COST 10-Q Quarterly Report May 12, 2019 | Alphaminr
COSTCO WHOLESALE CORP /NEW
ALPHAMINR

COST 10-Q Quarter ended May 12, 2019

Balance Sheet
Cash Flow
Income Statement
Debt
COSTCO WHOLESALE CORP /NEW
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10-Q 1 cost10q51219.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 12, 2019
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-20355
Costco Wholesale Corporation
(Exact name of registrant as specified in its charter)
Washington
91-1223280
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
999 Lake Drive, Issaquah, WA 98027
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code): (425) 313-8100

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $.01 Par Value
COST
The NASDAQ Global Select Market
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 ☒ NO ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES ☒ NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐


If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒

The number of shares outstanding of the issuer's common stock as of May 29, 2019 was 439,789,186 .


COSTCO WHOLESALE CORPORATION
INDEX TO FORM 10-Q
Page
PART I
Item 1.
Item 2.
Item 3.
Item 4.
PART II
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


2

PART I—FINANCIAL INFORMATION
Item 1—Financial Statements
COSTCO WHOLESALE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in millions, except par value and share data)
(unaudited)
May 12,
2019
September 2,
2018
ASSETS
CURRENT ASSETS
Cash and cash equivalents
$
7,013

$
6,055

Short-term investments
1,154

1,204

Receivables, net
1,704

1,669

Merchandise inventories
11,304

11,040

Other current assets
1,110

321

Total current assets
22,285

20,289

PROPERTY AND EQUIPMENT
Land
6,310

6,193

Buildings and improvements
16,644

16,107

Equipment and fixtures
7,858

7,274

Construction in progress
1,412

1,140


32,224

30,714

Less accumulated depreciation and amortization
(11,749
)
(11,033
)
Net property and equipment
20,475

19,681

OTHER ASSETS
992

860

TOTAL ASSETS
$
43,752

$
40,830

LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable
$
11,331

$
11,237

Accrued salaries and benefits
2,888

2,994

Accrued member rewards
1,160

1,057

Deferred membership fees
1,761

1,624

Current portion of long-term debt
1,699

90

Other current liabilities
3,993

2,924

Total current liabilities
22,832

19,926

LONG-TERM DEBT, excluding current portion
4,799

6,487

OTHER LIABILITIES
1,301

1,314

Total liabilities
28,932

27,727

COMMITMENTS AND CONTINGENCIES
EQUITY
Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding
0

0

Common stock $0.01 par value; 900,000,000 shares authorized; 439,811,000 and 438,189,000 shares issued and outstanding
4

4

Additional paid-in capital
6,307

6,107

Accumulated other comprehensive loss
(1,321
)
(1,199
)
Retained earnings
9,496

7,887

Total Costco stockholders’ equity
14,486

12,799

Noncontrolling interests
334

304

Total equity
14,820

13,103

TOTAL LIABILITIES AND EQUITY
$
43,752

$
40,830


The accompanying notes are an integral part of these condensed consolidated financial statements.

3

COSTCO WHOLESALE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(amounts in millions, except per share data)
(unaudited)
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
REVENUE
Net sales
$
33,964

$
31,624

$
102,903

$
95,020

Membership fees
776

737

2,302

2,145

Total revenue
34,740

32,361

105,205

97,165

OPERATING EXPENSES
Merchandise costs
30,233

28,131

91,576

84,481

Selling, general and administrative
3,371

3,155

10,310

9,613

Preopening expenses
14

8

45

37

Operating income
1,122

1,067

3,274

3,034

OTHER INCOME (EXPENSE)
Interest expense
(35
)
(37
)
(105
)
(111
)
Interest income and other, net
36

41

104

70

INCOME BEFORE INCOME TAXES
1,123

1,071

3,273

2,993

Provision for income taxes
207

309

679

867

Net income including noncontrolling interests
916

762

2,594

2,126

Net income attributable to noncontrolling interests
(10
)
(12
)
(32
)
(35
)
NET INCOME ATTRIBUTABLE TO COSTCO
$
906

$
750

$
2,562

$
2,091

NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO:
Basic
$
2.06

$
1.71

$
5.83

$
4.77

Diluted
$
2.05

$
1.70

$
5.79

$
4.74

Shares used in calculation (000’s):
Basic
439,859

438,740

439,767

438,576

Diluted
442,642

441,715

442,565

441,383


The accompanying notes are an integral part of these condensed consolidated financial statements.

4

COSTCO WHOLESALE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(amounts in millions)
(unaudited)
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
NET INCOME INCLUDING NONCONTROLLING INTERESTS
$
916

$
762

$
2,594

$
2,126

Foreign-currency translation adjustment and other, net
(42
)
(149
)
(124
)
(22
)
Comprehensive income
874

613

2,470

2,104

Less: Comprehensive income attributable to noncontrolling interests
9

4

30

37

COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO
$
865

$
609

$
2,440

$
2,067


The accompanying notes are an integral part of these condensed consolidated financial statements.

5

COSTCO WHOLESALE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(amounts in millions)
(unaudited)
12 Weeks Ended May 12, 2019
Common Stock
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Total Costco
Stockholders’
Equity
Noncontrolling
Interests
Total
Equity
Shares (000’s)
Amount
BALANCE AT FEBRUARY 17, 2019
439,989

$
4

$
6,218

$
(1,280
)
$
8,916

$
13,858

$
325

$
14,183

Net income
—

—

—

—

906

906

10

916

Foreign-currency translation adjustment and other, net
—

—

—

(41
)
—

(41
)
(1
)
(42
)
Stock-based compensation
—

—

93

—

—

93

—

93

Release of vested restricted stock units (RSUs), including tax effects
14

—

(1
)
—

—

(1
)
—

(1
)
Repurchases of common stock
(192
)
—

(3
)
—

(41
)
(44
)
—

(44
)
Cash dividend declared and other
—

—

—

—

(285
)
(285
)
—

(285
)
BALANCE AT MAY 12, 2019
439,811

$
4

$
6,307

$
(1,321
)
$
9,496

$
14,486

$
334

$
14,820

12 Weeks Ended May 13, 2018
Common Stock
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Total Costco
Stockholders’
Equity
Noncontrolling
Interests
Total
Equity
Shares (000’s)
Amount
BALANCE AT FEBRUARY 18, 2018
438,883

$
4

$
5,920

$
(897
)
$
6,727

$
11,754

$
299

$
12,053

Net income
—

—

—

—

750

750

12

762

Foreign-currency translation adjustment and other, net
—

—

—

(141
)
—

(141
)
(8
)
(149
)
Stock-based compensation
—

—

86

—

—

86

—

86

Release of vested RSUs, including tax effects
9

—

(1
)
—

—

(1
)
—

(1
)
Repurchases of common stock
(290
)
—

(5
)
—

(50
)
(55
)
—

(55
)
Cash dividend declared and other
—

—

1

—

(251
)
(250
)
1

(249
)
BALANCE AT May 13, 2018
438,602

$
4

$
6,001

$
(1,038
)
$
7,176

$
12,143

$
304

$
12,447




The accompanying notes are an integral part of these condensed consolidated financial statements.

6

COSTCO WHOLESALE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(amounts in millions)
(unaudited)
36 Weeks Ended May 12, 2019
Common Stock
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Total Costco
Stockholders’
Equity
Noncontrolling
Interests
Total
Equity
Shares (000’s)
Amount
BALANCE AT SEPTEMBER 2, 2018
438,189

$
4

$
6,107

$
(1,199
)
$
7,887

$
12,799

$
304

$
13,103

Net income
—

—

—

—

2,562

2,562

32

2,594

Foreign-currency translation adjustment and other, net
—

—

—

(122
)
—

(122
)
(2
)
(124
)
Stock-based compensation
—

—

484

—

—

484

—

484

Release of vested RSUs, including tax effects
2,525

—

(271
)
—

—

(271
)
—

(271
)
Repurchases of common stock
(903
)
—

(13
)
—

(182
)
(195
)
—

(195
)
Cash dividend declared and other
—

—

—

—

(771
)
(771
)
—

(771
)
BALANCE AT MAY 12, 2019
439,811

$
4

$
6,307

$
(1,321
)
$
9,496

$
14,486

$
334

$
14,820

36 Weeks Ended May 13, 2018
Common Stock
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Total Costco
Stockholders’
Equity
Noncontrolling
Interests
Total
Equity
Shares (000’s)
Amount
BALANCE AT SEPTEMBER 3, 2017
437,204

$
4

$
5,800

$
(1,014
)
$
5,988

$
10,778

$
301

$
11,079

Net income
—

—

—

—

2,091

2,091

35

2,126

Foreign-currency translation adjustment and other, net
—

—

—

(24
)
—

(24
)
2

(22
)
Stock-based compensation
—

—

434

—

—

434

—

434

Release of vested RSUs, including tax effects
2,735

—

(217
)
—

—

(217
)
—

(217
)
Repurchases of common stock
(1,337
)
—

(19
)
—

(214
)
(233
)
—

(233
)
Cash dividend declared and other
—

—

3

—

(689
)
(686
)
(34
)
(720
)
BALANCE AT May 13, 2018
438,602

$
4

$
6,001

$
(1,038
)
$
7,176

$
12,143

$
304

$
12,447



The accompanying notes are an integral part of these condensed consolidated financial statements.

7

COSTCO WHOLESALE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in millions)
(unaudited)
36 Weeks Ended
May 12,
2019
May 13,
2018
CASH FLOWS FROM OPERATING ACTIVITIES
Net income including noncontrolling interests
$
2,594

$
2,126

Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization
1,019

1,006

Stock-based compensation
482

431

Other non-cash operating activities, net
10

(3
)
Deferred income taxes
(33
)
(21
)
Changes in operating assets and liabilities:
Merchandise inventories
(409
)
(828
)
Accounts payable
0

1,160

Other operating assets and liabilities, net
400

349

Net cash provided by operating activities
4,063

4,220

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of short-term investments
(753
)
(679
)
Maturities and sales of short-term investments
800

743

Additions to property and equipment
(1,989
)
(1,913
)
Other investing activities, net
(3
)
(3
)
Net cash used in investing activities
(1,945
)
(1,852
)
CASH FLOWS FROM FINANCING ACTIVITIES
Change in bank payments outstanding
166

(23
)
Repayments of long-term debt
(89
)
(58
)
Tax withholdings on stock-based awards
(271
)
(217
)
Repurchases of common stock
(195
)
(238
)
Cash dividend payments
(752
)
(439
)
Other financing activities, net
(5
)
(39
)
Net cash used in financing activities
(1,146
)
(1,014
)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
(14
)
(23
)
Net change in cash and cash equivalents
958

1,331

CASH AND CASH EQUIVALENTS BEGINNING OF YEAR
6,055

4,546

CASH AND CASH EQUIVALENTS END OF PERIOD
$
7,013

$
5,877

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the first thirty-six weeks of year for:
Interest
$
72

$
81

Income taxes, net
$
780

$
779

SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Cash dividend declared, but not yet paid
$
285

$
250


The accompanying notes are an integral part of these condensed consolidated financial statements.

8

COSTCO WHOLESALE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in millions, except share, per share, and warehouse count data)
(unaudited)
Note 1—Summary of Significant Accounting Policies
Description of Business
Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. For the period ended May 12, 2019 , Costco operated 772 warehouses worldwide: 535 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 28 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland and France. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan.
Basis of Presentation
The condensed consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Company’s equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Company’s net income excludes income attributable to the noncontrolling interest in Taiwan. During the first quarter of 2018 , the Company purchased its former joint venture partner's remaining equity interest in its Korean operations. Unless otherwise noted, references to net income relate to net income attributable to Costco.
These unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q for interim financial reporting pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). While these statements reflect all normal recurring adjustments that are, in the opinion of management, necessary for fair presentation of the results of the interim period, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (U.S. GAAP) for complete financial statements. Therefore, the interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company's Annual Report filed on Form 10-K for the fiscal year ended September 2, 2018 .
Fiscal Year End
The Company operates on a 52/53 week fiscal year basis, with the fiscal year ending on the Sunday closest to August 31. Fiscal 2019 is a 52 week year ending on September 1, 2019 . References to the third quarter of 2019 and 2018 relate to the 12 week fiscal quarters ended May 12, 2019 , and May 13, 2018 , respectively. References to the first thirty-six weeks of 2019 and 2018 relate to the 36 weeks ended May 12, 2019 , and May 13, 2018 , respectively.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent 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 and assumptions.

9

Revenue Recognition
The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the condensed consolidated balance sheets.
Merchandise Sales - The Company offers merchandise in the following core merchandise categories: food and sundries, hardlines, softlines, and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is recognized upon shipment to the member to the extent there is no installation provided as a part of the contract. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the condensed consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the condensed consolidated balance sheets.
Principal Versus Agent - The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion.
Membership Fees - The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. For the first thirty-six weeks of 2019 , the Company recognized $2,302 of membership fees, of which $1,451 was included in deferred membership at the end of 2018 .
In certain countries, the Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum of approximately $1,000 per year), which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the condensed consolidated balance sheets. Estimated breakage is computed based on redemption data. In the third quarter of 2019 and 2018 the net reduction in sales was $346 and $316 , respectively. In the first thirty-six weeks of 2019 and 2018 the net reduction in sales was $1,060 and $962 , respectively.
Cash Cards - The Company sells and otherwise provides proprietary cash cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from cash cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding cash card balances as a cash card liability, net of estimated breakage and as of May 12, 2019 , and September 2, 2018, the liability was not material.
Co-Branded Credit Card Program - Citibank, N.A. (“Citi”) became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31 of each year. Breakage is estimated based on redemption data.

10

Recent Accounting Pronouncements Adopted
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, providing for changes in the recognition of revenue from contracts with customers. The guidance requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows. The Company adopted the standard in the first quarter of 2019, using the modified retrospective approach, and recorded a cumulative effect adjustment of $16 as an increase to retained earnings, which is included in cash dividend declared and other in the condensed consolidated statements of equity.
The standard impacted the presentation and timing of certain revenue transactions. Specifically, the changes included gross presentation of the Company’s estimate of merchandise returns reserve and the related recoverable assets, recognizing cash card breakage over the period of redemption, and accelerating the recognition of certain e-commerce and special-order sales. Additionally, the Company’s evaluation under the standard of its status as a principal in certain vendor arrangements resulted in the recognition of additional sales on a gross basis.
The effect of the standard on the Company's condensed consolidated balance sheet was an increase to other current liabilities and other current assets of $649 and $694 at adoption and at the end of the third quarter of 2019, respectively, related to the estimate of merchandise returns reserve and the related recoverable assets.
The effect of the adoption of this standard on the Company's condensed consolidated statement of income is as follows:
As Reported
ASU 2014-09 Effect
Excluding ASU 2014-09 Effect
12 Weeks Ended May 12, 2019
Net Sales
$
33,964

$
346

$
33,618

Merchandise Costs
30,233

342

29,891

Gross Margin (1)
3,731

4

3,727

36 Weeks Ended May 12, 2019
Net Sales
$
102,903

$
865

$
102,038

Merchandise Costs
91,576

856

90,720

Gross Margin (1)
11,327

9

11,318

_______________
(1)
Net sales less merchandise costs.
For related disaggregated revenue disclosures, see Note 10 .
Recent Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU 2016-02, which requires recognition on the balance sheet of rights and obligations created by leases with terms greater than twelve months. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and utilize the transition option, which allows for a cumulative-effect adjustment in the period of adoption and does not require application of the guidance to comparative periods. The primary effect of adoption will be recording right-of-use assets and corresponding lease obligations for current operating leases. Although the Company continues to evaluate the effect to the Company's consolidated financial statements and disclosures, management currently estimates total assets and liabilities will increase by approximately $2,500 to $ 3,000 upon adoption. This estimate could change as the Company continues to progress with implementation and will also fluctuate based on the lease portfolio, discount rates and currency exchange

11

rates as of the adoption date. The adoption is not expected to have a material impact to the Company's consolidated statements of income or cash flows. The Company is reviewing current accounting policies and related disclosures, and evaluating changes to business processes, systems and controls to support adoption of the new standard, which includes implementing a new lease accounting system.
Note 2—Investments
The Company's investments were as follows:
May 12, 2019:
Cost
Basis
Unrealized
Loss, Net
Recorded
Basis
Available-for-sale:
Government and agency securities
$
860

$
(3
)
$
857

Held-to-maturity:
Certificates of deposit
297

297

Total short-term investments
$
1,157

$
(3
)
$
1,154

September 2, 2018:
Cost
Basis
Unrealized
Loss, Net
Recorded
Basis
Available-for-sale:
Government and agency securities
$
912

$
(14
)
$
898

Held-to-maturity:
Certificates of deposit
306


306

Total short-term investments
$
1,218

$
(14
)
$
1,204

Gross unrecognized holding gains and losses on available-for-sale securities were not material for the periods ended May 12, 2019 , and September 2, 2018 . At May 12, 2019 , and September 2, 2018 , available-for-sale securities in an unrealized-loss position were not material.
There were no sales of available-for-sale securities during the first thirty-six weeks of 2019 . Proceeds from sales of available-for-sale securities were $39 during the first thirty-six weeks of 2018. Gross realized gains and losses for these sales were not material.
The maturities of available-for-sale and held-to-maturity securities at May 12, 2019 , are as follows:
Available-For-Sale
Held-To-Maturity
Cost Basis
Fair Value
Due in one year or less
$
397

$
396

$
297

Due after one year through five years
441

439

0

Due after five years
22

22

0

Total
$
860

$
857

$
297


12

Note 3—Fair Value Measurement
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The tables below present information regarding financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine fair value.
May 12, 2019:
Level 1
Level 2
Investment in government and agency securities (1)
$
0

$
1,009

Forward foreign-exchange contracts, in asset position (2)
0

7

Forward foreign-exchange contracts, in (liability) position (2)
0

(3
)
Total
$
0

$
1,013

September 2, 2018:
Level 1
Level 2
Money market mutual funds (3)
$
9

$
0

Investment in government and agency securities (1)
0

903

Forward foreign-exchange contracts, in asset position (2)
0

16

Forward foreign-exchange contracts, in (liability) position (2)
0

(2
)
Total
$
9

$
917

_______________
(1)
At May 12, 2019 , $ 152 cash and cash equivalents and $857 short-term investments are included in the accompanying condensed consolidated balance sheets. At September 2, 2018 , immaterial cash and cash equivalents and $898 short-term investments are included in the accompanying condensed consolidated balance sheets.
(2)
The asset and the liability values are included in other current assets and other current liabilities, respectively, in the accompanying condensed consolidated balance sheets.
(3)
Included in cash and cash equivalents in the accompanying condensed consolidated balance sheets.
During and at the periods ended May 12, 2019 , and September 2, 2018 , the Company did not hold any Level 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers in or out of Level 1 or 2 during the third quarter or the first thirty-six weeks of 2019 or 2018 .
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets recorded at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during the third quarter or first thirty-six weeks of 2019 and 2018 .

13

Note 4—Debt
The carrying value of the Company’s long-term debt consisted of the following:
May 12, 2019
September 2, 2018
1.70% Senior Notes due December 2019
$
1,200

$
1,200

1.75% Senior Notes due February 2020
500

500

2.15% Senior Notes due May 2021
1,000

1,000

2.25% Senior Notes due February 2022
500

500

2.30% Senior Notes due May 2022
800

800

2.75% Senior Notes due May 2024
1,000

1,000

3.00% Senior Notes due May 2027
1,000

1,000

Other long-term debt
529

613

Total long-term debt
6,529

6,613

Less unamortized debt discounts and issuance costs
31

36

Less current portion
1,699

90

Long-term debt, excluding current portion
$
4,799

$
6,487

The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japan subsidiary and are valued using Level 3 inputs. The fair value of the Company's long-term debt, including the current portion, was approximately $6,519 and $6,492 at May 12, 2019 , and September 2, 2018 , respectively.
Note 5—Equity
Dividends
The Company’s current quarterly dividend rate is $0.65 per share, compared to $0.57 in the third quarter of 2018 . On April 26, 2019 , the Board of Directors declared a quarterly dividend in the amount of $0.65 per share, which was paid on May 24, 2019 .
Stock Repurchase Programs
Stock repurchase activity during the third quarter and first thirty-six weeks of 2019 and 2018 is summarized below:
Shares Repurchased (000's)
Average Price per Share
Total Cost
Third quarter of 2019
192

$
226.57

$
44

First thirty-six weeks 2019
903

$
215.94

$
195

Third quarter of 2018
290

$
189.66

$
55

First thirty-six weeks 2018
1,337

$
174.30

$
233

These amounts may differ from the stock repurchase balances in the accompanying condensed consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of a quarter. On April 26, 2019 , the Board of Directors authorized a new share repurchase program in the amount of $4,000 , which expires in April 2023 . This authorization revoked previously authorized but unused amounts, totaling $2,237 . The remaining amount available for stock repurchases under the approved plan was $3,995 at May 12,

14

2019 . Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1.
Note 6—Stock-Based Compensation
On January 24, 2019, our shareholders approved the adoption of the 2019 Incentive Plan, which replaced the Seventh Restated 2002 Stock Incentive Plan (Seventh Plan). The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant under the Seventh Plan on January 24, 2019 and future forfeited shares from grants under the Seventh Plan up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes.
Summary of Restricted Stock Unit Activity
At May 12, 2019 , 15,649,000 shares were available to be granted as RSUs and the following awards were outstanding:
•
6,307,000 time-based RSUs that vest upon continued employment over specified periods of time;
•
78,000 performance-based RSUs, granted to executive officers of the Company, for which the performance targets have been met. The awards vest upon continued employment over specified periods of time; and
•
150,000 performance-based RSUs, granted to executive officers of the Company, subject to achievement of performance targets for fiscal 2019 , as determined by the Compensation Committee of the Board of Directors after the end of the fiscal year. These awards are included in the table below and the Company recognized compensation expense for these awards as it is currently deemed probable that the targets will be achieved.
The following table summarizes RSU transactions during the first thirty-six weeks of 2019 :
Number of
Units
(in 000’s)
Weighted-Average
Grant Date Fair
Value
Outstanding at September 2, 2018
7,578

$
140.85

Granted
2,792

224.00

Vested and delivered
(3,707
)
155.64

Forfeited
(128
)
163.68

Outstanding at May 12, 2019
6,535

$
167.55

The remaining unrecognized compensation cost related to non-vested RSUs at May 12, 2019 , was $ 817 , and the weighted-average period over which this cost will be recognized is 1.7 years.
Summary of Stock-Based Compensation
The following table summarizes stock-based compensation expense and the related tax benefits under the Company’s plans:
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Stock-based compensation expense before income taxes
$
93

$
85

$
482

$
431

Less recognized income tax benefit
(20
)
(19
)
(104
)
(98
)
Stock-based compensation expense, net of income taxes
$
73

$
66

$
378

$
333


15

Note 7—Taxes

Income Taxes
The effective tax rate for the third quarter and first thirty-six weeks of 2019 was favorably impacted by the reduction in the U.S. federal corporate tax rate from 35% to 21% , which was in effect for the entire third quarter and first thirty-six weeks of 2019, as compared to a higher blended rate effective for the third quarter and first thirty-six weeks of 2018. The effective tax rate for the first thirty-six weeks of 2019 included discrete net tax benefits of $165 .  During the third quarter of 2019, the Company recognized a net benefit of $73 related to U.S. taxation of deemed foreign dividends, net of losses of current year foreign tax credits, which impacted the effective tax rate.  The tax rate for the first thirty-six weeks of 2019 was 26.8% , excluding the discrete benefits, but including the impact of the lost foreign tax credits.
Other Taxes
The Company is undergoing multiple examinations for value added, sales-based, payroll, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. The possible losses or range of possible losses associated with these matters are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year.
Note 8—Net Income per Common and Common Equivalent Share
The following table shows the amounts used in computing net income per share and the weighted average number of shares of potentially dilutive common shares outstanding (shares in 000’s):
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Net income attributable to Costco
$
906

$
750

$
2,562

$
2,091

Weighted average number of common shares used in basic net income per common share
439,859

438,740

439,767

438,576

RSUs
2,783

2,975

2,798

2,807

Weighted average number of common shares and dilutive potential of common stock used in diluted net income per share
442,642

441,715

442,565

441,383


16

Note 9—Commitments and Contingencies
Legal Proceedings

The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties.

The Company is a defendant in a class action alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters in the Company’s California warehouses. Canela v. Costco Wholesale Corp., et al. (Case No. 5:13-CV-03598, N.D. Cal. filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys’ fees. The Company filed an answer denying the material allegations of the complaint. The action in the district court has been stayed pending review by the Ninth Circuit of the order certifying a class. In January 2019, an employee brought similar claims for relief concerning Costco employees engaged at member services counters in California. Rodriguez v. Costco Wholesale Corp. (Case No. RG19001310, Alameda Superior Court filed Jan. 4, 2019). In December 2018, a depot employee raised similar claims, alleging that employees in California did not receive suitable seating or appropriate workplace temperature conditions. Lane v. Costco Wholesale Corp. (Dec. 6, 2018 Notice to California Labor and Workforce Development Agency). In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438 Santa Clara Superior Court filed Jan. 3, 2019). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys’ fees. On March 25, 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez, et ano., v. Costco Wholesale Corp., et al . (Case No. 19ST-CV-10017 Los Angeles County Superior Court filed Mar. 25, 2019).
In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases filed against various defendants by counties, cities, hospitals, Native American tribes, and third-party payors concerning the impacts of opioid abuse. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal cases that name the Company, including actions filed by a number of counties and cities in Michigan, New Jersey, Oregon, a third-party payor in Ohio, and class actions filed on behalf of infants born with opioid-related medical conditions in New York, California, Illinois, Kentucky, Maryland, West Virginia, Ohio, and Missouri. Similar claims against the Company in state courts in New Jersey and Oklahoma have been dismissed. The Company is defending all of these matters.

The Company and its CEO and CFO are defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco

17

Wholesale Corp., et al. (W.D. Wash. filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash. filed Dec. 11, 2018).   The complaints allege violations of the federal securities laws stemming from the Company’s disclosures concerning internal control over financial reporting.  They seek unspecified damages, equitable relief, interest, and costs and attorneys’ fees.  On January 30, 2019, an order was entered consolidating the actions and a consolidated amended complaint was filed on April 16, 2019. The Company expects the consolidated action to be vigorously defended.

Members of the Board of Directors, one other individual, and the Company are defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash. filed Dec. 11, 2018). The complaint seeks unspecified damages, disgorgement of compensation, corporate governance changes, and costs and attorneys' fees.  Because the complaint is derivative in nature, it does not seek monetary damages from the Company, which is a nominal defendant. By agreement among the parties the action has been stayed pending further proceedings in the class actions. Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), and April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1). These actions have also been stayed.

In November 2016 and September 2017, the Company received notices of violation from the Connecticut Department of Energy and Environmental Protection regarding hazardous waste practices at its Connecticut warehouses, primarily concerning unsalable pharmaceuticals. On February 13, 2019, the Company's affiliate in Spain received notice from the General Directorate on Environment and Sustainability of the Regional Government of Madrid that the Directorate is investigating issues concerning rain, sewage and hydrocarbon drainage related to the Company's warehouse in Getafe. The relief to be sought is not known at this time. The Company is seeking to cooperate concerning the resolution of these notices.

The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company’s financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year.

Note 10—Segment Reporting
The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland and France and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on management’s organization of the operating segments for operational decisions and assessments of financial performance, which consider geographic locations. The material accounting policies of the segments are as described in the notes to the consolidated financial statements included in the Company's Annual Report filed on Form 10-K for the fiscal year ended September 2, 2018 , and Note 1 above. Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, are incurred on behalf of the Company's Canadian and Other International Operations, but are included in the U.S. Operations because those costs generally come under the responsibility of the Company's U.S. management team.

18

The following table provides information for the Company's reportable segments:
United States
Operations
Canadian
Operations
Other
International
Operations
Total
12 Weeks Ended May 12, 2019
Total revenue
$
25,536

$
4,792

$
4,412

$
34,740

Operating income
736

213

173

1,122

Depreciation and amortization
260

32

44

336

Additions to property and equipment
500

38

134

672

12 Weeks Ended May 13, 2018
Total revenue
$
23,475

$
4,647

$
4,239

$
32,361

Operating income
682

210

175

1,067

Depreciation and amortization
242

31

54

327

Additions to property and equipment
468

42

75

585

36 Weeks Ended May 12, 2019
Total revenue
$
76,958

$
14,561

$
13,686

$
105,205

Operating income
2,108

625

541

3,274

Depreciation and amortization
764

100

155

1,019

Additions to property and equipment
1,428

209

352

1,989

Net property and equipment
14,020

1,917

4,538

20,475

Total assets
30,416

4,637

8,699

43,752

36 Weeks Ended May 13, 2018







Total revenue
$
69,975

$
14,163

$
13,027

$
97,165

Operating income
1,818

652

564

3,034

Depreciation and amortization
756

94

156

1,006

Additions to property and equipment
1,323

156

434

1,913

Net property and equipment
12,924

1,829

4,425

19,178

Total assets
27,062

4,248

8,295

39,605

52 Weeks Ended September 2, 2018
Total revenue
$
102,286

$
20,689

$
18,601

$
141,576

Operating income
2,787

939

754

4,480

Depreciation and amortization
1,078

135

224

1,437

Additions to property and equipment
2,046

268

655

2,969

Net property and equipment
13,353

1,900

4,428

19,681

Total assets
28,207

4,303

8,320

40,830

Disaggregated Revenue
The following table summarizes net sales by merchandise category:
12 Weeks Ended
36 Weeks Ended
May 12, 2019
May 12, 2019
Foods and Sundries
$
13,524

$
41,131

Hardlines
5,666

17,276

Fresh Foods
4,568

13,551

Softlines
3,413

11,760

Ancillary
6,793

19,185

Total Net Sales
$
33,964

$
102,903


19

Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations
(amounts in millions, except per share, share, and warehouse count data)

FORWARD-LOOKING STATEMENTS
Certain statements contained in this Report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. They include statements that address activities, events, conditions or developments that we expect or anticipate may occur in the future and may relate to such matters as sales growth, changes in comparable sales, cannibalization of existing locations by new openings, price or fee changes, earnings performance, earnings per share, stock-based compensation expense, warehouse openings and closures, capital spending, the effect of adopting certain accounting standards, future financial reporting, financing, margins, return on invested capital, strategic direction, expense controls, membership renewal rates, shopping frequency, litigation, and the demand for our products and services. Forward-looking statements may also be identified by the words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “likely,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would,” or similar expressions and the negatives of those terms. Such forward-looking statements involve risks and uncertainties that may cause actual events, results, or performance to differ materially from those indicated by such statements. These risks and uncertainties include, but are not limited to, domestic and international economic conditions, including exchange rates, the effects of competition and regulation, uncertainties in the financial markets, consumer and small business spending patterns and debt levels, breaches of security or privacy of member or business information, conditions affecting the acquisition, development, ownership or use of real estate, capital spending, actions of vendors, rising costs associated with employees (generally including health care costs), energy and certain commodities, geopolitical conditions (including tariffs), the ability to remediate material weaknesses in internal control, and other risks identified from time to time in our public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and we do not undertake to update these statements, except as required by law.
This management discussion should be read in conjunction with the management discussion included in our fiscal 2018 Annual Report on Form 10-K, previously filed with the SEC.
OVERVIEW
We operate membership warehouses and e-commerce websites based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and 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, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers.
We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); changes in the cost of gasoline and associated competitive conditions; and changes from the revenue recognition standard. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and

20

regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items and through our online offerings.
Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our “pricing authority” on quality goods– consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members, but it generally has a significantly lower gross margin percentage relative to our non-gasoline businesses. A higher penetration of gasoline sales will generally lower our gross margin percentage. Changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SG&A) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin will be influenced in part by our merchandising and pricing strategies in response to potential cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results.
We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales.
Our membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets.
Our financial performance depends heavily on our ability to control costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, most particularly health care and utility expenses. With respect to compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low margins, modest changes in various items in the income statement, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income.

21

Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 10 included in Part I, Item 1, of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefits costs as a percentage of country sales, and/or less or no direct membership warehouse competition.
In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which relates to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period.
Our fiscal year ends on the Sunday closest to August 31. References to the third quarters of 2019 and 2018 relate to the 12 week fiscal quarters ended May 12, 2019 , and May 13, 2018 , respectively. References to the first thirty-six weeks of 2019 and 2018 relate to the 36 weeks ended May 12, 2019 , and May 13, 2018 , respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco.
Key items for the third quarter of 2019 as compared to the third quarter of 2018 include:
•
Net sales increased 7% to $33,964 , driven by an increase in comparable sales of 6% and sales at 23 net new warehouses opened since the end of the third quarter of 2018 ;
•
Membership fee revenue increased 5% to $776 , primarily due to sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017;
•
Gross margin percentage decreased six basis points primarily due to the impact of the new revenue recognition standard on net sales;
•
SG&A expenses as a percentage of net sales decreased six basis points primarily due to the impact of the new revenue recognition standard on net sales;
•
The provision for income taxes in the third quarter of 2019 was positively impacted by a non-recurring tax benefit of $73 , or $0.16 per diluted share;
•
Net income increased 21% to $906 , or $2.05 per diluted share, compared to $750 , or $1.70 per diluted share in 2018 ;
•
On April 26, 2019, our Board of Directors declared a quarterly cash-dividend of $0.65 per share, an increase from $0.57, which was paid on May 24, 2019; and
•
On April 26, 2019 , the Board of Directors authorized a new share repurchase program in the amount of $4,000 .


22

RESULTS OF OPERATIONS
Net Sales
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Net Sales
$
33,964

$
31,624

$
102,903

$
95,020

Changes in net sales
U.S
9
%
11
%
10
%
11
%
Canada
3
%
14
%
3
%
14
%
Other international
4
%
17
%
5
%
18
%
Total Company
7
%
12
%
8
%
12
%
Changes in comparable sales:
U.S
7
%
10
%
9
%
9
%
Canada
1
%
11
%
1
%
10
%
Other international
2
%
12
%
2
%
13
%
Total Company
6
%
10
%
7
%
10
%
Changes in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) :
U.S
6
%
8
%
7
%
7
%
Canada
5
%
5
%
6
%
4
%
Other international
7
%
6
%
6
%
7
%
Total Company
6
%
7
%
7
%
7
%
_______________
(1)
Excludes the impact of the revenue recognition standard for the periods ended May 12, 2019 . See Item 1 Note 1 .
Net Sales
Net sales increased $2,340 or 7% , and $7,883 or 8% during the third quarter and first thirty-six weeks of 2019 , respectively, compared to the third quarter and first thirty-six weeks of 2018 . These increases were attributable to an increase in comparable sales of 6% and 7% in the third quarter and first thirty-six weeks of 2019 , respectively, and sales at the 23 net new warehouses opened since the end of the third quarter of 2018 .
During the third quarter of 2019, changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $427 , or 135 basis points, compared to the third quarter of 2018 , attributable to our Other International and Canadian operations. The new revenue recognition standard positively impacted net sales by $ 346 , or 110 basis points. Gasoline prices had a slight positive impact on net sales.
During the first thirty-six weeks of 2019, changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $1,199 , or 126 basis points, compared to the first thirty-six weeks of 2018 , attributable to our Canadian and Other International operations. The new revenue recognition standard positively impacted net sales by $ 865 , or 91 basis points. Changes in gasoline prices also positively impacted net sales by approximately $240 , or 25 basis points, due to a 2% increase in the average price per gallon.


23

Comparable Sales
Comparable sales increased 6% and 7% in the third quarter and first thirty-six weeks of 2019 , respectively, and were positively impacted by increases in shopping frequency and average ticket. Comparable sales for the third quarter and first thirty-six weeks of 2019 were negatively impacted by cannibalization (established warehouses losing sales to our newly opened locations).
Membership Fees
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Membership fees
$
776

$
737

$
2,302

$
2,145

Membership fees as a percentage of net sales
2.29
%
2.33
%
2.24
%
2.26
%
Total paid members as of quarter end (000's)
53,100

50,900

—

—

Total cardholders as of quarter end (000's)
97,200

93,000

—

—

Membership fees increased 5% and 7% in the third quarter and first thirty-six weeks of 2019 , respectively. This was primarily due to sign-ups at existing and new warehouses and the fee increase (discussed below). Renewal rates are 91% in the U.S. and Canada and 88% worldwide.
As previously reported, in fiscal 2017 we increased our membership fees in the U.S. and Canada. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact on revenues during the third quarter and first thirty-six weeks of 2019 of approximately $ 11 and $ 72 , respectively.
Gross Margin
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Net sales
$
33,964

$
31,624

$
102,903

$
95,020

Less merchandise costs
30,233

28,131

91,576

84,481

Gross margin
$
3,731

$
3,493

$
11,327

$
10,539

Gross margin percentage
10.99
%
11.05
%
11.01
%
11.09
%
Quarterly Results
The gross margin of our core merchandise categories (food and sundries, hardlines, softlines, and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased 21 basis points, with increases in all core merchandise categories. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses.
Total gross margin percentage decreased six basis points compared to the third quarter of 2018 . Excluding the impacts of the new revenue recognition standard and gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.10%, an increase of five basis points. This was primarily due to a nine basis point increase across most core merchandise categories, partially offset by the Executive Membership 2% reward program, which negatively impacted gross margin by three basis points, due to increased spending by Executive Members. Warehouse ancillary and other businesses decreased by one basis point.
Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), decreased in our

24

U.S. operations, primarily due to warehouse ancillary and other businesses, partially offset by increases in our core merchandise categories. The segment gross margin percentage in our Canadian operations decreased, primarily due to our core merchandise categories. The segment gross margin percentage in our Other International operations decreased, primarily due to the Executive Membership 2% reward program which was recently introduced in Korea, and our core merchandise categories.
Year-to-date Results
The gross margin of core merchandise categories, when expressed as a percentage of core merchandise sales, increased eight basis points. This was attributable to increases in food and sundries and hardlines partially offset by decreases in softlines.
Total gross margin percentage decreased eight basis points compared to the first thirty-six weeks of 2018 . Excluding the impacts of gasoline price inflation and the new revenue recognition standard on net sales, gross margin as a percentage of adjusted net sales was 11.13%, an increase of four basis points from the first thirty-six weeks of 2018 . This was primarily due to a 15 basis point increase in our warehouse ancillary and other businesses, predominantly our gasoline business. This increase was partially offset by decreases of four basis points in our core merchandise categories and four basis points due to an adjustment to our estimate of breakage on rewards earned under our co-branded credit card program. Executive Membership 2% reward program negatively impacted gross margin by three basis points, due to increased spending by Executive Members.
The segment gross margin percentage increased in our U.S. operations, primarily due to our warehouse ancillary and other businesses, predominantly our gasoline business, partially offset by our core merchandise categories. The segment gross margin percentage in our Canadian operations decreased due to decreases across all core merchandise categories, except fresh foods, and warehouse ancillary and other businesses. The segment gross margin percentage in our Other International operations decreased, primarily in our core merchandise categories.
Selling, General and Administrative Expenses
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
SG&A expenses
$
3,371

$
3,155

$
10,310

$
9,613

SG&A expenses as a percentage of net sales
9.92
%
9.98
%
10.02
%
10.12
%
Quarterly Results
SG&A expenses as a percentage of net sales decreased six basis points compared to the third quarter of 2018 . Excluding the impacts of the new revenue recognition standard and gasoline price inflation on net sales, SG&A expenses as a percentage of adjusted net sales was 10.03%, an increase of five basis points compared to the prior year. Operating costs related to warehouse, ancillary and other businesses, which includes e-commerce and travel, increased two basis points, primarily due to the wage increases of our U.S. hourly employees that went into effect in June 2018. Central operating costs were higher by two basis points and stock compensation expense was higher by one basis point.
Year-to-date Results
SG&A expenses as a percentage of net sales decreased 10 basis points compared to the first thirty-six weeks of 2018 . Excluding the impacts of gasoline price inflation and the new revenue recognition standard on net sales, SG&A expenses as a percentage of adjusted net sales was 10.13%, an increase of one basis point. Stock compensation expense was higher by two basis points and operating costs related to warehouse, ancillary and other businesses, which includes e-commerce and travel, were lower by one basis point.

25

Preopening Expense
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Preopening expenses
$
14

$
8

$
45

$
37

Warehouse openings, including relocations
United States
1

0

9

7

Canada
0

0

2

1

Other International
2

2

2

2

Total warehouse openings, including relocations
3

2

13

10

Preopening expenses include startup costs related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse openings, the timing of the openings relative to our quarter-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new or international market. For the remainder of fiscal 2019 , we expect to open 13 warehouses, including two relocations.
Interest Expense
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Interest expense
$
35

$
37

$
105

$
111

Interest expense is primarily related to Senior Notes. In October 2018 we repaid a Guaranteed Senior Note issued by our Japanese subsidiary.
Interest Income and Other, Net
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Interest income
$
27

$
16

$
81

$
45

Foreign-currency transaction gains, net
3

20

6

10

Other, net
6

5

17

15

Interest income and other, net
$
36

$
41

$
104

$
70

Interest income increased for the third quarter and first thirty-six weeks of 2019 , due to higher interest rates and higher average cash and investment balances. Foreign-currency transaction gains, net, include the revaluation or settlement of monetary assets and liabilities by our Canadian and Other International operations and mark-to-market adjustments for forward foreign-exchange contracts. See Derivatives and Foreign Currency sections in Item 8, Note 1 of our Annual Report on Form 10-K, for the fiscal year ended September 2, 2018 .

26

Provision for Income Taxes
12 Weeks Ended
36 Weeks Ended
May 12,
2019
May 13,
2018
May 12,
2019
May 13,
2018
Provision for income taxes
$
207

$
309

$
679

$
867

Effective tax rate
18.5
%
28.8
%
20.7
%
29.0
%
The effective tax rate for the third quarter and first thirty-six weeks of 2019 was favorably impacted by the reduction in the U.S. federal corporate tax rate from 35% to 21%, which was in effect for the entire third quarter and first thirty-six weeks of 2019, as compared to a higher blended rate effective for the third quarter and first thirty-six weeks of 2018. The effective tax rate for the first thirty-six weeks of 2019 included discrete net tax benefits of $165. During the third quarter of 2019, we recognized a net benefit of $73 related to U.S. taxation of deemed foreign dividends, net of losses of current year foreign tax credits, which impacted the effective tax rate.  The tax rate for the first thirty-six weeks of 2019 was 26.8% , excluding the discrete benefits, but including the impact of the lost foreign tax credits.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes our significant sources and uses of cash and cash equivalents:
36 Weeks Ended
May 12,
2019
May 13,
2018
Net cash provided by operating activities
$
4,063

$
4,220

Net cash used in investing activities
(1,945
)
(1,852
)
Net cash used in financing activities
(1,146
)
(1,014
)
Our primary sources of liquidity are cash flows from warehouse operations, cash and cash equivalents, and short-term investment balances. Cash and cash equivalents and short-term investments were $8,167 and $7,259 at May 12, 2019 , and September 2, 2018 , respectively. Of these balances, approximately $1,460 and $1,348 represented unsettled credit and debit card receivables, respectively. These receivables generally settle within four days.
Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements and, beginning in the second quarter of fiscal 2018, we no longer consider earnings after fiscal 2017 of our non-U.S. consolidated subsidiaries to be indefinitely reinvested.

Cash Flows from Operating Activities

Net cash provided by operating activities totaled $4,063 in the first thirty-six weeks of 2019 , compared to $4,220 in the first thirty-six weeks of 2018 . Cash provided by operations is primarily derived from net sales and membership fees. Cash used in operations generally consists of payments to merchandise vendors, and warehouse operating costs, including payroll and employee benefits, utilities, and debit and credit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors including how fast our inventory is sold, the payment terms with our vendors, and the amount of payables we pay early to obtain favorable discounts from our vendors.


27

Cash Flows from Investing Activities

Net cash used in investing activities totaled $1,945 in the first thirty-six weeks of 2019 compared to $1,852 in the first thirty-six weeks of 2018 , and primarily related to capital expenditures. Net cash from investing activities also includes purchases and maturities of short-term investments.
Capital Expenditure Plans
Our primary requirements for capital are acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations and working capital. In the first thirty-six weeks of 2019 , we spent $1,989 on capital expenditures, and it is our current intention to spend approximately $2,800 to $3,100 during fiscal 2019 . We opened 13 new warehouses, including three relocations, in the first thirty-six weeks of 2019 and plan to open 13 additional new warehouses, including two relocations, in the remainder of fiscal 2019 . There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs.
Cash Flows from Financing Activities
Net cash used in financing activities totaled $1,146 in the first thirty-six weeks of 2019 compared to $1,014 in the first thirty-six weeks of 2018 . Cash flow used in financing activities primarily related to the payment of dividends, withholding taxes on stock-based awards, and repurchases of common stock. Dividends totaling $752 were paid during the first thirty-six weeks of 2019, of which $250 related to the dividend declared in August 2018.
Stock Repurchase Programs
On April 26, 2019 , the Board of Directors authorized a new share repurchase program in the amount of $4,000 , which expires in April 2023 . During the first thirty-six weeks of 2019 and 2018 , we repurchased 903,000 and 1,337,000 shares of common stock, at an average price per share of $215.94 and $174.30 , respectively, totaling approximately $195 and $233 , respectively. These amounts may differ from the stock repurchase balances in the accompanying condensed consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of a quarter. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act.
Dividends
On April 26, 2019 , our Board of Directors declared a quarterly dividend of $0.65 per share payable to shareholders of record on May 10, 2019 . The dividend was paid on May 24, 2019 .
Bank Credit Facilities and Commercial Paper Programs
We maintain bank credit facilities for working capital and general corporate purposes. At May 12, 2019 , we had borrowing capacity under these facilities of $880, including a $400 revolving line of credit, which expires in June 2019. The Company currently has no plans to draw upon this facility but intends to renew it. Our international operations maintain $353 of the borrowing capacity under bank credit facilities, of which $146 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of the third quarter of 2019 or at the end of fiscal 2018 .
The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $234. The outstanding commitments under these facilities at the end of the third quarter of 2019 totaled $162, most of which were standby letters of credit with expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding.

28

Contractual Obligations

As of the date of this Report, there were no material changes to our contractual obligations outside the ordinary course of business since the end of our last fiscal year.
Critical Accounting Estimates
The preparation of our consolidated financial statements in accordance with U.S. GAAP requires that we make estimates and judgments. We base these on historical experience and on assumptions that we believe to be reasonable. Our critical accounting policies are discussed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K, for the fiscal year ended September 2, 2018 . There have been no material changes to the critical accounting policies previously disclosed in that Report.
Recent Accounting Pronouncements
See discussion of Recent Accounting Pronouncements in Note 1 to the condensed consolidated financial statements included in Part I, Item 1 of this Report.
Item 3—Quantitative and Qualitative Disclosures About Market Risk
Our direct exposure to financial market risk results from fluctuations in foreign currency exchange rates and interest rates. There have been no material changes to our market risks as disclosed in our Annual Report on Form 10-K, for the fiscal year ended September 2, 2018 .
Item 4—Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of May 12, 2019 and, based on their evaluation, have concluded the disclosure controls and procedures were not effective as of that date due to a material weakness in internal control over financial reporting that was disclosed in our Annual Report on Form 10-K for the fiscal year ended September 2, 2018.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the third quarter of fiscal 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting except as described below.
Remediation
As previously described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended September 2, 2018, we began implementing a remediation plan to address the material weakness mentioned above. The weakness will not be considered remediated, until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2019.

29

PART II—OTHER INFORMATION
Item 1—Legal Proceedings
See discussion of Legal Proceedings in Note 9 to the condensed consolidated financial statements included in Part I, Item 1 of this Report.
Item 1A—Risk Factors
In addition to the other information set forth in the Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A, "Risk Factors" in our Annual Report on Form 10-K, for the fiscal year ended September 2, 2018 . There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K.
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth information on our common stock repurchase program activity for the third quarter of 2019 (amounts in millions, except share and per share data):
Period
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Programs (1)
Maximum Dollar Value of Shares that May Yet be Purchased Under the Programs (1)
February 18, 2019 - March 17, 2019
126,000

$
218.48

126,000

$
2,248

March 18, 2019 - April 14, 2019
41,000

241.07

41,000

2,238

April 15, 2019 - May 12, 2019
25,000

243.46

25,000

3,995

Total third quarter
192,000

$
226.57

192,000

_______________
(1)
Our stock repurchase program is conducted under a $4,000 authorization approved by of our Board of Directors in April 2019, which expires in April 2023 . This authorization revoked previously authorized but unused amounts, totaling $2,237 .
Item 3—Defaults Upon Senior Securities
None.
Item 4—Mine Safety Disclosures
Not applicable.
Item 5—Other Information
None.


30

Item 6—Exhibits
The following exhibits are filed as part of this Quarterly Report on Form 10-Q or are incorporated herein by reference.
Incorporated by Reference
Exhibit
Number
Exhibit Description
Filed
Herewith
Form
Period Ending
Filing Date
10-Q
2/17/2019
3/13/2019
8-K
4/30/2019
x
x
101.INS
XBRL Instance Document
x
101.SCH
XBRL Taxonomy Extension Schema Document
x
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
x
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
x
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
x
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
x

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
C OSTCO W HOLESALE C ORPORATION
(Registrant)
June 5, 2019
By
/s/ W. C RAIG J ELINEK
Date
W. Craig Jelinek
President, Chief Executive Officer and Director
June 5, 2019
By
/s/ R ICHARD A. G ALANTI
Date
Richard A. Galanti
Executive Vice President, Chief Financial Officer and Director

31
TABLE OF CONTENTS