COSTCO WHOLESALE CORP /NEW - Quarter Report: 2017 February (Form 10-Q)

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 February 12, 2017



☐	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

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). YES ☒ NO ☐

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



Large accelerated filer ☒		Accelerated filer ☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)		Smaller reporting company ☐

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 March 1, 2017 was 438,941,216.

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COSTCO WHOLESALE CORPORATION

INDEX TO FORM 10-Q



		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Income	4
	Condensed Consolidated Statements of Comprehensive Income	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30

PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3.	Defaults Upon Senior Securities	31
Item 4.	Mine Safety Disclosures	31
Item 5.	Other Information	31
Item 6.	Exhibits	32
	Signatures	32

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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)



	February 12, 2017			August 28, 2016
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	4,744		$	3,379
Short-term investments	1,221			1,350
Receivables, net	1,597			1,252
Merchandise inventories	9,530			8,969
Other current assets	368			268
Total current assets	17,460			15,218
PROPERTY AND EQUIPMENT
Land	5,436			5,395
Buildings and improvements	14,395			13,994
Equipment and fixtures	6,363			6,077
Construction in progress	697			701
	26,891			26,167
Less accumulated depreciation and amortization	(9,549		)	(9,124		)
Net property and equipment	17,342			17,043
OTHER ASSETS	828			902
TOTAL ASSETS	$	35,630		$	33,163
LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable	$	8,764		$	7,612
Current portion of long-term debt	2,257			1,100
Accrued salaries and benefits	2,780			2,629
Accrued member rewards	910			869
Deferred membership fees	1,458			1,362
Other current liabilities	2,691			2,003
Total current liabilities	18,860			15,575
LONG-TERM DEBT, excluding current portion	2,815			4,061
OTHER LIABILITIES	1,243			1,195
Total liabilities	22,918			20,831
COMMITMENTS AND CONTINGENCIES
EQUITY
Preferred stock $.005 par value; 100,000,000 shares authorized; no shares issued and outstanding	0			0
Common stock $.005 par value; 900,000,000 shares authorized; 438,941,000 and 437,524,000 shares issued and outstanding	2			2
Additional paid-in capital	5,631			5,490
Accumulated other comprehensive loss	(1,333		)	(1,099		)
Retained earnings	8,140			7,686
Total Costco stockholders’ equity	12,440			12,079
Noncontrolling interests	272			253
Total equity	12,712			12,332
TOTAL LIABILITIES AND EQUITY	$	35,630		$	33,163

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

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COSTCO WHOLESALE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in millions, except per share data)

(unaudited)



	12 Weeks Ended						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
REVENUE
Net sales	$	29,130		$	27,567		$	56,599		$	54,194
Membership fees	636			603			1,266			1,196
Total revenue	29,766			28,170			57,865			55,390
OPERATING EXPENSES
Merchandise costs	25,927			24,469			50,215			48,090
Selling, general and administrative	2,980			2,835			5,920			5,641
Preopening expenses	15			10			37			36
Operating income	844			856			1,693			1,623
OTHER INCOME (EXPENSE)
Interest expense	(31		)	(31		)	(60		)	(64		)
Interest income and other, net	(4		)	16			22			44
INCOME BEFORE INCOME TAXES	809			841			1,655			1,603
Provision for income taxes	288			286			579			561
Net income including noncontrolling interests	521			555			1,076			1,042
Net income attributable to noncontrolling interests	(6		)	(9		)	(16		)	(16		)
NET INCOME ATTRIBUTABLE TO COSTCO	$	515		$	546		$	1,060		$	1,026
NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO:
Basic	$	1.17		$	1.24		$	2.42		$	2.34
Diluted	$	1.17		$	1.24		$	2.41		$	2.32
Shares used in calculation (000’s):
Basic	439,127			439,648			438,567			438,990
Diluted	440,657			441,559			440,568			441,457
CASH DIVIDENDS DECLARED PER COMMON SHARE	$	0.45		$	0.40		$	0.90		$	0.80

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

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COSTCO WHOLESALE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in millions)

(unaudited)



	12 Weeks Ended					24 Weeks Ended
	February 12, 2017		February 14, 2016			February 12, 2017			February 14, 2016
NET INCOME INCLUDING NONCONTROLLING INTERESTS	$	521	$	555		$	1,076		$	1,042
Foreign-currency translation adjustment and other, net	114		(244		)	(231		)	(229		)
Comprehensive income	635		311			845			813
Less: Comprehensive income attributable to noncontrolling interests	14		4			19			10
COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO	$	621	$	307		$	826		$	803

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

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COSTCO WHOLESALE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in millions)

(unaudited)



	24 Weeks Ended
	February 12, 2017			February 14, 2016
CASH FLOWS FROM OPERATING ACTIVITIES
Net income including noncontrolling interests	$	1,076		$	1,042
Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization	609			556
Stock-based compensation	322			287
Excess tax benefits on stock-based awards	(37		)	(74		)
Other non-cash operating activities, net	(12		)	5
Deferred income taxes	45			(15		)
Changes in operating assets and liabilities:
Merchandise inventories	(735		)	(98		)
Accounts payable	1,579			(482		)
Other operating assets and liabilities, net	439			381
Net cash provided by operating activities	3,286			1,602
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of short-term investments	(625		)	(499		)
Maturities and sales of short-term investments	734			886
Additions to property and equipment	(1,183		)	(1,339		)
Other investing activities, net	22			0
Net cash used in investing activities	(1,052		)	(952		)
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft	(272		)	(146		)
Proceeds from short-term borrowings	0			99
Repayments of long-term debt	0			(1,200		)
Minimum tax withholdings on stock-based awards	(201		)	(219		)
Excess tax benefits on stock-based awards	37			74
Repurchases of common stock	(190		)	(213		)
Cash dividend payments	(198		)	(176		)
Other financing activities, net	(1		)	(6		)
Net cash used in financing activities	(825		)	(1,787		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	(44		)	(31		)
Net change in cash and cash equivalents	1,365			(1,168		)
CASH AND CASH EQUIVALENTS BEGINNING OF YEAR	3,379			4,801
CASH AND CASH EQUIVALENTS END OF PERIOD	$	4,744		$	3,633

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the first half of year for:
Interest (reduced by $8, interest capitalized in 2017 and 2016)	$	54		$	52
Income taxes, net	$	458		$	447
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Cash dividend declared, but not yet paid	$	198		$	176

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

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COSTCO WHOLESALE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in millions, except share, per share, membership fee, 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. At February 12, 2017, Costco operated 727 warehouses worldwide: 508 United States (U.S.) locations (in 44 states, Washington, D.C., and Puerto Rico), 94 Canada locations, 36 Mexico locations, 28 United Kingdom (U.K.) locations, 25 Japan locations, 13 Korea locations, 13 Taiwan locations, eight Australia locations and two Spain locations. The Company's online business operates websites in the U.S., Canada, U.K., Mexico, 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 noncontrolling interests in its operations in Taiwan and Korea. 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 August 28, 2016.

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 2017 is a 53-week year ending on September 3, 2017. References to the second quarters of 2017 and 2016 relate to the 12-week fiscal quarters ended February 12, 2017, and February 14, 2016, respectively. References to the first half of 2017 and 2016 relate to the twenty-four weeks ended February 12, 2017, and February 14, 2016, 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.

Fair Value of Financial Instruments

The Company accounts for certain assets and liabilities at fair value. The carrying value of the Company’s financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate

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Note 1—Summary of Significant Accounting Policies (Continued)

fair value due to their short-term nature or variable interest rates. See Notes 2, 3, and 4 for the carrying value and fair value of the Company’s investments, derivative instruments, and fixed-rate debt, respectively.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Significant unobservable inputs that are not corroborated by market data.

The Company’s current financial liabilities have fair values that approximate their carrying values. The Company’s long-term financial liabilities consist of long-term debt, which is recorded on the balance sheet at issuance price and adjusted for any applicable unamortized discounts or premiums and debt issuance costs. There have been no material changes to the valuation techniques utilized in the fair value measurement of assets and liabilities as disclosed in the Company's 2016 Form 10-K.

Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation rates and inventory levels for the year have been determined. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the first-in, first-out (FIFO) basis.

As of February 12, 2017, U.S. merchandise inventories valued at LIFO approximated FIFO after considering the lower of cost or market principle. As of August 28, 2016, the cumulative impact of the LIFO valuation on merchandise inventories was immaterial.

Derivatives

The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Company’s international subsidiaries, whose functional currency is not the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $521 and $572 at February 12, 2017, and August 28, 2016, respectively. The Company seeks to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which the Company has an established banking relationship. There can be no assurance that this practice is effective. The contracts are limited to less than one year in duration. See Note 3 for information on the fair value of unsettled forward foreign-exchange contracts as of February 12, 2017, and August 28, 2016.

The unrealized gains or losses recognized in interest income and other, net in the accompanying condensed consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts was a net loss of $29 in the second quarter and immaterial in first half of 2017. Unrealized

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Note 1—Summary of Significant Accounting Policies (Continued)

gains or losses on unsettled forward foreign-exchange contracts were immaterial in the second quarter and first half of 2016.

The Company is exposed to fluctuations in prices for the energy it consumes, particularly electricity and natural gas, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the “normal purchases or normal sales” exception under authoritative guidance and require no mark-to-market adjustment.

Foreign Currency

The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the accompanying condensed consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items resulted in a net gain of $9 and a net loss of $8 in the second quarter and first half of 2017, respectively, as compared to a net gain of $11 and $30 in the second quarter and first half of 2016, respectively.

Stock Repurchase Programs

Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 5 for additional information.

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (FASB) issued new guidance on the recognition of revenue from contracts with customers. The guidance converges the requirements for reporting revenue and requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows arising from these contracts. Transition is permitted either retrospectively or as a cumulative effect adjustment as of the date of adoption. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2017. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal year 2019 and is in the process of evaluating the impact and method of adoption of the standard and its related amendments. The Company is reviewing current accounting policies, business processes, systems and controls to identify potential differences or changes that would result from applying the new standard. The Company is still evaluating whether or not there will be a material impact on the Company's consolidated financial statements and related disclosures as a result of adopting this standard.

In February 2016, the FASB issued new guidance on leases, which will require lessees to recognize assets and liabilities on the balance sheet for the 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 year 2020. While the Company continues to evaluate this standard and the effect on related disclosures, the primary effect of adoption will be to record 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 results of operations or cash flows.

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Note 1—Summary of Significant Accounting Policies (Continued)

In March 2016, the FASB issued new guidance on stock compensation, intended to simplify accounting for share-based payment transactions. The guidance will change accounting for income taxes, forfeitures, and minimum statutory tax withholding requirements. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal year 2018. Adoption of this guidance will likely be material to the provision for income taxes on the Company’s consolidated income statements and earnings per share amounts for the change in the recognition of excess tax benefits or deficiencies. Due to the Company's annual vesting and release in its first fiscal quarter, this may create increased volatility in these amounts during that quarter of each fiscal year. Previously these amounts were reflected in equity. Additionally, these amounts will be reflected as an operating activity instead of financing activity in the consolidated statements of cash flows. Adoption of this guidance is not expected to have a material effect on the consolidated balance sheets, statements of cash flows, or related disclosures.

Note 2—Investments

The Company's major categories of investments have not materially changed from the annual reporting period ended August 28, 2016. The Company’s investments were as follows:



February 12, 2017:	Cost Basis		Unrealized Loss, Net			Recorded Basis
Available-for-sale:
Government and agency securities	$	1,051	$	(2	)	$	1,049
Asset and mortgage-backed securities	1		0			1
Total available-for-sale	1,052		(2		)	1,050
Held-to-maturity:
Certificates of deposit	171					171
Total short-term investments	$	1,223	$	(2	)	$	1,221



August 28, 2016:	Cost Basis		Unrealized Gains, Net		Recorded Basis
Available-for-sale:
Government and agency securities	$	1,028	$	6	$	1,034
Asset and mortgage-backed securities	1		0		1
Total available-for-sale	1,029		6		1,035
Held-to-maturity:
Certificates of deposit	306				306
Bankers' acceptances	9				9
Total held-to-maturity	315				315
Total short-term investments	$	1,344	$	6	$	1,350

At February 12, 2017, and August 28, 2016, there were no available-for-sale securities with continuous unrealized-loss positions. There were no unrealized gains and losses on cash and cash equivalents at the end of the second quarter of 2017 and unrealized gains and losses on cash and cash equivalents were not material during the first half of 2017. There were no unrealized gains and losses on cash and cash equivalents during the second quarter and first half of 2016.

The proceeds from sales of available-for-sale securities were $34 and $139 during the second quarter of 2017 and 2016, respectively, and $66 and $189 during the first half of 2017 and 2016, respectively. Gross

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Note 2—Investments (Continued)

realized gains or losses from sales of available-for-sale securities during the second quarter and first half of 2017 and 2016 were not material.

The maturities of available-for-sale and held-to-maturity securities at February 12, 2017, were as follows:



	Available-For-Sale				Held-To-Maturity
	Cost Basis		Fair Value		Held-To-Maturity
Due in one year or less	$	160	$	160	$	171
Due after one year through five years	837		836		0
Due after five years	55		54		0
	$	1,052	$	1,050	$	171

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.



February 12, 2017:	Level 1		Level 2
Money market mutual funds⁽¹⁾	$	32	$	0
Investment in government and agency securities	0		1,049
Investment in asset and mortgage-backed securities	0		1
Forward foreign-exchange contracts, in asset position⁽²⁾	0		6
Forward foreign-exchange contracts, in (liability) position⁽²⁾	0		(8		)
Total	$	32	$	1,048



August 28, 2016:	Level 1		Level 2
Money market mutual funds⁽¹⁾	$	222	$	0
Investment in government and agency securities	0		1,034
Investment in asset and mortgage-backed securities	0		1
Forward foreign-exchange contracts, in asset position⁽²⁾	0		11
Forward foreign-exchange contracts, in (liability) position⁽²⁾	0		(13		)
Total	$	222	$	1,033

_______________


(1)	Included in cash and cash equivalents 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. See Note 1 for additional information on derivative instruments.

At February 12, 2017, and August 28, 2016, 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 second quarter or first half of 2017 or 2016.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Financial assets measured at fair value on a nonrecurring basis include held-to-maturity investments that are carried at amortized cost. There were no fair value adjustments to these financial assets during the second quarter or first half of 2017 or 2016.

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Note 3—Fair Value Measurement (Continued)

Nonfinancial assets measured at fair value on a nonrecurring basis include items such as long-lived assets. There were no fair value adjustments resulting from an impairment to nonfinancial assets during the second quarter or first half of 2017 or 2016.

Note 4—Debt

The estimated fair value of the Company’s debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit risk. Substantially all of the Company's long-term debt is valued using Level 2 inputs.

The carrying and estimated fair values of the Company’s long-term debt consisted of the following:



	February 12, 2017				August 28, 2016
	Carrying Value		Fair Value		Carrying Value		Fair Value
5.5% Senior Notes due March 2017	$	1,100	$	1,105	$	1,100	$	1,129
1.125% Senior Notes due December 2017	1,099		1,100		1,099		1,103
1.7% Senior Notes due December 2019	1,197		1,210		1,196		1,219
1.75% Senior Notes due February 2020	498		499		498		508
2.25% Senior Notes due February 2022	497		497		497		512
Other long-term debt	681		705		771		803
Total long-term debt	5,072		5,116		5,161		5,274
Less current portion	2,257		2,264		1,100		1,130
Long-term debt, excluding current portion	$	2,815	$	2,852	$	4,061	$	4,144

Note 5—Equity and Comprehensive Income

Dividends

The Company’s current quarterly dividend rate is $0.45 per share, compared to $0.40 per share in the second quarter of 2016. On January 27, 2017, the Board of Directors declared a quarterly cash dividend in the amount of $0.45 per share, which was paid subsequent to the end of the second quarter, on February 24, 2017.

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Note 5—Equity and Comprehensive Income (Continued)

Stock Repurchase Programs

Stock repurchase activity during the second quarter and first half of 2017 and 2016 is summarized below:



	Shares Repurchased (000's)	Average Price per Share		Total Cost
Second quarter of 2017	411	$	159.86	$	66
First half of 2017	1,220	$	153.98	$	188

Second quarter of 2016	531	$	150.02	$	80
First half of 2016	1,429	$	146.79	$	210

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. The remaining amount available for stock repurchases under our approved plan, which expires in April 2019, was $3,034 at February 12, 2017. 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.

Components of Equity and Comprehensive Income

The following tables show the changes in equity attributable to Costco and the noncontrolling interests of consolidated subsidiaries:



	Attributable to Costco			Noncontrolling Interests		Total Equity
Equity at August 28, 2016	$	12,079		$	253	$	12,332
Comprehensive income:
Net income	1,060			16		1,076
Foreign-currency translation adjustment and other, net	(234		)	3		(231		)
Comprehensive income	826			19		845
Stock-based compensation	322			0		322
Release of vested restricted stock units (RSUs), including tax effects	(164		)	0		(164		)
Repurchases of common stock	(188		)	0		(188		)
Cash dividends declared and other	(435		)	0		(435		)
Equity at February 12, 2017	$	12,440		$	272	$	12,712

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Note 5—Equity and Comprehensive Income (Continued)



	Attributable to Costco			Noncontrolling Interests			Total Equity
Equity at August 30, 2015	$	10,617		$	226		$	10,843
Comprehensive income:
Net income	1,026			16			1,042
Foreign-currency translation adjustment and other, net	(223		)	(6		)	(229		)
Comprehensive income	803			10			813
Stock-based compensation	287			0			287
Release of vested RSUs, including tax effects	(145		)	0			(145		)
Repurchases of common stock	(210		)	0			(210		)
Cash dividends declared	(352		)	0			(352		)
Distribution to noncontrolling interest	0			(2		)	(2		)
Equity at February 14, 2016	$	11,000		$	234		$	11,234

Note 6—Stock-Based Compensation

The Seventh Restated 2002 Stock Incentive Plan authorized the issuance of 23,500,000 shares (13,429,000 RSUs) of common stock for future grants in addition to the shares authorized under the previous plan. 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 equal to the minimum statutory withholding taxes.

Summary of Restricted Stock Unit Activity

At February 12, 2017, 11,332,000 shares were available to be granted as RSUs and the following awards were outstanding:


•	7,662,000 time-based RSUs, which vest upon continued employment over specified periods of time;


•	165,000 performance-based RSUs, granted to certain 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

•

251,000 performance-based RSUs, granted to executive officers of the Company, subject to achievement of performance targets for fiscal 2017, 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 half of 2017:



	Number of Units (in 000’s)		Weighted-Average Grant Date Fair Value
Outstanding at August 28, 2016	8,326		$	120.56
Granted	3,855		144.11
Vested and delivered	(3,984	)	119.44
Forfeited	(119	)	129.93
Outstanding at February 12, 2017	8,078		$	132.21

The remaining unrecognized compensation cost related to non-vested RSUs at February 12, 2017, was $911, and the weighted-average period over which this cost will be recognized is 1.8 years.

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Note 6—Stock-Based Compensation (Continued)

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						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
Stock-based compensation expense before income taxes	$	111		$	101		$	322		$	287
Less recognized income tax benefit	(37		)	(34		)	(106		)	(97		)
Stock-based compensation expense, net of income taxes	$	74		$	67		$	216		$	190

Note 7—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				24 Weeks Ended
	February 12, 2017		February 14, 2016		February 12, 2017		February 14, 2016
Net income available to common stockholders used in basic and diluted net income per common share	$	515	$	546	$	1,060	$	1,026
Weighted average number of common shares used in basic net income per common share	439,127		439,648		438,567		438,990
RSUs	1,522		1,900		1,993		2,456
Conversion of convertible notes	8		11		8		11
Weighted average number of common shares and dilutive potential of common stock used in diluted net income per share	440,657		441,559		440,568		441,457

Note 8—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 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 previously recorded an immaterial accrual with respect to two matters 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 our view be reasonably

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Note 8—Commitments and Contingencies (Continued)

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 the following matters, among others:

Numerous putative class actions have been brought around the United States against motor fuel retailers, including the Company, alleging that they have been overcharging consumers by selling gasoline or diesel that is warmer than 60 degrees without adjusting the volume sold to compensate for heat-related expansion or disclosing the effect of such expansion on the energy equivalent received by the consumer. The Company is named in the following actions: Raphael Sagalyn, et al., v. Chevron USA, Inc., et al., Case No. 07-430 (D. Md.); Phyllis Lerner, et al., v. Costco Wholesale Corporation, et al., Case No. 07-1216 (C.D. Cal.); Linda A. Williams, et al., v. BP Corporation North America, Inc., et al., Case No. 07-179 (M.D. Ala.); James Graham, et al. v. Chevron USA, Inc., et al., Civil Action No. 07-193 (E.D. Va.); Betty A. Delgado, et al., v. Allsups, Convenience Stores, Inc., et al., Case No. 07-202 (D.N.M.); Gary Kohut, et al. v. Chevron USA, Inc., et al., Case No. 07-285 (D. Nev.); Mark Rushing, et al., v. Alon USA, Inc., et al., Case No. 06-7621 (N.D. Cal.); James Vanderbilt, et al., v. BP Corporation North America, Inc., et al., Case No. 06-1052 (W.D. Mo.); Zachary Wilson, et al., v. Ampride, Inc., et al., Case No. 06-2582 (D.Kan.); Diane Foster, et al., v. BP North America Petroleum, Inc., et al., Case No. 07-02059 (W.D. Tenn.); Mara Redstone, et al., v. Chevron USA, Inc., et al., Case No. 07-20751 (S.D. Fla.); Fred Aguirre, et al. v. BP West Coast Products LLC, et al., Case No. 07-1534 (N.D. Cal.); J.C. Wash, et al., v. Chevron USA, Inc., et al.; Case No. 4:07cv37 (E.D. Mo.); Jonathan Charles Conlin, et al., v. Chevron USA, Inc., et al.; Case No. 07 0317 (M.D. Tenn.); William Barker, et al. v. Chevron USA, Inc., et al.; Case No. 07-cv-00293 (D.N.M.); Melissa J. Couch, et al. v. BP Products North America, Inc., et al., Case No. 07cv291 (E.D. Tex.); S. Garrett Cook, Jr., et al., v. Hess Corporation, et al., Case No. 07cv750 (M.D. Ala.); Jeff Jenkins, et al. v. Amoco Oil Company, et al., Case No. 07-cv-00661 (D. Utah); and Mark Wyatt, et al., v. B. P. America Corp., et al., Case No. 07-1754 (S.D. Cal.). On June 18, 2007, the Judicial Panel on Multidistrict Litigation assigned the action, entitled In re Motor Fuel Temperature Sales Practices Litigation, MDL Docket No 1840, to Judge Kathryn Vratil in the United States District Court for the District of Kansas. On April 12, 2009, the Company agreed to settle the actions in which it is named as a defendant. Under the settlement, which was subject to final approval by the court, the Company agreed, to the extent allowed by law and subject to other terms and conditions in the agreement, to install over five years from the effective date of the settlement temperature-correcting dispensers in the States of Alabama, Arizona, California, Florida, Georgia, Kentucky, Nevada, New Mexico, North Carolina, South Carolina, Tennessee, Texas, Utah, and Virginia. Other than payments to class representatives, the settlement does not provide for cash payments to class members. On September 22, 2011, the court preliminarily approved a revised settlement, which did not materially alter the terms. On April 24, 2012, the court granted final approval of the revised settlement. A class member who objected has filed a notice of appeal from the order approving the settlement, and the appeal is pending. Plaintiffs moved for an award of $10 in attorneys’ fees, as well as an award of costs and payments to class representatives. A report and recommendation was issued in favor of a fee award of $4. On August 24, 2016, the district court affirmed the report and recommendation. On March 20, 2014, the Company filed a notice invoking a “most favored nation” provision under the settlement, under which it seeks to adopt provisions in later settlements with certain other defendants. The motion was denied on January 23, 2015. Final judgment was entered on September 22, 2015, and the Company's appeal is pending; and

A class action alleging violation of California Wage Order 7-2001 by failing to provide seating to member service assistants who act as greeters and exit attendants 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 has filed an answer denying the material allegations of the complaint.

The Company has received notices from most states stating that they have appointed an agent to conduct an examination of the books and records of the Company to determine whether it has complied with state unclaimed property laws. In addition to seeking the turnover of unclaimed property subject to escheat laws,

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Note 8—Commitments and Contingencies (Continued)

the states may seek interest, penalties, costs of examinations, and other relief. Certain states have separately also made requests for payment by the Company concerning a specific type of property, some of which have been paid in immaterial amounts.

The Company received from the Drug Enforcement Administration subpoenas and administrative inspection warrants concerning the Company's fulfillment of prescriptions related to controlled substances and related practices. Offices of the United States Attorney in various districts communicated to the Company their belief that the Company had committed civil regulatory violations concerning these subjects. On January 19, 2017, a civil settlement of these matters was announced, under which the Company is required to pay $12, for which the Company previously accrued.

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 Company is seeking to cooperate with the request.

In November 2016, 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 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; 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.

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Note 9—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, Australia, and Spain and through majority-owned subsidiaries in Taiwan and Korea. 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 the same 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 August 28, 2016, 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.



	United States Operations		Canadian Operations		Other International Operations		Total
Twelve Weeks Ended February 12, 2017
Total revenue	$	21,764	$	4,229	$	3,773	$	29,766
Operating income	520		180		144		844
Depreciation and amortization	241		27		44		312
Additions to property and equipment	358		56		102		516
Twelve Weeks Ended February 14, 2016
Total revenue	$	20,642	$	3,791	$	3,737	$	28,170
Operating income	552		156		148		856
Depreciation and amortization	212		24		49		285
Additions to property and equipment	460		30		134		624
Twenty-four Weeks Ended February 12, 2017
Total revenue	$	42,141	$	8,328	$	7,396	$	57,865
Operating income	1,026		371		296		1,693
Depreciation and amortization	467		53		89		609
Additions to property and equipment	784		166		233		1,183
Net property and equipment	12,040		1,688		3,614		17,342
Total assets	24,735		3,926		6,969		35,630
Twenty-four Weeks Ended February 14, 2016
Total revenue	$	40,488	$	7,673	$	7,229	$	55,390
Operating income	1,003		339		281		1,623
Depreciation and amortization	416		49		91		556
Additions to property and equipment	917		71		351		1,339
Net property and equipment	11,327		1,325		3,413		16,065
Total assets	22,733		3,076		6,579		32,388
Year Ended August 28, 2016
Total revenue	$	86,579	$	17,028	$	15,112	$	118,719
Operating income	2,326		778		568		3,672
Depreciation and amortization	946		109		200		1,255
Additions to property and equipment	1,823		299		527		2,649
Net property and equipment	11,745		1,628		3,670		17,043
Total assets	22,511		3,480		7,172		33,163

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Note 10—Subsequent Event

On March 2, 2017, the Company announced membership fee increases in the U.S. and Canada effective June 1, 2017. The annual membership fee for Goldstar (individual), Business and Business add-on members will increase $5 to $60 per year. The Executive membership fee will increase from $110 to $120 (annual membership fee of $60, plus the Executive upgrade of $60), and the maximum annual 2% reward will increase from $750 to $1,000.

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Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

(amounts in millions, except per share, share, membership fee, 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 net sales growth, increases 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 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 “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. 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, actions of vendors, rising costs associated with employees (generally including health care costs), energy and certain commodities, geopolitical conditions, and other risks identified from time to time in the Company's 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 2016 Annual Report on Form 10-K, previously filed with the SEC.

OVERVIEW

We operate membership warehouses 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 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. and Canadian operations). 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. While we cannot control or reliably predict general

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

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.

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” – 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 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 relative 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 online business growth domestically and internationally also increases 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 penetration of our Executive members, and sustain high renewal rates materially influences our profitability.

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 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 benefit costs as a percentage of country sales, and/or less or no direct membership warehouse competition. Additionally, we operate our lower-margin gasoline business in the U.S., Canada, Australia, U.K., Japan, and Spain.

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.

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

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 second quarters of 2017 and 2016 relate to the 12-week fiscal quarters ended February 12, 2017, and February 14, 2016, respectively. References to the first half of 2017 and 2016 relate to the twenty-four weeks ended February 12, 2017, and February 14, 2016, 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 second quarter of 2017 as compared to the second quarter of 2016 include:


•	Net sales increased 6% to $29,130, driven by sales at new warehouses opened since the end of the second quarter of fiscal 2016 and a 3% increase in comparable sales. Net and comparable sales results were positively impacted by higher gasoline prices;


•	Membership fee revenue increased 5% to $636, primarily due to sign-ups at existing and new warehouses and executive membership upgrades;


•	Gross margin percentage decreased 24 basis points, primarily from gross margin decreases in our warehouse ancillary and other businesses;


•	SG&A expenses as a percentage of net sales decreased five basis points;


•	Net income decreased 6% to $515, or $1.17 per diluted share, compared to $546, or $1.24 per diluted share in 2016;


•	On January 27, 2017, our Board of Directors declared a quarterly cash dividend in the amount of $0.45 per share, which was paid on February 24, 2017; and


•	On March 2, 2017, subsequent to the end of the second quarter, we announced an increase in our annual membership fees in the U.S. and Canada.

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

RESULTS OF OPERATIONS

Net Sales



	12 Weeks Ended						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
Net Sales	$	29,130		$	27,567		$	56,599		$	54,194
Changes in net sales:
U.S.	5		%	4		%	4		%	4		%
Canada	12		%	(5		)%	9		%	(7		)%
Other International	1		%	5		%	3		%	3		%
Total Company	6		%	3		%	4		%	2		%
Changes in comparable sales:
U.S.	3		%	3		%	2		%	3		%
Canada	8		%	(7		)%	6		%	(8		)%
Other International	(2		)%	(3		)%	(1		)%	(4		)%
Total Company	3		%	1		%	2		%	0		%
Increases in comparable sales excluding the impact of changes in foreign exchange rates and gasoline prices:
U.S.	3		%	4		%	2		%	5		%
Canada	2		%	10		%	3		%	10		%
Other International	3		%	6		%	3		%	6		%
Total Company	3		%	5		%	2		%	6		%

Net Sales

Net sales increased $1,563 or 6%, and $2,405 or 4% during the second quarter and first half of 2017, respectively, compared to the second quarter and first half of 2016. This increase was attributable to sales at the 29 net new warehouses opened since the end of the second quarter of 2016 and an increase in comparable sales of 3% and 2% in the second quarter and first half of 2017, respectively. During the first half of 2017, net sales were negatively impacted by price deflation, primarily in hardlines.

During the second quarter of 2017, changes in gasoline prices positively impacted net sales by approximately $244, or 89 basis points, due to a 12% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $20, or seven basis points, compared to the second quarter of 2016, attributable to certain foreign countries in which we operate, predominantly in Mexico of $130 and the U.K. of $127, partially offset by a positive impact in Canada of $167.

During the first half of 2017, net sales were positively impacted by changes in gasoline prices by approximately $161, or 30 basis points, due to a 4% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $121, or 22 basis points, compared to the first half of 2016. The negative impact was primarily attributable to the U.K. of $264 and Mexico of $230, partially offset by Canada of $153 and Japan of $124.

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

Comparable Sales

Comparable sales increased 3% in the second quarter of 2017 and were positively impacted by an increase in shopping frequency and the average ticket. Comparable sales increased 2% in the first half of 2017 and were positively impacted by shopping frequency. Comparable sales for the second quarter and first half of 2017 were negatively impacted by cannibalization (established warehouses losing sales to our newly opened locations).

Membership Fees



	12 Weeks Ended						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
Membership fees	$	636		$	603		$	1,266		$	1,196
Membership fees as a percentage of net sales	2.18		%	2.19		%	2.24		%	2.21		%
Total paid members as of quarter end (000's)	48,300			46,100			—			—
Total cardholders as of quarter end (000's)	88,100			84,000			—			—

Membership fees increased 5% and 6% in the second quarter and first half of 2017, respectively. This was primarily due to sign-ups at existing and new warehouses and increased penetration of our higher-fee Executive Membership program. Our member renewal rates are currently 90% in the U.S. and Canada and 88% worldwide.

On March 2, 2017, we announced membership fee increases in the U.S. and Canada effective June 1, 2017. The annual membership fee for Goldstar (individual), Business and Business add-on members will increase $5 to $60 per year. The Executive membership fee will increase from $110 to $120 (annual membership fee of $60, plus the Executive upgrade of $60), and the maximum annual 2% reward will increase from $750 to $1,000. Membership fee revenue represents annual fees paid by our members, net of estimated refunds, and is recognized ratably over the one-year membership period. These increases did not impact our membership fee revenue for the second quarter of 2017 and are not expected to have a material impact for the remainder of fiscal year 2017.

Gross Margin



	12 Weeks Ended						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
Net sales	$	29,130		$	27,567		$	56,599		$	54,194
Less merchandise costs	25,927			24,469			50,215			48,090
Gross margin	$	3,203		$	3,098		$	6,384		$	6,104
Gross margin percentage	11.00		%	11.24		%	11.28		%	11.26		%

Quarterly Results

The gross margin of 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 seven basis points. This was attributable to increases in all core merchandise categories, except fresh foods, which decreased. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses.

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

Total gross margin percentage decreased 24 basis points compared to the second quarter of 2016. Excluding the impact of changes in gasoline prices on net sales, gross margin as a percentage of adjusted net sales was 11.09%, a decrease of 15 basis points from the second quarter of 2016. This decrease was primarily due to lower warehouse ancillary and other businesses margin of 18 basis points, predominantly driven by lower gasoline margins. Our core merchandise categories also decreased by seven basis points, primarily driven by food and sundries as a result of a decrease in sales penetration, partially offset by an increase in softlines. These decreases were partially offset, by 16 basis points, by amounts earned under our new co-branded credit card arrangement in the U.S.

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, due to our warehouse ancillary and other businesses, primarily our gasoline business, and our core merchandise categories, primarily food and sundries. These were partially offset by increased amounts earned under the new co-branded credit card agreement discussed above. The segment gross margin percentage in our Canadian operations increased, primarily due to our warehouse ancillary and other businesses, primarily pharmacy, e-commerce, and gasoline businesses, and across all core merchandise categories, except fresh foods which was lower. The segment gross margin percentage in our Other International operations increased, predominantly due to an increase in core merchandise categories, primarily food and sundries.

Year-to-date Results

The gross margin of core merchandise categories, when expressed as a percentage of core merchandise sales (rather than total net sales), increased 12 basis points. This was attributable to increases across all core merchandise categories.

Total gross margin percentage increased two basis points compared to the first half of 2016. Excluding the impact of changes in gasoline prices on net sales, gross margin as a percentage of adjusted net sales was 11.31%, an increase of five basis points from the first half of 2016. This increase was primarily due to amounts earned under our co-branded credit card arrangement in the U.S. of 14 basis points and a benefit from a non-recurring legal settlement of nine basis points during the first quarter of 2017. These increases were partially offset by a decrease in our warehouse ancillary and other businesses of 12 basis points, primarily our gasoline business. Core merchandise categories decreased two basis points compared to the first half of 2016, primarily due to food and sundries, which were negatively impacted by a decrease in sales penetration.

The segment gross margin percentage decreased in our U.S. operations, predominantly due to our warehouse ancillary and other businesses, primarily our gasoline business, and core merchandise categories, primarily food and sundries. These were partially offset by amounts earned under our co-branded credit card agreement and the non-recurring legal settlement discussed above. The segment gross margin percentage in our Canadian operations increased, predominantly due to an increase in our warehouse ancillary and other businesses, primarily pharmacy and e-commerce, and across all our core merchandise categories, except fresh foods which was lower. The segment gross margin percentage in our Other International operations increased, predominantly due to food and sundries.

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

Selling, General and Administrative Expenses



	12 Weeks Ended						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
SG&A expenses	$	2,980		$	2,835		$	5,920		$	5,641
SG&A expenses as a percentage of net sales	10.23		%	10.28		%	10.46		%	10.41		%

Quarterly Results

SG&A expenses as a percentage of net sales decreased five basis points compared to the second quarter of 2016. Excluding the impact of gasoline price inflation on net sales, SG&A expenses as a percentage of adjusted net sales were 10.32%, an increase of four basis points. This increase was driven by higher central operating costs of three basis points, due to costs associated with our information systems modernization, including increased depreciation expense for completed projects, incurred by our U.S. operations. Stock compensation expense was higher by two basis points, due to appreciation in the trading price of our stock at the time of the grant. The SG&A expense increase was offset by lower warehouse operating costs of one basis point, primarily due to lower costs associated with the new co-branded credit card arrangement in the U.S. of 24 basis points, which was offset by an increase of 24 basis points in payroll and employee benefit expenses. The increase in payroll and employee benefit expenses was incurred across all segments, primarily in our U.S. operations.

Year-to-date Results

SG&A expenses as a percentage of net sales increased five basis points compared to the first half of 2016. Excluding the impact of gasoline price inflation on net sales, SG&A expenses as a percentage of adjusted net sales were 10.49%, an increase of eight basis points. This increase was driven by higher central operating costs of six basis points, due to costs associated with our information systems modernization, including increased depreciation expense for completed projects, incurred by our U.S. operations. Stock compensation expense was higher by four basis points, due to accelerated vesting for long service and appreciation in the trading price of our stock at the time of the grant. Warehouse operating costs were higher by two basis points, due to an increase of 26 basis points in payroll and employee benefit expenses across all segments, primarily in our U.S. operations. This increase was offset by lower costs associated with the new co-branded credit card arrangement in the U.S. of 25 basis points. SG&A expense increases were partially offset by four basis points for non-recurring legal and regulatory matters recorded in the first half of 2016.

Preopening Expense



	12 Weeks Ended				24 Weeks Ended
	February 12, 2017		February 14, 2016		February 12, 2017		February 14, 2016
Preopening expenses	$	15	$	10	$	37	$	36
Warehouse openings, including relocations
United States	2		1		8		10
Canada	0		0		3		1
Other International	2		0		2		3
Total warehouse openings, including relocations	4		1		13		14

Preopening expenses include costs for startup operations related to new warehouses, including relocations, development in new international markets, and expansions at existing warehouses. Preopening expenses

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

vary due to the number of warehouse openings, the timing of the opening 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 2017, we expect to open up to 19 additional warehouses, including two relocations, consistent with our openings in the remainder of fiscal 2016.

Interest Expense



	12 Weeks Ended				24 Weeks Ended
	February 12, 2017		February 14, 2016		February 12, 2017		February 14, 2016
Interest expense	$	31	$	31	$	60	$	64

Interest expense is primarily related to Senior Notes issued by the Company.

Interest Income and Other, Net



	12 Weeks Ended					24 Weeks Ended
	February 12, 2017			February 14, 2016		February 12, 2017			February 14, 2016
Interest income	$	11		$	7	$	19		$	16
Foreign-currency transaction (losses) gains, net	(20		)	6		(7		)	24
Other, net	5			3		10			4
Interest income and other, net	$	(4	)	$	16	$	22		$	44

Foreign-currency transaction (losses) gains, net include mark-to-market adjustments for forward foreign-exchange contracts and the revaluation or settlement of monetary assets and liabilities by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Part I, Item 1, Note 1 of this Report.

Provision for Income Taxes



	12 Weeks Ended						24 Weeks Ended
	February 12, 2017			February 14, 2016			February 12, 2017			February 14, 2016
Provision for income taxes	$	288		$	286		$	579		$	561
Effective tax rate	35.6		%	34.0		%	35.0		%	35.0		%

The effective tax rate for the second quarter of 2016 was impacted by immaterial discrete net tax benefits.

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

LIQUIDITY AND CAPITAL RESOURCES

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



	24 Weeks Ended
	February 12, 2017			February 14, 2016
Net cash provided by operating activities	$	3,286		$	1,602
Net cash used in investing activities	(1,052		)	(952		)
Net cash used in financing activities	(825		)	(1,787		)

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 $5,965 and $4,729 at February 12, 2017, and August 28, 2016, respectively. Of these balances, approximately $997 and $1,071 represented unsettled credit and debit card receivables at the end of the second quarter of 2017 and fiscal year 2016, respectively. These receivables generally settle within four days.

We have not provided for U.S. deferred taxes on cumulative undistributed earnings of certain non-U.S. consolidated subsidiaries, including a portion of the undistributed earnings of our Canadian operations, because our subsidiaries have invested or will invest the undistributed earnings indefinitely, or the earnings if repatriated would not result in an adverse tax consequence. Although we have historically asserted that certain non-U.S. undistributed earnings will be permanently reinvested, we may repatriate such earnings to the extent we can do so without an adverse tax consequence. If we determine that such earnings are no longer indefinitely reinvested, deferred taxes, to the extent required and applicable, are recorded at that time.

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 have no current plans to repatriate for use in the U.S. cash and cash equivalents and short-term investments held by non-U.S. consolidated subsidiaries whose earnings are considered indefinitely reinvested. Cash and cash equivalents and short-term investments held at these subsidiaries and considered to be indefinitely reinvested totaled $1,167 at February 12, 2017.

Cash Flows from Operating Activities

Net cash provided by operating activities totaled $3,286 in the first half of 2017, compared to $1,602 in the first half of 2016. Cash provided by operations is primarily derived from net sales and membership fees. Cash used in operations generally consists of payments to our merchandise vendors, warehouse operating costs including payroll, employee benefits, and utilities, as well as payments for income taxes. The increase in net cash provided by operating activities for the first half of 2017 when compared to the first half 2016 was primarily due to accelerated vendor payments of approximately $1,700 made in the last week of fiscal 2016, in advance of implementing our modernized accounting system at the beginning of fiscal 2017, which had a positive impact on cash flows from operating activities in the first half of 2017.

Cash Flows from Investing Activities

Net cash used in investing activities totaled $1,052 in the first half of 2017 compared to $952 in the first half of 2016. Cash used in investing activities is primarily to fund warehouse expansion and remodeling activities. Net cash from investing activities also includes purchases and maturities of short-term investments.

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

Capital Expenditure Plans

We opened 12 new warehouses and relocated one in the first half of 2017 and plan to open up to 17 new warehouses and relocate two for the remainder of fiscal 2017. Our primary requirements for capital are acquiring land, buildings, and equipment for new and remodeled warehouses. To a lesser extent, capital is required for initial warehouse operations, the modernization of our information systems, and working capital. In the first half of 2017, we spent approximately $1,183, and it is our current intention to spend approximately $2,700 to $2,800 during fiscal 2017. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. 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 $825 in the first half of 2017 compared to $1,787 in the first half of 2016. Cash flow used in financing activities primarily related to the excess of account draws above cash on deposit at the banks on which funds were drawn, withholding taxes on stock-based awards, dividend payments, and repurchases of common stock. In the first half of 2016, cash flow used in financing activities included the $1,200 repayment of our 0.65% Senior Notes.

On March 15, 2017, we will pay the outstanding balance and accrued interest on the 5.5% Senior Notes of approximately $1,100, with our existing cash and cash equivalents and short-term investments.

Stock Repurchase Programs

During the first half of 2017 and 2016, we repurchased 1,220,000 and 1,429,000 shares of common stock, at an average price of $153.98 and $146.79, totaling approximately $188 and $210, 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. The amount available for stock repurchases under our approved plan was $3,034 at February 12, 2017. 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

Our current quarterly cash dividend rate is $0.45 per share. On January 27, 2017, our Board of Directors declared a quarterly dividend of $0.45 per share payable to shareholders of record on February 10, 2017. The dividend was paid on February 24, 2017.

Bank Credit Facilities and Commercial Paper Programs

We maintain bank credit facilities for working capital and general corporate purposes. As of February 12, 2017, we had borrowing capacity within these facilities of $406, of which $333 was maintained by our international operations. Of the $333, $160 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of the second quarter of 2017 or at the end of 2016.

The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $152. The outstanding commitments under these facilities at the end of the second quarter of 2017 totaled $97, including $94 in standby letters of credit with expiration dates within one year. The bank credit facilities have various expiration dates, all 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.

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

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. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and judgments. We base our estimates and judgments 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 August 28, 2016. 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 August 28, 2016.

Item 4—Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, we performed an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934 (the Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures are effective.

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) during our most recently completed fiscal quarter that has materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1—Legal Proceedings

See discussion of Legal Proceedings in Note 8 to the condensed consolidated financial statements included in Part I, Item 1 of this Report.

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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 August 28, 2016. 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 second quarter of fiscal 2017 (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⁾
November 21, 2016 - December 18, 2016	149,000	$	154.11	149,000	$	3,077
December 19, 2016 - January 15, 2017	138,000	161.77		138,000	3,055
January 16, 2017 - February 12, 2017	124,000	164.61		124,000	3,034
Total second quarter	411,000	$	159.86	411,000

_______________


(1)	Our stock repurchase program is conducted under a $4,000 authorization approved by of our Board of Directors in April 2015, which expires in April 2019.

Item 3—Defaults Upon Senior Securities

None.

Item 4—Mine Safety Disclosures

Not applicable.

Item 5—Other Information

None.

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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

3.1	Articles of Incorporation as amended of the registrant		10-Q	2/15/2015	3/11/2015

3.2	Bylaws as amended of the registrant		8-K		9/30/2016

10.1*	Executive Employment Agreement, effective January 1, 2017, between W. Craig Jelinek and Costco Wholesale		10-Q	11/20/2016	12/15/2016

31.1	Rule 13(a) – 14(a) Certifications	x

32.1	Section 1350 Certifications	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

______________

*Management contract, compensatory plan or arrangement.

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.



	COSTCO WHOLESALE CORPORATION (Registrant)

March 8, 2017	By	/s/ W. CRAIG JELINEK
Date		W. Craig Jelinek President, Chief Executive Officer and Director

March 8, 2017	By	/s/ RICHARD A. GALANTI
Date		Richard A. Galanti Executive Vice President, Chief Financial Officer and Director