STA N FO RD

GRADUATE SCHOOL O F BUSIN

ESS

CASE: A-186A
DATE: 06/19/03

COSTCO WHOLESALE CORPORATION

FINANCIAL STATEMENT ANALYSIS (A)
INTRODUCUON

Margarita Torres first purchased shares in Costco Wholesale Corporation in 1997 as part of her
personal investment pottfolio. Between 1997 and 2002, she added slightly to her holdings from
time to time when the company sold stock for what she felt was a reasonable valuation, and up
to that time she did not sell any of her shares. Having watched Costco grow from 265
warehouses to 365 worldwide, and from sales revenue of $21.8 billion to $34.1 billion, she
wondered what factors led to such successful growth. She also wanted to determine whether
those factors would hold consistent going forward.

At this point, Costco was one of a special breed of retailers called wholesale clubs. Unlike other
retailers, wholesale clubs required that customers purchase annual memberships in order to shop
at their stores. Costco operated a chain of warehouses that sold food and general merchandise at
large discounts to member customers. The company was able to maintain low margins by
selling items in bulk, keeping operating expenses to a minimum, and turning inventory over
rapidly. Costco's closest competitors were SAM'S Club (a division of Wal-Mart) and BJ's
Wholesale, which both operated as wholesale clubs. Other competitors included general
discounters (such as Wal-Mart), general retailers (such as Sears), grocery store chains (such as
Safeway), and specialty discounters (such as Best Buy).

( Torres first considered investing in Costco because she herself was a member. She was
impressed by the company's low prices and noticed in particular that her local Costco was
always crowded. She decided to research the company and started, as always, with their annual
reports. She discovered a company with tremendous growth potential, strong operational
efficiency, and a dedicated management team - and a stock selling at a reasonable price. Now,
in July 2002, having profited well from her investment, she decided it was time to update her
analysis and determine whether the company was still operating efficiently.

Brian Tayan prepared this case under the supervision of Professor Maureen McNichols as the basis for class discussion rather
than to illustrate either effective or ineffectivehandling of an administrativesituation.
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 Costco WJ,o/esa/e Corp.: Finandal Stateme11t Analysis (A) A-186A J!: 3

Wal-Martalso expanded its product offerings. Wal-Mart stores sold clothing, health and beauty
products, prescription,selectronics, sporting goods, music, and toys. In 1983, Wal-Mart opened
its first SAM'S wholesale club to compete with Price Club. In 1987, Wal-Mart opened its first
Supercenter, which included a full-sized grocery store along with the complete product line of a
traditional Wal-Mart store. By 2000, Wal-Mart was also selling its products online through
Walmart.com.

During this era of Wal-Mart expansion, another type of discounter developed, specializing in the
sale of only one category of product, such as electronics, hardware, or furniture. Dubbed
"category killers," these companies looked to beat discounters at their own game by achieving
even greater efficiencies of scale. Although not all specialty discounters gained lasting success,
several continued to dominate their respective categories, including Home Depot, Circuit City,
and Walgreens.

Discounters and specialty discounters had been very successful stealing sales from deparbnent
stores. As a result, general merchandisers from Sears to J.C. Penney have been forced to
( reinvent themselves in order to stay in business. Whether they would succeed, however, was still
in question. Montgomery Ward, a once-formidable competitor to Sears, was forced to shut
down its stores in 2000 after 128 years of operations.

Wholesale Clubs

The early 1980s saw the introduction of a new trend in retailing - the wholesale club. Wholesale
clubs are based on the same premise as discounters: offer the best value to shoppers. They
delivered that value, however, in a different way. First, customers purchased an annual
membership in order to shop in the stores. Second, the clubs carried a very limited selection of
goods, generally 4,000 SKUs compared to 40,000 SKUs at most grocery stores. Whereas
discounters and specialty discounters carried a broad product line, clubs generally carried one or
two brands in each category. Third, the clubs sold items in bulk. By limiting the selection of
goods and selling in bulk, clubs were able to negotiate discounts from vendors and pass on those
discounts to customers in the form of lower prices. These two factors also allowed clubs to tum
inventory over faster. Fourth, the clubs kept operating expenses to a minimum. Low operating
expenses were essential in order for them to maintain profitability, because they worked on very
( low gross margins. Clubs achieved low operating expenses by running their stores in warehouse-
style facilities and by reducing stocking costs. Wholesale clubs saw annual revenue and earnings
growth of 12 - 15 percent during the 1990s compared to 5 - 6 percent annual growth for general
retailers.

Wholesale clubs expanded internationally with limited success. They gained traction in Canada
and Mexico, but growth was not as effective in Europe, South America, and Asia. Although
prices of wholesale clubs were attractive to international consumers, there were many challenges
in growing internationally, including differences in consumer purchasing behavior, less space at
home for consumers to store bulk items, high real estate costs for warehouses, government
regulations, and difficulties in implementing a distribution system (see Exhibit 1).

Online Retailers

In 2000, online retailers were thought to be the next dominant player in retailing. Shipping items
from centralized distribution centers, online retailers were thought to have a fundamental cost
Costco WholesaleCorp.: Finandal State,ne,1tAnalysis (A) A-186A I!: 5

Costco Strategy

In 2001, Costco was the largest wholesale club in the industry with sales of $34 billion. The
company, however, was smaller than SAM'S in number of warehouses (365 for Costco vs. 528
for SAM'S). Costco differentiated itself from SAM'S by targeting a wealthier clientele of small
business owners and middle class shoppers (see Exhibit 4).

Costco, through its history with Price Club, took great pride in having invented and developed
the club warehouse concept. The company demonstrated its value to customers by refusing to
mark up products more than 14 percent over the distributor's price. By comparison, a typical
retailer marked up products 25 percent to 40 percent. Although selling items in bulk allowed for
many operating efficiencies, management's main focus was on delivering the lowest per unit
price on the products it sold. For example, a 100 fl. ounce container of Tide liquid detergent
would sell at a general retailer for $8.99, or $0.0899 per fl. ounce. At Wal-Mart, a 100 fl. ounce
container sold for $7.44, or $0.0744 per fl. ounce. Costco sold the same detergent in a 300 fl.
ounce container at a price of $17.99, or $0.06 fl. per ounce. Costco was able to sell at such a
low per unit cost precisely because of its bulk packaging. The size of the container, however,
was not maximized in order to compel consumers to purchase more goods. Costco had a policy
of not increasing the size of a container unless it resulted in a lower per unit cost. That is,
they would not sell Tide detergent in containers greater than 300 fl. ounces unless the resulting
price was less than $0.06 per fl. ounce. They believed that lowering the unit price of goods was
what allowed them to deliver value to the customer.

Selling through Costco was a mixed blessing for product manufacturers. On the one hand,
Costco offered a broad distribution channel that brought increased revenues. In addition, Costco
only purchased a handful of SKUs from its vendors. This allowed manufacturers to greatly
reduce production costs. For example, when Costco ordered toilet paper from Kimberly Clark, it
ordered one color, one print, and one ply. This allowed Kimberly Clark to set up the production
line only once and run continuous batches of the same product, lowering per unit production
costs. On the other hand, because Costco was a powerful purchaser, it could demand that
production savings be passed on to itself in the form of lower prices. As a result, the
manufacturer would see increased revenues, but increases in profits would be limited. Costco
passed these savings on to its own customers. The result was lower profits throughout the supply
chain.

Costco created value for the customer through these savings. This drove the value of its
membership and allowed Costco to raise fees over time. In 1986, Costco's membership fee was
$25. By 2002, it was $45. The more savings Costco was able to pass on to customers, the more
it would be able to increase its membership fee over time.

Costco also delivered value to customers by expanding its selection of name-brand products and
by adding ancillary services. Costco offered such items as Levi's jeans, Polo bed comforters,
and Compaq computers. Through its proprietary brand, Kirkland, the company offered
everything from cheese and ice cream to cookware and vitamins. Kirkland products were
developed wherever Costco recognized a need for high quality, low cost items that did not exist
in the market. In addition, Costco added photo development services, pharmacies, gas stations,
and tire changing stations in many of its stores. The company also increased its fresh food
department and added high-end wines and jewelry in an attemptt o serve the needs of its
 Costco Wholesale Corp.: Fina11dal Stateme11t Analysis (A) A-186A 1!: !_

Third, SAM'S suffered large amounts of management turnover during the 1990s. SAM'S saw
four different presidents come and go between 1994 and 1998. In contrast, James Sinegal and
Jeff Brotman had been in charge of Costco since the company's founding.

In 2001, SAM'S began undergoing transformation. Its president, Thomas Grimm, was providing
stronger leadership to the organization. He was pursuing an aggressive push to regain the lead
from Costco by increasing the rate of expansion in warehouse stores. In fiscal year 2002,
SAM'S was planning to open 80 new warehouses. The company had also outlined new plans to
renovate older warehouses, add higher-end merchandise to appeal to wealthier clientele, and
introduce ancillary product lines similar to Costco's in order to increase customer visits.

Most importantly, SAM'S and Costco's expansion plans would pit the two warehouse clubs
directly against each other in local markets. Traditionally, SAM'S and Costco did not have a
large number of stores competing in the same markets. The majority of SAM'S Clubs were
located in the South and most Costco's were in the West. With plans for both clubs to enter each
other's markets, it was unclear how much cannibalism would take place. One indication came
from a recent Costco store, which opened in the Dallas market in 2000. Although SAM'S
already had 14 warehouses in Dallas, Costco claimed that their own first-year sales were in line
with historical averages, approximately $55 million (see Exhibit 7).

BJ's Wholesale Club

BJ's Wholesale Club was a small but efficient competitor to Costco. BJ's was founded in 1984
in Medford, Massachusetts. By 2002, the company had 130 warehouses, all located in the United
States. 2001 sales were $5 billion, on a membership of 6.7 million. BJ's strategy was similar to
Co_stco' s: to target small business owners and middle-class customers, include high-value
goods in the product line to increase sales per customer, and increase store visits through
ancillary products.

BJ's strategy diverged from Costco's in that its stores were smaller (110,000 square feet versus
148,000 square feet), it carried more SKUs (6,000 per store versus 4,000 per store), and it
marked up select items more than 14 percent, which was Costco's limit. Also, BJ's spent more
money on flooring, lighting, and signage in its warehouse facilities in an attempt to improve the
shopping atmosphere.
( The results were mixed. In more recent years, BJ's had achieved sales and profit growth greater
than Costco's. BJ's customers visited its stores 12 times per year versus 9 times for Costco and
SAM'S. BJ's also reported gross margins of 9.2 percent, which allowed it to claim that its
operations were even more efficient than Costco's6. On the other hand, sales per store were only
$55 million versus $101 million at Costco, and its membership fee was not as high as Costco's
($40 for a basic membership versus $45) (see Exhibit 8).

6
A direct comparison of gross margins between the two companies is misleading in that BJ's cost of goods sold
figure includes procurement expenses. Costco excludes such expenses from cost of goods sold. Both methods are
acceptable under GAAP. BJ's accounting method results in shifting costs from operating expenses to cost of
goods sold, decreasing its reported gross margins, decreasing operating expenses, but leaving operating profits the
same. Information is not available in the BJ's annual report to allow us to quantify the company's procurement
expenses.
 Costco W/10/esale Corp.: Fina11dal Statement Analysis (A) A-186A I!: 9

would hold constant over time. In reality, however, companies frequently experienced changes
in their return on equity, and most companies distributed some portion of earnings to investors.
As a result, at the highest level, the company's sustainable growth rate could be expressed as the
product of the following two ratios:

* Earnings Retention Ratio = 1 - Dividend Payout Ratio

* Return on Equity (ROE) = Net Income/ Owner's Equity

If a company retained all of its earnings, its dividend payout ratio was O and its earnings
retention ratio was 1. As it paid out more of its earnings in dividends, its earnings available for
reinvestment in the business necessarily go down. Return on equity measured how much profit
is generated in net income for every dollar invested in equity capital.

Step 2: Leverage
The ROE component could be expressed as the product of two ratios: financial leverage and
( return on assets. Issuing debt allowed a company to increase its return on equity, so long as the
return on invested capital is greater than the cost of debt. For example, if a company's core
business earned 15 percent return on invested capital and it could borrow debt at 10 percent,
financial leverage would increase its ROE. Financial leverage was expressed as the ratio

* Financial Leverage= Assets I Owner's Equity

Assets represented the sum of capital employed in the business at any given time. Likewise,
return on assets was a measure of the business' overall profit.ability, making no distinction
between funds due to shareholders and funds due to creditors. Return on assets was expressed as
the ratio

* Return on Assets (ROA)= Net Income/ Assets

By breaking down Costco's ROE into these components, Torres could better understand how
leverage influenced its return on equity. She could also analyze how the increased asset base
from warehouse expansion was affecting the company's profit.ability.
( Step 3: Tumover and Margins
A company's return on assets could be further broken down into two components to determine
whether increased sales or increased margins accounted for changes in profitability. The first
ratio was asset turnover. Asset turnover measured how many dollars in sales were made for
each dollar in assets. The second component was net income margin, which measured how
much profit was generated per dollar of sales.

* Asset Turnover = Sales / Assets

* Net Income Margin = Net Income / Sales

Relating this to Costco, she could see how an increase in the asset base affected both sales and
net margin.
 Costco Wholesale Corp.: Financial Statement Analysis(A) A-186A p. 11

Inventory turnover was a reflection of how long inventory remains in the store before sale.
Companies with high inventory turnover were at a competitive advantage because they tied less
money up in unsold inventory and because they had the flexibility to adjust their product mix
more frequently.

* Inventory Turns= Cost of Goods Sold/ [(Opening Inventory+ Ending Inventory)/ 2]

Average collection period for receivables measured how many days, on average, it took for
a company to receive collectionsfrom customers.

* Average Receivables Period= 365 Days* Accounts Receivables/ Sales

Average payables period measured how many days, on average, it took a company to pay
suppliers.

* Average Payables Period= 365 * Accounts Payable/ Cost of Goods Sold

(
In reviewing these numbers, Torres considered how they reflected the differences in strategies
between Costco and its competitors. She also wondered what they implied about competitive
differences in the companies (see Exhibit 11).

(
 Costco Wllolesale Corp.: FinancialStatement Analysis (A) A-186A P: 13

Exhibitl
Retail and Wholesale Trade as a Percentage of GDPt

1950 1960 1970 1980 1990 2000

Gross domestic 241 415 801 2,708 5,546 9,873
product, $bn
Retail & wholesale 41 64 121 437 884 1568
trade,$bn
Retail & wholesale 17% 15% 15% 16% 16% 16%
trade, as % of GDP
t In current dollars

Source: U.S. Bureauof Economic Analysis, Survey o/Current Business, 1952, 1962, 1972, 1982, 1992, 2001

Exhibit3
Per Capita
Iocomet

1950 1960 1970 1980 1990 2000

Gross domestic 1,892 2,918 5,069 12,276 23,215 36,174
product, $bn
Personal income, $ 1,502 2,283 4,101 10,205 19,614 30,069

Disposable personal 1,369 2,026 3,591 8,869 17,176 25,379

income,$
Personal 1,270 1,838 3,164 7,741 15,327 24,534
consumption exp., $
t In current dollars

( Source: U.S. Bureau of Economic Analysis, Surveyof Current Business, 1952, 1962, 1972, 1982, 1992, 2001
 Costco Wholesale Corp.: Financial Statement Analysis (A) A-186A p. 15

Exhibit S
Financial Statements for Costco Wholesale Corp. (1997 - 2001)

Warehouses in Operation 2001 2000 1999 1998 1997

Beginning of year (including Mexico) 331 308 292 274 265
Openings 41 27 23 19 17
Closings {7} {4} {7} {1} {8}
End of year 365 331 308 292 274

Members at Year End (thousands)

Business (primary cardholders) 4,358 4,170 3,887 3,676 3,537
Gold Star 12,737 10,521 9,555 8,654 7,845

Income Statement(millions) 2001 2000 1999 1998 1997

Revenue
Net sales 34,137 31,621 26,976 23,830 21,484
( Membesrhip fees and other 660 543 480 440 390
Total revenues 34,797 32,164 27,456 24,270 21,874
Operating ex penses
Merchandise costs 30,598 28,322 24,170 21,380 19,314
SG&A 3,129 2,756 2,338 2,070 1,877
Preopening expenses 60 42 31 27 27
Provision for impaired assets / closings 18 7 57 6 75
Total operatingexpenses 33,805 31,127 26,596 23,483 21,293
Operating income 992 1,037 860 787 581
Other income (expenses)
Interest expense (32) (39) (45) (48) (76)
Interest income and other 43 54 44 27 15
Provision for merger and restructuring 0 0 0 0 0
Income continuing ops before taxes 1,003 1,052 859 766 520
Provision for income taxes 401 421 344 306 208
Income before cumulative effect of accting 602 631 515 460 312
Cumulative effect of accting, net of tax 0 0 {118} 0 0
Income from continuing operations 602 631 397 460 312
Discontinued operations
( Income (loss), net of tax 0 0 0 0 0
Loss on disposal 0 0 0 0 0
Net Income (loss) 602 631 397 460 312

Net income per common share:

Basic, before accounting change 1.34 1.41 1.17 1.07 0.76
Cumulative effect of accounting changes 0.00 0.00 {0.2?2 0.00 0.00
Basic 1.34 1.41 0.90 1.07 0.76
Diluted 1.29 1.35 0.86 1.01 0.73

Number of common shares for calculation

Basic 449,631 446,255 439,253 431,012 414,758
Diluted 475,827 475,737 471,120 463,371 449,336
 Costco Wholesale Corp.: Financial State111e11t A11alysis (A) A-186A p. 17

Exhibit6
Financial Statements for Sears, Roebuck (1997 - 2001)

Stores 2001 2000 1999 1998 1997

Full-line stores 867 863 858 845 833
Specialty stores 1318 2158 2153 2198 2697
Total 2185 3021 3011 3043 3530

Income Statement (millions) 2001 2000 1999 1998 1997

Revenues
Merchandise sales and services 35,843 36,366 36,728 36,704 36,371
Credit and financial products revenues 5,235 4,571 4,343 4,618 4,925
Total revenues 41,078 40,937 41,071 41,322 41,296

Costs and Expenses

( Cost of sales, buying and occupancy 26,322 26,721 27,212 27,257 26,779
Selling and administrative 8,892 8,807 8,418 8,318 8,322
Provision for uncollectible accounts 1,344 884 871 1,287 1,532
Provision for previously securitized receivables 522 0 0 830 0
Depreciation and amortization 863 839 848 1,423 785
Interest 1,415 1,248 1,268 0 1,409
Special charges and impairments 542 251 41 352 475
Total costs and expenses 39,900 38,750 38,658 39,467 39,302
Operating income 1,178 2,187 2,413 1,855 1,994
Other income, net 45 36 6 28 144

Income before income taxes and minority interest 1,223 2,223 2,419 1,883 2,138
Income truces 467 831 904 766 912
Minority interest 21 49 62 45 38
Net Income Before Extraordinary Loss 735 1,343 1,453 1,072 1,188
Extraordinary loss on extinguishment of debt 0 0 0 24 0
Net Income 735 143 1,453 1,048 1,188

( Net income per common share:

Basic 2.25 3.89 3.83 2.70 3.03
Diluted 2.24 3.88 3.81 2.68 2.99

Number of common shares for calculation 326.4 345.1 379.2 388.6 391.6
Basic 328.5 346.3 381.0 391.7 397.8
Diluted
 Costco Wl,o/esale Corp.: Finanda/ Stateme11t Analysis (A) A-186A p.19

Exhibi t 7
Financial Statements for Wal-Mart Corp. (1997 - 2001)
Stores in Operation 2001 2000 1999 1998 1997
Wal-Martstores 2,348 2,373 2,389 2,421 2,209
Supercenters 1,294 1,104 713 502 370
SAM'S Clubs 528 512 497 483 475
Other 19 7 4 0 0
Total 4,189 3,996 3,603 3,406 3,054

Income Statement (millions) 2001 2000 1999 1998 1997

Revenue
Net sales 191,329 165,013 137,634 117,958 104,859
Other income-net 1,966 1,796 1,574 1,341 1,319
Total revenues 193,295 166,809 139,208 119,299 106,178
Costs and Expenses
( Cost of sales 150,255 129,664 108,725 93,438 83,510
Operating: SG&A 31,550 27,040 22,363 19,358 16,946
Interest Costs
Debt 1,095 756 529 555 629
Capital leases 279 266 268 229 216
183,179 157,726 131,885 113,580 101,301
Income Before Taxes, Minority Interest, and
Cumulative Effect of Accounting Change 10,116 9,083 7,323 5,719 4,877
Provision for Income Taxes
Current 3,350 3,476 3,380 2,095 1,974
Deferred 342 {138} {640} 20 {180}
3,692 3,338 2,740 2,115 1,794
Income Before Minority Interest and
Cumulative Effect of Accounting Change 6,424 5,745 4,583 3,604 3,083
Minority Interest (129} (170} {153} (78} {27}
Income Before Cumulative Effect of
Accounting Change 6,295 5,575 4,430 3,526 3,056
Cumulative Effect of Accounting Change, Net
ofTax Benefit of$119 0 (198} 0 0 0
Net Income 6,295 5,377 4,430 3,526 3,056
( Net income per common share:
Basic, before accounting change 1.41 1.25 0.99 0.78 0.67
Cumulative effect of accounting changes 0.00 (0.04) 0.00 0.00 0.00
Basic 1.41 1.21 0.99 0.78 0.67
Diluted 1.40 1.20 0.99 0.78 0.67

Number of common shares for calculation

Basic 4,465 4,451 4,464 4,516 4,585
Diluted 4,484 4,474 4,485 4,533 4,592
 Costco Wholesale Corp.: Fi11ancial Statement Analysis (A) A-186A p. 21

,.. Exhibit8
Financial Statements for BJ's Wholesale Corp. (1997- 2001)

Warehouses in Operation 2001 2000 1999 1998 1997

Beginning of year 118 107 96 84 81
Openings 12 11 11 12 4
Closings 0 0 0 0 {l)
End of year 130 118 107 96 84

Members at Year End (thousands)

Business (primary cardholders) 1,552 1,575 1,435 1,296 1,132
Gold Star 5,322 5,021 4,379 3,763 3,465

Income Statement (thousands) 2001 2000 1999 1998 1997

Revenue
Net sales 5,161,164 4,828,273 4,115,825 3,476,846 3,159,786
( Membership fees and other 118,566 103,822 90,422 75,335 67,556
Total revenues 5,279,730 4,932,095 4,206,247 3,552,181 3,227,342
Operating expenses
Cost of sales, including buying and occupancy 4,686,429 4,376,451 3,725,638 3,154,017 2,872,303
SG&A 350,000 339,305 293,538 255,087 231,203
?reopening expenses 10,343 8,471 9,536 7,743 3,190
Pension tennination costs 0 0 0 1,521 0
Operating income 232,958 207,868 177,535 133,813 120,646
Interest income (expense), net 3,934 5,955 3,785 956 (8,733)
Loss on contingent lease obligations {106,359) 0 0 0 0
Income before income taxes 130,533 213,823 181,320 134,769 111,913
Provision for income taxes 48,185 82,322 70,171 52,964 43,646
Income before cumulative effect of accounting principle 82,348 131,501 111,149 81,805 68,267
Cumulative effect of accounting changes 0 0 0 {19,326) 0
Net income 82,348 131,501 111,149 62,479 68,267

Net income per common share:

Basic, before accounting change 1.14 1.80 1.51 1.09 0.91
Cumulative effect of accounting changes 0.00 0.00 0.00 {0.26) 0.00
( Basic 1.14 1.80 1.51 0.83 0.91
Diluted 1.11 1.77 1.47 0.82 0.90

Number of common shares for calculation

Basic 72,519,032 72,870,668 73,657,016 74,804,538 74,962,346
Diluted 73,981,148 74,380,544 75,391,489 76,095,876 75,487,798
 Costco WholesaleOJrp.: Finot1cial Stotemmt At1olysis (A) A-186A J!: 23

Exhibit 9
Margarita Torres: Common-Size Financial Statements for Costco (1997 - 2001)

Income Statement 2001 2000 1999 1998 1997

Revenue
Net sales 100.00% 100.00% 100.00% 100.00% 100.00%
Membership fees and other 1.93% 1.72% 1.78% 1.85% 1.82%
Total revenues 101.93% 101.72% 101.78% 101.85% 101.82%
Operating expenses
Merchandise costs 89.63% 89.57% 89.60% 89.72% 89.90%
SG&A 9.17% 8.72% 8.67% 8.69% 8.74%
Preopening expenses 0.18% 0.13% 0.11% 0.11% 0.13%
Provision for impaired assets / closings 0.05% 0.02% 0.21% 0.03% 0.35%
Total operating expenses 99.03% 98.44% 98.59% 98.54% 99.11%
Operating income 2.91% 3.28% 3.19% 3.30% 2.70%
( Other income (expenses)
Interest expense -0.09% -0.12% -0.17% -0.20% -0.35%
Interest income and other 0.13% 0.17% 0.16% 0.11% 0.07%
Provision for merger and restructuring 0.00% 0.00% 0.00% 0.00% 0.00%
Income continuing ops before taxes 2.94% 3.33% 3.18% 3.21% 2.42%
Provision for income taxes 1.17% 1.33% 1.28% 1.28% 0.97%
Income before cumulative effect of accting 1.76% 2.00% 1.91% 1.93% 1.45%
Cumulative effect of accting, netof tax 0.00% 0.00% -0.44% 0.00% 0.00%
Income from continuing operations 1.76% 2.00% 1.47% 1.93% 1.45%
Discontinued operations 0.00% 0.00% 0.00% 0.00% 0.00%
Income (loss), net of tax 0.00% 0.00% 0.00% 0.00% 0.00%
Loss on disposal 0.00% 0.00% 0.00% 0.00% 0.00%
NetIncome (loss) 1.76% 2.00% 1.47% 1.93% 1.45%

(_
 Costco Wllolesale Corp.: Financial StaJement Analysis (A) A-186A I!: 25

Exhibit 10
Margarita Torres: Sustainable Growth Model for Costco (1997 - 2001)

Sustainable Growth Model (millions) 2001 2000 1999t 1998 1997

Net Income 602 631 515 460 312

Owner's Equity 4,240 3,532 2,966 2,468 NA
Return on Equity (ROE) 14.2% 17.9% 17.4% 18.6% NA

Dividend 0 0 0 0 0
Net Income 602 631 515 460 312
Dividend Payout 0.0% 0.0% 0.0% 0.0% 0.0%
Earnings Retention Ratio 100% 100% 100% 100% 100%

Net Income 602 631 515 460 312

Assets 8,634 7,505 6,260 5,476 NA
Return on Assets (ROA) 7.0% 8.4% 8.2% 8.4% NA

Assets 8,634 7,505 6,260 5,476 NA

Owner's Equity 4,240 3,532 2,966 2,468 NA
Financial Leverage 2.04 2.12 2.11 2.22 NA

Net Income 602 631 515 460 312

Sales 34,797 32,164 27,456 24,270 21,874
Net Margin (Return on Sales) 1.73% 1.96% 1.88% 1.90% 1.43%

Sales 34,797 32,164 27,456 24,270 21,874

Assets 8,634 7,505 6,260 5,476 NA
Asset Turnover 4.03 4.29 4.39 4.43 NA

Pretax Income (continuing operations) 1,003 1,052 859 766 520

Sales 34,797 32,164 27,456 24,270 21,874
Pretax Return on Sales 2.88% 3.27% 3.13% 3.16% 2.38%

( Pretax Income (continuing operations)

Taxes
1,003
401
1,052
421
859
344
766
306
520
208
Tax Rate 40.0% 40.0% 40.0% 39.9% 40.0%
Tax Effect (1 -Tax Rate) 60.0% 60.0% 60.0% 60.1% 60.0%

t 1999 net income figures used for calculation are before cumulative effect of account change.

A. Has Costco become more or less efficient over time?

B. What areas of improvement can you suggest for the future? Organize your analysis as Common size analysis,
Sustainable growth models, and Benchmarking ratio (industry benchmark).