, and are designated and qualify as fair value hedges of the Company’s $300,000 7 1/8% Senior Notes and the Company’s $300,000 5 1/2% Senior Notes, respectively. As the terms of the swaps match those of the underlying hedged debt, the changes in the fair value of these swaps are offset by corresponding changes in the fair value recorded on the hedged debt, and result in no net earnings impact.

 

Foreign Currency Translations

 

The functional currencies of the Company’s international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies, as well as the Company’s investment in the Costco Mexico joint venture, are translated at the exchange rate on the balance sheet date.

 

35


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

Translation adjustments resulting from this process are charged or credited to other comprehensive income (loss). Revenue and expenses of the Company’s consolidated foreign operations are translated at average rates of exchange prevailing during the year. Gains and losses on foreign currency transactions are included in expenses and were not significant in either fiscal 2003 or 2002.

 

Revenue Recognition

 

The Company recognizes sales, net of estimated returns, at the time the member takes possession of merchandise or receives services. When the Company collects payment from customers prior to the transfer of ownership of merchandise or the performance of services, the amount received is recorded as deferred revenue. The Company provides for estimated sales returns based on historical returns levels. The reserve for sales returns (sales returns net of cost of goods sold) was $4,869 and $3,507 at August 31, 2003 and September 1, 2002, respectively.

 

Membership fee revenue represents annual membership fees paid by substantially all of the Company’s members. The Company accounts for membership fee revenue on a “deferred basis,” whereby membership fee revenue is recognized ratably over the one-year life of the membership. The Company’s Executive members qualify for a 2% reward (which can be redeemed at Costco warehouses), up to a maximum of $500 per year, on all qualified purchases made at Costco. The Company accounts for this 2% reward as a reduction in sales, with the related liability being classified within other current liabilities. The sales reduction and corresponding liability are computed after giving effect to the estimated impact of non-redemptions based on historical data. The reduction in sales for the fiscal years ended August 31, 2003, September 1, 2002 and September 2, 2001, and the related liability as of those dates were as follows:

 

     Fiscal Year Ended

     August 31,
2003


   September 1,
2002


   September 2,
2001


Two-percent reward sales reduction

   $ 169,612    $ 143,637    $ 84,243

Two-percent unredeemed reward liability

   $ 114,681    $ 94,448    $ 57,840

 

Merchandise Costs

 

Merchandise costs consist of the purchase price of inventory sold, inbound shipping charges and all costs related to our depot operations, including freight from depots to selling warehouses. Merchandise costs also include salaries, benefits, depreciation on production equipment, and other related expenses incurred in certain fresh foods and ancillary departments.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses consist primarily of salaries, benefits and workers’ compensation costs for warehouse employees, other than fresh foods and certain ancillary businesses, as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include utilities, bank charges and substantially all building and equipment depreciation, as well as other operating costs incurred to support warehouse operations.

 

Marketing and Promotional Expenses

 

Costco’s policy is generally to limit marketing and promotional expenses to new warehouse openings, occasional direct mail marketing to prospective new members and annual direct mail marketing programs to existing members promoting selected merchandise. Marketing and promotional costs are expensed as incurred.

 

36


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

Preopening Expenses

 

Preopening expenses related to new warehouses, major remodels/expansions, regional offices and other startup operations are expensed as incurred.

 

Stock-Based Compensation

 

The Company adopted the fair value based method of recording stock options consistent with SFAS No. 123 “Accounting for Stock-Based Compensation,” for all employee stock options granted subsequent to fiscal year end 2002. Specifically, the Company adopted SFAS No. 123 using the “prospective method” with guidance provided from SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure.” All employee stock option grants made in fiscal 2003 and in future years will be expensed over the stock option vesting period based on the fair value at the date the options are granted. Prior to fiscal 2003 the Company applied Accounting Principles Board Opinion (APB) No. 25 and related interpretations in accounting for stock options. Because the Company granted stock options to employees at exercise prices equal to fair market value on the date of grant, accordingly, no compensation cost was recognized for option grants.

 

Had compensation costs for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards made prior to fiscal 2003, under those plans and 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:

 

     Fiscal Year Ended

 
     August 31,
2003


    September 1,
2002


    September 2,
2001


 

Net income, as reported

   $ 721,000     $ 699,983     $ 602,089  

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

     7,513              

Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects

     (70,257 )     (75,743 )     (65,077 )
    


 


 


Pro-forma net income

   $ 658,256     $ 624,240     $ 537,012  
    


 


 


Earnings per share:

                        

Basic—as reported

   $ 1.58     $ 1.54     $ 1.34  
    


 


 


Basic—pro-forma

   $ 1.44     $ 1.38     $ 1.19  
    


 


 


Diluted—as reported

   $ 1.53     $ 1.48     $ 1.29  
    


 


 


Diluted—pro-forma

   $ 1.40     $ 1.32     $ 1.15  
    


 


 


 

Fair Value of Financial Instruments

 

The carrying value of the Company’s financial instruments, including cash and cash equivalents, short-term investments and receivables approximate fair value due to their short-term nature or variable interest rates. The fair value of fixed rate debt at August 31, 2003 and September 1, 2002 was $1,415,252 and $1,382,569,  respectively.

 

37


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

Reorganization of Canadian Administrative Operations

 

On January 17, 2001, the Company announced plans to reorganize and consolidate the administration of its operations in Canada. Total costs related to the reorganization were $26,765 pre-tax, of which $7,765 pre-tax ($4,775 after-tax, or $.01 per diluted share) was expensed in fiscal 2002 and $19,000 pre-tax ($11,400 after-tax, or $.02 per diluted share) was expensed in fiscal 2001 and reported as part of the provision for impaired assets and closing costs. These costs consisted primarily of employee severance, implementation and consolidation of support systems and employee relocation. The reorganization was completed in the first quarter of fiscal 2002.

 

Closing Costs

 

Warehouse closing costs incurred relate principally to the Company’s efforts to relocate certain warehouses that were not otherwise impaired to larger and better-located facilities. The provision for fiscal 2003 included charges of $11,836 for warehouse closing expenses and $2,967 for losses on the sale of real property. The fiscal 2002 provision included charges of $13,683 for warehouse closing expenses and $7,765 for Canadian administrative reorganization, which were offset by $398 of net gains on the sale of real property. As of August 31, 2003, the Company’s reserve for warehouse closing costs was $8,609, of which $7,833 related to lease obligations. This compares to a reserve for warehouse closing costs of $11,845 at September 1, 2002, of which $10,395 related to lease obligations.

 

Interest Income and Other

 

Interest income and other includes:

 

     Fiscal Year Ended

    

August 31,

2003


  

September 1,

2002


  

September 2,

2001


Interest income

   $ 21,200    $ 16,005    $ 25,908

Minority interest/earnings of affiliates and other

     17,325      19,740      17,330
    

  

  

Total

   $ 38,525    $ 35,745    $ 43,238
    

  

  

 

Income Taxes

 

The Company accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” That standard requires companies to account for deferred income taxes using the asset and liability method.

 

Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized.

 

38


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

Net Income Per Common and Common Equivalent Share

 

The following data show the amounts used in computing earnings per share and the effect on income and the weighted average number of shares of dilutive potential common stock.

 

     52 Weeks Ended
August 31, 2003


   52 Weeks Ended
September 1, 2002


   52 Weeks Ended
September 2, 2001


Net income available to common stockholders used in basic EPS

   $ 721,000    $ 699,983    $ 602,089

Interest on convertible bonds, net of tax

     11,109      10,602      9,992
    

  

  

Net income available to common stockholders after assumed conversions of dilutive securities

   $ 732,109    $ 710,585    $ 612,081
    

  

  

Weighted average number of common shares used in basic EPS (000’s)

     456,335      453,650      449,631

Stock options (000’s)

     3,646      6,267      6,851

Conversion of convertible bonds (000’s)

     19,345      19,345      19,345
    

  

  

Weighted number of common shares and dilutive potential common stock used in diluted EPS (000’s)

     479,326      479,262      475,827
    

  

  

 

The diluted share base calculation for fiscal years ended August 31, 2003, September 1, 2002 and September 2, 2001, excludes 33,362,000, 6,908,000 and 7,108,000 stock options outstanding, respectively. These options are excluded due to their anti-dilutive effect.

 

On November 30, 2001, the Company’s Board of Directors approved a stock repurchase program authorizing the repurchase of up to $500,000 of Costco Common Stock through November 30, 2004. Under the program, the Company can repurchase shares at any time in the open market or in private transactions as market conditions warrant. The repurchased shares would constitute authorized, but non-issued shares and would be used for general corporate purposes, including stock option grants under stock option programs. To date, no shares have been repurchased under this program.

 

Recent Accounting Pronouncements

 

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which provides the accounting requirements for retirement obligations associated with tangible long-lived assets. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. SFAS No. 143 was effective for the Company’s 2003 fiscal year. The adoption of SFAS No. 143 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” effective for the Company’s 2003 fiscal year. This Statement supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and other related accounting guidance. The adoption of SFAS No. 144 did not have a material impact on the Company’s consolidated results of operations, financial position, or cash flows.

 

39


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This statement requires that a liability for a cost associated with an exit or disposal activity should be recognized at fair value when the liability is incurred. SFAS No. 146 was effective for the Company’s 2003 fiscal year. The adoption of SFAS No. 146 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows, other than to impact the timing of charges related to future warehouse relocations.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” which provides guidance for transition to the fair value based method of accounting for stock-based employee compensation and the required financial statement disclosure. Effective September 3, 2002 the Company adopted the fair value based method of accounting for stock-based compensation. See Note (1) and Note (5) of the Company’s consolidated financial statements.

 

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This standard established financial statement disclosure requirements for companies that enter into or modify certain types of guarantees subsequent to December 31, 2002. Beginning in calendar 2003, the standard requires that companies record the fair value of certain types of guarantees as a liability in the financial statements. The adoption of this interpretation did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In January 2003, the FASB issued FASB Interpretation No. 46 “Consolidation of Variable Interest Entities.” In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of Interpretation No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of the Interpretation did not have a material impact on the Company’s consolidated results of operation, financial position or cash flows.

 

In November 2002, the EITF reached a consensus on EITF 00-21, “Revenue Arrangements with Multiple Deliverables,” with respect to determining when and how to allocate revenue from sales with multiple deliverables. The EITF 00-21 consensus provides a framework for determining when and how to allocate revenue from sales with multiple deliverables based on a determination of whether the multiple deliverables qualify to be accounted for as separate units of accounting. The consensus is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this consensus did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In November 2002, the EITF reached consensus on certain issues discussed in EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” with respect to determining how a reseller should characterize consideration received from a vendor and when to recognize and how to

 

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COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 1—Summary of Significant Accounting Policies (Continued)

 

measure that consideration in its income statement. Requirements for recognizing volume-based rebates are effective for arrangements entered into or modified after November 21, 2002 and resellers with other supplier payments should generally apply the new rules prospectively for agreements entered into or modified after December 31, 2002. The adoption of this consensus did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows in fiscal 2003 and is not expected to have a significant impact in the future on an annual basis. However, the Company does expect the adoption of this consensus to impact interim quarterly financial information, commencing with the first quarter of fiscal 2004, as the application of the consensus will result in a change in the timing for the recognition of some vendor allowances for certain agreements entered into subsequent to December 31, 2002.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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—Comprehensive Income

 

Comprehensive income is net income, plus certain other items that are recorded directly to stockholders’ equity. Comprehensive income was $800,745 for fiscal 2003 and $715,868 for fiscal 2002. Foreign currency translation adjustments are the predominant components applied to net income to calculate the Company’s comprehensive income.

 

Note 3—Debt

 

Bank Lines of Credit and Commercial Paper Programs

 

The Company has in place a $500,000 commercial paper program supported by a $300,000 bank credit facility with a group of 10 banks, of which $150,000 expires on November 9, 2004 and $150,000 expires on November 15, 2005. At August 31, 2003, no amounts were outstanding under the commercial paper program and no amounts were outstanding under the credit facility.

 

In addition, a wholly owned Canadian subsidiary has a $144,000 commercial paper program supported by a $43,000 bank credit facility with a Canadian bank, which expires in March 2004. At August 31, 2003, no amounts were outstanding under the Canadian commercial paper program or the bank credit facility.

 

The Company has agreed to limit the combined amount outstanding under the U.S. and Canadian commercial paper programs to the $343,000 combined amounts of the respective supporting bank credit facilities.

 

The Company’s wholly-owned Japanese subsidiary has a short-term ¥3 billion ($25,782) bank line of credit, which expires in November 2004. At August 31, 2003, no amounts were outstanding under the line of credit.

 

The Company’s UK subsidiary has a £60 million ($94,842) bank revolving credit facility and a £20 million ($31,614) bank overdraft facility, both expiring in February 2007. At August 31, 2003, $47,421 was outstanding under the revolving credit facility with an applicable interest rate of 4.413% and no amounts were outstanding under the bank overdraft facility.

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 3—Debt (Continued)

 

Letters of Credit

 

The Company has letter of credit facilities (for commercial and standby letters of credit), totaling approximately $369,000. The outstanding commitments under these facilities at August 31, 2003 totaled approximately $125,000, including approximately $44,000 in standby letters of credit.

 

Short-Term Borrowings

 

The weighted average borrowings, highest borrowings and interest rate under all short-term borrowing arrangements were as follows for fiscal 2003 and 2002:

 

Category of Aggregate

Short-term Borrowings


   Maximum Amount
Outstanding
During the Fiscal Year


  

Average Amount
Outstanding

During the Fiscal Year


   Weighted Average
Interest Rate
During the Fiscal Year


 

Fiscal year ended August 31, 2003

                    

Bank borrowings:

                    

Canadian

   $ 5,655    $ 367    4.65 %

Other International

     127,098      81,431    3.68  

U.S. Commercial Paper

     17,657      2,065    4.92  

Fiscal year ended September 1, 2002

                    

Bank borrowings:

                    

Canadian

   $ 17,195    $ 351    4.14 %

Other International

     111,293      44,495    4.36  

U.S. Commercial Paper

     332,000      70,401    2.29  

 

Long-term Debt

 

Long-term debt at August 31, 2003 and September 1, 2002:

 

     2003

   2002

7 1/8% Senior Notes due June 2005

   $ 308,684    $ 307,787

5 1/2% Senior Notes due March 2007

     325,520      328,139

2.070% Promissory notes due October 2007

     30,079      29,400

1.187% Promissory notes due July 2008

     25,782      25,200

0.88% Promissory notes due November 2009

     25,782     

0.92% Promissory notes due April 2010

     34,376     

3 1/2% Zero Coupon convertible subordinated notes due August 2017

     524,735      506,883

Notes payable secured by trust deeds on real estate

     8,023      8,213

Capital lease obligations and other

     13,719      12,600
    

  

       1,296,700      1,218,222

Less current portion (included in other current liabilities)

     7,051      7,584
    

  

Total long-term debt

   $ 1,289,649    $ 1,210,638
    

  

 

In June 1995, the Company issued $300,000 of 7 1/8% Senior Notes due June 15, 2005. 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. In November 2001, the Company entered into “fixed-to-floating” interest rate swap agreements that replaced the fixed interest rate with a floating rate indexed to LIBOR.

 

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COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 3—Debt (Continued)

 

In March 2002, the Company issued $300,000 of 5 1/2% Senior Notes due March 15, 2007. Interest is payable semi-annually on March 15 and September 15. Simultaneous with the issuance of the 5 1/2% Senior Notes, the Company entered into interest rate swap agreements converting the interest to a floating rate indexed to LIBOR. As of August 31, 2003, the Company was in compliance with all restrictive covenants.

 

In October 2000, the Company’s wholly-owned Japanese subsidiary issued 2.070% promissory notes in the aggregate amount of approximately $30,079, through a private placement. Interest is payable annually and principal is due on October 23, 2007.

 

In July 2001, the Company’s wholly-owned Japanese subsidiary issued 1.187% promissory notes in the aggregate amount of approximately $25,782, through a private placement. Interest is payable semi-annually and principal is due on July 9, 2008.

 

In November 2002, the Company’s wholly-owned Japanese subsidiary issued promissory notes bearing interest at 0.88% in the aggregate amount of approximately $25,782, through a private placement. Interest is payable semi-annually and principal is due on November 7, 2009.

 

In April 2003, the Company’s wholly-owned Japanese subsidiary issued promissory notes bearing interest at 0.92% in the aggregate amount of approximately $34,376, through a private placement. Interest is payable semi-annually and principal is due on April 26, 2010.

 

During April 2001, the Company retired its unsecured note payable to banks of $140,000 using cash provided from operations, cash and cash equivalents, and short-term borrowings under its commercial paper program.

 

On August 19, 1997, the Company completed the sale of $900,000 principal amount at maturity 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 19,344,969 shares of Costco Common Stock shares at an initial conversion price of $22.00. 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, 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. As of August 31, 2003, $48,140 in principal amount of the Zero Coupon Notes had been converted by note holders to shares of Costco Common Stock.

 

In February 1996, the Company filed with the Securities and Exchange Commission a shelf registration statement for $500,000 of senior debt securities. On October 23, 2001, an additional $100,000 in debt securities were registered, bringing the total amount of debt registered under the shelf registration to $600,000. The $300,000 of 5.5% Senior Notes issued in March 2002, reduced the amount of registered securities available for future issuance to $300,000.

 

At August 31, 2003, the fair value of the 7 1/8% Senior Notes, and the 5 1/2% Senior Notes, based on market quotes, was approximately $321,780 and $320,760, respectively. The Senior Notes are not redeemable prior to maturity. The fair value of the 3 1/2% Zero Coupon Subordinated Notes at August 31, 2003, based on market quotes, was approximately $634,951. The fair value of other long-term debt approximates carrying value.

 

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COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 3—Debt (Continued)

 

Maturities of long-term debt during the next five fiscal years and thereafter are as follows:

 

2004

   $ 7,051

2005

     311,536

2006

     1,870

2007

     327,563

2008

     58,095

Thereafter

     590,585
    

Total

   $ 1,296,700
    

 

Note 4—Leases

 

The Company leases land and/or warehouse buildings at 85 of the 397 warehouses open at August 31, 2003, and certain other office and distribution facilities under operating leases with remaining terms ranging from 1 to 40 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; or (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. The Company accounts for its leases with step-rent provisions on a straight-line basis over the original term of the lease.

 

Additionally, the Company leases certain equipment and fixtures under short-term operating leases that permit the Company to either renew for a series of one-year terms or to purchase the equipment at the then fair market value.

 

Aggregate rental expense for fiscal 2003, 2002, and 2001, was $84,146, $69,894, and $70,394, respectively. Future minimum payments, net of sub-lease income of $142,975, during the next five fiscal years and thereafter under non-cancelable leases with terms in excess of one year, at August 31, 2003, were as follows:

 

2004

   $ 85,862

2005

     86,654

2006

     87,342

2007

     82,540

2008

     79,561

Thereafter

     983,303
    

Total minimum payments

   $ 1,405,262
    

 

Note 5—Stock Options

 

The Company’s 1993 Combined Stock Grant and Stock Option Plan (the “1993 plan”) provided for the issuance of up to 60 million shares of its common stock upon the exercise of stock options and up to 3,333,332 shares through stock grants. During fiscal 2002 the 2002 Stock Incentive Plan (the “2002 plan”) was adopted following shareholder approval. The 2002 plan authorized 30 million shares of common stock for issuance, subject to adjustment. For future grants, the 2002 plan replaces the 1993 plan and the 1993 plan has been amended to provide that no more options or stock grants may be issued under such plan. Any shares under the

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 5—Stock Options (Continued)

 

1993 plan that remain available for future option grants (and any additional shares that subsequently become available through cancellation of unexercised options outstanding) will be added to the number of shares available for grant under the 2002 plan. The 2002 plan authorizes the Company to grant stock options to eligible employees, directors and consultants. Options granted under these plans have a ten-year term and a vesting period of five years. At August 31, 2003, options for approximately 25.1 million shares were vested and 18.6 million shares were available for future grants under the plan.

 

The Company adopted the fair value based method of recording stock options consistent with SFAS No. 123 “Accounting for Stock-Based Compensation,” for all employee stock options granted subsequent to fiscal year end 2002 using the “prospective method.” All employee stock option grants made in fiscal 2003 and in future years will be expensed over the stock option vesting period based on the fair value at the date the options are granted. Prior to fiscal 2003 the Company applied APB No. 25 and related interpretations in accounting for stock options. Because the Company granted stock options to employees at exercise prices equal to fair market value on the date of grant, accordingly, no compensation cost was recognized for option grants.

 

In fiscal 2003, the Company recognized stock compensation costs of $12,069 versus no stock compensation costs in fiscal 2002. The effects of applying SFAS No. 123 are substantially less in fiscal 2003 than the effects on net income and earnings per share expected in future periods because this is the initial year of adoption. Future years will reflect compensation expense from options granted in that year, as well as continuing recognition of expense associated with options issued in prior years as they vest. Shares granted in fiscal 2003 totaled 8,479,550 shares, with the majority of these shares being granted in the middle of the third quarter.

 

Total stock compensation costs on a pre-tax basis that would have been recorded had SFAS No. 123 been adopted as of its initial effective date would have totaled $112,863 in fiscal 2003 and $123,159 and $108,462 in fiscal 2002 and 2001, respectively.

 

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 2003, 2002 and 2001:

 

     2003

   2002

   2001

Risk free interest rate

   3.30%    4.45%    4.96%

Expected life

   6 years    5 years    5 years

Expected volatility

   46%    46%    43%

Expected dividend yield

   0%    0%    0%

 

Stock option transactions relating to the aggregate of the 1993 and 2002 plans are summarized below (shares in thousands):

 

     2003

   2002

   2001

     Shares

    Price(1)

   Shares

    Price(1)

   Shares

    Price(1)

Under option at beginning of year

   42,961     $ 31.49    39,578     $ 29.15    36,021     $ 26.09

Granted(2)

   8,480       30.47    7,641       38.10    8,822       34.18

Exercised

   (2,154 )     16.13    (3,571 )     18.77    (4,457 )     14.04

Cancelled

   (497 )     37.14    (687 )     37.12    (808 )     31.35
    

 

  

 

  

 

Under option at end of year

   48,790     $ 31.93    42,961     $ 31.49    39,578     $ 29.15
    

 

  

 

  

 


(1)   Weighted-average exercise price/grant price.

 

(2)   The weighted-average fair value based on the Black-Scholes model of options granted during fiscal 2003, 2002 and 2001, were $14.84, $17.83 and $15.47, respectively.

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 5—Stock Options (Continued)

 

The following table summarizes information regarding stock options outstanding at August 31, 2003 (number of options in thousands):

 

     Options Outstanding

   Options Exercisable

Range of Prices


   Number

   Remaining
Contractual
Life(1)


   Price(1)

   Number

   Price(1)

$6.66–$30.47

   19,035    6.22    $ 22.61    11,054    $ 17.01

$31.55–$36.91

   16,604    6.80      35.19    8,660      35.82

$38.79–$52.50

   13,151    7.51      41.30    5,433      42.59
    
  
  

  
  

     48,790    6.77    $ 31.93    25,147    $ 29.02
    
  
  

  
  


(1)   Weighted-average.

 

At September 1, 2002 and September 2, 2001, there were 19,843 and 15,500 options exercisable at weighted average exercise prices of $25.40 and $21.57, respectively.

 

Note 6—Retirement Plans

 

The Company has a 401(k) Retirement Plan that is available to all U.S. employees who have completed 90 days of employment. For all US employees, with the exception of 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.

 

California union employees participate in a defined benefit plan sponsored by their union. The Company makes contributions based upon its union agreement. For all the California union employees, the Company sponsored 401(k) plan currently allows pre-tax deferral against which the Company matches 50% of the first four hundred dollars of employee contributions. The Company has a defined contribution plan for Canadian and United Kingdom employees and contributes a percentage of each employee’s salary.

 

Amounts expensed under these plans were $149,392, $127,189, and $108,256 for fiscal 2003, 2002 and 2001, respectively. The Company has defined contribution 401(k) and retirement plans only, and thus has no liability for post-retirement benefit obligations under the SFAS No. 106 “Employer’s Accounting for Post-retirement Benefits Other than Pensions.”

 

46


Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 7—Income Taxes

 

The provisions for income taxes for fiscal 2003, 2002 and 2001 are as follows:

 

     2003

    2002

   2001

 

Federal:

                       

Current

   $ 295,323     $ 331,455    $ 285,460  

Deferred

     35,150       5,263      1,102  
    


 

  


Total federal

     330,473       336,718      286,562  
    


 

  


State:

                       

Current

     58,739       48,256      55,484  

Deferred

     (470 )     4,269      (415 )
    


 

  


Total state

     58,269       52,525      55,069  
    


 

  


Foreign:

                       

Current

     9,634       46,197      19,161  

Deferred

     38,857       2,761      40,600  
    


 

  


Total foreign

     48,491       48,958      59,761  
    


 

  


Total provision for income taxes

   $ 437,233     $ 438,201    $ 401,392  
    


 

  


 

In the fourth quarter of fiscal 2003 and 2002 the Company adjusted the annual effective tax rate used in calculating the tax provision from 38.5% to 37.75%, and from 40% to 38.5%, respectively, resulting in the reduction in the income tax provision in the fourth quarter of $5,873 and $11,315, respectively.

 

Reconciliation between the statutory tax rate and the effective rate for fiscal 2003, 2002 and 2001 is as follows:

 

     2003

    2002

    2001

 

Federal taxes at statutory rate

   $ 405,382     35.00 %   $ 398,364    35.00 %   $ 351,218    35.00 %

State taxes, net

     37,875     3.27       34,145    3.00       35,824    3.57  

Foreign taxes, net

     (396 )   (0.03 )     2,732    0.24       10,938    1.09  

Other

     (5,628 )   (0.49 )     2,960    0.26       3,412    0.34  
    


 

 

  

 

  

Provision at effective tax rate

   $ 437,233     37.75 %   $ 438,201    38.50 %   $ 401,392    40.00 %
    


 

 

  

 

  

 

The components of the deferred tax assets and liabilities are as follows:

 

     August 31,
2003


    September 1,
2002


Accrued liabilities and reserves

   $ 168,683     $ 151,520

Deferred membership fees

     141,005       137,231

Other

     28,465       30,271
    


 

Total deferred tax assets

     338,153       319,022
    


 

Property and equipment

     210,822       175,344

Merchandise inventories

     64,701       51,951

Other receivables

     91,126       46,686
    


 

Total deferred tax liabilities

     366,649       273,981
    


 

Net deferred tax (liabilities) assets

   $ (28,496 )   $ 45,041
    


 

 

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Table of Contents

COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 7—Income Taxes (Continued)

 

The deferred tax accounts at August 31, 2003 and September 1, 2002 include current deferred income tax assets of $213,939 and $173,602, respectively; non-current deferred income tax assets of $14,316 and $0, respectively; current deferred income tax liabilities of $74,002 and $0, respectively; and non-current deferred income tax liabilities of $182,749 and $128,561, respectively.

 

The Company has not provided for U.S. deferred taxes on cumulative undistributed earnings of non-U.S. affiliates aggregating approximately $622,017 at August 31, 2003, as such earnings have been reinvested for the foreseeable future. Because of the availability of U.S. foreign tax credits, it is not practicable to determine the U.S. federal income tax liability or benefit associated with such earnings if such earnings were not reinvested for the foreseeable future.

 

Note 8—Commitments and Contingencies

 

Legal Proceedings

 

The Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company is a defendant in two actions purportedly brought as class actions on behalf of certain present and former Costco managers in California, in which plaintiffs allege that they have not been properly compensated for overtime work. Presently, claims are made under various provisions of the California Labor Code and the California Business and Professions Code. Plaintiffs seek restitution/disgorgement, compensatory damages, various statutory penalties, liquidated damages, punitive, treble and exemplary damages, and attorneys’ fees. In neither case has the Court been asked yet to determine whether the action should proceed as a class action or, if so, the definition of the class. The Company expects to vigorously defend these actions. The Company does not believe that any 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 its operations.

 

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COSTCO WHOLESALE CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data) (Continued)

 

Note 9—Segment Reporting

 

The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the United States, Canada, Japan and through majority-owned subsidiaries in the United Kingdom, Taiwan and Korea and through a 50%-owned joint venture in Mexico. The Company’s reportable segments are based on management responsibility and exclude the Mexico joint-venture, as it is accounted for under the equity method and therefore its operations are not consolidated in the Company’s financial statements.

 

     United States
Operations


   Canadian
Operations


   Other
International
Operations


    Total

Year Ended August 31, 2003

                            

Total revenue

   $ 35,119,039    $ 5,237,023    $ 2,189,490     $ 42,545,552

Operating income

     927,590      199,043      29,995       1,156,628

Depreciation and amortization

     323,850      33,732      33,720       391,302

Capital expenditures

     698,713      68,432      43,520       810,665

Long lived assets

     5,705,675      612,647      641,686       6,960,008

Total assets

     10,522,260      1,579,972      1,089,456       13,191,688

Net assets

     5,141,056      783,521      630,403       6,554,980

Year Ended September 1, 2002

                            

Total revenue

   $ 32,310,812    $ 4,750,173    $ 1,701,514     $ 38,762,499

Operating income

     924,330      192,161      15,044       1,131,535

Depreciation and amortization

     281,812      33,477      26,492       341,781

Capital expenditures

     868,069      35,098      135,438       1,038,605

Long lived assets

     5,387,772      514,854      620,993       6,523,619

Total assets

     9,418,500      1,198,992      1,002,771       11,620,263

Net assets

     4,485,487      617,731      591,019       5,694,237

Year Ended September 2, 2001

                            

Total revenue

   $ 28,636,483    $ 4,695,778    $ 1,464,776     $ 34,797,037

Operating income (loss)

     813,665      179,095      (493 )     992,267

Depreciation and amortization

     241,777      35,377      24,143       301,297

Capital expenditures

     1,298,889      43,092      105,568       1,447,549

Long lived assets

     4,835,598      516,489      474,498       5,826,585

Total assets

     8,216,242      1,093,789      779,755       10,089,786

Net assets

     3,811,158      548,196      523,586       4,882,940

 

The accounting policies of the segments are the same as those described in Note 1. All inter-segment net sales and expenses are immaterial and have been eliminated in computing net sales and operating profit.

 

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COSTCO WHOLESALE CORPORATION

 

QUARTERLY STATEMENTS OF INCOME (UNAUDITED)

(dollars in thousands, except per share data)

 

Note 10—Quarterly Financial Data (Unaudited)

 

The two tables that follow reflect the unaudited quarterly results of operations for fiscal 2003 and 2002.

 

     52 Weeks Ended August 31, 2003

 
    

First
Quarter

12 Weeks


   

Second
Quarter

12 Weeks


   

Third
Quarter

12 Weeks


   

Fourth
Quarter

16 Weeks


   

Total

52 Weeks


 

REVENUE

                                        

Net sales

   $ 9,010,571     $ 9,920,324     $ 9,344,959     $ 13,416,845     $ 41,692,699  

Membership fees and other

     188,014       193,843       198,112       272,884       852,853  
    


 


 


 


 


Total revenue

     9,198,585       10,114,167       9,543,071       13,689,729       42,545,552  

OPERATING EXPENSES

                                        

Merchandise costs

     8,048,897       8,840,411       8,358,323       11,987,752       37,235,383  

Selling, general and administrative

     888,779       967,051       923,309       1,318,259       4,097,398  

Preopening expenses

     18,117       7,145       5,853       5,528       36,643  

Provision for impaired assets and closing costs

     5,000       4,500       6,000       4,000       19,500  
    


 


 


 


 


Operating income

     237,792       295,060       249,586       374,190       1,156,628  

OTHER INCOME (EXPENSE)

                                        

Interest expense

     (8,468 )     (8,003 )     (8,715 )     (11,734 )     (36,920 )

Interest income and other

     7,634       8,983       9,179       12,729       38,525  
    


 


 


 


 


INCOME BEFORE INCOME TAXES

     236,958       296,040       250,050       375,185       1,158,233  

Provision for income taxes

     91,229       113,975       96,270       135,759       437,233  
    


 


 


 


 


NET INCOME

   $ 145,729     $ 182,065     $ 153,780     $ 239,426     $ 721,000  
    


 


 


 


 


NET INCOME PER COMMON SHARE:

                                        

Basic

   $ .32     $ .40     $ .34     $ .52     $ 1.58  
    


 


 


 


 


Diluted

   $ .31     $ .39     $ .33     $ .51     $ 1.53  
    


 


 


 


 


Shares used in calculation (000’s)

                                        

Basic

     455,570       455,927       456,370       457,187       456,335  

Diluted

     478,857       478,564       479,183       480,384       479,326  

 

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COSTCO WHOLESALE CORPORATION

 

QUARTERLY STATEMENTS OF INCOME (UNAUDITED)

(dollars in thousands, except per share data)

 

Note 10—Quarterly Financial Data (Unaudited) (Continued)

 

     52 Weeks Ended September 1, 2002

 
    

First
Quarter

12 Weeks


   

Second
Quarter

12 Weeks


   

Third
Quarter

12 Weeks


   

Fourth
Quarter

16 Weeks


   

Total

52 Weeks


 

REVENUE

                                        

Net sales

   $ 8,297,076     $ 9,208,413     $ 8,436,807     $ 12,050,797     $ 37,993,093  

Membership fees and other

     169,477       174,439       179,940       245,550       769,406  
    


 


 


 


 


Total revenue

     8,466,553       9,382,852       8,616,747       12,296,347       38,762,499  

OPERATING EXPENSES

                                        

Merchandise costs

     7,434,397       8,212,030       7,583,251       10,753,443       33,983,121  

Selling, general and administrative

     786,118       840,005       806,617       1,142,796       3,575,536  

Preopening expenses

     22,134       8,616       6,077       14,430       51,257  

Provision for impaired assets and closing costs

     8,550       3,000       4,500       5,000       21,050  
    


 


 


 


 


Operating income

     215,354       319,201       216,302       380,678       1,131,535  

OTHER INCOME (EXPENSE)

                                        

Interest expense

     (6,238 )     (6,199 )     (8,643 )     (8,016 )     (29,096 )

Interest income and other

     6,977       7,926       9,624       11,218       35,745  
    


 


 


 


 


INCOME BEFORE INCOME TAXES

     216,093       320,928       217,283       383,880       1,138,184  

Provision for income taxes

     86,437       128,372       86,913       136,479       438,201  
    


 


 


 


 


NET INCOME

   $ 129,656     $ 192,556     $ 130,370     $ 247,401     $ 699,983  
    


 


 


 


 


NET INCOME PER COMMON SHARE:

                                        

Basic

   $ 0.29     $ 0.43     $ 0.29     $ 0.54     $ 1.54  
    


 


 


 


 


Diluted

   $ 0.28     $ 0.41     $ 0.28     $ 0.52     $ 1.48  
    


 


 


 


 


Shares used in calculation (000’s)

                                        

Basic

     451,990       452,882       454,272       455,008       453,650  

Diluted

     477,395       479,931       480,256       479,240       479,262  

 

Note 11—Subsequent Events

 

Subsequent to the Company’s fiscal year end, the Company, on October 3, 2003, acquired from Carrefour Nederland B.V. its 20% equity interest in Costco Wholesale UK Limited for cash of approximately $95,000, bringing Costco’s ownership in Costco Wholesale UK Limited to 100%.

 

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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 that 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)
2.1.3    Amendment No. 1 to Agreement Concerning Transfer of Certain Assets dated May 29, 1997(2)
3.1      Amended and Restated Articles of Incorporation of Costco Wholesale Corporation(3)
3.2      Bylaws of Costco Wholesale Corporation(11)
4.1.1    Form of 7 1/8% Senior Notes(4)
4.1.2    Indenture between Price/Costco, Inc. and American Bank National Association, as Trustee(4)
4.2.1    Form of Zero Coupon Note due 2017(2)
4.2.2    Indenture dated as of August 19, 1997 between Costco Companies, Inc. and Firstar Bank of Minnesota as Trustee(2)
4.3      Costco Wholesale Corporation Stock Certificate(9)
4.4      Form of 5 1/2% Senior Notes(14)
10.1.1    Costco Companies, Inc. 1993 Combined Stock Grant and Stock Option Plan(1)
10.1.2    Amendments to Stock Option Plan, 1995(7)
10.1.3    Amendments to Stock Option Plan, 1997(8)
10.1.4    Amendments to Stock Option Plan, 2000(10)
10.1.5    Amendments to Stock Option Plan, 2002(13)
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)
10.5.3    A $250 million Short-Term Revolving Credit Agreement among Costco Wholesale Corporation and a group of ten banks, dated November 15, 2000(12)
10.5.4    A $250 million Extended Revolving Credit Agreement among Costco Wholesale Corporation and a group of ten banks dated November 15, 2000(12)
10.6.1    Executive Employment Agreement between James D. Sinegal and Costco Wholesale Corporation
10.7      Revolving Credit Agreement between Costco Wholesale Canada Ltd and Royal Bank of Canada, dated March 24, 2003(16)
12.1      Statement re computation of ratios(11)
16.1      Letter regarding change in certifying accountant(15)
21.1      Subsidiaries of the Company
23.1      Consent of KPMG LLP
23.2      Notice of Inability to Obtain Consent from Arthur Andersen LLP
31.1      Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2      Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1      Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2      Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  (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.

 

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Table of Contents
  (2)   Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10-K of Costco Companies, Inc. for the fiscal year ended August 31, 1997.

 

  (3)   Incorporated by reference to the exhibits filed as part of the Current Report on Form 8-K filed by Costco Wholesale Corporation on August 30, 1999.

 

  (4)   Incorporated by reference to Annex A to Schedule 14A of Costco Wholesale Corporation filed December 13, 1999.

 

  (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 Annual Report on Form 10-K of Price/Costco, Inc. for the fiscal year ended September 3, 1995.

 

  (8)   Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10-K of Costco Companies, Inc. for the fiscal year ended August 30, 1998.

 

  (9)   Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10-K of Costco Wholesale Corporation for the fiscal year ended August 29, 1999.

 

(10)   Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10-K of Costco Wholesale Corporation for the fiscal year ended September 3, 2000.

 

(11)   Incorporated by reference to the exhibits filed as part of the Registration Statement of Costco Wholesale Corporation on Form S-3 (File No. 333-72122) dated October 23, 2001.

 

(12)   Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10-K of Costco Wholesale Corporation for the fiscal year ended September 2, 2001.

 

(13)   Incorporated by reference to the exhibits filed as part of the Registration Statement of Costco Wholesale Corporation on Form S-8 (File No. 333-82782) dated February 14, 2002.

 

(14)   Incorporated by reference to the exhibits filed as part of the current report on form 8-K filed by Costco Wholesale Corporation on March 25, 2002.

 

(15)   Incorporated by reference to the exhibits filed as part of the current report on Form 8-K and 8-K/A filed by Costco Wholesale Corporation on May 17, 2002 and May 31, 2002, respectively.

 

(16)   Incorporated by reference to exhibits filed as part of the Quarterly Report on Form 10-Q of Costco Wholesale Corporation for the fiscal third quarter ended May 11, 2003.

 

53