UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549 

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

The number of shares outstanding of the issuer's common stock as of December 13, 201712, 2018 was 439,105,871.440,490,478.

Description of Business

Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses and ecommerce websites based on the concept that offering members low prices on a limited selection of nationally brandednationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At November 26, 2017,25, 2018, Costco operated 746768 warehouses worldwide: 518533 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 98100 Canada locations, 3739 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 1315 Korea locations, 13 Taiwan locations, nine10 Australia locations, two Spain locations, one Iceland location, and one France location. 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 interests in its operationsinterest in Taiwan. During the first quarter of 2018, Costcothe 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 3, 2017.2, 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 20182019 is a 52-week year ending on September 2, 2018.1, 2019. References to the first quartersquarter of 20182019 and 20172018 relate to the 12-week fiscal quarters ended November 26, 2017,25, 2018, and November 20, 2016,26, 2017, 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 and events could differ from those estimates and assumptions.

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 and merchandise returns. The Company reserves for estimated sales 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.

In certain countries, the Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum reward of approximately $1,000 per year), which does not expire and can be no assurance thatredeemed only at Costco warehouses. The Company accounts for this practice is effective. The contracts are limited to less than one yearreward as a reduction in duration. See Note 3 for information onsales, net of the fair valueestimated impact of unsettled forward foreign-exchange contractsnon-redemptions (breakage), with the corresponding liability classified as of November 26, 2017, and September 3, 2017.

Cash Cards - The Company sells and resulted inotherwise 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 gain of $30 inestimated breakage and as of the end of the first quarter of 2017.2019 and 2018, the cash card liability was not material.

Co-Brand Credit Card Program - Under the terms of the Company's 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 is exposedused to fluctuationsfund the rebate that cardholders receive after giving rise to estimated breakage. The rebates are issued in prices for the energy it consumes, particularly electricityFebruary and natural gas, which it seeks to partially mitigate through the useexpire on December 31 of fixed-price contracts for certaineach year. Breakage is estimated based on redemption data.

Recent Accounting Pronouncements Adopted

The new standard impacted the presentation and timing of certain revenue transactions. Specifically, the changes included gross presentation of the dateCompany’s estimate of adoption. merchandise returns reserve and 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 new standard of its status as a principal in certain vendor arrangements resulted in the recognition of additional sales on a gross basis.

The new

While its review is continuing, based on preliminary assessments, the Company believes the new guidance will change recognition timing of cash-card breakage income to reflect the historical pattern of gift card redemption rather than the current methodology of recognizing income when redemption is considered remote. The Company will also present estimated sales returns on a gross basis rather than neteffect of the sales return reserveadoption of this standard on the Company's condensed consolidated balance sheets. The Company continues to evaluate various areas suchstatement of income for the first quarter of 2019 is as gross versus netfollows:

In February 2016, the FASB issued guidance on leases,ASU 2016-02, which will require recognition on the balance sheet for theof rights and obligations created by all 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 plans to utilize the transition option, which does not require application of the guidance to comparative periods in the year 2020. While the Company continues to evaluate this standard and the effect on related disclosures, theof adoption. The primary effect of adoption will be to require recording right-of-use assets and corresponding lease obligations for current operating leases. The adoption is expected to have a material impact on the Company's consolidated balance sheets, but not on the consolidated statements of income or consolidated statementscash flows. Additionally, the Company is in the process of cash flows.

Gross unrealized gains and losses on available-for-sale securities were not material for the first quarter of 2019 or 2018. At November 26, 2017,25, 2018, and September 3, 2017,2, 2018, available-for-sale securities that were in a continuous unrealized-loss position were immaterial. During the first quarter of 2018, therenot material.

There were no unrealized gains or losses on cash and cash equivalents. During the first quarter of 2017, unrealized gains or losses on cash and cash equivalents were immaterial.

The maturities of available-for-sale and held-to-maturity securities at November 26, 2017,25, 2018, were as follows:

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.

During and at the periods ended November 26, 2017,25, 2018, and September 3, 2017,2, 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 first quarter of 20182019 or 2017.

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 first quarter of 20182019 or 2017.2018.

The carrying value of the Company’s long-term debt consisted of the following:

The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists primarily of promissory notes and term loansGuaranteed Senior Notes issued by the Company's Japan subsidiary and are valued primarily using Level 3 inputs. The fair value of the Company's long-term debt, including the current portion, was approximately $6,641$6,360 and $6,753$6,492 at November 26, 2017,25, 2018, and September 3, 2017,2, 2018, respectively.

Dividends

The Company’s current quarterly dividend rate is $0.50$0.57 per share, compared to $0.45$0.50 per share in the first quarter of 2017.2018. On October 30, 2017,24, 2018, the Board of Directors declared a quarterly cash dividend in the amount of $0.50$0.57 per share, which was paid on December 1, 2017.November 23, 2018.

Stock Repurchase Programs

Stock repurchase activity during the first quarter of 20182019 and 20172018 is summarized below:

The remaining unrecognized compensation cost related to non-vested RSUs at November 26, 2017,25, 2018, was $999,$1,011, and the weighted-average period over which this cost will be recognized is 1.8 years.

Summary of Stock-Based Compensation

The following table summarizes stock-based compensation expense and the related tax benefits under the Company’s plans:

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):

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 an immaterial accrual with respect to one matter 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.

On November 23, 2016, the Company’s Canadian subsidiary received from the Ontario Ministry of Health and Long Term Care a request for an inspection and information concerning compliance with the anti-rebate provisions in the Ontario Drug Benefit Act and the Drug Interchangeability and Dispensing Fee Act. The Ministry has indicated that it has reason to believe the Company received payments in violation of these laws and is seeking disgorgement of these sums, and the Company is seekingengaged in discussions concerning a settlement payment.

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. The Company is seeking to cooperate concerning the resolution of these notices.

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 3, 2017,2, 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 are not allocated internally and generally come under the responsibility of the Company's U.S. management team.

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)

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 net sales growth, increaseschanges in comparable warehouse 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,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,“seek,” “should,” “target,” “will,” “would,” “will be,” “will continue,” “will likely result,”or similar expressions and similar expressions. Forward-lookingthe 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 20172018 Annual Report on Form 10-K, previously filed with the SEC.

We operate membership warehouses and ecommercee-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 warehouse sales (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); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S.conditions; and Canadian operations).the implementation of the new 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 to our members 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 regional wholesalers and retailers.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

Our philosophy is to provide our members with quality goods and services at the most 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, all 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 business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly 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. We operate our lower-margin gasoline business in all countries except Korea and France.

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 increasingly less significant relativecontinuing 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, both domestically and internationally has also increased our sales.

Our membership format is an integral part of our business model 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, historically, some significant costs are partially outside our control, most particularly health care and utility expenses. With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of 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.

Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 10 to the consolidated financial statements included in Part I, Item 1, Note 9 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 are references 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.

Our fiscal year ends on the Sunday closest to August 31. References to the first quarters of 20182019 and 20172018 relate to the 12-week fiscal quarters ended November 26, 2017,25, 2018, and November 20, 2016,26, 2017, 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 first quarter of 20182019 as compared to the first quarter of 20172018 include:

Membership fees increased 10% in the first quarter of 2018.2019. This was primarily due to the fee increase (discussed below) and sign-ups at existing and new warehouses and the fee increase (discussed below).warehouses. Renewal rates are 90%91% in the U.S. and Canada and 87%88% worldwide.

As previously reported, in fiscal 2017 we increased our annual membership fees in certain of our Other International operations and 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 first quarter of 20182019 of approximately $24$37, and will positively impact the next several quarters relative to the same periods for the prior year. We expect these increases to positively impact revenue bytotaling approximately $175$70 in fiscal 2018.2019.

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), decreased slightly,six basis points, primarily due to decreases in softlines and fresh foods and hardlines, partially offset by an increaseincreases in softlines and food and sundries.sundries and hardlines. 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 3350 basis points compared to the first quarter of 2017.2018. Excluding the impactimpacts of gasoline price inflation and the new revenue recognition standard on net sales, gross margin as a percentage of adjusted net sales was 11.39%10.99%, a decrease of 1926 basis points. This decrease was primarily due to a benefit of 1922 basis point decrease in our core merchandise categories and was also negatively impacted by 13 basis points receiveddue to an adjustment to our estimate of breakage on rewards earned under our co-branded credit card program. These decreases were partially offset by an 11 basis point increase in the first quarter of 2017 for a non-recurring legal settlement. Ancillaryour warehouse ancillary and other businesses, gross margins were higher by nine basis points, primarily due topredominantly our gasoline business partially offset by our pharmacy business.

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 U.S. operations, primarily due to the non-recurring legal settlement and decreases in fresh foods and food and sundries. This was partially offset by increaseslower gross margins in our ancillary warehousecore merchandise categories and other businesses, primarily our gasoline business.the breakage adjustment mentioned above. The segment gross margin percentage in our Canadian operations increased due todecreased, predominantly in food and sundries, hardlines and certain of our warehouse ancillary warehouse and other businesses, predominantlybusinesses. Other International operations decreased, primarily in our gasoline business. The segment gross margincore merchandise categories.

SG&A expenses as a percentage of net sales decreased 3423 basis points compared to the first quarter of 2017.2018. Excluding the impactimpacts of gasoline price inflation and the new revenue recognition standard on net sales, SG&A expenses as a percentage of adjusted net sales was 10.36%, or flat compared to the prior year. Operating costs related to warehouse, ancillary and other businesses, which includes e-commerce and travel, were 10.50%, a decrease of 20 basis points. Warehouse and central operating costs decreased 12 and sevenlower by four basis points, respectively,predominantly in our U.S. operations, due to leveraging increased sales.sales, partially offset by the wage increases of our U.S. hourly employees that went into effect in June 2018. Central operating costs were lower by two basis points. Stock compensation expense decreasedwas higher by onesix basis point.points, primarily due to appreciation in share price.

Interest expense is primarily related to Senior NotesNotes. In October 2018 we repaid a Guaranteed Senior Note issued by the Company. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes.our Japanese subsidiary.

The effective tax rate for the first quarter of 2019 was favorably impacted by a reduction in the U.S. federal corporate rate from 35% to 21% and discrete net tax benefits of $93. Net discrete tax benefits included $59 related to the stock-based compensation accounting standard adopted in the first quarter of 2018 and $27 related to continuing implementation of the 2017 Tax Act. Excluding the discrete net tax benefits, the tax rate was 26.8% for the quarter. The effective tax rate for the first quarter of 2018 was favorably impacted by the adoptiona discrete tax benefit of an accounting standard$41 related to the stock-based compensation of $41. Excluding this benefit, the tax rate was 34.8% for the first quarter of 2018. See Recently Adopted Accounting Pronouncements in Part I, Item 1, Note 1 of this Report.accounting standard.

The following table summarizes our significant sources and uses of cash and cash equivalents: