Costco Wholesale Corp (COST) — Q2 2016 Earnings Call Transcript

Thank you, Brittney. Good morning to everyone. I'll start by stating that our discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. That these statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call as well as 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. So last night's press release reported our second quarter and first half fiscal year 2016 operating results for the 12 and 24 week periods ended February 14 as well as our monthly sales results for the four week reporting month of February which ended this past Sunday, February 28. For the quarter, reported earnings came in at $1.24 a share compared to last year's second quarter earnings per share of $1.35. Note that last year's earnings were positively impacted by two discreet income tax items that together benefited last year's second quarter earnings by $43 million or $0.10 a share, and that, excluding these two items, earnings for the second quarter last year would have been $1.25 a share. Among the factors that impacted our second quarter year-over-year earnings comparison, foreign exchange (FX) as compared to a year ago. During the quarter the foreign currencies where we operate continue to weaken versus the U.S. dollar in all countries but primarily in Canada, Mexico and Korea, resulting in our foreign earnings in the second quarter when converted into U.S. dollars being lower by about $32 million or $0.07 a share and if exchange rates had been flat year-over-year. The second item of comparison is our co-branded credit card transition in the U.S. As you know we're transitioning to a new co-branded credit card relationship in the U.S. this year as we wind down our current relationship. New co-branded credit card sign-up stopped several months ago. The short-term negative earnings impact to the loss of co-branded credit card sign-ups was $18 million pre-tax or a $0.03 per share hit to the second quarter. Recall that the earnings impact was $15 million pre-tax or $0.02 a share last fiscal quarter, and it will continue to impact earnings in Q3 and even into the first month of Q4. As of today, we expect to have the new co-branded Visa cards in the hands of our members in May with a go-live transition date in June. While I can't give you any specifics regarding the new card, contractually I can't do that yet. I do look forward to sharing more details with you at that time. The third item, IT modernization, our major IT modernization efforts continue to impact SG&A expense percentages especially as depreciation begins on the new systems that are now being placed into service. In the second quarter on an incremental year-over-year basis these costs impacted SG&A by about $10 million or an estimated 3 basis points – 2 basis points without the gas deflation, which was about $0.01 a share. There is a light at the end of this tunnel with the SG&A headwinds. Based on our current estimates we expect the year-over-year basis point impact to SG&A to be just a couple of additional basis points in fiscal year 2017, and then flatten out, hopefully a little better than flattening out over the next couple of years after that. Stock compensation expense was higher year-over-year in the second quarter by $14 million or $0.02 a share. And lastly in terms of the year-over-year comparison LIFO. Last year in the second quarter we recorded a pre-tax LIFO credit of $4 million. This year in the second quarter, with deflation being a little more impactful than in the past couple of months, we had a LIFO pre-tax credit of $15 million resulting in a year-over-year delta of $11 million or $0.02 a share. Now turning to our second quarter sales. Reported sales were up 3% and our 12 week reported comp sales figure was up 1%. For the quarter, sales were negatively impacted by gasoline price deflation to the tune of 80 basis points. And by weakening foreign currencies relative to the U.S. dollar by minus 340 basis points. Such that excluding gas deflation, the reported plus 3% U.S. comp for the second quarter would have been a plus 4%. The reported Canadian comp of a minus 7% in the second quarter would be a plus 10%, excluding both gas deflation and assuming flat FX rates year-over-year. And the reported minus 3% international comp figure for the quarter, excluding gas and FX, would have been a plus 6%. Total comps again reported 1% for the quarter, and excluding gas and FX would have been up 5. The four-week month of February, which again ended this past Sunday, reported comps came in flat at 0%. That consisted of a plus 2% comp on a reported basis in the U.S., minus 2% reported in Canada and a minus 8% other international. As we discussed last month, the calendar shift of the Super Bowl moved sales out of January reporting period into February. We estimated that this shift benefited our U.S. sales for the month of February by about 0.75% and the total company by about 0.5%. Sales were negatively impacted again by gas deflation which started to head down again during