COSTCO WHOLESALE: NEW Management report and analysis of financial conditions and results of operations (amounts in millions, except per share, per share, per contribution and per number of warehouses) (form 10-K)

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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 consolidated financial statements and
the accompanying Notes to Financial Statements (Part II, Item 8 of this Form
10-K). This section generally discusses the results of operations for 2021
compared to 2020. For discussion related to the results of operations and
changes in financial condition for 2020 compared to 2019 refer to Part II, Item
7, Management's Discussion and Analysis of Financial Condition and Results of
Operations in our fiscal year 2020 Form 10-K, which was filed with the United
States Securities and Exchange Commission (SEC) on October 7, 2020. In 2021, we
combined the hardlines and softlines merchandise categories into non-foods. This
change did not have a material impact on the discussion of our results of
operations.
Overview
We believe that the most important driver of our profitability is increasing net
sales, particularly comparable sales growth. Net sales includes our core
merchandise categories (foods and sundries, non-foods, and fresh foods),
warehouse ancillary (includes gasoline, pharmacy, optical, food court, hearing
aids, and tire installation) and other businesses (includes e-commerce, business
centers, travel and other). We define comparable sales 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. 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. The higher our comparable sales exclusive of these items, the more
we can leverage certain of our selling, general and administrative (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" on quality goods - 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 as a percentage of net sales
(gross margin percentage). We believe our gasoline business draws members, but
it generally has a lower gross margin percentage relative to our non-gasoline
business. It also has lower SG&A expenses as a percent of net sales compared 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 SG&A expenses as a
percentage of net sales. A decline in gasoline prices has the inverse effect.
Additionally, actions in various countries, particularly China, the United
States and the United Kingdom, have created
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uncertainty with respect to how tariffs will affect the costs of some of our
merchandise. The degree of our exposure is dependent on (among other things) the
type of goods, rates imposed, and timing of the tariffs. Certain merchandise
categories were impacted by inflation higher than what we have experienced in
recent years. The impact to our net sales and gross margin is influenced in part
by our merchandising and pricing strategies in response to cost increases. While
these potential impacts are uncertain, they could have an adverse impact on 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 operating floor space square footage growth is generally
higher in foreign markets, due to the smaller base in those markets, and we
expect that to continue. Our e-commerce business growth, domestically and
internationally, has also increased our sales but it generally has a lower gross
margin percentage relative to 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, 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 selling, general and administrative 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 12   to the consolidated financial
statements included in Item 8 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 an e-commerce business.
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. 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 2021,
2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021,
August 30, 2020, and September 1, 2019, 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.
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Highlights for 2021 included:
•We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4
net new in our Canadian segment, and 4 new in our Other International segment,
compared to 16 new warehouses, including 3 relocations in 2020;
•Net sales increased 18% to $192,052 driven by a 16% increase in comparable
sales and sales at new warehouses opened in 2020 and 2021;
•Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades
to Executive membership;
•Gross margin percentage decreased seven basis points, driven primarily by a
shift in sales penetration from our core merchandise categories to our warehouse
ancillary and other businesses;
•SG&A expenses as a percentage of net sales decreased 40 basis points, primarily
due to leveraging increased sales and decreased incremental wages related to
COVID-19;
•The effective tax rate in 2021 was 24.0% compared to 24.4% in 2020;
•Net income increased 25% to $5,007, or $11.27 per diluted share compared to
$4,002, or $9.02 per diluted share in 2020;
•We paid a special cash dividend of $10.00 per share in December 2020 and in
April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share
totaling $5,748.

COVID-19[female[feminine

During 2021, our sales mix began returning to pre-pandemic levels. This included
sales increases in non-foods and in many of our warehouse ancillary and other
businesses, certain of which experienced closures or restrictions in 2020.
COVID-related supply and logistics constraints have adversely affected some
merchandise categories and are expected to do so for the foreseeable future.
We paid $515 in incremental wages during 2021 related to COVID-19. The
incremental wage and benefit costs associated with COVID-19, which began on
March 1, 2020 and ended on February 28, 2021, totaled approximately $825.
Effective March 1, 2021, we permanently increased wages for hourly and most
salaried warehouse employees. The estimated annualized pre-tax cost is
approximately $400. Additionally, in certain areas in the United States
governments have mandated or are considering mandating extra pay for classes of
employees that include our employees, which has and will result in higher costs.

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RESULTS OF OPERATIONS
Net Sales
                                                             2021                 2020                 2019
Net Sales                                               $      192,052       $      163,220       $      149,351
Increases in net sales:
U.S.                                                           16    %               9    %               9    %
Canada                                                         22    %               5    %               3    %
Other International                                            23    %              13    %               5    %
Total Company                                                  18    %               9    %               8    %
Increases in comparable sales:
U.S.                                                           15    %               8    %               8    %
Canada                                                         20    %               5    %               2    %
Other International                                            19    %               9    %               2    %
Total Company                                                  16    %               8    %               6    %
Increases in comparable sales excluding the impact of
changes in foreign currency and gasoline prices(1):
U.S.                                                           14    %               9    %               6    %
Canada                                                         12    %               7    %               5    %
Other International                                            13    %              11    %               6    %
Total Company                                                  13    %               9    %               6    %


_______________
(1)Excluding the impact of the revenue recognition standard for the year ended
September 1, 2019.
Net Sales
Net sales increased $28,832 or 18% during 2021. The improvement was attributable
to an increase in comparable sales of 16%, and sales at new warehouses opened in
2020 and 2021. While sales in all core merchandise categories increased, sales
were particularly strong in non-foods. Sales increases were also strong in our
warehouse ancillary and other businesses, predominantly e-commerce and gasoline.
Certain merchandise categories were impacted by inflation higher than what we
have experienced in recent years.
Changes in foreign currencies relative to the U.S. dollar positively impacted
net sales by approximately $2,759, or 169 basis points, compared to 2020,
attributable to our Canadian and Other International operations. Changes in
gasoline prices positively impacted net sales by $1,636, or 100 basis points,
compared to 2020, due to a 12% increase in the average price per gallon. The
volume of gasoline sold increased approximately 10%, positively impacting net
sales by $1,469, or 90 basis points.
Comparable Sales
Comparable sales increased 16% during 2021 and were positively impacted by
increases in shopping frequency and average ticket. There was an increase of 44%
in e-commerce comparable sales in 2021, driven by an increase of 80% in the
first half of the year.
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Membership Fees
                             2021         2020         2019
Membership fees            $   3,877    $   3,541    $   3,352

Contributions increase 9% 6% 7%


Membership fees increased 9% in 2021, driven by sign-ups and upgrades to
Executive membership. Excluding the positive impact of changes in foreign
currencies relative to the U.S. dollar, membership fees increased 8%. At the end
of 2021, our member renewal rates were 91% in the U.S. and Canada and 89%
worldwide. Our renewal rate 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
                               2021            2020            2019
Net sales                  $    192,052    $    163,220    $    149,351
Less merchandise costs          170,684         144,939         132,886
Gross margin               $     21,368    $     18,281    $     16,465
Gross margin percentage      11.13    %      11.20    %      11.02    %


The gross margin of our core merchandise categories (foods and sundries,
non-foods and fresh foods), when expressed as a percentage of core merchandise
sales (rather than total net sales), increased 23 basis points. This measure
eliminates the impact of changes in sales penetration and gross margins from our
warehouse ancillary and other businesses. The increase was across all
categories, most significantly in non-foods.
Total gross margin percentage decreased seven basis points compared to 2020.
Excluding the impact of gasoline price inflation on net sales in 2021, gross
margin percentage was 11.22%, an increase of two basis points. This increase was
due to a two basis point improvement in our core merchandise categories,
predominantly non-foods, and in our warehouse ancillary and other businesses,
largely e-commerce. The comparison was also positively impacted by a three basis
point reserve on inventory recorded in 2020 with no such reserve this year.
Gross margin percentage was negatively impacted three basis points due to
increased 2% rewards and two basis points due to a LIFO charge for higher
merchandise costs. Changes in foreign currencies relative to the U.S. dollar
positively impacted gross margin by approximately $301 in 2021.
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. segment, due to our
warehouse ancillary and other businesses, our core merchandise categories, and
the LIFO charge, partially offset by the reserve for certain inventory in 2020.
Our Canadian and Other International segments increased, primarily due to our
warehouse ancillary and other businesses and certain of our core merchandise
categories. These increases were partially offset by increased 2% rewards.
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Selling, general and administrative expenses

