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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED SEPTEMBER 1, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-20355
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PRICE/COSTCO, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0572969
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
999 LAKE DRIVE, ISSAQUAH, WA 98027
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206) 313-8100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $.01 Par Value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant at October 31, 1996, was $3,780,185,250.
The number of shares outstanding of the registrant's common stock as of
October 31, 1996 was 196,576,879.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on January 29, 1997 are incorporated by reference into
Part III of this Form 10-K.
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PRICE/COSTCO, INC.
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 1, 1996
2
PART I
ITEM 1--BUSINESS
Price/Costco, Inc. ("PriceCostco" or the "Company") began operations in 1976
in San Diego, California as The Price Company ("Price"), pioneering the
membership warehouse concept. Costco Wholesale Corporation ("Costco") began
operations in 1983 in Seattle, Washington with a similar membership warehouse
concept. PriceCostco was formed in October 1993 as a result of a merger of Price
and Costco--a combination that resulted in a company which had, at that time,
over $15 billion in annual sales, more than 200 warehouse clubs in operation and
in excess of 40,000 employees throughout the United States and Canada (See "Note
2--Merger of Price and Costco").
In the second quarter of fiscal 1995, the Company completed the spin-off of
Price Enterprises, Inc. ("Price Enterprises"), consisting of PriceCostco's
discontinued non-club commercial real estate operations and certain other
assets. (See "Note 3--Spin-off of Price Enterprises, Inc. and Discontinued
Operations").
GENERAL
PriceCostco 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 PriceCostco to operate
profitably at significantly lower gross margins than traditional wholesalers,
discount retailers and supermarkets.
PriceCostco buys virtually all of its merchandise directly from
manufacturers for shipment either directly to PriceCostco'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, PriceCostco 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, PriceCostco meets the needs of business customers who
otherwise would pay a premium for small purchases and for the distribution
services of traditional wholesalers, and who cannot otherwise obtain the full
range of their product requirements from any single source. In addition, these
business members will often combine personal shopping with their business
purchases. Individuals shopping for their personal needs are primarily motivated
by the cost savings on brand name merchandise. PriceCostco'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, PriceCostco
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 PriceCostco 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.
PriceCostco's typical warehouse format averages approximately 127,000 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, PriceCostco's warehouses need not be
located on prime commercial real estate sites or have elaborate facilities.
3
By strictly controlling the entrances and exits of its warehouses and by
limiting membership to selected groups and businesses, PriceCostco has been able
to limit inventory losses to less than one-half of one percent of net
sales--well below those of typical discount retail operations. Losses associated
with dishonored checks have also been minimal, since individual memberships are
limited primarily to members of qualifying groups, and bank information from
business members is verified prior to establishing a check purchase limit.
Memberships are invalidated at the point of sale for those members who have
issued dishonored checks to PriceCostco.
PriceCostco's policy is generally to limit advertising and promotional
expenses to new warehouse openings and occasional direct mail advertisements to
prospective new members. These practices result in lower marketing expenses as
compared to typical discount retailers and supermarkets. In connection with new
warehouse openings, PriceCostco's marketing teams personally contact businesses
in the area who are potential wholesale members. These contacts are supported by
direct mailings during the period immediately prior to opening. Potential Gold
Star (individual) members are contacted by direct mail generally distributed
through credit unions, employee associations and other entities representing
individuals who are eligible for Gold Star membership. After a membership base
is established in an area, most new memberships result from word of mouth
advertising, follow-up contact by direct mail distributed through regular
payroll or other organizational communications to employee groups, and ongoing
direct solicitations of prospective wholesale members.
PriceCostco's warehouses generally operate on a seven-day, 68-hour week, and
are open somewhat longer during the holiday season. Generally, warehouses are
open weekdays between 10:00 a.m. and 8:30 p.m., with earlier closing hours on
the weekend. Because these hours of operation are shorter than those of
traditional discount grocery retailers and supermarkets, labor costs are lower
relative to the volume of sales. Merchandise is generally stored on racks above
the sales floor and displayed on pallets containing large quantities of each
item, thereby reducing labor required for handling and stocking. In addition,
sales are processed through centralized, automated check-out stands. Items are
not individually price marked; rather, each item is bar-coded so it can be
scanned into electronic cash registers. This allows price changes without
remarking merchandise. Substantially all manufacturers provide special, larger
package sizes and merchandise pre-marked with the item numbers and bar codes.
PriceCostco'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
PriceCostco can provide its members significant cost savings. Items which
members may request but which cannot be purchased at prices low enough to pass
along meaningful cost savings are usually not carried. PriceCostco seeks to
limit specific items in each product line to fast selling models, sizes and
colors and therefore carries only an average of approximately 3,500 to 4,500
active stockkeeping units ("SKU's") per warehouse as opposed to discount
retailers and supermarkets which normally stock 40,000 to 60,000 SKU's or more.
These practices are consistent with PriceCostco'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.
PriceCostco's policy is to accept returns of merchandise within a reasonable
time after purchase.
4
The following table indicates the approximate percentage of net sales
accounted for by each major category of items sold by PriceCostco during fiscal
1996, 1995 and 1994:
PriceCostco has direct buying relationships with many producers of national
brand name merchandise. No significant portion of merchandise is obtained by
PriceCostco from any one of these or other suppliers. PriceCostco 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. PriceCostco also purchases different
national brand name or selected private label merchandise of the same product,
as long as cost, quality and customer demand are comparable.
PriceCostco is incorporated in the State of Delaware, and 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
PriceCostco's operations, except an increased level of sales and earnings during
the Christmas holiday season.
MEMBERSHIP POLICY
PriceCostco's membership format is designed to reinforce customer loyalty
and provide a continuing source of membership fee revenue. PriceCostco has two
primary types of members: Business and Gold Star (individual members).
Businesses, including individuals with a business license, retail sales
license or other evidence of business existence, may become Business members.
PriceCostco promotes Business membership through its merchandise selection and
its membership marketing programs. Business members generally pay an annual
membership fee of $30 for the primary membership card with additional membership
cards available for an annual fee of $20.
Individual memberships are available to employees of federal, state and
local governments, financial institutions, corporations, utility and
transportation companies, public and private educational institutions, and other
selected organizations. Individual members generally pay an annual membership
fee of $35, which includes a spouse card.
As of September 1, 1996, PriceCostco had approximately 3.4 million Business
memberships and approximately 7.1 million Gold Star memberships. Members can
utilize their memberships at any Price Club or Costco Wholesale location.
LABOR
As of September 1, 1996, PriceCostco had approximately 53,000 employees,
about 50% of which were part time. Substantially all Price Club's 10,000 hourly
employees in California, Maryland, New Jersey, New
5
York and one Price Club warehouse in Virginia are represented by the
International Brotherhood of Teamsters. All remaining hourly Price employees and
all employees of Costco are non-union. PriceCostco considers its employee
relations to be good.
COMPETITION
The Company operates in the rapidly changing and highly competitive
merchandising industry. When Price pioneered the membership warehouse club
concept in 1976, the dominant companies selling comparable lines of merchandise
were department stores, grocery stores and traditional wholesalers. Since then,
new merchandising concepts and aggressive marketing techniques have led to a
more intense and focused competitive environment. Wal-Mart and Kmart have become
the largest retailers in the United States and have recently expanded into food
merchandising. Target has also emerged as a significant retail competitor.
Approximately 750 warehouse clubs exist across the U.S. and Canada, including
the 247 warehouses operated by the Company in North America; and every major
metropolitan area has some, if not several, club operations. Low cost operators
selling a single category or narrow range of merchandise, such as Home Depot,
Office Depot, Petsmart, Toys-R-Us, Circuit City and Barnes & Noble Books, have
significant market share in their respective categories. New forms of retailing
involving modern technology are boosting sales in stores such as The Sharper
Image, while home shopping is becoming increasingly popular. Likewise, in the
institutional food business, companies such as Smart & Final, which operates in
Arizona, California and Florida, are capturing an increasingly greater share of
the institutional food business from wholesale operators and others; and many
supermarkets now offer food lines in bulk sizes and at prices comparable to
those offered by the Company. (See "Item--7 Management's Discussion and Analysis
of Financial Condition and Results of Operations")
REGULATION
Certain state laws require that the Company apply minimum markups to its
selling prices for specific goods, such as tobacco products and alcoholic
beverages, and prohibit the sale of specific goods, such as tobacco and
alcoholic beverages, at different prices in one location. While compliance with
such laws may cause the Company to charge somewhat higher prices than it
otherwise would charge, other retailers are also typically governed by the same
restrictions, and the Company believes that compliance with such laws does not
have a material adverse effect on its operations.
It is the policy of the Company to sell at lower than manufacturers'
suggested retail prices. Some manufacturers attempt to maintain the resale price
of their products by refusing to sell to the Company or to other purchasers that
do not adhere to suggested retail prices. To date, the Company believes that it
has not been materially affected by its inability to purchase directly from such
manufacturers. Both federal and state legislation is proposed from time to time
which, if enacted, would restrict the Company's ability to purchase goods or
extend the application of laws enabling the establishment of minimum prices. The
Company cannot predict the effect on its business of the enactment of such
federal or state legislation.
6
ITEM--2 PROPERTIES
WAREHOUSE PROPERTIES
At September 1, 1996, PriceCostco operated warehouse clubs in 22 states, 9
Canadian provinces and the United Kingdom under the "Price Club" and "Costco
Wholesale" names. The following is a summary of owned and leased warehouses by
region:
NUMBER OF WAREHOUSES
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, 1996:
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(a) As of September 1, 1996, the Company operated (through a 50%-owned joint
venture) thirteen warehouses in Mexico (one opened in fiscal 1992, two
opened in fiscal 1993, five opened in fiscal 1994, and five opened in fiscal
1995). These warehouses are not included in the number of warehouses open in
any period because the joint venture is accounted for on the equity basis
and therefore 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 and packaging facilities to support ancillary businesses.
DISCONTINUED OPERATIONS - NON-CLUB REAL ESTATE SEGMENT
As a result of the 1995 spin-off of Price Enterprises, the Company's
business now consists primarily of its warehouse club operations in the United
States, Canada and the United Kingdom; and the Company has ceased to have any
significant real estate activities that are not directly related to its
warehouse club business.
7
ITEM 3--LEGAL PROCEEDINGS
On April 6, 1992, Price was served with a Complaint in an action entitled
FECHT ET AL. v. THE PRICE COMPANY ET AL., Case No. 92-497, United States
District Court, Southern District of California (the "Court"). Subsequently, on
April 22, 1992, Price was served with a First Amended Complaint in the action.
The case was dismissed without prejudice by the Court on September 21, 1992, on
the grounds the plaintiffs had failed to state a sufficient claim against
defendants. Subsequently, plaintiffs filed a Second Amended Complaint which, in
the opinion of the Company's counsel, alleged substantially the same facts as
the prior complaint. The Complaint alleged violation of certain state and
federal laws during the time period prior to Price's earnings release for the
second quarter of fiscal year 1992. The case was dismissed with prejudice by the
Court on March 9, 1993, on grounds the plaintiffs had failed to state a
sufficient claim against defendants. Plaintiffs filed an Appeal in the Ninth
Circuit Court of Appeals. In an opinion dated November 20, 1995, the Ninth
Circuit reversed and remanded the lawsuit. The Company believes that this
lawsuit is without merit and is vigorously defending the lawsuit. The Company
does not believe that the ultimate outcome of such litigation will have a
material adverse effect on the Company's financial position or results of
operations.
On December 19, 1994, a Complaint was filed against PriceCostco in an action
entitled SNYDER v. PRICE/ COSTCO, INC. ET. AL., Case No. C94-1874Z, United
States District Court, Western District of Washington. On January 4, 1995, a
Complaint was filed against PriceCostco in an action entitled BALSAM v.
PRICE/COSTCO, INC. ET. AL., Case No. C95-0009Z, United States District Court,
Western District of Washington. The Snyder and Balsam Cases were subsequently
consolidated and on March 15, 1995, plaintiffs' counsel filed a First Amended
And Consolidated Class Action And Derivative Complaint. On November 9, 1995,
plaintiffs' counsel filed a Second Amended And Consolidated Class Action And
Derivative Complaint. The Second Amended Complaint alleged violation of certain
state and federal laws arising from the spin-off and Exchange Transaction and
the merger between Price and Costco. In July 1996, an agreement in principle was
reached to resolve the lawsuit. Subject to court approval, the resolution will
involve the transfer from Price Enterprises, Inc. to the Company of certain
intangible assets, including elimination of certain existing non-compete
restrictions and operating agreements and the termination or amendment of
certain trademark license and assignment agreements. The cash portion of the
settlement will be funded by the Company's director and officer insurance
coverage and by Price Enterprises. The Company will contribute no money to the
settlement.
In May 1996, PriceCostco reached an agreement in principle with the
Environmental Protection Agency and the U.S. Department of Justice to settle an
enforcement action under the Federal Clean Air Act. The action is based on
claims that PriceCostco failed to maintain required documentation related to its
sale of freon products. Under the terms of the proposed settlement, PriceCostco
will agree to pay a civil penalty of $232,000 and to comply with federal
regulations relating to the sale of ozone-depleting substances.
The Company is involved from time to time in claims, proceedings and
litigation arising from its business and property ownership. The Company does
not believe that any such claim, proceeding or litigation, either alone or in
the aggregate, will have a material adverse effect on the Company's financial
position or results of operations.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting is scheduled for 7:30 p.m. on January 29, 1997,
at the DoubleTree Paradise Valley Resort in Scottsdale, Arizona. 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
ITEM 4A--EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a list of the names, ages and positions of the executive
officers of the registrant.
James D. Sinegal has been President, Chief Executive Officer and a director
of the Company since October 1993 upon consummation of the Merger of Costco
Wholesale Corporation ("Costco") and The Price Company ("Price"). From its
inception until 1993, he was President and Chief Operating Officer of Costco and
served as Chief Executive Officer from August 1988 until October 1993. Mr.
Sinegal is a co-founder of Costco and has been a director of Costco since its
inception.
Jeffrey H. Brotman is a native of the Pacific Northwest and is a 1967
graduate of the University of Washington Law School. Mr. Brotman was a founder
and Chairman of the Board of the Company from its inception. Upon the
consummation of the Merger, Mr. Brotman became the Vice Chairman, and has served
as Chairman since the spin-off on December 21, 1994. Mr. Brotman is a founder of
a number of other specialty retail chains. He is a director of Seafirst Bank,
Starbucks Corp., the Sweet Factory and Garden Botanika.
Richard D. DiCerchio has been Executive Vice President, Chief Operating
Officer--Merchandising, Distribution, Construction and Marketing and a director
of the Company since October 1993 (upon consummation of the Merger) and, until
mid-August 1994, also served as Executive Vice President, Chief Operating
Officer--Northern Division. He was elected Chief Operating Officer--Western
Region of Costco in August 1992 and was elected Executive Vice President and
director of Costco in April 1986. From June 1985 to April 1986, he was Senior
Vice President, Merchandising of Costco. He joined Costco as Vice President,
Operations in May 1983.
Richard A. Galanti has been Executive Vice President and Chief Financial
Officer of PriceCostco since the Merger and has been a Director of PriceCostco
since January 1995. He was Senior Vice President, Chief Financial Officer and
Treasurer of Costco since January 1985, having joined Costco as Vice
President--Finance in March 1984. From 1978 to February 1984, Mr. Galanti was an
Associate with Donaldson, Lufkin & Jenrette Securities Corporation. Mr. Galanti
also currently serves as a director of Hollywood Entertainment Corporation.
Franz E. Lazarus was named Executive Vice President--International
Operations in September, 1995, prior to which he had served as Executive Vice
President, Chief Operating Officer-- Northern Division of PriceCostco since
August 1994 and Executive Vice President, Chief Operating Officer--Eastern
Division since the Merger. He was named Executive Vice President, Chief
Operating Officer--East Coast Operations of Costco in August 1992. Mr. Lazarus
joined Costco in November 1983 and has held various management positions prior
to his current position.
9
David B. Loge has been Executive Vice President--Manufacturing and Ancillary
Businesses since August 1994. Mr. Loge joined Price as a Director of Price Club
Industries in March 1989 and became Vice President of Price and President of
Price Club Industries in December 1990. Prior to joining Price, he served as
Vice President of Operations of Sundale Beverage in Belmont, California.
Walter C. ("Craig") Jelinek has been Executive Vice President, Chief
Operating Officer--Northern Division since September 1995. He had been Senior
Vice President, Operations--Northwest Region since September 1992. From May 1986
to September 1994 he was Vice President, Regional Operations Manager--Los
Angeles Region and has held various management positions since joining Costco in
April 1984.
Edward B. Maron has been Executive Vice President, Chief Operating
Officer--Canadian Division of PriceCostco since the Merger. He had been Senior
Vice President--Canadian Division of Costco since April 1990. He has held
various management positions since joining Costco in June 1985.
Joseph P. Portera has been Executive Vice President, Chief Operating
Officer--Eastern Division of PriceCostco since August 1994. He was Senior Vice
President, Operations--Northern California Region from October 1993 to August
1994. From August 1991 to October 1993 he was Senior Vice President,
Merchandising--Non Foods of Costco, and has held various management positions
since joining Costco in April 1984.
Dennis R. Zook has been Executive Vice President, Chief Operating
Officer--Southern Division of PriceCostco since the Merger. He was Executive
Vice President of Price since February 1989. Mr. Zook became Vice President of
West Coast Operations of Price in October 1988 and has held various management
positions since joining Price in October 1981.
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Trading in PriceCostco Common Stock commenced on October 22, 1993, and is
quoted on The Nasdaq Stock Market's National Market under the symbol "PCCW."
In June 1996, a public offering was completed whereby 19,500,000 shares of
PriceCostco Common Stock (plus an overallotment of 1,691,301 shares) were sold
by Fourcar B.V., an indirect subsidiary of Carrefour S.A.. The shares were sold
through a group of underwriters at $19.50 per share. As a result of this
offering, Fourcar B.V. no longer owns any shares of PriceCostco Common Stock.
PriceCostco received no proceeds from the sale of this stock.
10
The following table sets forth the high and low sales prices of PriceCostco
Common Stock for the period January 1, 1994 through October 31, 1996. The
quotations are as reported in published financial sources.
On October 31, 1996, the Company had 8,324 stockholders of record.
DIVIDEND POLICY
PriceCostco does not pay regular dividends and does not anticipate the
declaration of a cash dividend in the foreseeable future. Under its two
revolving credit agreements, PriceCostco 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
PriceCostco for the ten fiscal years in the period ended September 1, 1996,
giving effect to the Merger 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 PriceCostco for fiscal 1996.
11
PRICE/COSTCO, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
12
PRICE/COSTCO, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT WAREHOUSE AND PER SHARE DATA)
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(a) In 1989 Price paid to its shareholders a one-time special cash dividend of
$74,621 or $1.50 per share of Price Common Stock.
(b) In 1989 stockholders' equity reflects a $20,100 reduction of retained
earnings related to conforming Price's accounting for income tax method to
Costco's accounting for income tax method as of fiscal 1989.
13
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPARISON OF FISCAL 1996 (52 WEEKS) AND FISCAL 1995 (53 WEEKS):
(DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
Net operating results for fiscal 1996 reflect net income of $248,793, or
$1.22 per share (fully diluted), as compared to a fiscal 1995 net income of
$133,878, or $.68 per share (fully diluted). The fiscal 1995 results include a
non-cash charge of $83,363, or $.37 per share, reflecting the final calculation
for the loss on the disposal of the discontinued real estate operations
following the completion of the Spin-off of Price Enterprises.
CONTINUING OPERATIONS
Income from continuing operations for fiscal 1996 was $248,793, or $1.22 per
share, compared to income from continuing operations for fiscal 1995 of
$217,241, or $1.05 per share.
Net sales increased 7.3% to $19,213,866 in fiscal 1996 (a 52-week year) from
$17,905,926 in fiscal 1995 (a 53-week year). This increase was due to: (i) first
year sales at the 20 new warehouses opened during fiscal 1996, which increase
was partially offset by eight warehouses closed during fiscal 1996 that were in
operation during fiscal 1995; (ii) increased sales at 24 warehouses that were
opened in fiscal 1995 and that were in operation for the entire 1996 fiscal
year; and (iii) higher sales at existing locations opened prior to fiscal 1995.
Changes in prices did not materially impact sales levels.
Comparable sales, that is sales in warehouses open for at least a year,
increased at a 5% annual rate in fiscal 1996, compared to a 2% annual rate
during fiscal 1995. The improvement in comparable sales levels in fiscal 1996,
as compared to fiscal 1995, reflects new marketing and merchandising efforts,
including the rollout of fresh foods and various ancillary businesses to certain
existing locations.
Membership fees and other revenue increased 3.3% to $352,590, or 1.84% of
net sales, in fiscal 1996 from $341,360, or 1.91% of net sales, in fiscal 1995.
This increase is primarily due to membership sign-ups at the 20 new warehouses
opened in fiscal 1996. Effective with renewals in the United States, subsequent
to April 1, 1996, the Company increased the annual membership fee for its
Business "Add-on" members from $15 to $20. There are currently approximately 3.4
million Business "Add-on" members.
Gross margin (defined as net sales minus merchandise costs) increased 11.2%
to $1,868,551, or 9.73% of net sales, in fiscal 1996 from $1,680,078, or 9.38%
of net sales, in fiscal 1995. Gross margin as a percentage of net sales
increased due to greater purchasing power realized since the Merger, favorable
inventory shrink results, the expanded use of the Company's depot facilities,
and increased sales penetration of certain higher margin ancillary businesses.
The gross margin figures reflect accounting for most U.S. merchandise
inventories on the last-in, first-out (LIFO) method. For fiscal 1996 there was
no LIFO charge due to the use of the LIFO method compared to the first-in,
first-out (FIFO) method. This compares to a $9,500 LIFO charge, or $.03 per
share (fully diluted), in fiscal 1995.
Selling, general and administrative expenses as a percent of net sales
increased to 8.80% during fiscal 1996 from 8.69% during fiscal 1995, primarily
reflecting higher expenses associated with international expansion and certain
ancillary operations. In addition, as a result of a strong second half
performance, the Company achieved its annual profit goals for the 1996 fiscal
year, resulting in a year-over-year increase of $11.2 million in the employee
bonus accrual, which covers bonuses payable to more than seven hundred
management employees participating in the Company's Annual Bonus Plan.
Preopening expenses totaled $29,231, or 0.15% of net sales, during fiscal
1996 and $25,018, or 0.14% of net sales, during fiscal 1995. During fiscal 1996,
the Company opened 20 new warehouses compared to 24 new warehouses during fiscal
1995. Fiscal 1996 preopening expenses also included an increased level of costs
associated with remodeling and expanding fresh foods and ancillary operations at
existing warehouses.
14
The Company recorded a pre-tax provision for warehouse closing costs of
$10,000, or $.03 per share, on an after-tax basis (fully diluted). The provision
includes estimated closing costs for certain warehouses, which were or will be
replaced by new warehouses, the closing of a regional office and additional
costs related to warehouse clubs closed in prior years. Warehouse closing costs
were $7,500 (pre-tax), or $.02 per share, in fiscal 1995.
Interest expense totaled $78,078 in fiscal 1996, and $67,911 in fiscal 1995.
In both fiscal years, interest expense was incurred as a result of the interest
on the three series of outstanding convertible subordinated debentures and
interest on borrowings on the Company's bank lines and commercial paper
programs. The increase in interest expense is primarily related to higher
borrowings and interest rates under the Company's bank lines and commercial
paper programs and the issuance of $300,000 in Senior Notes in June 1995.
Interest income and other totaled $10,832 in fiscal 1996, and $2,783 in
fiscal 1995. This increase was primarily due to the Company reflecting a
reduction in its share of losses in certain unconsolidated joint ventures
(primarily Price Quest) and an increase in income from its joint venture with
Price Club Mexico.
In fiscal 1996 and 1995, the effective income tax rate on income from
continuing operations before provision for income taxes was 41.25% and 41.00%
respectively.
COMPARISON OF FISCAL 1995 (53 WEEKS) AND FISCAL 1994 (52 WEEKS):
(DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
Net operating results for fiscal 1995 reflect net income of $133,878, or
$.68 per share (fully diluted), as compared to a fiscal 1994 net loss of
$112,368, or $.51 per share (fully diluted). The fiscal 1995 results include a
non-cash charge of $83,363, or $.37 per share, reflecting the final calculation
for the loss on the disposal of the discontinued real estate operations
following the completion of the Spin-off of Price Enterprises. The fiscal 1994
loss of $112,368 includes the provision for merger and restructuring costs of
$120,000 pre-tax ($80,000, or $.36 per share after tax), a provision included in
loss from discontinued operations of $80,500 pre-tax ($47,500, or $.22 per share
after tax) arising from a change in accounting estimates caused by the Spin-off
and Exchange Transaction, and a non-cash charge of $182,500, or $.83 per share,
reflecting the estimated loss on disposal of the discontinued non-club real
estate operations. The Exchange Transaction was completed on December 20, 1994,
and the estimated loss on disposal was adjusted to actual. For a more detailed
discussion of the Spin-off and Exchange Transaction, see "Note 3-- Spin-off of
Price Enterprises, Inc. and Discontinued Operations."
CONTINUING OPERATIONS
Income from continuing operations for fiscal 1995 was $217,241, or $1.05 per
share, compared to income from continuing operations for fiscal 1994 of
$110,898, or $.51 per share. Excluding the $120,000 pre-tax ($80,000 after tax)
merger and restructuring charge, income from continuing operations for fiscal
1994 would have been $190,898, or $.87 per share.
Net sales increased 10.8% to $17,905,926 in fiscal 1995 from $16,160,911 in
fiscal 1994. This increase was due to: (i) first year sales at the 24 new
warehouses opened during fiscal 1995, which increase was partially offset by 5
warehouses closed during fiscal 1995 that were in operation during fiscal 1994;
(ii) increased sales at 29 warehouses that were opened in 1994 and that were in
operation for the entire 1995 fiscal year; (iii) higher sales at existing
locations opened prior to fiscal 1994; and (iv) one additional week of sales
related to having a 53-week fiscal year. 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 2% annual rate in fiscal 1995, compared to a negative 3% annual
rate during fiscal 1994. The improvement in comparable
15
sales levels in fiscal 1995, as compared to fiscal 1994, reflects new marketing
and merchandising efforts, including the rollout of fresh foods and various
ancillary businesses to certain existing locations.
Membership fees and other revenue increased 6.8% to $341,360, or 1.91% of
net sales, in fiscal 1995 from $319,732, or 1.98% of net sales, in fiscal 1994.
This increase is primarily due to membership sign-ups at the 24 new warehouses
opened in fiscal 1995 and one additional week of membership fees related to
having a 53-week fiscal year.
Gross margin (defined as net sales minus merchandise costs) increased 12.2%
to $1,680,078, or 9.38% of net sales, in fiscal 1995 from $1,498,020, or 9.27%
of net sales, in fiscal 1994. Gross margin as a percentage of net sales
increased due to greater purchasing power realized since the Merger and the
expanded use of the Company's depot facilities. The gross margin figures reflect
accounting for most U.S. merchandise inventories on the last-in, first-out
(LIFO) method. For fiscal 1995 there was a $9,500 LIFO charge, or $.03 per share
(fully diluted), decreasing income after tax due to the use of the LIFO method
compared to the first-in, first-out (FIFO) method. This compares to a $2,600
LIFO benefit, or $.01 per share (fully diluted), in fiscal 1994.
Selling, general and administrative expenses as a percent of net sales
improved to 8.69% during fiscal 1995 from 8.82% during fiscal 1994, reflecting
lower expense ratios resulting from improved comparable sales increases, as well
as the implementation of front-end scanning and automated receiving at certain
existing warehouse, partially offset by higher expenses associated with
international expansion and certain ancillary operations.
Preopening expenses totaled $25,018, or 0.14% of net sales, during fiscal
1995 and $24,564, or 0.15% of net sales, during fiscal 1994. During fiscal 1995,
the Company opened 24 new warehouses compared to opening 29 new warehouses
during fiscal 1994. Fiscal 1995 preopening expenses also included an increased
level of costs associated with remodels and expanding fresh foods and ancillary
operations at existing warehouses.
The Company recorded a pre-tax provision for warehouse closing costs of
$7,500, or $.02 per share, on an after-tax basis (fully diluted) in fiscal 1995.
The provision included estimated closing costs for certain warehouses, which
were or will be replaced by new warehouses, the closing of a regional office and
additional costs related to warehouse clubs closed in prior years. Warehouse
closing costs were also $7,500 (pre-tax), or $.02 per share, in fiscal 1994.
Interest expense totaled $67,911 in fiscal 1995, and $50,472 in fiscal 1994.
In both fiscal years, interest expense was incurred as a result of the interest
on the convertible subordinated debentures and interest on borrowings on the
Company's bank lines and commercial paper programs. Interest expense in fiscal
1995 also included interest on the $300,000 Senior Notes (as hereafter defined)
issued in June, 1995. The increase in interest expense is primarily related to
higher borrowings and interest rates under the Company's bank lines and
commercial paper programs and the issuance of the Senior Notes.
Interest income and other totaled $2,783 in fiscal 1995, and $13,888 in
fiscal 1994. This decrease was primarily due to the Company reflecting its share
of losses in certain unconsolidated joint ventures, the elimination of interest
income on certain notes receivable that were transferred to Price Enterprises as
of fiscal 1994 year-end, and an approximate $2,500 pre-tax charge representing
the Company's share of foreign currency exchange losses incurred by Price Club
Mexico due to Mexico's currency devaluation during fiscal 1995.
The $120,000 pre-tax provision for merger and restructuring costs reflected
in fiscal 1994 includes direct transaction costs, expenses related to
consolidating and restructuring certain functions, the closing of certain
facilities and disposal of related properties, severance and employee payouts,
write-offs of certain redundant capitalized costs and certain other costs. These
costs were provided for in the first quarter of fiscal 1994. For additional
information see "Note 2--Merger of Price and Costco" to the consolidated
financial statements.
16
In both fiscal 1995 and 1994, the effective income tax rate on income from
continuing operations before provision for income taxes was 41.0% (excluding the
merger and restructuring charges in fiscal 1994).
DISCONTINUED OPERATIONS
Income from discontinued real estate operations was not included in
operating results for periods subsequent to the announcement date (fourth
quarter of fiscal 1994) and through the date of disposal (second quarter of
fiscal 1995). The fiscal 1994 loss on discontinued real estate operations (net
of operating expenses and taxes) included the results of income-producing
properties, gains on sale of property, interest income and a provision of
$90,200 pre-tax, of which $80,500 pre-tax ($47,500 after tax, or $.22 per share)
related to a change in calculating estimated losses for assets which were
considered to be economically impaired. This change in accounting estimates
resulted from the spin-off of the real estate segment assets into Price
Enterprises, and Price Enterprises' decision to pursue business plans and
operating strategies as a stand-alone entity which were significantly different
than the strategies of the Company.
Discontinued operations in fiscal 1995 included a non-cash charge of
$83,363, or $.37 per share, reflecting the final calculation for the loss on
disposal of the discontinued real estate operations. Fiscal 1994 included a
charge of $182,500, or $.83 per share, for the estimated loss on the disposal of
the discontinued real estate operations. These charges related to the transfer
of the Company's commercial real estate operations, together with certain other
assets, to Price Enterprises as part of the Exchange Transaction. The Exchange
Transaction was completed on December 20, 1994, and the estimated loss on
disposal was adjusted to actual. For a more detailed discussion of the Exchange
Transaction, see "Note 3-- Spin-off of Price Enterprises, Inc. and Discontinued
Operations."
RECENT SALES RESULTS
PriceCostco's net sales for the nine-week period ended November 3, 1996 were
approximately $3,470,000, an increase of 11% from approximately $3,140,000 for
the same nine-week period of the prior fiscal year. Comparable warehouse sales
(sales in warehouses open for at least a year) increased by 8 percent during the
nine-week period.
LIQUIDITY AND CAPITAL RESOURCES
(DOLLARS IN THOUSANDS)
The discussion below contains forward-looking statements that involve risks
and uncertainties, including those risks and uncertainties detailed in the
Company's reports filed with the SEC. Actual results may differ materially.
PriceCostco'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.
In fiscal 1996, cash provided from operations was approximately $426,400. In
April 1996, the Company borrowed $140,000 from a group of banks under a
five-year unsecured term loan. The net proceeds from the term loan were used to
repay existing indebtedness incurred under the Company's Canadian and U.S.
commercial paper programs. Cash flow from operations and borrowings under the
Company's commercial paper programs provided the primary sources of funds for
additions to property and equipment for warehouse clubs and related operations
of approximately $506,800.
Expansion plans for the United States and Canada during fiscal 1997 are to
open 22 new warehouse clubs, including seven relocations. The Company also
expects to continue expansion of its international
17
operations and plans to open one to two additional United Kingdom units through
its 60%-owned subsidiary during the second half of fiscal 1997. Other markets
are being assessed, particularly in the Pacific Rim, and include the planned
opening of a warehouse club in Taiwan in January 1997.
PriceCostco and its Mexico-based joint venture partner, Controladora
Comercial Mexicana, each own a 50% interest in Price Club Mexico following the
Company's acquisition of Price Enterprises' interest in Price Club Mexico in
April, 1995. See "Note 4--Acquisition of Price Enterprises' Interest in Price
Club Mexico" in Notes to Consolidated Financial Statements. As of September 1,
1996, Price Club Mexico operated 13 Price Club warehouses in Mexico.
While there can be no assurance that current expectations will be realized,
and plans are subject to change upon further review, it is management's current
intention to spend an aggregate of approximately $400,000 to $420,000 during
fiscal 1997 in the United States and Canada for real estate, construction,
remodeling and equipment for warehouse clubs and related operations; and
approximately $80,000 to $100,000 for international expansion, including the
United Kingdom and other potential ventures. These expenditures will be financed
with a combination of cash provided from operations, the use of cash and cash
equivalents (which totaled $101,955 at September 1, 1996), short-term borrowings
under revolving credit facilities and/or commercial paper facilities, and other
financing sources as required.
The Company has a domestic multiple-option loan facility with a group of 12
banks, which provides for borrowings of up to $500,000 or standby support for a
$500,000 commercial paper program. Of this amount, $250,000 expires on January
27, 1997, and $250,000 expires on January 30, 2001. The interest rate on bank
borrowings is based on LIBOR or rates bid at auction by the participating banks.
At September 1, 1996, no amounts were outstanding under the loan facility or the
commercial paper program. The Company expects to renew for an additional
one-year term the $250,000 portion of the loan facility expiring on January 27,
1997 at substantially the same terms.
In addition, a wholly-owned Canadian subsidiary has a $102,000 commercial
paper program supported by a bank credit facility with three Canadian banks, of
which $62,000 will expire in March 1997 and $40,000 will expire in March 1999.
The interest rate on bank borrowings is based on the prime rate or the "Bankers'
Acceptance" rate. At September 1, 1996, $1,053 was outstanding under the bank
credit facility and $59,928 was outstanding under the Canadian commercial paper
program. The Company expects to renew for an additional one-year term the
$62,000 portion of the loan facility expiring in March 1997, at substantially
the same terms.
The Company also has separate letter of credit facilities (for commercial
and standby letters of credit), totaling approximately $198,000. The outstanding
commitments under these facilities at September 1, 1996 totaled approximately
$156,000, including approximately $56,000 in standby letters of credit for
workers' compensation requirements.
On February 21, 1996, the Company filed with the Securities and Exchange
Commission a shelf registration statement relating to $500,000 of senior debt
securities. The registration statement was declared effective on February 29,
1996. As part of that filing, the Company announced its intention, subject to
market conditions, to offer $300,000 of senior notes to refinance existing
indebtedness. The Company has deferred issuance of these notes due to
unfavorable interest rate market conditions.
In April 1996, the Company borrowed $140,000 from a group of banks under a
five-year unsecured term loan. Interest only is payable at rates based on LIBOR.
Proceeds of the loan were used to retire $40,000 outstanding under the Canadian
commercial paper program and $100,000 outstanding under the U.S. commercial
paper program.
Due to rapid inventory turnover, the Company's operations provide a higher
level of supplier trade payables than generally encountered in other forms of
retailing. When combined with other current liabilities, the resulting amount
typically approaches the current assets needed to operate the business (e.g.,
merchandise inventories, accounts receivable and other current assets). At
September 1, 1996,
18
working capital totaled approximately $57,000 compared to working capital of
approximately $9,000 at September 3, 1995. This increase in net working capital
is primarily related to an increase in cash and cash equivalents of
approximately $56,000, reductions in notes payable of approximately $16,000 as
long-term debt proceeds were used to refinance certain short-term borrowings,
and increases in owned inventories (inventories less accounts payables) of
approximately $91,000, offset by increases in accrued salaries and benefits of
approximately $52,000 and increases in other current liabilities of
approximately $53,000.
In fiscal 1995, cash provided from operations was approximately $278,000.
These funds, combined with borrowings under the Company's commercial paper
program and the proceeds from the $300,000 Senior Notes offering provided the
primary sources of funds for additions to property and equipment for warehouse
clubs and related operations of $531,000 and other investing activities related
primarily to investments in unconsolidated joint ventures of $11,500.
ITEM 8--FINANCIAL STATEMENTS
Financial statements of PriceCostco are as follows:
ITEM 9--CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information with respect to the executive officers of the Registrant,
see Item--4A "Executive Officers of the Registrant" at the end of Part I of this
report. The information required by this Item concerning the Directors and
nominees for Director of the Company is incorporated herein by reference to
PriceCostco's Proxy Statement for its Annual Meeting of Stockholders, to be held
on January 29, 1997, to be filed with the Securities and Exchange Commission
within 120 days of the end of the Company's fiscal year.
ITEM 11--EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to
PriceCostco's Proxy Statement for its Annual Meeting of Stockholders, to be held
on January 29, 1997, to be filed with the Securities and Exchange Commission
within 120 days of the end of the Company's fiscal year.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to
PriceCostco's Proxy Statement for its Annual Meeting of Stockholders to be held
on January 29, 1997 to be filed with the Securities and Exchange Commission
within 120 days of the end of the Company's fiscal year.
19
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference to
PriceCostco's Proxy Statement for its Annual Meeting of Stockholders, to be held
on January 29, 1997 to be filed with the Securities and Exchange Commission
within 120 days of the end of the Company's fiscal year.
PART IV
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report are as follows:
1. Financial Statements:
See listing of Financial Statements included as a part of this Form
10-K on Item 8 of Part II.
2. Financial Statement Schedules--None.
3. Exhibits:
The required exhibits are included at the end of the Form 10-K Annual
Report and are described in the Exhibit Index immediately preceding
the first exhibit.
(b) No reports on Form 8-K were filed during the last quarter of the period
covered by this Annual Report.
20
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
November 7, 1996
Price/Costco, Inc.
(Registrant)
By /s/ RICHARD A. GALANTI
--------------------------------------
Richard A. Galanti
EXECUTIVE VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
21
22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Price/Costco, Inc.:
We have audited the accompanying consolidated balance sheets of
Price/Costco, Inc. (a Delaware corporation) and subsidiaries (PriceCostco) as of
September 1, 1996 and September 3, 1995, and the related consolidated statements
of operations, stockholders' equity and cash flows for the 52 weeks ended
September 1, 1996, the 53 weeks ended September 3, 1995 and the 52 weeks ended
August 28, 1994. These financial statements are the responsibility of
PriceCostco's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of PriceCostco as of September
1, 1996 and September 3, 1995, and the results of its operations and its cash
flows for the 52 weeks ended September 1, 1996, the 53 weeks ended September 3,
1995, and the 52 weeks ended August 28, 1994 in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Seattle, Washington
October 8, 1996
23
PRICE/COSTCO, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
The accompanying notes are an integral part of these balance sheets.
24
PRICE/COSTCO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of these financial statements.
25
PRICE/COSTCO, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE 52 WEEKS ENDED SEPTEMBER 1, 1996, THE 53 WEEKS ENDED SEPTEMBER 3,
1995 AND THE
52 WEEKS ENDED AUGUST 28, 1994
(IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
26
PRICE/COSTCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
27
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Price/Costco,
Inc., a Delaware corporation, and its subsidiaries ("PriceCostco" or the
"Company"). PriceCostco is a holding company which operates primarily through
its major subsidiaries, The Price Company and subsidiaries ("Price"), and Costco
Wholesale Corporation and subsidiaries ("Costco"). All intercompany transactions
between the Company and its subsidiaries have been eliminated in consolidation.
As described more fully in "Note 2-- Merger of Price and Costco", on October 21,
1993, Price and Costco became wholly-owned subsidiaries of PriceCostco. Price
and Costco primarily operate cash and carry membership warehouses.
PriceCostco 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 September 1, 1996, PriceCostco operated warehouse clubs in 22
states, 9 Canadian provinces and the United kingdom under the "Price Club" and
"Costco Wholesale" names. As of September 1, 1996, the Company also operated
(through a 50%-owned joint venture) 13 warehouses in Mexico.
The Company's investment in the Price Club Mexico joint venture and in other
unconsolidated joint ventures that are less than majority owned are accounted
for under the equity method.
As described more fully in "Note 3--Spin-off of Price Enterprises, Inc. and
Discontinued Operations," the Company treated the spin-off of its non-club real
estate operations as discontinued operations in the fourth quarter of fiscal
1994.
FISCAL YEARS
The Company reports on a 52/53 week fiscal year basis which ends on the
Sunday nearest August 31st. Fiscal year 1996 was 52 weeks; fiscal year 1995 was
53 weeks; and fiscal year 1994 was 52 weeks.
CASH AND CASH EQUIVALENTS
The Company considers all investments in highly liquid debt instruments
maturing within 90 days after purchase as cash equivalents unless amounts are
held in escrow for future property purchases or restricted by agreements.
SHORT-TERM INVESTMENTS AND RESTRICTED CASH
Short-term investments include highly liquid investments in United States
and Canadian government obligations, along with other investment vehicles, some
of which have maturities of three months or less at the time of purchase. The
Company's policy is to classify these investments as short-term investments
rather than cash equivalents if they are acquired and disposed of through its
investment trading account, held for future property purchases, or restricted by
agreement.
RECEIVABLES
Receivables consist primarily of vendor rebates and promotional allowances
and other miscellaneous amounts due to the Company, and are net of allowance for
doubtful accounts of $3,498 at September 1, 1996 and $4,628 at September 3,
1995.
28
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MERCHANDISE INVENTORIES
Merchandise inventories are valued at the lower of cost or market as
determined primarily by the retail inventory method, and are stated using the
last-in, first-out (LIFO) method for substantially all U.S. merchandise
inventories. The Company believes the LIFO method more fairly presents the
results of operations by more closely matching current costs with current
revenues. If all merchandise inventories had been valued using the first-in,
first-out (FIFO) method, inventories would have been higher by $16,150 at both
September 1, 1996, and September 3, 1995, and $6,650 at August 28, 1994.
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.
When required in the normal course of business, the Company enters into
agreements securing vendor interests in inventories. At September 1, 1996,
substantially no inventory was pledged as security.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
expenses are computed using the straight-line method for financial reporting
purposes and by accelerated methods for tax purposes. Buildings are depreciated
over twenty-five to thirty-five years; equipment and fixtures are depreciated
over three to ten years; and land rights and leasehold improvements are
amortized over the initial term of the lease.
Interest costs incurred on property and equipment during the construction
period are capitalized. The amount of interest costs capitalized related to
continuing operations was approximately $5,612 in fiscal 1996, $3,275 in fiscal
1995, and $5,209 in fiscal 1994. The amount of capitalized interest relating to
the discontinued real estate operations for fiscal 1994 was $1,961.
GOODWILL
Goodwill, included in other assets, totaled $50,746 at September 1, 1996 and
$51,063 at September 3, 1995, resulting from certain previous business
combinations and the purchase of Price Enterprises' interest in Price Club
Mexico in March 1995. Goodwill is being amortized over 5 to 40 years using the
straight-line method. Accumulated amortization was $8,815 at September 1, 1996
and $7,016 at September 3, 1995.
29
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
The calculation of net income per common and common equivalent share for
each period presented prior to the Merger reflects the issuance of 2.13 shares
of PriceCostco Common Stock for each share of Price Common Stock used in such
calculation and one share of PriceCostco Common Stock for each share of Costco
Common Stock used in such calculation. For fiscal 1996 and 1995, the calculation
eliminates interest expense, net of income taxes, on the 5 1/2% convertible
subordinated debentures (primary and fully diluted) and the 6 3/4% convertible
subordinated debentures (fully diluted only), and includes the additional shares
issuable upon conversion of these debentures. For fiscal 1994, the 6 3/4% and
5 1/2% convertible subordinated debentures were not dilutive for either primary
or fully diluted purposes. For all periods presented, the 5 3/4% convertible
subordinated debentures were not dilutive for either primary or fully diluted
purposes. The weighted average number of common and common equivalent shares
outstanding for primary and fully diluted share calculations for fiscal 1996,
1995, and 1994 were as follows (in thousands):
PREOPENING EXPENSES
Preopening expenses related to new warehouses, major remodels/expansions,
regional offices and other startup operations are expensed as incurred.
MEMBERSHIP FEES
Membership fee revenue represents annual membership fees paid by
substantially all of the Company's members. In accordance with industry
practice, annual membership fees are recognized as income when received.
FOREIGN CURRENCY TRANSLATION
The accumulated foreign currency translation relates to the Company's
consolidated foreign operations and its investment in the Price Club Mexico
joint venture. It is determined by application of the current rate method and
included in the determination of consolidated stockholders' equity at the
respective balance sheet dates.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes."
That standard requires companies to account for deferred income taxes using the
asset and liability method.
30
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
FISCAL 1996 NON-CASH ACTIVITIES
- None.
FISCAL 1995 NON-CASH ACTIVITIES
- During December 1994, the Company exchanged 23,224,028 shares of Price
Enterprises common stock valued at $282,462 for an equal number of shares
of Price Costco common stock.
- In February 1995, the Company exchanged 3,775,972 shares of Price
Enterprises common stock valued at $45,925 for an interest-bearing note
receivable from Price Enterprises.
- As of August 28, 1994, the net assets of Price Enterprises consisted
primarily of the discontinued operations net assets of $377,085 and
certain other assets. In connection with the spin-off of Price
Enterprises, all of these assets were eliminated from the Company's
consolidated balance sheet during fiscal 1995. For additional information
see "Note 3--Spin-off of Price Enterprises, Inc. and Discontinued
Operations."
- In April 1995, the Company purchased Price Enterprises' 25.5% interest in
Price Club Mexico for $30,500 by a partial offset to the $45,925 note
receivable due from Price Enterprises.
- During fiscal 1995, the Company increased its investment in certain
unconsolidated joint ventures by $23,100 through reductions of accounts
receivable due from those joint ventures.
FISCAL 1994 NON-CASH ACTIVITIES
- During fiscal 1994, the Company transferred approximately $127,055 of
property and equipment and other assets to its discontinued non-club real
estate operations.
DERIVATIVES
The Company has limited involvement with derivative financial instruments
and only uses them to manage well-defined interest rate and foreign exchange
risks. Forward foreign exchange contracts are used to hedge the impact of
fluctuations of foreign exchange on inventory purchases. The amount of interest
rate and foreign exchange contracts outstanding at year-end or in place during
fiscal 1996 was immaterial to the Company's results of operations or its
financial position.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1995, the Financial Accounting Standards Board issued Statement No.
121 ("SFAS No. 121") on accounting for the impairment of long-lived assets,
certain identifiable intangibles, and goodwill related to assets to be held and
used. SFAS No. 121 also establishes accounting standards for long-lived assets
and certain identifiable intangibles to be disposed. The Company intends to
adopt SFAS No. 121 in fiscal 1997, and has estimated a pre-tax, cumulative
non-cash charge relating to the writedown of impaired long-term assets of
approximately $65,000.
31
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In November 1995, the Financial Accounting Standards Board issued Statement
No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), which
established financial accounting and reporting standards for stock-based
employee compensation plans. SFAS No. 123 specifies a fair value-based method of
accounting for stock-based compensation plans and encourages (but does not
require) entities to adopt that method in place of the provisions of APB Opinion
25, "Accounting for Stock Issued to Employees". The Company has not yet
determined which method of accounting will be used or what impact the adoption
of the accounting requirements of SFAS No. 123 might have on the Company's
results of operations.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
NOTE 2--MERGER OF PRICE AND COSTCO
On October 21, 1993, the shareholders of both Price and Costco approved the
mergers of Price and Costco into PriceCostco (the "Merger"). PriceCostco was
formed to effect the Merger, which qualified as a "pooling-of-interests" for
accounting and financial reporting purposes. The pooling-of-interests method of
accounting is intended to present as a single interest two or more common
shareholder interests which were previously independent. Consequently, the
historical financial statements for periods prior to the Merger were restated as
though the companies had been combined. The restated financial statements were
adjusted to conform the accounting policies of the separate companies.
All fees and expenses related to the Merger and to the consolidation and
restructuring of the combined companies were expensed as required under the
pooling-of-interests accounting method. In the first quarter of fiscal 1994, the
Company recorded a provision for merger and restructuring costs of $120,000
pre-tax ($80,000 after tax) related to the Merger.
32
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 2--MERGER OF PRICE AND COSTCO (CONTINUED)
Components of the $120,000 provision for merger and restructuring expenses
were as follows:
NOTE 3--SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS
On July 28, 1994, PriceCostco entered into an Agreement of Transfer and Plan
of Exchange (as amended and restated, the "Transfer and Exchange Agreement")
with Price Enterprises, Inc. ("Price Enterprises"). Price Enterprises was an
indirect, wholly-owned subsidiary of PriceCostco, formed in July 1994. The
transactions contemplated by the Transfer and Exchange Agreement are referred to
herein as the "Exchange Transaction." Pursuant to the Transfer and Exchange
Agreement, PriceCostco offered to exchange one share of Price Enterprises Common
Stock for each share of PriceCostco Common Stock, up to a maximum of 27 million
shares of Price Enterprises Common Stock (the "Exchange Offer").
In the fourth quarter of fiscal 1994, the Company recorded an estimated loss
on disposal of its discontinued operations (the non-club real estate segment) of
$182,500 as a result of entering into the Transfer and Exchange Agreement. The
loss also included the direct expenses related to the Exchange Transaction. For
purposes of recording such estimated loss, the Company assumed that (i) the
Exchange Offer would be fully subscribed, (ii) a per share price of Price
Enterprises Common Stock of $15.25 (the closing sales price of PriceCostco
Common Stock on October 24, 1994), and (iii) direct expenses and other costs
related to the Exchange Transaction of approximately $15,250.
The Exchange Transaction was completed on December 20, 1994, with 23,224,028
shares of PriceCostco Common Stock tendered and exchanged for an equal number of
shares of Price Enterprises Common Stock. On February 9, 1995, Price Enterprises
purchased from PriceCostco 3,775,972 shares of
33
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS
(CONTINUED)
Price Enterprises Common Stock, constituting all of the remaining shares of
Price Enterprises Common Stock held by PriceCostco. Price Enterprises issued to
PriceCostco a secured promissory note in the amount of $45,925 due in December
1996 as payment for such shares, based on an average closing sales price
$12.1625 of Price Enterprises Common Stock. The price per share of Price
Enterprises Common Stock represented the average closing sales price of Price
Enterprises Common Stock during the 20 trading days commencing on the sixth
trading day following the closing of the Exchange Offer.
Based on the aggregate number of shares of Price Enterprises Common Stock
(27 million shares) exchanged for PriceCostco Common Stock and sold to Price
Enterprises for a secured promissory note and an average closing sales price of
$12.1625 per share for Price Enterprises Common Stock, the loss on disposal of
the discontinued real estate operations increased by $83,363 (27 million shares
multiplied by $3.0875 per share representing the difference between the
estimated and actual price per share). This non-cash charge was reflected as an
additional loss on disposal of discontinued operations in the second quarter
ended May 7, 1995.
The following real estate-related assets were transferred to Price
Enterprises:
- Substantially all of the real estate properties which historically formed
the non-club real estate segment of PriceCostco.
- Four Price Club warehouses ("Warehouse Properties") which were adjacent to
existing non-club real estate properties, which are now being leased back
to PriceCostco, effective August 29, 1994, at initial collective annual
rentals of approximately $8,600.
- Notes receivable from various municipalities and agencies ("City Notes").
- Note receivable in the principal amount of $41,000 made by Atlas Hotels,
Inc., secured by a hotel and convention center property located in San
Diego, California ("Atlas Note").
In addition, PriceCostco transferred to Price Enterprises 51% of the
outstanding capital stock of Price Quest, Inc. ("Price Quest") and Price Global
Trading, Inc. ("Price Global"). Price Quest operated the Quest interactive
electronic shopping business and provides other services to members. Price
Global has the rights to develop membership warehouse club businesses in certain
geographical areas specified in the Transfer and Exchange Agreement.
On or about September 1, 1996, Price Quest discontinued the Quest
interactive electronic shopping business in the Company's warehouses, but
continues to provide other services to members, including auto referral and
travel related services. As a result of the proposed resolution of the
shareholder litigation arising from the spin-off and Exchange Transaction (see
Note 10--"Commitments and Contingencies"), PriceCostco would retain no ownership
interest in Price Quest or Price Global.
PriceCostco also transferred to Price Enterprises a 25.5% interest in the
Price Club Mexico joint venture. This interest was subsequently acquired from
Price Enterprises in fiscal 1995. Price Club Mexico is a joint venture with
Controladora Comercial Mexicana, S.A. de CV. operating Price Clubs in Mexico.
See "Note 4--Acquisition of Price Enterprises' Interest in Price Club Mexico."
PriceCostco and Price Enterprises entered into an unsecured revolving credit
agreement under which PriceCostco agreed to advance Price Enterprises up to a
maximum principal amount of $85,000. All
34
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS
(CONTINUED)
amounts have been paid under this agreement and PriceCostco no longer has any
obligations to provide financing for Price Enterprises.
DISCONTINUED OPERATIONS
Historically, the Company treated non-club real estate investments as a
separate reportable business segment. The primary assets generating operating
income for the segment were non-club real estate properties, consisting of
property owned directly and property owned by real estate joint venture
partnerships in which the Company had a controlling interest. Real estate joint
ventures related to real estate partnerships that were less than majority owned.
In fiscal 1994, the Atlas Note was purchased and the related interest income was
included in the non-club real estate segment.
Additionally, the Warehouse Properties and City Notes transferred to Price
Enterprises as of August 28, 1994 were included in the net assets of the
discontinued operations as of August 28, 1994, in the accompanying consolidated
balance sheet. However, the operating expenses of the Warehouse Properties and
the interest income on the City Notes have not been included in the real estate
segment operating results because historically these amounts have been included
as part of merchandising operations and other income. The operating results and
net assets of Price Quest, Price Global and the 25.5% interest in the Price Club
Mexico joint venture transferred to Price Enterprises are included in continuing
operations because they were not related to the discontinued real estate
operations.
LOSS FROM DISCONTINUED OPERATIONS
Components of the loss from discontinued operations for fiscal 1994, prior
to the effective date of the Exchange Transaction, were as follows:
PROVISION FOR ASSET IMPAIRMENTS
The loss on discontinued real estate operations includes a provision of
$90,200 of which $80,500 ($47,500 after tax) relates to a change in calculating
estimated losses for assets which are economically impaired. This change in
accounting estimates results from the spin-off of the real estate segment assets
into Price Enterprises and Price Enterprises' decision to pursue business plans
and operating strategies as a stand-alone entity which are significantly
different than the previous strategies of the Company. Price
35
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS
(CONTINUED)
Enterprises' management believes that as a separate operating business it will
not have the same access to capital as the Company or generate internal funds
from operations to the same extent as the Company.
PriceCostco's accounting policies with respect to estimating the amount of
impairments on individual real estate properties and related assets were such
that impairment losses would be recorded if the carrying amount of the asset
could not be recovered from estimated future cash flows on an undiscounted
basis. Price Enterprises' management believed that in view of its strategies
with respect to the number and nature of properties that would be selected for
disposition, it would be more appropriate to estimate impairment losses based on
fair values of the real estate properties as determined by appraisals and/or a
risk-adjusted discounted cash flow approach. In determining impairment losses,
individual real estate assets were reduced to estimated fair value, if lower
than historical cost. For those assets which have an estimated fair value in
excess of cost, the asset continues to be recorded at cost. The impairment
losses recorded as a result of this change in accounting estimates reduced the
book basis of certain of the real estate and related assets.
Under the previous policy, PriceCostco and Price Enterprises had determined
that a provision for asset impairments of approximately $9,700 was required
relating to four properties which were under contract or in final negotiations
for sale.
GAINS ON SALE OF NON-CLUB REAL ESTATE PROPERTIES
During fiscal 1994, the Company entered into a transaction with The Price
REIT, Inc. On October 1, 1993, the Company sold a single shopping center and
adjacent Price Club (which is being leased back to the Company) for $28,200. The
Company recorded a $4,210 pre-tax gain in connection with this sale.
RELATED PARTY TRANSACTIONS
Joseph Kornwasser, a former director of PriceCostco until July 28, 1994, is
a general partner and has a two-thirds ownership interest in Kornwasser and
Friedman Shopping Center Properties (K & F). K & F was a partner with Price in
two partnerships. As of August 28, 1994, Price's total capital contributions to
the partnerships were $83,000. Aggregate cumulative distributions from these
partnerships were $14,300 at August 28, 1994. Price had also entered into a
Development Agreement with K & F for the development of four additional
properties. As of August 28, 1994, Price's total capital expenditures for these
properties were $58,000. Aggregate cumulative distributions from these
properties were $4,500 at August 28, 1994. Both partnership agreements and the
Development Agreement provided for a preferred return to Price on a varying
scale from 9% to 10% on its invested capital after which operating cash flows or
profits are distributed 75% to Price and 25% to K & F. On August 12, 1993, Mr.
Kornwasser became Chief Executive Officer and director of The Price REIT. On
that date, The Price REIT also obtained the right to acquire certain of the
partnership interest of K & F described above. On August 28, 1994, the Company
purchased both K & F's interest in the two partnerships and its rights under the
Development Agreement for a total of $2,500.
NOTE 4--ACQUISITION OF PRICE ENTERPRISES' INTEREST IN PRICE CLUB MEXICO
In April 1995, the Company purchased Price Enterprises' 25.5% interest in
Price Club Mexico for $30,500. The purchase price was paid by a partial offset
of the $45,925 secured promissory note owed to
36
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 4--ACQUISITION OF PRICE ENTERPRISES' INTEREST IN PRICE CLUB MEXICO
(CONTINUED)
PriceCostco by Price Enterprises (see "Note 1--Summary of Significant Accounting
Policies"). As a result of the purchase, the Company owns a 50% interest in the
Price Club Mexico joint venture. Controladora Comercial Mexicana owns the other
50% interest in the Price Club Mexico joint venture. In January 1995,
PriceCostco assumed management responsibility over operations, merchandising and
site acquisitions for Price Club Mexico.
NOTE 5--DEBT
SHORT-TERM BORROWINGS
The Company has a domestic, multiple-option loan facility with a group of 12
banks which provides for borrowings of up to $500,000 or standby support for a
$500,000 commercial paper program. Of this amount, $250,000 expires on January
27, 1997, and $250,000 expires on January 30, 2001. The interest rate on bank
borrowings is based on LIBOR or rates bid at auction by the participating banks.
At September 1, 1996, no amounts were outstanding under the loan facility or the
commercial paper program. The Company expects to renew for an additional
one-year term the $250,000 portion of the loan facility expiring on January 27,
1997, at substantially the same terms. The Company is required to maintain
certain financial covenants, among other restrictions. The Company was in
compliance with all requirements as of September 1, 1996.
In addition, a wholly-owned Canadian subsidiary has a $102,000 commercial
paper program supported by a bank credit facility with three Canadian banks of
which $62,000 will expire in March 1997 and $40,000 will expire in March 1999.
The interest rate on bank borrowings is based on the prime rate or the "Bankers'
Acceptance" rate. At September 1, 1996, $1,053 was outstanding under the bank
credit facility and $59,928 was outstanding under the Canadian commercial paper
program. The Company expects to renew for an additional one-year term the
$62,000 portion of the loan facility expiring in March 1997, at substantially
the same terms.
37
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--DEBT (CONTINUED)
The weighted average borrowings, highest borrowings and interest rate under
all short-term borrowing arrangements were as follows for fiscal 1996, 1995, and
1994:
The Company has separate letter of credit facilities (for commercial and
standby letters of credit) totaling approximately $198,000. The outstanding
commitments under these facilities at September 1, 1996 totaled approximately
$156,000, including approximately $56,000 in standby letters for workers'
compensation requirements.
38
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--DEBT (CONTINUED)
LONG-TERM DEBT
Long-term debt at September 1, 1996 and September 3, 1995 consists of:
Effective upon consummation of the Merger, PriceCostco became a co-obligor
under each of the convertible subordinated debentures originally issued by Price
and Costco. These debentures are convertible into shares of PriceCostco.
Conversion rates of Price subordinated debentures have been adjusted for the
exchange ratio pursuant to the Merger.
The 5 3/4% convertible subordinated debentures due May 2002 are convertible
at any time prior to maturity, unless previously redeemed, into shares of
PriceCostco common stock at a conversion price of $41.25 per share, subject to
adjustment in certain events. Interest on the debentures is payable semiannually
on November 15 and May 15. Commencing on June 1, 1995, these debentures are
redeemable at the option of the Company, in whole or in part, at certain
redemption prices.
The 6 3/4% convertible subordinated debentures are convertible into shares
of PriceCostco common stock at any time on or before March 2001, unless
previously redeemed, at a conversion price of $22.54 per share, subject to
adjustment in certain events. Interest on the debentures is payable semiannually
on March 1 and September 1. The debentures are redeemable at the option of the
Company after March 1, 1994 at certain redemption prices. During fiscal 1994 in
connection with the Merger, approximately $2,421 of these debentures were
purchased at their face value.
The 5 1/2% convertible subordinated debentures are convertible into shares
of PriceCostco common stock at a conversion price of $23.77 per share, subject
to adjustment in certain events. The debentures provide for payments to an
annual sinking fund in the amount of 5% of the original principal amount
($10,000), commencing February 1998, calculated to retire 70% of the principal
amount prior to maturity. During fiscal 1990, the Company repurchased debentures
with a face value of $20,597 and will apply this purchase to the initial sinking
fund payments. Interest is payable semiannually on February 28 and August 31.
39
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--DEBT (CONTINUED)
The 7 1/8% Senior Notes were issued on June 7, 1995. Interest on the notes
is payable semiannually on June 15 and December 15. The indentures contain
limitations on the Company's and certain subsidiaries' ability to create liens
securing indebtedness and to enter into certain sale leaseback transactions.
In April 1996, the Company borrowed $140,000 from a group of banks under a
five-year unsecured term loan. Interest only is payable quarterly at rates based
on LIBOR. Proceeds of the loan were used to retire $40,000 outstanding under the
Canadian commercial paper program and $100,000 outstanding under the U.S.
commercial paper program.
On February 21, 1996, the Company filed with the Securities and Exchange
Commission a shelf registration statement relating to $500,000 of senior debt
securities. The registration statement was declared effective on February 29,
1996. As part of that filing, the Company announced its intention, subject to
market conditions, to offer $300,000 of senior notes to refinance existing
indebtedness. The Company has deferred issuance of these notes due to
unfavorable interest rate market conditions.
At September 1, 1996, the fair values of the 5 3/4%, 6 3/4% and 5 1/2%
convertible subordinated debentures, based on current market quotes, were
approximately $275,000, $297,000, and $184,000 respectively. Early retirement of
these debentures would result in the Company paying a call premium. The fair
value of the 7 1/8% Senior Notes, based on market quotes on September 1, 1996,
was approximately $286,000. The Senior Notes are not redeemable prior to
maturity.
Maturities of long-term debt during the next five fiscal years and
thereafter are as follows:
NOTE 6--LEASES
The Company leases land and/or warehouse buildings at 48 warehouses open at
September 1, 1996 and certain other office and distribution facilities under
operating leases with remaining terms ranging from 2 to 30 years. These leases
generally contain one or more of the following options which the Company can
exercise at the end of the initial lease term: (a) renewal of the lease for a
defined number of years at the then fair market rental rate; (b) purchase of the
property at the then fair market value; (c) right of first refusal in the event
of a third party purchase offer. Certain leases provide for periodic rental
increases based on the price indices and some of the leases provide for rents
based on the greater of minimum guaranteed amounts or sales volume. Contingent
rents have not been material. Additionally, the Company leases certain equipment
and fixtures under short-term operating leases which permit the Company to
either renew for a series of one-year terms or to purchase the equipment at the
then fair market value.
40
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--LEASES (CONTINUED)
Aggregate rental expense for fiscal 1996, 1995, and 1994 was $55,686,
$53,600, and $44,900, respectively. Future minimum payments during the next five
fiscal years and thereafter under noncancelable leases with terms in excess of
one year, at September 1, 1996, were as follows:
NOTE 7--STOCK OPTIONS AND WARRANTS
Prior to the Merger, Price and Costco adopted various incentive and
non-qualified stock option plans which allowed certain key employees and
directors to purchase or be granted common stock of Price and Costco
(collectively the Old Stock Option Plans). Options were granted for a maximum
term of ten years, and were exercisable upon vesting. Options granted under
these plans generally vest ratably over five to nine years. Subsequent to the
Merger, new grants of options are not being made under the Old Stock Option
Plans.
The PriceCostco 1993 Combined Stock Grant and Stock Option Plan (the New
Stock Option Plan) provides for the issuance of up to 10 million shares of the
Company's common stock pursuant to the exercise of stock options or up to
1,666,666 shares through stock grants.
Stock option transactions relating to the Old and New Stock Option Plans are
summarized below:
41
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7--STOCK OPTIONS AND WARRANTS (CONTINUED)
A foreign subsidiary of the Company has a separate stock option plan whereby
employees of the subsidiary receive stock option grants of subsidiary stock. At
September 1, 1996, stock option grants were approximately 1% of the subsidiary's
outstanding shares.
In 1986 and 1987, Price granted warrants to purchase a total of 1,065,000
shares of common stock at $17.37 per share to a joint venture partner. The
warrants granted in 1987 vested over a five year period from the date of
issuance and were exercisable up to eight years and one month from the grant
date. A total of 532,500 warrants have been exercised. The remaining 532,500
warrants were cancelled during fiscal 1995.
NOTE 8--RETIREMENT PLANS
On January 1, 1995, the Company amended and restated The Price Company
Retirement Plan, The Price Company 401(k) Plan and the Costco Wholesale 401(k)
Plan into the PriceCostco 401(k) Retirement Plan. This new plan is available to
all U.S. employees who have one year or more of service, except California union
employees. The plan allows pre-tax deferral against which the Company matches
50% of the first one thousand dollars of employee contributions. In addition,
the Company will provide each participant a contribution based on salary and
years of service. The Company has a defined contribution plan for Canadian
Price, Canadian Costco and United Kingdom Costco employees and contributes a
percentage of each employee's salary.
California union employees participate in a defined benefit plan sponsored
by its union. The Company makes contributions based upon its union agreement. In
June 1995, the Company also established a 401(k) plan for the California union
employees. The plan allows pre-tax deferral against which the Company matches
50% of the first two hundred fifty dollars of employee contributions.
Amounts expensed under these plans were $51,996, $37,298, and $27,859 for
fiscal 1996, 1995, and 1994, respectively. The Company has defined contribution
401(k) and retirement plans only and thus has no liability for postretirement
benefit obligations under the Financial Accounting Standards Board Statement No.
106 "Employer's Accounting for Postretirement Benefits Other than Pensions."
42
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--INCOME TAXES
The provisions for income taxes from continuing operations for fiscal 1996,
1995, and 1994 are as follows:
A reconciliation between the statutory tax rate and the effective rate from
continuing operations for fiscal 1996, 1995, and 1994 is as follows:
The components of the deferred tax assets and liabilities related to
continuing operations are as follows:
43
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The net deferred tax liabilities at September 1, 1996 and September 3, 1995
include current deferred income tax assets of $55,452 and $56,909, respectively,
and non-current deferred income tax liabilities of $56,734 and $64,293,
respectively.
NOTE 10--COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On April 6, 1992, Price was served with a Complaint in an action entitled
FECHT ET AL. V. THE PRICE COMPANY ET AL., Case No. 92-497, United States
District Court, Southern District of California (the "Court"). Subsequently, on
April 22, 1992, Price was served with a First Amended Complaint in the action.
The case was dismissed without prejudice by the Court on September 21, 1992, on
the grounds the plaintiffs had failed to state a sufficient claim against
defendants. Subsequently, plaintiffs filed a Second Amended Complaint which, in
the opinion of the Company's counsel, alleged substantially the same facts as
the prior complaint. The Complaint alleged violation of certain state and
federal laws during the time period prior to Price's earnings release for the
second quarter of fiscal year 1992. The case was dismissed with prejudice by the
Court on March 9, 1993, on grounds the plaintiffs had failed to state a
sufficient claim against defendants. Plaintiffs filed an Appeal in the Ninth
Circuit Court of Appeals. In an opinion dated November 20, 1995, the Ninth
Circuit reversed and remanded the lawsuit. The Company believes that this
lawsuit is without merit and is vigorously defending the lawsuit. The Company
does not believe that the ultimate outcome of such litigation will have a
material adverse effect on the Company's financial position or results of
operations.
On December 19, 1994, a Complaint was filed against PriceCostco in an action
entitled SNYDER V. PRICE/ COSTCO, INC. ET. AL., Case No. C94-1874Z, United
States District Court, Western District of Washington. On January 4, 1995, a
Complaint was filed against PriceCostco in an action entitled BALSAM V.
PRICE/COSTCO, INC. ET. AL., Case No. C95-0009Z, United States District Court,
Western District of Washington. The Snyder and Balsam Cases were subsequently
consolidated and on March 15, 1995, plaintiffs' counsel filed a First Amended
And Consolidated Class Action And Derivative Complaint. On November 9, 1995,
plaintiff's counsel filed a Second Amended And Consolidated Class Action And
Derivative Complaint. The Second Amended Complaint alleged violation of certain
state and federal laws arising from the spin-off and Exchange Transaction and
the merger between Price and Costco. In July 1996, an agreement in principle was
reached to resolve the lawsuit. Subject to court approval, the resolution will
involve the transfer from Price Enterprises, Inc. to the Company of certain
intangible assets, including elimination of certain existing non-compete
restrictions and operating agreements and termination or amendment of certain
trademark license and assignment agreements. The cash portion of the settlement
will be funded by the Company's director and officer insurance coverage and by
Price Enterprises. The Company will contribute no money to the settlement.
In May 1996, PriceCostco reached an agreement in principle with the
Environmental Protection Agency and the U.S. Department of Justice to settle an
enforcement action under the Federal Clean Air Act. The action is based on
claims that PriceCostco failed to maintain required documentation related to its
sale of freon products. Under the terms of the proposed settlement, PriceCostco
will agree to pay a civil penalty of $232 and to comply with federal regulations
relating to the sale of ozone-depleting substances.
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.
44
PRICE/COSTCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 11--GEOGRAPHIC INFORMATION
The following table indicates the relative amounts of total revenue,
operating income and identifiable assets for the Company during fiscal 1996,
1995 and 1994:
NOTE 12--QUARTERLY FINANCIAL DATA (UNAUDITED)
The tables that follow on the next two pages reflect the unaudited quarterly
results of operations for fiscal 1996 and 1995.
Shares used in the earnings per share calculation fluctuate by quarter
depending primarily upon whether convertible subordinated debentures are
dilutive during the respective period.
45
PRICECOSTCO, INC.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
46
PRICECOSTCO, INC.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
47
EXHIBIT INDEX
The following exhibits are filed as part of this Annual Report on Form 10-K
or are incorporated herein by reference. Where an exhibit is incorporated by
reference, the number which follows the description of the exhibit indicates the
document to which cross reference is made. See the end of this exhibit index for
a listing of cross reference documents.
------------------------
(1) Registration Statement of The Price Company on Form SE filed February 12,
1987 is hereby incorporated by reference
(2) Registration Statement of The Price Company on Form S-3 (File No. 33-38966)
filed February 27, 1991 is hereby incorporated by reference
(3) Incorporated herein by reference to the identical exhibit filed as part of
The Price Company's Form 10-K for the fiscal year ending August 31, 1991
(4) Incorporated by reference to the Registration Statement of Price/Costco,
Inc. Form S-4 (File No. 33-50359) dated September 22, 1993
(5) Incorporated by reference to Costco's Registration Statement on Form S-3
(File No. 33-47750) filed May 22, 1992
(6) Incorporated by reference to Schedule 13E-4 of The Price Company and
Price/Costco, Inc. filed November 4, 1993
(7) Incorporated by reference to the exhibits filed as part of Amendment No. 1
to the Registration Statement on Form 8-A of The Price Company
(8) Incorporated by reference to the exhibits filed as part of Amendment No. 2
to the Registration Statement on Form 8-A of Costco
(9) Incorporated by reference to the exhibits filed as part of the Annual Report
on Form 10-K/A of Price/ Costco, Inc. for the fiscal year ended August 29,
1993
(10) Incorporated by reference to the exhibits filed as part of the Registration
Statement on Form S-4 of Price Enterprises, Inc. (File No. 33-55481) filed
on September 15, 1994
(11) Incorporated by reference to the exhibits filed as part of the Quarterly
Report on Form 10-Q of Price/ Costco, Inc. for the 12 weeks ended February
13, 1994
(12) Incorporated by reference to the exhibits filed as part of the Registration
Statement on Form S-3 of Price/Costco, Inc. (File No. 33-59403) filed on May
17, 1995.
(13) 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.