the month by about 180 basis point negative impact to the number and also by weakening FX currencies relative to the U.S. dollar to the tune of 250 basis points. Excluding gas deflation in the U.S., the reported plus 2% U.S. comp for February would have been a plus 4%. Excluding gas deflation and FX, in February minus 2% comp in Canada would have been a plus 10%. And the reported minus 8% international comp would have been flat year-over-year ex gas and FX. Total company comps reported, again zero for the month would have been a plus 4% excluding gas and FX. I might mention that the other international normalized number in other words ex gas and FX was zero, mostly related to the timing of the Chinese Lunar New Year holidays. We don't think that will be an issue after the timing of that. Final comment on deflation. Beyond gasoline price deflation that we've always pointed out each month, we have seen a little additional deflation across many merchandise categories such that sales have been impacted a bit more in the past couple of months. In terms of new openings, our opening activities and plans, we opened 13 new units in Q1, including two relocations, so a net of 11 new locations in the first quarter. In Q2 we opened one new business center in Westminster, California. For all of fiscal 2016, we're still on target to do 30 net new locations, 21 of which will be in the U.S., three in Canada, two in Japan, and one each in the U.K., Taiwan, Australia, and Spain. Also this morning I'll review with you our e-commerce activities, membership trends and renewal information, additional discussion, of course, on margins and SG&A, and a couple of other items of note. Okay. In terms of the second quarter results, sales for the quarter were $27.57 billion, up 3% from last year. On a reported comp basis, Q2 comps were up 1% for the quarter, up 5% ex gas and FX. For the quarter, our plus 1% reported comp was a combination of an average transaction decrease of minus 2.5% and an average shopping frequency increase of just over 3%. Now in terms of the minus 2.5% average transaction decrease, again, taking FX and gas out of that number, that minus 2.5% would have been a positive number that would be just under plus 2%. In terms of sales comparisons geographically, in the U.S., the Midwest, Texas and California regions were strongest. Internationally in Q2 in local currencies better performing countries were Mexico, Canada, Australia, and Taiwan. In terms of merchandising categories for the quarter – for the second quarter within food and sundries, overall flattish. Meat, deli, and sundries were the leaders. Tobacco, negative in low-double digits as we continue to eliminate tobacco SKUs from various locations. For hardlines, overall in the mid-single digit range. Departments with the strongest results were consumer electronics, which was up in the low- to mid-teens, sporting goods, lawn and garden, and tires. Within the low- to mid-single digit softlines, domestics and apparel were the standouts. And in fresh foods, comp sales were in the low-single digit range with produce showing the best results among the four main fresh foods categories. Lastly, as we mentioned during the December and January sales calls, in the U.S., we're seeing deflation in the low-single digit range for foods, sundries, and fresh foods, and now, again, a little bit more on the non-food side as well. In terms of February, traffic was up a little over 3.5%, while the average transaction was down a little under 4%; about 3.75%. Again, gas, as I mentioned earlier, fell again a little more dramatically in February. The average sale price year-over-year in gas was down 21% for the month, which is a bigger decline year-over-year than we saw in the quarter overall. In terms of geographic regions, again, for February, Texas, Southeast, and the Midwest regions were strongest. And internationally in local currencies, Mexico and Canada were at the top. From a merchandise category standpoint ex-FX, all categories, food, sundries, hardlines, softlines, fresh foods were in the mid-single digit range for February reporting period. Again, a little deflation impacting these. And it's a little deflation, but it's more than we have seen historically of recent history. Moving down the line items of the income statement, membership fees, we came in for this fiscal year at $603 million, up 4% or $21 million from $582 million a year ago and up 2 basis points as a percent of sales. Again, that $21 million increase and 4% dollar increase, if you assumed flat FX, the $21 million would have been a $40 million increase, and the 4% increase ex FX would have been a 7% increase. And in terms of membership, renewal rates remain strong; 91% in the U.S. and Canada and 88% rounded up in worldwide. Continuing increasing penetration in the Executive Membership I think helps that. New membership sign ups in Q2 company-wide were up 4%. I will point out last month, the early part of February and into the second week of February, for 12 days we ran a new membership promotion on LivingSocial. Recall that we also ran a membership promotion with LivingSocial about 18 months ago. Like that one, it went well and we don't do it too often, and we don't want to get people used to it, but it was a good result. In terms of new members at Q2 end, Gold Star members at Q2 end was 35.4 million, up from 34.7 million at Q1 end 12 weeks earlier. Business primary remained at 7.2 million. Business add-ons remained at 3.5 million. So all total, at Q2 end, we were at 46.1 million versus 45.4 million at Q1 end. And total cardholders would be 84.0 million, up from 82.7 million. As of the end of the second quarter, paid Executive Memberships totaled 16.6 million of our members, an increase of 214,000 over the 12-week month, or 18,000 a week increase in the quarter. As I've mentioned before, Executive Members are a little more than a third of our membership base and two-thirds of our sales results. In terms of renewal rates, as I mentioned, they continue to be strong. Business in the U.S. and Canada was at 94.5%, the same as it was a quarter ago. Gold Star was 89.7%, the same as a quarter ago. Total U.S. and Canada, 90.5%, same as a quarter ago. Worldwide at 87.7%, down a tick from 87.8% at Q1 end. And a little bit of rounding, and then as you know. In all new markets we generally have in the first year lower renewal rates, and that second year and the first year of renewals. I've mentioned in the last couple months that in Canada when we did the credit card conversion, which is a little different than the one we're doing here, it was what was referred to as a de novo thing where everybody had to sign up for a new credit card and apply, and what have you. And so your renewal rates related to auto renewals, which by definition are high, come down a little. That will be anniversaried after next quarter. So, we saw a little tick down in Canada this quarter year-over-year as we had in the last couple quarters as well. There should be one more quarter of that, again, not terribly meaningful but we've been asked. Going down the gross margin line, our gross margin in the second quarter was higher year-over-year on a reported basis by 17 basis points. As always, we'll jot down four columns of numbers with six line items. The first two columns are Q1 2016 and Q1 2016. The columns would be reported, column one. Column two would be without gas deflation. Then we'd have Q2 2016, two columns reported and without gas deflation. Reading across, core merchandise in Q1 on a reported basis was up 24 basis points. Ex gas deflation was down 3 basis points year-over-year. For Q2 2016, reported was plus 5 basis points, and without deflation minus 3 basis points. Ancillary, plus 11 basis points and plus 4 basis points in the first quarter year-over-year. Plus 9 basis points and plus 7 basis points in Q2. 2% Reward, minus 3 basis points and minus 1 basis point. Q2, minus 1 basis points and zero. LIFO, plus 1 basis point and plus 1 basis point. And in Q2, plus 4 basis points and plus 4 basis points. Other was minus seven and minus seven a year ago. And not an issue, zero and zero in Q2. Such that total reported year-over-year in Q1, we were up 26 basis points in gross margin. Without gas deflation, down 6 basis points. And in Q2 we were up 17 basis points and up 8 basis points ex gas deflation. As you can see the core component of gross margin was higher by 5 basis points. 3 basis points excluding gas deflation in the quarter. Core gross margins, food and sundries, hardlines, softlines and fresh foods as a percentage of their own sales were positive year-over-year in Q1 by 11 basis points, with food, sundries and hardlines showing higher year-over-year gross margins as a percent of their own sales. While softlines and fresh foods are a little lower year-over-year as a percent of sales. But again, the net of those four major categories as a percent of their own sales was up year-over-year in the quarter by 11 basis points. Ancillary and other business gross margins were up 9 basis points, 7 basis points without gas. Both – in terms of ancillary businesses, our gas business, our food courts, our hearing aid centers, our tire shops and our mini labs all showed higher gross margins year-over-year as a percentage of their own sales. Again, Executive Membership not an issue without deflation, a zero impact year-over-year. And again, LIFO, a 4 basis point benefit to the gross margin year-over-year. Moving to reported SG&A. Our SG&A percentage in Q2 was higher or worse year-over-year by 34 basis points on a reported basis and higher or up by 27 basis points ex deflation. Let me again give you these tabular numbers and then I'll give you some text around those. Again, the four columns would be report Q1. The first two columns would be Q1 2016 year-over-year reported and without gas and deflation, and Q2 reported without gas. Those would be the four columns. First line item, operations would be zero basis points in Q1 reported and plus 26 basis points without gas deflation, the plus