                                                2021          2020          

2019

SG&A expenses                                $   18,461    $   16,332    $  

14,994

SG&A costs as a percentage of net sales 9.61% 10.01% 10.04%


SG&A expenses as a percentage of net sales decreased 40 basis points compared to
2020. SG&A expenses as a percentage of net sales excluding the impact of
gasoline price inflation was 9.69%, a decrease of 32 basis points. Warehouse
operations and other businesses were lower by 24 basis points, largely
attributable to payroll leveraging increased sales. Incremental wages as a
result of COVID-19, which ended on February 28, 2021, were lower by eight basis
points. Central operating costs were lower by five basis points. Stock
compensation expense was lower by three basis points, and costs associated with
the acquisition of Innovel were lower by one basis point. These decreases were
offset by an increase of five basis points related to a partial reversal of a
product tax assessment in 2020, as well as an increase of four basis points
related to a write-off of certain information technology assets in the fourth
quarter of 2021 that are no longer expected to be utilized as part of the
modernization of our information systems. Changes in foreign currencies relative
to the U.S. dollar increased our SG&A expenses by approximately $228 in 2021.
Preopening
                                                    2021      2020      2019
Preopening expenses                                $ 76      $ 55      $ 86
Warehouse openings, including relocations
United States                                        13         9        18
Canada                                                5         4         3
Other International                                   4         3         4

Total warehouse openings, including moves 22 16 25


Preopening expenses include startup costs for new warehouses and relocations,
developments in new international markets, new manufacturing and distribution
facilities, and expansions at existing warehouses and corporate facilities.
Preopening expenses vary due to the number of warehouse and facility openings,
the timing of the opening relative to our year-end, whether the warehouse is
owned or leased, and whether the opening is in an existing, new or international
market.
Interest Expense
                      2021       2020       2019
Interest expense     $ 171      $ 160      $ 150


Interest expense primarily relates to Senior Notes. For more information on our
debt arrangements, refer to the consolidated financial statements included in
Item 8 of this Report.
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Interest and other income, net

                                           2021       2020      2019
Interest income                           $  41      $ 89      $ 126

Gains on foreign currency transactions, net 56 7 27 Other, net

                                   46        (4)        25
Interest income and other, net            $ 143      $ 92      $ 178


The decrease in interest income in 2021 is mainly explained by the fall in interest rates in the we and Canada, partially offset by higher average cash and investment balances. Net gains on foreign currency transactions include mark-to-market adjustments for forward exchange contracts and the revaluation or settlement of monetary assets and liabilities by our Canadian and other international operations. See the Derivatives and Foreign Currencies sections in

  Note 1   to the consolidated financial statements included in Item 8 of this
Report. During 2020, other, net was impacted by a $36 charge related to the
repayment of certain Senior Notes.
Provision for Income Taxes
                                 2021          2020          2019
Provision for income taxes    $ 1,601       $ 1,308       $ 1,061
Effective tax rate               24.0  %       24.4  %       22.3  %


The effective tax rate for 2021 included discrete net tax benefits of $163,
including a benefit of $75 due to excess benefits from stock compensation, $70
related to the special dividend payable through our 401(k) plan, and $19 related
to a reduction in the valuation allowance against certain deferred tax assets.
Excluding these benefits, the tax rate was 26.4% for 2021.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes our significant sources and uses of cash and cash
equivalents:
                                               2021         2020         

2019

Net cash provided by operating activities    $ 8,958      $ 8,861      $ 6,356
Net cash used in investing activities         (3,535)      (3,891)      (2,865)
Net cash used in financing activities         (6,488)      (1,147)      (1,147)


Our primary sources of liquidity are cash flows generated from our operations,
cash and cash equivalents, and short-term investments. Cash and cash equivalents
and short-term investments were $12,175 and $13,305 at the end of 2021 and 2020,
respectively. Of these balances, unsettled credit and debit card receivables
represented approximately $1,816 and $1,636 at the end of 2021 and 2020,
respectively. These receivables generally settle within four days. Cash and cash
equivalents were positively impacted by a change in exchange rates of $46 and
$70 in 2021 and 2020, respectively, and negatively impacted by $15 in 2019.
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. See   Notes
5   and   6   to the consolidated financial statements included in Item 8 of
this Report for amounts outstanding on August 29, 2021, related to debt and
leases.
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.
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Management believes that our cash and investment position and operating cash
flows as well as 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 $8,958 in 2021, compared to
$8,861 in 2020. 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 how
fast inventory is sold, the forward deployment of inventory to accelerate
delivery times, payment terms with our suppliers, and early payments to obtain
discounts from suppliers.
Cash Flows from Investing Activities
Net cash used in investing activities totaled $3,535 in 2021, compared to $3,891
in 2020, and is primarily related to capital expenditures. In 2020, we acquired
Innovel (Costco Wholesale Logistics) and a minority interest in Navitus. Net
cash flows from investing activities also includes purchases and maturities of
short-term investments.
Capital Expenditures
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 2021, we spent $3,588 on capital
expenditures, and it is our current intention to spend approximately $3,800 to
$4,200 during fiscal 2022. These expenditures are expected to be financed with
cash from operations, existing cash and cash equivalents, and short-term
investments. We opened 22 new warehouses, including two relocations, in 2021,
and plan to open approximately up to 35 additional new warehouses, including
five relocations, in 2022. We have experienced delays in real estate and
construction activities due to COVID-19. 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 or based on the current economic
environment.
Cash Flows from Financing Activities
Net cash used in financing activities totaled $6,488 in 2021, compared to $1,147
in 2020. Cash flows used in financing activities primarily related to the
payment of dividends, repurchases of common stock, and withholding taxes on
stock-based awards.
In 2020, we issued $4,000 in aggregate principal amount of Senior Notes and
repaid $3,200 of Senior Notes.
Stock Repurchase Programs
During 2021 and 2020, we repurchased 1,358,000 and 643,000 shares of common
stock, at average prices of $364.39 and $308.45, respectively, totaling
approximately $495 and $198, respectively. These amounts may differ from the
stock repurchase balances in the accompanying consolidated statements of cash
flows due to changes in unsettled stock repurchases at the end of each fiscal
year. 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. The remaining amount available to be purchased under our
approved plan was $3,250 at the end of 2021.
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Dividends

Cash dividends declared in 2021 totaled $12.98 per share, as compared to $2.70
per share in 2020. Dividends in 2021 included a special dividend of $10.00 per
share, resulting in an aggregate payment of approximately $4,430. In April 2021,
the Board of Directors increased our quarterly cash dividend from $0.70 to $0.79
per share.
Bank Credit Facilities and Commercial Paper Programs
We maintain bank credit facilities for working capital and general corporate
purposes. At August 29, 2021, we had borrowing capacity under these facilities
of $1,050. Our international operations maintain $574 of the total borrowing
capacity under bank credit facilities, of which $201 is guaranteed by the
Company. Short-term borrowings outstanding under the bank credit facilities at
the end of 2021 were immaterial, and there were none outstanding at the end of
2020.
The Company has letter of credit facilities, for commercial and standby letters
of credit, totaling $235. The outstanding commitments under these facilities at
the end of 2021 totaled $197, most of which were standby letters of credit which
do not expire or have expiration dates within one year. The bank credit
facilities have various expiration dates, most of which are within one year, and
we generally intend to renew these facilities. The amount of borrowings
available at any time under our bank credit facilities is reduced by the amount
of standby and commercial letters of credit outstanding.
Off-Balance Sheet Arrangements
In the opinion of management, we have no off-balance sheet arrangements that
have had or are reasonably likely to have a material current or future effect on
our financial condition or financial statements.
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 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. We base our estimates on historical experience and
on assumptions that we believe to be reasonable, and we continue to review and
evaluate these estimates. For further information on significant accounting
policies, see discussion in   Note 1   to the consolidated financial statements
included in Item 8 of this Report.
Insurance/Self-insurance Liabilities
Claims for employee health-care benefits, workers' compensation, general
liability, property damage, directors' and officers' liability, vehicle
liability, inventory loss, and other exposures are funded predominantly through
self-insurance. Insurance coverage is maintained for certain risks to seek to
limit exposures arising from very large losses. We use different risk management
mechanisms, including a wholly-owned captive insurance subsidiary, and
participate in a reinsurance program. Liabilities associated with the risks that
we retain are not discounted and are estimated by using historical claims
experience, demographic factors, severity factors, and other actuarial
assumptions. The costs of claims are highly unpredictable and can fluctuate as a
result of inflation rates, regulatory or legal changes, and unforeseen
developments in claims over time. While we believe our estimates are reasonable
and provide for a certain degree of coverage to account for these variables,
actual claims and costs could differ significantly from recorded liabilities.
Historically, adjustments to our estimates have not been material.
Recent Accounting Pronouncements
We do not expect that any recently issued accounting pronouncements will have a
material effect on our financial statements.
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