COSTCO WHOLESALE CORP /NEW 10-Q

Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, percentages and warehouse count data) FORWARD-LOOKING STATEMENTS Certain statements contained in this document constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For these purposes, forward-looking statements are statements that address activities, events, conditions or developments that the Company expects or anticipates may occur in the future and may relate to such matters as net 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. In some cases, forward-looking statements can be identified because they contain words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “likely,” “may,” “might,” “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, inflation or deflation, 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 and the Ukraine conflict), the ability to maintain effective internal control over financial reporting, regulatory and other impacts related to climate change, public-health related factors, and other risks identified from time to time in the Company's public statements and reports filed with the Securities and Exchange Commission. Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update these statements, except as required by law. OVERVIEW The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to promote understanding of the results of operations and financial condition. MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying Notes to Financial Statements (Part I, Item 1 of this Form 10-Q), as well as our consolidated financial statements, the accompanying Notes to Financial Statements, and the related Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal year 2023 Form 10-K, filed with the United States Securities and Exchange Commission on October 11, 2023. 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 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 often sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales. Net sales includes our core merchandise categories (foods and sundries, non-foods, and fresh foods), warehouse ancillary (gasoline, pharmacy, optical, food court, hearing aids, and tire installation) and other businesses (e-commerce, business centers, travel and other). Comparable sales is 17 Table of Contents defined as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. The measure is intended as supplemental information and is not a substitute for net sales presented in accordance with U.S. generally accepted accounting principles (U.S. GAAP). 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 our international operations); inflation or deflation and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage our SG&A 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 net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net 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, 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 merchandise mix, including increasing the penetration of our private-label items, and through 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” – consistently providing the most competitive values. Our investments in merchandise pricing may 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 gross margin and gross margin as a percentage of net sales (gross margin percentage). We believe our gasoline business enhances traffic in our warehouses, but it generally has a lower gross margin percentage and lower SG&A expense, relative to our non-gasoline businesses. 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 SG&A expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Government actions in various countries relating to tariffs, particularly China and the United States, have affected 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. Higher tariffs could adversely impact our results. We also achieve net sales growth by opening new warehouses. As our warehouse base grows, available and desirable 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, domestically and internationally, generally has a lower gross margin percentage than our warehouse operations. The 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, 18 Table of Contents 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 controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, particularly health care and utility expenses. With respect 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 operates on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and SG&A expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canadian, and Other International operating segments (see Note 9 to the consolidated financial statements included in Part I, Item 1, of this Report). Certain operations in the Other International segment have relatively higher rates of square footage growth, lower wage and benefit costs as a percentage of sales, less or no direct membership warehouse competition, or lack e-commerce or business delivery. 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 differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars. This impact of foreign-exchange rate changes is calculated based on the difference between the current and prior period's exchange rates. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current and prior period's average price per gallon sold. Results expressed excluding the impacts of foreign exchange and gasoline prices are intended as supplemental information and are not a substitute for net sales presented in accordance with U.S. GAAP and should be reviewed in conjunction with results reported in accordance with U.S. GAAP. Our fiscal year ends on the Sunday closest to August 31. References to the first quarter of 2024 and 2023 relate to the 12-week fiscal quarters ended November 26, 2023, and November 20, 2022. Certain percentages presented are calculated using actual results prior to rounding. Highlights for the first quarter of 2024 versus 2023 include: • Net sales increased 6% to $56,717, driven by a 4% increase in comparable sales and sales at 25 net new warehouses opened since the end of the first quarter of 2023; • Membership fee revenue increased 8% to $1,082, driven by new member sign-ups, upgrades to Executive Membership, and a higher renewal rate; • Gross margin percentage increased 43 basis points, driven primarily by our warehouse operations and other businesses and the absence of a charge of $93, $0.15 per diluted share, predominantly related to the discontinuation of our charter shipping activities, which was recorded in the first quarter of 2023; • SG&A expenses as a percentage of net sales increased 25 basis points, primarily due to increased costs in warehouse operations and other businesses, including the impact of wage increases in March and September 2023; • The provision for income taxes in the first quarter of 2024 was positively impacted by a benefit related to stock compensation of $44, $0.10 per diluted share, compared to $53, $0.12 per diluted share, in the first quarter of 2023; • Net income was $1,589, $3.58 per diluted share, compared to $1,364, $3.07 per diluted share in 2023; • A quarterly cash dividend of $1.02 per share was declared on October 18, 2023, and paid on November 17, 2023; and • Subsequent to the end of the quarter, on December 13, 2023, the Board of Directors declared a special cash dividend of $15.00 per share, payable January 12, 2024. 19 Table of Contents RESULTS OF OPERATIONS Net Sales 12 Weeks Ended November 26, 2023 November 20, 2022 Net Sales $ 56,717 $ 53,437 Changes in net sales: U.S. 4 % 11 % Canada 7 % 3 % Other International 16 % — % Total Company 6 % 8 % Changes in comparable sales: U.S. 2 % 9 % Canada 6 % 2 % Other International 11 % (3) % Total Company 4 % 7 % E-commerce 6 % (4) % Changes in comparable sales excluding the impact of changes in foreign-currency and gasoline prices: U.S. 3 % 7 % Canada 8 % 8 % Other International 7 % 9 % Total Company 4 % 7 % E-commerce 6 % (2) % Net Sales Net sales increased $3,280 or 6%, during the first quarter of 2024. The improvement was attributable to an increase in comparable sales of 4%, and sales at the 25 net new warehouses opened since the end of the first quarter of 2023. Sales increased $2,921, or 7% in core merchandise categories, led by fresh foods and foods and sundries. Sales in warehouse ancillary and other businesses increased $359, or 3%, led by pharmacy. During the first quarter of 2024, l ower gasoline prices negatively impacted net sales by $341, 64 basis points, compared to 2023, with a 4% decrease in the average price per gallon. C hanges in foreign currencies relative to the U.S. dollar positively impacted net sales by approximately $195, 36 basis points, compared to the first quarter of 2023, attributable to our Other International operations, partially offset by our Canadian operations. Comparable Sales Comparable sales increased 4% in the first quarter of 2024 and were positively impacted by increases in shopping frequency, partially offset by a slight decrease in average ticket. 20 Table of Contents Membership Fees 12 Weeks Ended November 26, 2023 November 20, 2022 Membership fees $ 1,082 $ 1,000 Membership fees increase 8 % 6 % Total paid members (000s) 72,000 66,900 Total cardholders (000s) 129,500 120,900 Membership fee revenue increased 8%, driven by new member sign-ups, upgrades to Executive Membership, and a higher renewal rate. At the end of the first quarter of 2024, our renewal rates were 92.8% in the U.S. and Canada and 90.5% worldwide. Renewal rates benefited from higher penetration of Executive members. Our renewal rate, which excludes affiliates of Business members, is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. Gross Margin 12 Weeks Ended November 26, 2023 November 20, 2022 Net sales $ 56,717 $ 53,437 Less merchandise costs 50,457 47,769 Gross margin $ 6,260 $ 5,668 Gross margin percentage 11.04 % 10.61 % Gross margin percentage increased 43 basis points. Excluding the impact of gasoline price deflation on net sales, gross margin percentage was 10.97%, an increase of 36 basis points. The 36 basis-point increase was positively impacted by: 22 basis points related to our warehouse ancillary and other businesses, primarily gasoline and e-commerce; 17 basis points due to the absence of a charge related to the discontinuation of our charter shipping activities that was recorded in the first quarter of 2023; and three basis points due to a LIFO benefit. These were partially offset by: three basis points due to core merchandise categories, predominantly fresh foods; and three basis points due to increased 2% rewards. The gross margin in core merchandise categories, when expressed as a percentage of core merchandise sales (rather than total net sales), increased five basis points. The increase was primarily due to non-foods, partially offset by fresh foods and foods and sundries. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. 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), increased across all segments. Our U.S. segment performed similarly to the results above. The increases in our Canadian and Other International segments were primarily due to increases in warehouse ancillary and other businesses and core merchandise categories. All segments were negatively impacted by increased 2% rewards. 21 Table of Contents Selling, General and Administrative Expenses 12 Weeks Ended November 26, 2023 November 20, 2022 SG&A expenses $ 5,358 $ 4,917 SG&A expenses as a percentage of net sales 9.45 % 9.20 % SG&A expenses as a percentage of net sales increased 25 basis points. SG&A expenses as a percentage of net sales excluding the impact of gasoline price deflation was 9.39%, an increase of 19 basis points. The comparison to last year was negatively impacted by 14 basis points in warehouse operations and other businesses which included the impact of wage increases in March and September 2023. Stock compensation and preopening costs were each higher by two basis points, and central operating costs were higher by one basis point. Interest Expense 12 Weeks Ended November 26, 2023 November 20, 2022 Interest expense $ 38 $ 34 Interest expense is primarily related to Senior Notes and financing leases. Interest Income and Other, Net 12 Weeks Ended November 26, 2023 November 20, 2022 Interest income $ 154 $ 54 Foreign-currency transaction gains (losses), net 3 (9) Other, net 3 8 Interest income and other, net $ 160 $ 53 The increase in interest income in the first quarter was due to higher global interest rates and higher average cash and investment balances. Foreign-currency transaction gains (losses), net, include 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 3, 2023. Provision for Income Taxes 12 Weeks Ended November 26, 2023 November 20, 2022 Provision for income taxes $ 517 $ 406 Effective tax rate 24.5 % 23.0 % The effective tax rate for the first quarter of 2024 was impacted by net discrete tax benefits of $40, primarily due to excess tax benefits related to stock compensation. Excluding discrete net tax benefits, the tax rate was 26.4% for the first quarter of 2024. The effective tax rate for the first quarter of 2023 was impacted by net discrete tax benefits of $56, primarily due to excess tax benefits related to stock compensation. Excluding discrete net tax benefits, the tax rate was 26.1% for the first quarter of 2023. 22 Table of Contents LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: 12 Weeks Ended November 26, 2023 November 20, 2022 Net cash provided by operating activities $ 4,651 $ 2,610 Net cash used in investing activities (366) (1,057) Net cash used in financing activities (974) (863) Our primary sources of liquidity are cash flows from operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $17,864 and $15,234 at November 26, 2023, and September 3, 2023. Of these balances, unsettled credit and debit card receivables represented approximately $2,603 and $2,282 at November 26, 2023, and September 3, 2023. These receivables generally settle within four days. Material contractual obligations arising in the normal course of business primarily consist of purchase obligations, long-term debt and related interest payments, leases, and construction and land purchase obligations. Purchase obligations consist of contracts primarily related to merchandise, equipment, and third-party services, the majority of which are due in the next 12 months. Construction and land purchase obligations consist of contracts primarily related to the development and opening of new and relocated warehouses, the majority of which (other than leases) are due in the next 12 months. Management believes that our cash and investment position and operating cash flows with capacity under existing and available credit agreements 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. Cash Flows from Operating Activities Net cash provided by operating activities totaled $4,651 in the first quarter of 2024, compared to $2,610 in the first quarter of 2023. Our cash flow provided by operations is primarily from net sales and membership fees. Cash flow used in operations generally consists of payments to merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit 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 inventory levels and turnover, the forward deployment of inventory to accelerate delivery times, payment terms with suppliers, and early payments to obtain discounts. Cash Flows from Investing Activities Net cash used in investing activities totaled $366 in the first quarter of 2024, compared to $1,057 in the first quarter of 2023, and is 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 quarter of 2024, we spent $1,040 on capital expenditures, and it is our current intention to spend approximately $4,400 to $4,600 during fiscal 2024. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 10 new warehouses, including one relocation, in the 23 Table of Contents first quarter of 2024 and plan to open 23 additional new warehouses, including one relocation, in the remainder of fiscal 2024. 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 and the economic environment. Cash Flows from Financing Activities Net cash used in financing activities totaled $974 in the first quarter of 2024, compared to $863 in the first quarter of 2023. Cash flow used in financing activities during the first quarter of 2024 was primarily related to the payment of dividends, withholding taxes on stock-based awards, and repurchases of common stock. In November 2023, our Japanese subsidiary issued four Guaranteed Senior Notes totaling approximately $500 at fixed interest rates ranging from 1.400% to 2.120%. Dividends A quarterly cash dividend of $1.02 per share was declared on October 18, 2023, payable to shareholders of record on November 3, 2023, which was paid on November 17, 2023. Subsequent to the end of the quarter, on December 13, 2023, the Board of Directors declared a special cash dividend of $15.00 per share, payable January 12, 2024, to shareholders of record as of the close of business on December 28, 2023. The aggregate amount of payments will be approximately $6.7 billion. Share Repurchase Program On January 19, 2023, the Board of Directors authorized a share repurchase program in the amount of $4,000, which expires in January 2027. During the first quarter of 2024 and 2023, we repurchased 288,000 and 285,000 shares of common stock, at an average price per share of $564.06 and $495.94, totaling approximately $162 and $141. These amounts may differ from the accompanying condensed consolidated statements of cash flows due to changes in unsettled 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, pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. The remaining amount available to be purchased under our approved plan was $3,401 at the end of the first quarter. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At November 26, 2023, we had borrowing capacity under these facilities of $1,245. Our international operations maintain $757 of this capacity under bank credit facilities, of which $163 is guaranteed by the Company. Short-term borrowings outstanding under the bank credit facilities, which are included in other current liabilities on the consolidated balance sheets, were immaterial at the end of the first quarter of 2024 and at the end of fiscal 2023. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $223. The outstanding commitments under these facilities at the end of the first quarter of 2024 totaled $188, most of which were standby letters of credit that do not expire or have expiration dates within one year. The bank credit facilities have various expiration dates, most 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. 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 24 Table of Contents on Form 10-K, for the fiscal year ended September 3, 2023. There have been no material changes to the critical accounting estimates 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 1, 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 3, 2023.