meaning lower or better. In Q2 minus 22 basis points and minus 16 basis points. Central minus 8 basis points and minus 6 basis points in Q1. In Q2 minus 8 basis points and minus 7 basis points. Stock expense minus 12 basis points and minus 10 basis points in Q1. In Q2, minus 4 basis points and minus 4 basis points. And quarterly adjustments or unusual items, minus 8 basis points and minus 8 basis points in Q1. And no unusual items to point out, zero and zero in Q2. Such that in Q1 year-over-year on a reported basis, SG&A was a minus 28 basis points or higher by 28 basis points. And Q1 ex-gas it was better or lower by 2 basis points, so a plus 2 basis points. In Q2 it was minus 34 basis points as I mentioned and minus 27 basis points ex-gas deflation, so higher by 27 basis points. Now core operations, again component, the minus 22 basis points. Again, minus 16 ex-gas, ex the impact of gas deflation. Of that minus 16 basis points, payroll was about minus 2 basis points. Benefits and workers’ comp were minus 8 basis points, with the remaining minus 6 basis points being a variety of items including bank fees, depreciation, and various other items. Again, I think a few of those things relate to a very slight change in sales increases. And a couple things just going 1 basis point in the wrong direction. I'll also point out that within the benefits and workers’ comp, about – one thing that stood out, is just in January we had what were referred to as high-cost claims for employee benefits, medical claims. Typically it averages over the last two years – this is U.S. – about $6 million or $7 million. A year ago it was a little lower than that, about $3.5 million. This year it was about $13 million. So nothing unusual other than what we refer to as high-cost claims, anything over $100,000 but it just spiked and that's a few basis points there. But again, that will come and go in both directions. In terms of central expense, higher year-over-year in Q2 by 8 basis points, 7 basis points without gas. As I mentioned earlier, IT was 3 basis points of that or 2 basis points without gas deflation. In addition we had several one-time items which in total represented about $9 million. Again, we always have a few one-time things that go either way. We had three items that together totaled $9 million. But they are what they are and it didn't impact our SG&A. And lastly, the stock compensation expense was 4 basis points. Now before I move on from SG&A, I do want to mention one additional expense headwind that is just starting. In March every three years, we review our pay scales and in fact our entire employee agreement. We always review top of scale and historically increase the top of scale every year in March where the roughly 60%, 65% of our employees that are at top of scale already. In addition, this year we're also changing the starting level or entry-level hourly wages. This is the first change to the entry-level wages in nine years. Since 2007 our entry-level wage in the U.S. and Canada was $11.50 or $12 an hour. Effective this month in the U.S. and Canada, we're increasing our starting wages from $11.50 and $12 to $13 and $13.50. So up a dollar and a half. We estimate that this will cost us about $0.01 a share in Q3 year-over-year, and about $0.02 a share in each of the next three fiscal quarters. Again, it's part of what we do and as – there are a few warehouses that we've already started people at a higher level. Simply markets like the Bay Area or some limited markets like that. At the end of the day, it will be about the numbers that I mentioned in terms of the impact to our earnings. Next on the income statement is pre-opening expense. Pretty much the same year-over-year. $9 million last year and $10 million this year. Last year we had no actual openings in the quarter but a lot of that relates to openings that are just getting ready to occur or just occurred, as well as one opening this year. All told, operating income in Q2 came in at $856 million, down 2% from a year ago's $877 million. Below the operating income line, reported interest expense in Q2 came in at $31 million. That's up $4 million from last year's $27 million. The increase is primarily due to interest on the $1 billion debt offering that was completed in Q3 last year related to our one-time special dividend that we did back in February a year ago. Interest income and other was lower year-over-year by $4 million, coming in at $20 million last year and only $16 million this year. Actual interest income for the quarter was lower year-over-year by about $8 million, primarily a factor of less cash on hand this year as compared to a year earlier. This is a result again of two things. We had a $1.2 billion debt payoff last December as well as we used about $1 billion of our cash towards paying that $5 a share special dividend last February 27, a year ago. Overall pre-tax income was lower by 3% or $29 million in Q2, going from $870 million a year ago to $841 million. In terms of income taxes, we got a little help there. Our company income tax rate for this quarter came in right at 34%, up from a little over 30% a year ago in the quarter. The income tax line on this year's Q2 benefited from a few positive discrete items resulting in the 34% rate. Our normalized rate would have been a shade over 35%. While last year's income tax line benefited from, as I mentioned – we mentioned earlier, a $43 million benefit primarily relating to our $5 special cash dividend. Overall reported net income of $598 million last year in Q2 compares to $546 million of net income this year in Q2 on a reported basis. All right. A rundown of a few other items. A balance sheet is included in this morning's press release. A couple of things I always point out on this call. Depreciation and amortization for Q2 totaled $285 million for the quarter, and $556 million year-to-date. Our accounts payable (AP) ratio, accounts payable as a percent of payables, last year in Q2 on a reported basis was 97%, and this year 5 percentage points lower at 92%. That includes construction and other payables. So if you just looked at merchandise payables as a percent of inventories it would be 87% a year ago, and 4% lower or at 83% this year. Last year being higher by 4% or 5% a year is actually the anomaly. A couple of factors, part of it was last year's West Coast port slowdowns where you had a lot less inventory a year ago on some big ticket low-turn items like electronics. Just that one department was over $120 million of higher inventory and only a few million dollars of higher accounts payable. And then gas payables again were $20 million or $30 million to the wrong side of this AP calculation as we try to keep our tanks a little fuller when prices decline. So again, that's running the business, and nothing per se exceptional there. In terms of average inventory per warehouse. Pretty much flat year-over-year coming in just $6,000 higher this year, an average inventory per warehouse of $12.761 million, up from $12.755 million a year ago. Ex-FX year-over-year inventory levels per warehouse were up more than the $6,000, they were up $286,000 or up 2%. But that again, on a normalized basis I think is one of the smaller increases we've seen year-over-year in that. Overall, inventory is in good shape. Not only in good shape, we just completed mid-year or our mid-year physical inventories and it's our best shrink results ever by 1 basis point plus. So again, I think it's indicative of running a clean shop there. In terms of CapEx, in Q1 we spent $715 million, in Q2 we spent approximately $650 million more. We were still on track this year for fiscal 2016 CapEx to be in the range of $2.8 billion-plus. Maybe as high as $3 billion but $2.8 billion to $3 billion, that compares to $2.4 billion CapEx in fiscal 2015. Next, Costco e-commerce, Costco online. We're now in six countries, having recently opened in Korea and Taiwan. We're also in the U.S., Canada, U.K., and Mexico. For Q2, sales and profits were up over last year. Our total sales were up 19% in the quarter, up 22% ex-FX and on a comp basis, up 18% reported and up 21% ex-FX. So continued good results in terms of growing our e-commerce efforts. In terms of expansion, fiscal 2016 again we opened ahead of 11 units in Q1. One new unit in Q2. So 12 through midyear. We plan seven net openings in Q3, nine openings including two relocations. So seven net. And in Q4 we are on task to do 11. So that would give us 30 total for the fiscal year. If you go back a year ago in fiscal 2015 we added 23 net new units on a base of what was then – beginning basis 653. So about 3.5% square footage growth. This year assuming we get to the 30, that will be about 4.5% square footage growth. Again the new locations by country if we do the 30 are 21 in the U.S., three in Canada, one in the U.K. and three in Asia – one in Taiwan and two in Japan. One more in Australia and one more in Spain. At Q2 end, total square footage stood at 100.7 million square feet. Next in terms of stock buybacks, in Q1 as I mentioned a quarter ago, we spent about $130 million buying 898,000 shares back, with an average price of just under $145 a share. In Q2 we spent $80 million on 531,000 shares, so an average price at just over $150 a share. During the first five weeks of the past quarter, very little stock was repurchased. In fact, of the total $80 million, $3 million of the $80 million was purchased in the first five weeks, and the remainder, the vast majority was in the last seven weeks. And that's purely a function of how we do it. We look at kind of a matrix pricing. As it goes up a little, we buy a little less, and when it comes down a little, we buy a little more. As long as we feel comfortable about our runway, I think we'll continue to do that. In terms of dividends, our current quarterly dividend stands at $0.40 a share, so $1.60 annualized, which on an annual basis is about a $700 million number. That's the quick and dirty of how Q2 went. I'll turn it back to Brittney now and be happy to answer any questions. Brittney?

Hey, Richard, I know you have this data; I don't know if you have how deeply you dig into it, but if you look at traffic in the U.S. by your different customer segments, and particularly your most loyal customers, right, so are the most loyal customers generally fresh food customers? Is that a good part of the basket? And do you think – is it possible that a little bit of the moderation in traffic is are you maxing out with your truly best customers? It's just kind of hard to grow frequency with that group?

Well, I'd have to look into it. I don't know. My guess would be that our more frequent customers are bimodal. They're the ones that you mentioned that would – are shopping for frequency as families on a regular basis, and certainly food is a meaningful part of that. That's in my view, one of the two or three main factors that get people in the door on a more frequent basis. We also have small business members who are buying a lot of things, not necessarily fresh foods, but obviously some restaurants and community stores will buy some of that. But in terms of maxing out, I've said it before, I continue to be surprised how many more Executive Members we're getting even up on the existing longer-tenured members. And so we – look, we've got to keep doing what we're doing in terms of being good merchants and constantly improving the value. And there's always saturation in everything you do. We're pretty good at figuring out ways to offset that. In the last year or two, certainly organics have helped, not only bringing in arguably some newer perhaps younger members but taking existing members who love Costco but there are certain things they didn't buy at Costco because they're an organic family. So I think we'll keep coming up with stuff. But I don't – I would bet that logically that makes a little sense, but I bet you it's not that big of a factor, that concern.

Do you think the – are your best customers, do you think they're shopping three, four times a month or more frequently than that?

Yeah, I'd say three or four times a month. I think you – look, you have some customers shopping twice a week. A core of are small business. I have a friend that shops six times a week. That's what he tells me, and I run into him a lot, and I scratch my head why. So, but no, jokes aside, arguably when there's a family that's getting to shop four times a week, are they on that curve of incremental frequency increases that would be – it's going to be harder and harder to do. But again, we're pretty good at figuring out a reason why they need to come back. And we're getting more – we feel good about the fact that in the last couple years, our average members' age which a half a dozen years ago was about a four-year – they were four years older than the U.S. population, that's now just under two. So it's going – that's going in the right direction for a lot of reasons. The fact that we keep adding some gas stations is driving frequency. I remember years ago, I've heard for 30 years, now that this thing is maxing out, fresh foods or gas stations, whatever it is, we keep figuring out new things. And I feel good about some of the things we're doing in a lot of the non-foods categories. Fresh foods never ceases to amaze me, and we'll keep going.

All right. And then just lastly, you talked about two of the categories were up in gross, two were down. So just maybe a little more color on the ones up versus down? How much – mix a factor. I guess I thought fresh food might, just because of deflation and a little bit of delayed pass through. I guess maybe you pass through that a little more quickly?

Well, we do that – by the way, one thing that Bob here reminded me of. Another issue in terms of a year-over-year comparison, or as some of you like to talk to the two-year stack. It was a year ago when gas fell dramatically in a big way and we had a couple of months there, we had a 5.5% frequency for a couple of months. So, I think some of it's the deflation that we're seeing now a little bit, but some of it's that year-over-year comparison when we had some pretty nice numbers there. Now I'm hopeful that we'll find out in the next couple of months once we – not that we've anniversaried that.

Hi. This is Joshua Siber on for Simeon. If gas prices stay low, do you expect to see traffic slow as that competitive advantage starts to diminish?

Again, in theory, it should be less of a factor helping sales because we're not on the news every night. We love it every year when GasBuddy comes out. Now, three or four years in a row since they started it, we were the lowest price nationally on average. I think we still get positive feedback from that. So yes, I mean at the end of the day, is it better when we had – is it better than when we had gas going down a buck year-over-year or over a couple months and it's on the news every night? Sure, that helps us a little more. But we still find people that are just signing up and can't believe our gas prices. Again, it's a net positive. It's less of a positive than it was in the first year, the second year, and the third year.

Okay. And a follow up to John's question. I don't know if you have this in front of you, but would you be able to compare traffic and ticket growth across demographic groups?

I don't have – I know that our membership and marketing people looked at that and I've seen it, but I don't know if want to go that – I don't have it in front of me so I can't answer that question.

Okay. Last one for me, then. If you could talk about the dynamics between the credit card transition and a potential membership price increase in terms of timing?

Well, there's no real dynamic. It looks like we're on task, as you know. Just last week, I believe, American Express and Citi announced the agreement to purchase the portfolio. And in which I believe we're on track to issue – Citi's on track to issue cards to the existing millions of members that have the current co-branded card in May with a transition date likely in early June. But, again, that could slow up a week or two, too, we'll see. And in terms of transition, there's not a lot contractually that we can do until then. And of course, when the cardholders are being sent those cards by Citi, they'll be getting information from Citi. And I think that will start that process of making our members aware of what the new card brings to them and then we'll go from there. Look, we're excited about getting it done. It is a big transition in a sense that there are millions of members that have the current card and they'll get the new card in the mail. We're excited about the value proposition to our members and we think it will be a net positive long term. Like anything, when we can save money, we want to give most of it to our members, and this will be like that, as well. We'll get a little benefit from it. As it relates to the fee increase, we really haven't made any decisions which would be consistent with the six times we did it in the past. History has shown that if you just dot it out chronologically, it's about every five to six years. The last time we did it was in January of 2012. So five years would be January of 2017 and six years would be a year later. I can only tell you that, logic would dictate we certainly wouldn't do anything during the transition. We've got enough going on this year, mid-year when we're doing this credit card transition. And so all those align to a possible answer. At the end of the day, I don't know when we'll do it. I can tell you that we feel as comfortable today as ever about the loyalty of our members and we feel as comfortable as ever today that we feel that we've improved the value on that membership way more than the likely increases that you've seen in the past. So stay tuned.

Okay. Thanks, Richard.

Thanks. Good morning. So I want to follow up on the potential membership fee increases. While last time you raised the Executive Membership price in addition to Gold Star, but I believe – correct me if I'm wrong. That was the first time you had ever done it. So can you walk us through how you thought about that last time? And maybe reflect on how – what that could possibly mean for the next potential increase?

Well, I think the bigger issue is for about I think it's 10 or 12 or so years we had the Executive Membership out there. The Executive Membership from its inception was $100. And our view at the time was let's build it. And in theory every time – if you think about it when we originally did the Exec, I think the Gold Star was $45. And so there was a $55 delta if you will. And $55 assuming a 2% reward break-even if you will between do I stay a regular member, become an executive was $27. An incremental $2,750 of annual purchases. And as the $45 went to $50 and $55 that delta became less, so in theory another bucket of – I think it was 2 million-plus million additional members that fell into that bucket of being above break-even than below break-even. And so we wanted to grow it. As we decided to raise it almost five years ago, four-plus years ago, not only from $50 to $55 but the $100 to $110, I think felt that we've gotten a lot of that benefit. And certainly there's a lot more benefit incrementally than $10 and so we felt comfortable doing that. That's how we got there. How we get to next one, stay tuned.

Understood. And then just reflecting back on the traffic I think, ex the Super Bowl, still three plus traffic comp. Do you think that much has changed in terms of the behavior of the consumer within the box in terms of maybe are you seeing it in different mix, buying less discretionary items, less sort of trade up within the category or any commentary there that you can talk about the consumer and how they're behaving in the store?

Well, in terms of discretionary, some of our stronger categories are non-foods. And so that flies in the face of that concern. Did we see a little bit of – a little less strong numbers in some of those higher ticket categories in parts of Texas or Canada or – well, Canada was strong notwithstanding that. Or I guess North Dakota, I don't know about North Dakota. I know Texas it was a little different even though Texas overall was fine. I know that when I talked to our head of International, because of the strong dollar they saw a little bit of – a little weakening of that strength in the bigger ticket discretionary items. But overall we've had our best percentage dollar increases in electronics and statistically in TVs the last couple of months in a few years.

Hi. Good morning, thank you. My question was around membership as well. You obviously have a good retention rate and then presumably in existing clubs you have members that sign up to help fill the gap. I'm just curious if you can give us some metrics around comp membership growth, how that looks in the U.S. and then how that looks on international?

Well, first of all, any new market even when we went into New Orleans where we had been in Louisiana before a couple years ago. You're going to see a year hence when you have your first class of renewals, it's going be a number quite a bit lower than our company average. I think in the U.S. we typically see numbers in that first full year in a new market – and there aren't that many new markets anymore, but when we do something in the low 70%s, perhaps. Overseas when we first opened in Korea, Taiwan and Japan and as we've opened new units in new geographic markets in those countries, we might see in the first year our renewal rates in the high 50%s low 60%s and it grows from there. So our renewal rates – and that's why you see that we separate U.S. and Canada which is the most mature. That number is a little higher than the worldwide number for that very reason. We always see a higher renewal rate among the Executive Members. They get it. They're spending – they're investing another $55 on top of the main $55 on that upgrade because they get it and they get the value of it. And we think that works, reward programs work. Co-branded credit card rewards work. Fresh food and gas work, all those things help.

So looking in aggregate, mature clubs and new markets, is the Company actually experiencing a comp store membership growth?

Yes. I'm sorry. And most of our sign-ups are comp sign-ups, so the answer is yes. I mean this is a rounded number here. But when asked, hey, if you have a 90% or 91%, well we'll use 90% for this example. If you have a 90% renewal rate and you had 100 members, what do you have a year hence? Well you have about 101 or 102. You lose 10 and you gain 11 or 12. That's kind of how it's been. And that's, and I'm shooting from the hip with this one, but that's pretty consistent with my assumption of if overall new member sign-ups are in the 4% range this past quarter.

And you mentioned the Living Social campaign was good. Can you give us a little color around how many and how many were millennials?

No. Millennials were – well, not in terms of the number. We were pleased with our results based on our expectations of it. But, again, we don't want to get people comfortable waiting for that kind of value proposition to sign up. And so that's why we waited 18 months. And as it relates to millennials, I know I don't have the chart in front of me, but I know the chart that our head of membership marketing shared at the budget meeting. