Letter #31: Costco

Jeff Brotman's and Jim Sinegal's 1985 Costco Shareholder Letter

Hi there! I go by KG, and I love studying the history of business and investing. I’ll be sharing some notes from one Investor/Shareholder letter per weekday (mostly from my compilations) here.

Today’s notes are on the Jeff Brotman and Jim Sinegal 1985 Costco Shareholder Letter. This was Costco’s first year as a public company, and just two years after they had opened their first warehouse.

You can find this essay in my Jim Sinegal Compilation under Consumer/Retail Operators. This particular letter starts on Page 1.


Writing Costco’s first annual report as a public company is both difficult and exciting considering that the Company’s primary corporate history dates back just two years to the first warehouse opening on September 15, 1983. So much activity has been compressed into such a short period of time that selecting just a few events and achievements to highlight becomes difficult.

  • Costco IPO’ed just 2 years after opening its first warehouse — talk about moving fast

In reviewing fiscal year 1985, the following events and achievements are noteworthy:

  • Rather than taking the time to write a full-blown letter, Sinegal simply lists off the important milestones (See Barry Diller)

  • Net sales increased 263% from $101.0 million in fiscal 1984 to $366.4 million in fiscal 1985

  • Comparable warehouse net sales increased 43%

  • The number of warehouses in operation more than doubled from seven at the end of fiscal 1984 to fifteen at the end of fiscal 1985.

  • Solid growth across the bored

  • KPIs =

    1. Net Sales

    2. Comparable warehouse net sales

    3. Warehouses in operation

  • New markets were entered and existing markets were strengthened. At the end of fiscal 1985, the Company had operations in Washington, Oregon, Alaska, Nevada, Utah, Florida and Western Canada, and was preparing to enter California.

  • Regional offices were established in Florida and Western Canada, and plans for a California regional office were underway.

  • Super interesting that they opened up in Alaska and Western Canada before California — businesses typically focus on the Continental US

  • Also curious for motivation of opening in Florida — everything else is adjacent-linked to Washington

  • Wholesale memberships increased from 38,000 at the end of fiscal 1984 to 115,000 at the end of fiscal 1985.

  • Group memberships increased from 206,000 at the end of fiscal 1984 to 608,000 at the end of fiscal 1985.

  • Both types of membership nearly tripled — look into Costo’s membership tiers/types over the years

  • Sales to wholesale members, the cornerstone of our business, increased from 53% of net sales in fiscal 1984 to 58% of net sales in fiscal 1985.

  • Core KPI — keep track of this over the years (and see if it ever changes)

  • During the fourth quarter of fiscal 1985, Costco tested the use of two paid group membership programs designed to lower prices and attract customers who shop frequently and make large average purchases.

  • As the 1985 fiscal year approached its end, growth in membership sign-ups continued. During the fourth quarter of fiscal 1985 wholesale memberships at the seven warehouses opened the previous fiscal year were growing at an annualized rate of 55%; group memberships were increasing at a 39% annualized rate.

  • A/B test programs — Always be testing

  • High volume + High average purchase = ideal customer

  • The company’s gross profit percentage remained constant at 11.2% of revenue in both fiscal years.

  • Operating and administrative expenses as a percent of revenue substantially declined from 13.3% in fiscal 1984 to 11.3% in fiscal 1985.

  • Expenses relatively constant — how do these fluctuate over time? Especially interesting considering second year in existence. I wish there was more early public data on companies.

Notable events occurring subsequent to our 1985 fiscal year end include the following:

  • On December 5, 1985, Costco successfully concluded its initial public offering of 4,830,000 shares of Common Stock, including 3,830,000 shares sold by the Company at a price of $10 per share. Proceeds to the Company, net of offering costs, were approximately $35,200,000.

  • On December 6, 1985, Costco opened its 21st warehouse, located in Santa Clara, California

  • On January 13, 1986, after meeting certain conditions in the $20,000,000 Convertible Subordinated Note, Costco gave notice of redemption to the holder of the note. The holder has until February 3, 1986 to advise Costco whether it will convert the note into 2,666,667 shares of Common Stock or allow redemption.

  • On January 13, 1986, Costco reported its first quarter results for fiscal 1986, which included record sales. It was the Company’s first quarterly period of profitable operations. First quarter highlights included (1) net sales increased 130% from $58.4 million during the first quarter of fiscal 1985 to $134.5 million for the first quarter of fiscal 1986, (2) comparable warehouse net sales increased 33%, (3) net income of $38,000 was achieved during the first quarter of fiscal 1986, versus a $1,420,000 loss during the first quarter of fiscal 1985, (4) five new warehouses were opened, including our first warehouses in California and Western Canada, (5) operating and administrative expenses as a percent of revenue continued to decline, from 12.1% during the first quarter of fiscal 1985 to 10.7% during the first quarter of fiscal 1986 and (6) during the first quarter of fiscal 1986, the Company expanded the introduction and use of the two paid group membership programs virtually company-wide, furthering efforts to bring lower prices to its members.

  • Is this basically the Q1 report?

  • First quarter highlights very promising (note the metrics highlighted)

    1. Net Sales — +130% YoY

    2. Comparable Warehouse Net Sales — +33%

    3. Net Income — Broke even and now profitable

    4. New Warehouses — 5 new warehouses (2 of which were in new geographies)

    5. Operating and Administrative Expenses — Down from 12.1% to 10.7% (how low can they go?)

    6. Memberships — lower prices for members (on membership? goods? total savings?)

As will be seen in the Management’s Discussion and Analysis of Financial Condition and Results of Operations, which follows, a substantial portion of our fiscal 1984 and fiscal 1985 losses were attributed to preopening expenses, nonrecurring deferred compensation charges and net interest expense, all of which represent an investment in our Company’s future. Included in the $3,258,000 fiscal 1984 loss are $1,074,000 of these types of expenses; included in the $5,728,000 fiscal 1985 loss are $5,467,000 of these types of expenses. Additionally, the Company’s fiscal 1986 first quarter profit of $38,000 is after deducting preopening expenses of $1,068,000 and net interest expense of $579,000.

  • Losses result of investing in the future — NOT faulty unit economics

  • Reminder to always read the footnotes

The foundation of and the resource for Costco’s past and future success remains its employees. What Costco has accomplished to date and what we hope to accomplish in the years to come is simply a function and result of the quality and dedication of our more than 2,500 employees. We are grateful for all of their efforts, and we thank you for your continued support as a Costco shareholder.

  • Notice that Costco doesn’t thank it’s customers first and foremost — it thanks its employees.

  • Interesting that they don’t even mention their customers — typically it’s Customers, then employees, then shareholders.

    • Seems like a “If we focus on providing value and being the best we can, customers will come”

    • Is this a we provide value to the customers — we don’t have to thank them type of thing?


If you’ve got any thoughts, questions, or feedback, please drop me a line - I would love to chat! You can find me on twitter at @kgao1412 or my email at kevin@12mv2.com.

Please DM or email me any time — to share non-obvious intel, views and correct or solicit mine. I appreciate your continued support and partnership :D.

All compilations here.


As many of you know, making compilations and this newsletter is a (very time consuming) passion project for me. Multiple people have reached out about how they can support me so that I continue, so I set up with a few ways:

Thank you!