Costco 2007 Annual Report Download

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YEAR ENDED SEPTEMBER 2, 2007
2007
Annual
Report
2007

Table of contents

  • Page 1
    Annual Report 2007 2007 YEAR ENDED SEPTEMBER 2, 2007

  • Page 2
    ... for Costco Common Stock, Dividend Policy and Stock Repurchase Program ...Five Year Operating and Financial Highlights ...Management's Discussion and Analysis of Financial Condition and Results of Operations ...Directors, Executive Officers and Corporate Governance ...Management's Reports ...Reports...

  • Page 3
    ... 400 0 397 2003 2004 2005 2006 2007 0 2003 2004 2005 Fiscal Year 2006 2007 0 2003 2004 2005 Fiscal Year 2006 2007 Excludes Mexico At Fiscal Year End Comparable Sales Growth Gold Star Members 12% 19 Membership Business Members 5.6 18.619 10% 10% 18 8% 17.338 5.4 5.214 5.401 Percent Increase...

  • Page 4
    ... behind. Two warehouses had sales of more than $300 million, and we expect that figure to continue to grow in the upcoming years. Costco's sales levels are the result, we believe, of well-executed merchandising, a focus on low-cost operations, and fiercely loyal membership and employee bases. People...

  • Page 5
    ... companies in the world to provide our members with a wide range of top quality merchandise. To ensure an ever-changing array of exciting, highquality products, we constantly seek new partnerships and "best of" global suppliers. This past year we are pleased to have established direct relationships...

  • Page 6
    ...money while helping Costco capture a portion of the multi-billion dollar online office supply business. Another way we are servicing our business members is through our Business Centers, which carry a product selection tailored specifically for food service, convenience stores and offices, and offer...

  • Page 7
    ...has no public relations department! On behalf of Costco's management team and employees around the globe, we thank you for your ongoing trust and support. We value your partnership and hope to see many of you at our upcoming Annual Meeting of Shareholders on January 29, 2008, in Bellevue, Washington...

  • Page 8
    ... Concord Corona Redding Redwood City Richmond Rohnert Park Roseville Sacramento Salinas San Bernardino San Diego S.E. San Diego San Francisco S. San Francisco San Jose N.E. San Jose San Juan Capistrano San Leandro San Luis Obispo San Marcos Sand City Santa Clara Santa Clarita Santa Cruz Santa Maria...

  • Page 9
    ... West Homestead W. Bountiful Lehi Murray S. Ogden Orem St. George Salt Lake City Sandy West Valley Aurora Village Bellingham Burlington Clarkston Everett Federal Way Fife - Bus. Ctr. Gig Harbor Issaquah Kennewick Kirkland Kirkland - Costco Home St. John's NOVA SCOTIA (1) Querétaro QUINTANA ROO...

  • Page 10
    BUSINESS OVERVIEW We operate membership warehouses based on the concept that offering our 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. ...

  • Page 11
    ... in Mexico operated 30 warehouses. Our electronic commerce businesses, costco.com in the U.S. and costco.ca in Canada, provide our members additional products generally not found in our warehouses, in addition to services such as digital photo processing, pharmacy, travel and membership services. 9

  • Page 12
    ..., which allows us to offer low prices. Members can utilize their memberships at any Costco warehouse location in any country. We have two primary types of members: Business, and Gold Star (individual). In addition, U.S. and Canadian members can upgrade to an Executive Membership. We continue to...

  • Page 13
    ... 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, business telephone service, check printing, and real estate...

  • Page 14
    ... we formed the Costco Corporate Sustainability and Energy Group, comprised of individuals whose backgrounds include Merchandising, Legal, Operations and Purchasing. This group is responsible for developing company-wide solutions to manage the various aspects of our business most directly related to...

  • Page 15
    ... purchase monthly bus passes. In addition, we encourage employees to ride bikes to work when practical. All of these programs and activities help to reduce our carbon footprint. Available Information We maintain an internet website at www.costco.com. We make available through the Investor Relations...

  • Page 16
    ... stores, supermarkets, supercenter stores, wholesale clubs, internet-based retailers and catalog businesses. Such retailers and wholesale club operators compete in a variety of ways, including merchandise selection and availability, services offered to members, location, store hours and price...

  • Page 17
    ... costs; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets; and failing consistently to provide high quality products and innovative new products to retain our existing member...

  • Page 18
    ... prices. We have no assurances of continued supply, pricing or access to new products, and any vendor could at any time change the terms upon which it sells to us or discontinue selling to us. Sales demands may lead to insufficient in-stock positions of our merchandise. We purchase our merchandise...

  • Page 19
    ... our future operating results. Any failure to meet these expectations for our comparable warehouse sales growth rates, earnings and earnings per share or new warehouse openings could cause the market price of our stock to drop. Cost related to natural disasters could unfavorably affect our financial...

  • Page 20
    ... and wholesale club operators, we receive certain personal information about our members. In addition, our online operations at www.costco.com and www.costco.ca depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments...

  • Page 21
    ... 68.6 million square feet of operating floor space: 54.4 million in the United States, 9.6 million in Canada and 4.6 million in other international locations, excluding Mexico. Administration and Merchandise Distribution Properties Our executive offices are located in Issaquah, Washington and occupy...

  • Page 22
    MARKET FOR COSTCO COMMON STOCK Market Information and Dividend Policy Our common stock is traded on the National Market tier of the NASDAQ Stock Market LLC ("NASDAQ") under the symbol "COST." We are authorized to issue up to 900,000,000 shares of common stock, par value $.005, and up to 100,000,000 ...

  • Page 23
    ... stock repurchase program is provided in Note 5- Stockholders' Equity on pages 64 and 65 of this Annual Report. Equity Compensation Plans Information related to our equity compensation plans is incorporated herein by reference to the Proxy Statement filed with the Securities and Exchange Commission...

  • Page 24
    ...of peer companies (based on weighted market capitalization) selected by the Company: BJ's Wholesale Club, Inc.; The Home Depot, Inc.; Lowe's Companies; Best Buy Co., Inc.; Office Depot, Inc.; Staples Inc.; Target Corporation; Kroger Company; and Wal-Mart Stores, Inc. The information provided is from...

  • Page 25
    ... per share and warehouse data) As of and for the fiscal year ended(1) Sept. 2, 2007 (52 weeks) Sept. 3, 2006 (53 weeks) Aug. 28, 2005 (52 weeks) Aug. 29, 2004 (52 weeks) Aug. 31, 2003 (52 weeks) RESULTS OF OPERATION Net sales ...Merchandise costs ...Gross Margin ...Membership fees ...Operating...

  • Page 26
    ... cost of $54.39 per share. Results of Operations (dollars in thousands, except per share and warehouse number data) The following unusual items impacted fiscal 2007 results: • Sales returns reserve: In connection with changes to our consumer electronics returns policy, we completed a review...

  • Page 27
    ...: Fiscal 2007 (amounts in thousands) Sales return reserve Employee tax consequences on stock options Deferred Membership Excise tax refund Total Net sales ...Membership fees ...Total revenue ...Merchandise costs ...Gross margin(1) ...SG&A ...Operating income ...Interest expense ...Interest income...

  • Page 28
    ... in comparable warehouse sales and $2.03 billion from sales at new warehouses opened during fiscal 2007 and 2006, partially offset by the change in the reserve for estimated sales returns. Changes in prices of merchandise did not materially affect the sales increase. Gasoline sales contributed to...

  • Page 29
    ... and Canada Gold Star (individual), Business and Business Add-on members, which was effective May 1, 2006 for new members and July 1, 2006 for existing members; increased penetration of the higher-fee Executive Membership program; and additional membership sign-ups at the 30 new warehouses opened...

  • Page 30
    ... costs incurred for startup operations related to new warehouses, warehouse remodel projects and the expansion of ancillary operations at existing warehouses. Preopening expenses per warehouse opening can vary due to the timing of the opening relative to our fiscal year end, whether the warehouse...

  • Page 31
    ..., we adjusted our method of accounting for leases (entered into over the previous twenty years), primarily related to ground leases at certain owned warehouse locations that did not require rental payments during the period of construction. We recorded a cumulative pre-tax, non-cash charge of $16...

  • Page 32
    ... in the related debt discount. 2006 vs. 2005 Interest expense totaled $12.6 million in fiscal 2006, compared to $34.4 million in fiscal 2005. Interest expense in fiscal 2006 primarily included interest on the 2002 Senior Notes, the Zero Coupon Notes, and balances outstanding under our bank credit...

  • Page 33
    ...attributable to a non-recurring $54.2 million income tax benefit, primarily from the settlement of a transfer pricing dispute between the United States and Canada (covering the years 1996-2003) and a net tax benefit on excess foreign tax credits on unremitted foreign earnings subject to repatriation...

  • Page 34
    ... card receivables, primarily related to weekend sales immediately prior to the year-end close. The increase in our most liquid assets of $522.4 million to $3.36 billion at September 2, 2007 was due primarily to the issuance of the 2007 Senior Notes and the cash provided by our operating activities...

  • Page 35
    ..., remodeling and equipment for warehouse clubs and related operations. These expenditures are expected to be financed with a combination of cash provided from operations and the use of cash and cash equivalents and short-term investments. Plans for the United States and Canada during fiscal 2008 are...

  • Page 36
    ... plans in our international operations, including the United Kingdom and Asia, along with other international markets. Additional Equity Investments in Subsidiaries and Joint Ventures In each of fiscal years 2006 and 2005, we contributed an additional $15 million to our investment in Costco Mexico...

  • Page 37
    ... the 2.070% promissory notes are reported in the current portion of long-term debt on our consolidated balance sheets. In August 1997, we completed the sale of $900.0 million principal amount at maturity Zero Coupon Notes due in August 2017. The Zero Coupon Notes were priced with a yield to maturity...

  • Page 38
    ... that have had, or are reasonably likely to have, a material current or future effect on our financial condition or consolidated financial statements. Stock Repurchase Programs In January and July of 2006, our Board of Directors approved an additional $1.00 billion and $2.00 billion of stock...

  • Page 39
    ... our financial statements requires that we make estimates and judgments. We continue to review our accounting policies and evaluate our estimates, including those related to revenue recognition, merchandise inventory valuation, impairment of long-lived assets, warehouse closing costs, insurance/self...

  • Page 40
    ...warehouse location. Our judgments are based on existing market and operational conditions. Future events could cause us to conclude that impairment factors exist, requiring a downward adjustment of these assets to their then-current fair market value. We provide estimates for warehouse closing costs...

  • Page 41
    ... effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of a company's first fiscal year that begins after November 15, 2007. We must adopt these new requirements no later than...

  • Page 42
    ... a maturity of three months to five years from the purchase date. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. As the...

  • Page 43
    ... for Director is included in Costco's Proxy Statement for its Annual Meeting of Shareholders to be held on January 29, 2008. A list of the names and positions of the Directors, as well as the Executive and Senior officers of the Company, appears on page 79 of this report. The following is a list of...

  • Page 44
    ... free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. Costco's Form 10-K for its fiscal year ended September 2, 2007, as filed with the Securities and Exchange Commission, includes the certifications of Costco's Chief Executive Officer and Chief...

  • Page 45
    ...in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting...

  • Page 46
    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders Costco Wholesale Corporation: We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries as of September 2, 2007 and September 3, 2006 and the related ...

  • Page 47
    ... OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders Costco Wholesale Corporation: We have audited Costco Wholesale Corporation's (the Company) internal control over financial reporting as of September 2, 2007, based on criteria established in Internal Control...

  • Page 48
    COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in thousands, except par value) September 2, 2007 September 3, 2006 ASSETS CURRENT ASSETS Cash and cash equivalents ...Short-term investments ...Receivables, net ...Merchandise inventories ...Deferred income taxes and other current ...

  • Page 49
    ... CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in thousands, except per share data) 52 weeks ended September 2, 2007 53 weeks ended September 3, 2006 52 weeks ended August 28, 2005 REVENUE Net sales ...Membership fees ...Total revenue ...OPERATING EXPENSES Merchandise costs ...Selling...

  • Page 50
    COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (in thousands) Common Stock Shares...tax benefits and other ...Conversion of convertible notes ...Stock repurchase ...Stock-based compensation ...Cash...part of these consolidated financial statements. 48

  • Page 51
    COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in thousands) 52 Weeks ended September 2, 2007 53 Weeks ended September 3, 2006 52 Weeks ended August 28, 2005 CASH FLOWS FROM OPERATING ACTIVITIES Net income ...Adjustments to reconcile net income to net cash provided by ...

  • Page 52
    ..." or the "Company"). All material inter-company transactions between the Company and its subsidiaries have been eliminated in consolidation. Costco operates membership warehouses that offer low prices on a limited selection of nationally branded and selected private label products in a wide range...

  • Page 53
    ... of fair value is based on publicly available market information or other estimates determined by management. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis. Receivables, net Receivables consist primarily of vendor...

  • Page 54
    ...method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the expected annual effect of inflation, and these estimates are adjusted to actual results determined at year-end. At...

  • Page 55
    ... in the fourth quarter of each fiscal year, or more frequently if circumstances dictate. No impairment of goodwill has been incurred to date. Accounts Payable The Company's banking system provides for the daily replenishment of major bank accounts as checks are presented. Accordingly, included in...

  • Page 56
    ... sheets until the sale or service is completed. The Company provides for estimated sales returns based on historical merchandise returns levels. During 2007, in connection with changes to its consumer electronic returns policy, the Company developed more detailed operational data regarding member...

  • Page 57
    ... the purchase price of inventory sold, inbound shipping charges and all costs related to the Company's depot operations, including freight from depots to selling warehouses and are reduced by vender consideration received. Merchandise costs also include salaries, benefits, depreciation on production...

  • Page 58
    ... 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 direct mail marketing programs to...

  • Page 59
    ... units and the "if converted" method for the convertible note securities. Stock Repurchase Programs Share repurchases are not displayed separately as treasury stock on the consolidated balance sheets or consolidated statements of stockholders' equity in accordance with the Washington Business 57

  • Page 60
    ... tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for financial statements issued for fiscal years beginning after December 15, 2006, and the Company will adopt these new...

  • Page 61
    ... government and agency securities ...Corporate notes and bonds ...Asset and mortgage backed securities ...Total available-for-sale securities ...Held-to-maturity Certificates of deposit ...Money market mutual funds ...Total held-to-maturity securities ...Total short-term investments ... $ 5,931 268...

  • Page 62
    ...2006) supported by a $113,874 bank credit facility ($54,200 at September 3, 2006) with a Canadian bank, which is guaranteed by the Company and expires in March 2008. At September 2, 2007 and September 3, 2006, no amounts were outstanding under the Canadian commercial paper program or the bank credit...

  • Page 63
    ...490 bank overdraft facility ($66,500 at September 3, 2006) renewable on a yearly basis in May 2008 and a $40,280 uncommitted money market line entered into in February 2007 and renewable on a yearly basis beginning in May 2008. At September 2, 2007, $20,140 was outstanding under the revolving credit...

  • Page 64
    ... overdraft facility: United Kingdom ...Other: United Kingdom Money Market Line Borrowing ...Fiscal year ended September 3, 2006 Bank borrowings: Canada ...United Kingdom ...Japan ...Bank overdraft facility: United Kingdom ...Long-Term Debt $103,599 77,732 18,031 34,922 $37,809 40,532 10,103 6,002...

  • Page 65
    ... Coupon Notes outstanding are convertible into a maximum of 1,535,907 shares of Costco Common Stock shares at an initial conversion price of $22.71. Holders of the Zero Coupon Notes may require the Company to purchase the Zero Coupon Notes (at the discounted issue price plus accrued interest to date...

  • Page 66
    ...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 or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of...

  • Page 67
    ... are made from time-to-time as conditions warrant in the open market or in block purchases, or pursuant to share repurchase plans under SEC Rule 10b5-1. Repurchased shares are retired. These amounts differ from the stock repurchase balances in the statements of cash flows due to repurchases that are...

  • Page 68
    ... generally vest over five years with an equal amount vesting on each anniversary of the grant date, the Company's plans allow for daily vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination...

  • Page 69
    ... Service on November 30, 2006, the Compensation Committee of the Board of Directors approved a program intended to protect approximately 1,000 Company employees who are United States taxpayers from certain adverse tax consequences resulting from their options having been granted originally at prices...

  • Page 70
    ... upon qualified retirement for recipients that have attained certain years of service with the Company. Recipients are not entitled to vote or receive dividends on unvested shares. Accordingly, the fair value of RSUs is the quoted market value of the Company's common stock on the date of grant...

  • Page 71
    ... this cost will be recognized is 2.2 years. Note 7-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 U.S. employees, with the exception of California union employees, the plan allows pre-tax deferral...

  • Page 72
    ... Stock options ...Deferred income/membership fees ...Excess foreign tax credits ...Accrued liabilities and reserves ...Other ...Total deferred tax assets ...Property and equipment ...Merchandise inventories ...Translation gain ...Total deferred tax liabilities ...Net deferred tax assets ...70 $ 87...

  • Page 73
    ... tax benefit resulting from the settlement of a transfer pricing dispute between the United States and Canada (covering the years 1996-2003) and a net tax benefit on unremitted foreign earnings of $20,592. The Company recognized a tax benefit of $30,602, resulting from excess foreign tax credits...

  • Page 74
    ... brought as a class action on behalf of present and former hourly employees in California, in which the plaintiff principally alleges that Costco's routine closing procedures and security checks cause employees to incur delays that qualify as uncompensated working time and that effectively...

  • Page 75
    ...et al. v. Costco Wholesale Corp., Case No. 2:07-CV-1491-AHM (JWJx). This is a consumer class action filed in March 2007 in the United States District Court for the Central District of California alleging willful violations of the 15 U.S.C. § 1681c(g) of the Fair Credit Reporting Act (FCRA). Section...

  • Page 76
    ... that, on or after January 1, 2005, Costco printed the expiration date and/ or more than the last five digits of their credit card or debit card number on electronically printed receipts provided at the point of sale involving transactions at Costco's gasoline dispensers throughout the United States...

  • Page 77
    ... others, the Company's warehouse managers and buyers. None of the options in which the review identified imprecision in the grant process were issued to the Company's chief executive officer, chairman, or non-employee directors, except in April 1997 both the chief executive officer and the chairman...

  • Page 78
    ... engaged in the operation of membership warehouses in the United States, Canada, Japan and the United Kingdom and through majority-owned subsidiaries in Taiwan and Korea and through a 50%-owned joint-venture in Mexico. The Company's reportable segments are based on management responsibility. The...

  • Page 79
    ... to merchandise costs in the second and third quarter of fiscal 2007, respectively, to reflect a change in the reserve for estimated sales returns (See Note 1- Revenue Recognition). (c) Includes a $46,215 charge related to protecting employees from adverse tax consequences resulting from the Company...

  • Page 80
    ... Weeks Second Quarter 12 Weeks Third Quarter 12 Weeks Fourth Quarter 17 Weeks Total 53 Weeks REVENUE Net sales ...Membership fees ...Total revenue ...OPERATING EXPENSES Merchandise costs ...Selling, general and administrative ...Preopening expenses ...Provision for impaired assets and closing costs...

  • Page 81
    ... Inc.; Chairman of the Board of Daily Journal Corporation; and Chairman and CEO of Westco Financial Corporation Jill S. Ruckelshaus Director, Lincoln National Corporation James D. Sinegal President and Chief Executive Officer, Costco EXECUTIVE AND SENIOR OFFICERS Joel Benoliel Senior Vice President...

  • Page 82
    ... Services & Food Court Deb Cain GMM - Foods - Northwest Region Deborah Calhoun GMM - Foods - San Diego Region Patrick Callans Corporate Purchasing, Business Centers and Costco Home Richard Chang Country Manager - Taiwan Jeff Cole U.S. Gas Purchasing & Operations Victor Curtis Pharmacy Richard Delie...

  • Page 83
    ... INFORMATION A copy of Costco's annual report to the Securities and Exchange Commission on Form 10-K and quarterly reports on Form 10-Q will be provided to any shareholder upon written request directed to Investor Relations, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, Washington...

  • Page 84