Costco Wholesale Corporation is an American wholesale chain with headquarters in Issaquah near Seattle, Washington State.
UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
Commission file number 0-20355
Costco Wholesale Corporation (Exact name of registrant as specified in its charter)
(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:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
The registrant had 454,783,073 common shares, par value $.005, outstanding at June 1, 2002.
COSTCO WHOLESALE CORPORATION
INDEX TO FORM 10-Q
PART I—FINANCIAL INFORMATION
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ITEM 1. Financial Statements
Costco Wholesale Corporation's ("Costco" or the "Company") unaudited condensed consolidated balance sheet as of May 12, 2002, the condensed consolidated balance sheet as of September 2, 2001, the unaudited condensed consolidated statements of income and cash flows for the 12- and 36-week periods ended May 12, 2002 and May 13, 2001, are included elsewhere herein. Also included elsewhere herein are notes to the unaudited condensed consolidated financial statements and the results of the limited review of the unaudited financial statements as of May 12, 2002 and for the 12 and 36-week periods then ended performed by KPMG LLP, independent public accountants. Arthur Andersen LLP, the Company's prior independent public accountants, performed a limited review as of May 13, 2001, and for the 12 and 36-week periods then ended.
The Company reports on a 52/53-week fiscal year, consisting of 13 four-week periods and ending on the Sunday nearest the end of August. Fiscal 2002 is a 52-week year with period 13 ending on September 1, 2002, with the first, second, and third quarters consisting of 12 weeks each and the fourth quarter consisting of 16 weeks. Fiscal 2001 was a 52-week year that ended on September 2, 2001, with the first, second, and third quarters consisting of 12 weeks each and the fourth quarter consisting of 16 weeks.
ITEM 2. 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 and ownership or use of real estate, actions of vendors and other risks identified in the Company's reports filed with the Securities and Exchange Commission.
It is suggested that this management discussion be read in conjunction with the management discussion included in the Company's fiscal 2001 annual report on Form 10-K previously filed with the Securities and Exchange Commission.
Comparison of the 12 Weeks ended May 12, 2002 and May 13, 2001(dollars in thousands, except per share data)
Net income for the third quarter of fiscal 2002 increased 24% to $130,370, or $.28 per diluted share, compared to $105,257, or $.23 per diluted share, during the third quarter of fiscal 2001.
Net sales increased 12% to $8,436,807 during the third quarter of fiscal 2002, from $7,563,494 during the third quarter of fiscal 2001. This increase was due to opening a net of 29 new warehouses (34 opened, 5 closed) since the end of the third quarter of fiscal 2001 and an increase in comparable warehouse sales. Comparable sales, that is sales in warehouses open for at least a year, increased 6% during the third quarter of fiscal 2002 over the third quarter of fiscal 2001. Changes in prices of merchandise did not materially contribute to sales increases.
Membership fees and other revenue increased 16% to $179,940, or 2.13% of net sales, in the third quarter of fiscal 2002 from $155,401, or 2.05% of net sales, in the third quarter of fiscal 2001. Increases in membership fee income, which is accounted for on a "deferred basis", whereby income is recognized ratably over the one-year life of the membership, reflect an increase in the annual membership fee – averaging approximately $5 per member across all member categories – beginning with renewals on October 1, 2000; new membership sign-ups, both at the new warehouses opened since the end of the third quarter of fiscal 2001 and at existing warehouse locations; and increased penetration of the Company's
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Executive Membership. Overall, member renewal rates remain consistent with the prior year, currently at 86%.
Gross margin (defined as net sales minus merchandise costs) increased 16% to $853,556, or 10.12% of net sales, in the third quarter of fiscal 2002 from $737,858, or 9.76% of net sales, in the third quarter of fiscal 2001. The increase in gross margin as a percentage of net sales primarily reflects an overall gross margin improvement across nearly all categories within the core warehouse business and from pharmacy and gasoline ancillary operations, which was partially offset by the costs related to the Executive Membership two-percent reward program. The gross margin figures reflect accounting for merchandise costs on the last-in, first-out (LIFO) method. The third quarters of fiscal 2002 and fiscal 2001 each included a $2,500 LIFO provision.
Selling, general and administrative expenses as a percent of net sales increased to 9.56% during the third quarter of fiscal 2002 from 9.33% during the third quarter of fiscal 2001. This percentage increase was primarily due to higher expense ratios at new warehouses, where the ratio of operating expenses to sales is typically higher than at more mature warehouses. In addition, salary and health care costs had a negative impact quarter-over-quarter.
Preopening expenses totaled $6,077, or 0.07% of net sales, during the third quarter of fiscal 2002 compared to $12,751, or 0.17% of net sales, during the third quarter of fiscal 2001. Four new warehouses were opened in the third quarter of fiscal 2002 compared to nine warehouses opened during last year's third quarter.
The provision for impaired assets and closing costs was a net $4,500 in the third quarter of fiscal 2002 compared to a net of $0 in the third quarter of fiscal 2001. The fiscal 2002 provision includes warehouse closing costs of $5,126, whereas the fiscal 2001 provision reflected warehouse closing costs of $5,157, and a $3,000 charge related to the reorganization of the Canadian administrative operations. Both years' provisions were offset by gains on the sale of real property.
Interest expense totaled $8,643 in the third quarter of fiscal 2002 compared to $9,023 in the third quarter of fiscal 2001. The decrease is primarily attributable to the retirement of a $140,000 unsecured note payable to banks in April 2001 and to the interest rate reduction on the Company's $300,000 71/8% Senior Notes, resulting from interest rate swap agreements entered into effective November 13, 2001, converting the interest rate from fixed to floating. Offsetting this decrease was interest on the $300,000 51/2% Senior Notes sold in March, 2002. Additionally, capitalized interest related to warehouse construction was lower 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.
Interest income and other totaled $9,624 in the third quarter of fiscal 2002 compared to $9,801 in the third quarter of 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 the third quarter of fiscal 2002 as compared to the third quarter of fiscal 2001. Increased earnings year-over-year in Costco Mexico, the Company's 50% -owned joint venture, offset the majority of this decrease.
The effective income tax rate on earnings in the third quarter of both fiscal 2002 and 2001 was 40%.
Comparison of the 36 Weeks ended May 12, 2002 and May 13,2001(dollars in thousands, except per share data)
Net income for the first thirty-six weeks of fiscal 2002 increased 10% to $452,582, or $.96 per diluted share, from $411,355, or $.88 per diluted share, during the first thirty-six weeks of fiscal 2001.
Net sales increased 12% to $25,942,296 during the first thirty-six weeks of fiscal 2002, from $23,222,453 during the first thirty-six weeks of fiscal 2001. This increase was due to opening a net of 29 new warehouses (34 opened, 5 closed) since the end of the first thirty-six weeks of fiscal 2001 and an increase in
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comparable warehouse sales. Comparable sales, that is sales in warehouses open for at least a year, increased 6% during the first thirty-six weeks of fiscal 2002. Changes in prices of merchandise did not materially contribute to sales increases.
Membership fees and other revenue increased 19% to $523,856, or 2.02% of net sales, in the first thirty-six weeks of fiscal 2002 from $440,029, or 1.89% of net sales, in the first thirty-six weeks of fiscal 2001. Increases in membership fee income reflect an increase in the annual membership fee – averaging approximately $5 per member across all member categories – beginning with renewals on October 1, 2000; new membership sign-ups, both at the new warehouses opened since the end of the third quarter of fiscal 2001 and at existing warehouse locations; and increased penetration of the Company's Executive Membership. Overall, member renewal rates remain consistent with the prior year, currently at 86%.
Gross margin (defined as net sales minus merchandise costs) increased 13% to $2,712,618, or 10.46% of net sales, in the first thirty-six weeks of fiscal 2002 from $2,407,215, or 10.37% of net sales, in the first thirty-six weeks of fiscal 2001. The increase in gross margin as a percentage of net sales primarily reflects merchandise gross margin improvement predominately within the fresh foods department and within other warehouse ancillary businesses, which was partially offset by the increased costs related to the Executive Membership two-percent reward program. The gross margin figures reflect accounting for merchandise costs on the last-in, first-out (LIFO) method. The first thirty-six weeks of fiscal 2002 and fiscal 2001 each included a $7,500 LIFO provision.
Selling, general and administrative expenses as a percent of net sales increased to 9.38% during the first thirty-six weeks of fiscal 2002 from 9.17% during the first thirty-six weeks of 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. In addition, salary and health care costs had a negative impact on a period-over-period basis.
Preopening expenses totaled $36,827 or 0.14% of net sales during the first thirty-six weeks of fiscal 2002 compared to $43,003 or 0.19% of net sales during the first thirty-six weeks of fiscal 2001. Twenty-seven new warehouses (including three relocated warehouses) were opened in the first thirty-six weeks of fiscal 2002, compared to 32 warehouses opened (including five relocated warehouses) during last year's first thirty-six weeks. Preopening expenses also include costs related to remodels, including expanded fresh foods and ancillary operations at existing warehouses, as well as costs associated with expanding international operations.
A provision for impaired assets and closing costs of $16,050 was recorded in the first thirty-six weeks of fiscal 2002 compared to $2,000 in the first thirty-six weeks of fiscal 2001. The current year provision includes costs related to the reorganization and consolidation of the Canadian administrative operations (which has been completed) totaling $8,550, compared to a reorganization and consolidation charge of $3,000 in the first thirty-six weeks of fiscal 2001. The provision also includes warehouse closing costs of $8,643 and $7,157 in fiscal 2002 and 2001, respectively, which were offset by gains on sales of real property.
Interest expense totaled $21,080 in the first thirty-six weeks of fiscal 2002 compared to $24,889 in the first thirty-six weeks of fiscal 2001. The decrease is primarily attributable to the retirement of a $140,000 unsecured note payable to banks in April 2001 and to the interest rate reduction on the Company's $300,000 71/8% 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. Additional offsets to this decrease resulted from interest on the $300,000 51/2% Senior Notes sold in March, 2002, and higher average outstanding commercial paper balances in fiscal 2002.
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Interest income and other totaled $24,527 in the first thirty-six weeks of fiscal 2002 compared to $36,635 in the first thirty-six weeks of 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 the first thirty-six weeks of fiscal 2002, as compared to the year-earlier first thirty-six weeks. This was partially offset by increased earnings in Costco Mexico, the Company's 50%-owned joint venture, year-over-year.
The effective income tax rate on earnings in the first thirty-six weeks of both fiscal 2002 and 2001 was 40%.
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 $950,000 to $1,050,000 during fiscal 2002 in the United States and Canada for real estate, construction, remodeling and equipment for warehouse clubs and related operations; and approximately $100,000 to $150,000 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 revolving credit facilities and other financing sources as required.
Expansion plans during fiscal 2002 are to open approximately 35 new warehouse clubs, primarily in the United States, including six relocations to larger and better-situated sites. The Company opened one warehouse in the United States and three additional units in the United Kingdom, through its 80%-owned subsidiary, during the third quarter. Expansion plans for the fourth quarter of fiscal 2002 are to open eight warehouses in the United States, including three relocations.
Reorganization of Canadian Administrative Operations
On January 17, 2001, the Company announced plans to reorganize and consolidate the administration of its operations in Canada. Anticipated costs related to the reorganization were estimated to total $26,000 pre-tax ($15,600 after-tax, or $.03 per diluted share), expensed as incurred in the third and fourth quarters of fiscal 2001 and the first quarter of fiscal 2002. During the first quarter of fiscal 2002 the Company expensed $8,550 (of the actual total of $27,550) related to this reorganization and consolidation process and reported this charge 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 has been completed and no additional costs were incurred in the third quarter of fiscal 2002, or are anticipated to occur in the future.
Bank Credit Facilities and Commercial Paper Programs (all amounts stated in thousands of US dollars, unless otherwise noted)
The Company has in place a $500,000 commercial paper program supported by a $500,000 bank credit facility with a group of ten banks, of which $250,000 expires on November 12, 2002 and $250,000 expires on November 15, 2005. At May 12, 2002, no amounts were outstanding under the commercial paper program or the credit facility.
In addition, a wholly owned Canadian subsidiary has a $128,000 commercial paper program supported by a $51,000 bank credit facility with three Canadian banks, which expires in March, 2003. At
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May 12, 2002, 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 $551,000 combined amounts of the respective supporting bank credit facilities.
The Company's wholly-owned Japanese subsidiary has a short-term ¥3 billion bank line of credit, equal to approximately $23,000, expiring in November 2002. At May 12, 2002, $3,900 was outstanding under the line of credit.
The Company's 80%-owned UK subsidiary has a £60 million ($87,000) bank revolving credit facility and a £20 million ($29,000) bank overdraft facility, both expiring in February, 2007. At May 12, 2002, $50,904 was outstanding under the revolving credit facility and $11,199 was outstanding under the bank overdraft facility.
Letters of Credit
The Company has separate letter of credit facilities (for commercial and standby letters of credit), totaling approximately $389,000. The outstanding commitments under these facilities at May 12, 2002 totaled approximately $71,000, including approximately $31,000 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 May 12, 2002.
Financing Activities
On October 23, 2001, the Company filed with the Securities and Exchange Commission a shelf registration statement for $600,000 of senior debt securities. On March 20, 2002 the Company completed the sale of $300,000 principal amount of 51/2% senior notes due March 15, 2007. Net proceeds of the sale of the senior notes were used to retire outstanding commercial paper of $222,000, with the balance placed in short-term investments. On March 25, 2002, the Company entered into a "fixed-to-floating" interest rate swap agreement that replaced the fixed interest rate on this $300,000 51/2% senior debt with a floating interest rate indexed to LIBOR.
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
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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 May 12, 2002, the Company had "fixed-to-floating" interest rate swaps with an aggregate notional amount of $600,000 and an aggregate fair value of $3,206, of which $7,240 is recorded in other assets and $4,034 is recorded in other long-term liabilities. 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 71/8% Senior Notes and the Company's $300,000 51/2% 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.
Financial Position and Cash Flows
Working capital totaled approximately $57,000 at May 12, 2002, compared to a negative working capital position of approximately $230,000 at September 2, 2001. The increase of approximately $287,000 was primarily due to increases in cash and cash equivalents of approximately $239,000; an increase in net inventory levels (inventories less accounts payable) of approximately $174,000 and a decrease in short-term borrowings of approximately $140,000, offset by increases in other current liabilities of approximately $136,000; accrued salaries and benefits of approximately $53,000; deferred membership income of approximately $46,000 and a decrease in receivables of approximately $36,000.
Net cash provided by operating activities totaled $850,316 in the first thirty-six weeks of fiscal 2002, compared to $753,561 in the first thirty-six weeks of fiscal 2001. The increase of $96,755 is primarily a result of a larger increase in the change in receivables, other current assets, accrued and other current liabilities of $175,302; higher net income in fiscal 2002 over fiscal 2001of $41,227 and a larger add-back for depreciation and amortization of $24,626, offset by a larger increase in net inventories (inventories less accounts payable) of $133,896.
Net cash used in investing activities totaled $764,705 in the first thirty-six weeks of fiscal 2002, compared to $924,420 in the first thirty-six weeks of fiscal 2001, a decrease of $159,715. This decrease is primarily a result of decreases in the change in additions to property and equipment for new and remodeled warehouses of $216,693 and investments in unconsolidated joint ventures of $27,500 which was offset by the decrease in the change in net cash proceeds from sales of short-term investments of $36,835 and proceeds from the sale of property and equipment of $30,176.
Net cash provided by financing activities totaled $153,928 in the first thirty-six weeks of fiscal 2002 compared to $213,614 in the first thirty-six weeks of fiscal 2001, a decrease of $59,686. The decrease primarily resulted from an increase in the change in net repayments of short-term borrowings of $225,082 and a decrease in the change in bank overdrafts of $239,765, offset by an overall increase in the change in proceeds from the issuance of long-term debt of $255,949 and a decrease in repayments of long-term debt of $134,363.
The Company's balance sheet as of May 12, 2002 reflects a $1,057,731 or 10.5% increase in total assets since September 2, 2001. The increase is primarily due to an increase in net property and equipment of $512,615; an increase in inventories of $286,820; and an increase in cash and cash equivalents of $238,529.
Stock Repurchase Program (dollars in thousands except per share data)
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. 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 unissued 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.
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Membership Fee Increases
Effective September 1, 2000, the Company increased annual membership fees for its Gold Star (individual), Business, and Business Add-on Members. These fee increases averaged approximately $5 per member across its member categories, and are recorded as income ratably using the deferred method of accounting.
Significant 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 reserves. 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. The Company records a provision each quarter for the estimated annual effect of inflation, and these estimates are adjusted to actual results determined at year-end. 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.
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 Reserve
The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers' compensation, general liability, property insurance, 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, 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 (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. On September 3, 2001, the Company adopted SFAS No. 142 and accordingly will continue to test previously reported goodwill for impairment on an annual basis, or more frequently if circumstances dictate. The overall effect of the adoption of SFAS No. 142 on the Company's financial statements was not material and the Company recorded no impairment charge. The reduction in amortization expense going forward, as a result of the adoption, is not material.
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In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," effective for the Company on September 2, 2002 (beginning of fiscal 2003). This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company is in the process of evaluating the financial statement impact of the adoption of SFAS No. 143.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," effective for the Company on September 2, 2002 (beginning of fiscal 2003). 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 Company is in the process of evaluating the financial statement impact of the adoption of SFAS No. 144, but does not believe it will have any significant impact at this time.
PART II—OTHER INFORMATION (dollars in thousands)
ITEM 1. Legal Proceedings
The Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company's financial position or results of its operations.
ITEM 2. Changes in Securities
None.
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 5. Other Information
ITEM 6. Exhibits and Reports on Form 8-K
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SIGNATURES
Pursuant to the requirements 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.
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COSTCO WHOLESALE CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS(dollars in thousands, except par value)(unaudited)
The accompanying notes are an integral part of these financial statements
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COSTCO WHOLESALE CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF INCOME(dollars in thousands, except per share data)(unaudited)
The accompanying notes are an integral part of these financial statements.
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COSTCO WHOLESALE CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(dollars in thousands)(unaudited)
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)(unaudited)
NOTE (1)—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and pursuant to the rules and regulations of the Securities and Exchange Commission. While these statements reflect all normal recurring adjustments which are, in the opinion of management, necessary for fair presentation of the results of the interim period, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report filed on Form 10-K for the fiscal year ended September 2, 2001.
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 Wholesale Corporation primarily operates membership warehouses under the Costco Wholesale name.
Costco operates membership warehouses that offer very low prices on a limited selection of nationally branded and selected private label products in a wide range of merchandise categories in no-frills, self-service warehouse facilities. At May 12, 2002, Costco operated 389 warehouse clubs: 285 in the United States; 60 in Canada; 14 in the United Kingdom; five in Korea; three in Taiwan; and two in Japan. The Company also operated (through a 50%-owned joint venture) 20 warehouses in Mexico. Additionally, the Company operates Costco Online, an electronic commerce web site, at www.costco.com.
The Company's investments 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.
Fiscal Years
The Company reports on a 52/53-week fiscal year basis, which ends on the Sunday nearest August 31st. Fiscal year 2002 is a 52-week year, with the first, second and third quarters consisting of 12 weeks each and the fourth quarter, ending September 1, 2002, consisting of 16 weeks. Fiscal year 2001 was also a 52-week year, which ended September 2, 2001.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less, at the time of purchase, to be cash equivalents.
Receivables, net
Receivables consist primarily of vendor rebates and promotional allowances and other miscellaneous amounts due to the Company, and are net of allowance for doubtful accounts of $2,429 and $3,474 at May 12, 2002 and September 2, 2001, respectively.
Merchandise Inventories, net
Merchandise inventories are valued at the lower of cost or market as determined primarily by the retail inventory method, and are stated using the last-in, first-out (LIFO) method for substantially all U.S. merchandise inventories. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. If all merchandise inventories had been valued using the first-in, first-out (FIFO) method, inventories would have been higher by $21,150
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at May 12, 2002 and $13,650 at September 2, 2001. The Company provides for estimated inventory losses between physical inventory counts on the basis of a percentage of sales. This provision is adjusted periodically to reflect the trend of the actual physical inventory count, which generally occur in the second and fourth fiscal quarters.
Goodwill
Goodwill, net of accumulated amortization, resulting from certain business combinations is included in other assets, and totaled $43,705 at May 12, 2002 and $43,831 at September 2, 2001. On September 3, 2001, the Company adopted Statement of Financial Accounting Standards (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 will test previously reported goodwill for impairment on an annual basis, or more frequently if circumstances dictate.
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 May 12, 2002 and September 2, 2001, are $222,720 and $270,757, respectively, representing the excess of outstanding checks over cash on deposit at the banks on which the checks were drawn.
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 May 12, 2002, the Company had "fixed-to-floating" interest rate swaps with an aggregate notional amount of $600,000 and an aggregate fair value of $3,206, of which $7,240 is recorded in other assets and $4,034 is recorded in other long-term liabilities. 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 71/8% Senior Notes and the Company's $300,000 51/2% 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
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. 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 period. Gains and losses on foreign currency transactions are included in expenses.
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Membership Fees
Membership fee revenue represents annual membership fees paid by substantially all of the Company's members. Membership fee income is accounted for on a "deferred basis," whereby income is recognized ratably over the one-year life of the membership.
Preopening Expenses
Preopening expenses relate to new warehouses, major remodels/expansions, regional offices and other start-up operations and are expensed as incurred.
Closing Costs
Closing costs incurred generally relate to the Company's efforts to relocate certain warehouses that were not otherwise impaired to larger and better-located facilities. In the first thirty-six weeks of fiscal 2002, closing costs also included costs incurred in the reorganization of the Company's Canadian administrative operations. At May 12, 2002, the reserve for warehouse closing costs was $13,433, this compares to a reserve of $15,434 at September 2, 2001.
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.
The diluted share base calculation for the fiscal quarters ended May 12, 2002 and May 13, 2001, excludes 6,893,720 and 7,091,411 stock options outstanding, respectively. The diluted share base calculation for the fiscal year-to-date periods ended May 12, 2002 and May 13, 2001, excludes 6,950,007 and 7,132,315 stock options outstanding, respectively. These options are excluded due to their anti-dilutive effect as a result of their exercise prices being greater than the average market price of the common shares during those fiscal periods.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," effective for the Company on September 2, 2002 (beginning of fiscal 2003). This Statement addresses
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financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company is in the process of evaluating the financial statement impact of the adoption of SFAS No. 143.
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 shareholders' equity. Comprehensive income was $150,867 and $77,660 for the third quarter of fiscal 2002 and 2001, respectively and $447,306 and $345,490 for the first thirty-six weeks of fiscal 2002 and 2001, respectively. Comprehensive income includes the impact of foreign currency translation adjustments.
NOTE (3)—DEBT
Bank Lines of Credit and Commercial Paper Programs
In addition, a wholly owned Canadian subsidiary has a $128,000 commercial paper program supported by a $51,000 bank credit facility with three Canadian banks, which expires in March, 2003. At May 12, 2002, no amounts were outstanding under the Canadian commercial paper program or the bank credit facility.
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Long-term Debt
On March 20, 2002 the Company completed the sale of $300,000 principal amount of 51/2% senior notes due March 15, 2007. Additionally, on March 25, 2002, the Company entered into a "fixed-to-floating" interest rate swap agreement that replaced the fixed interest rate on this $300,000 51/2% senior debt with a floating interest rate indexed to LIBOR.
NOTE (4)—COMMITMENTS AND CONTINGENCIES
The Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company's financial position or results of operations.
NOTE (5)—SEGMENT REPORTING
The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the United States, Canada, and Japan; 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.
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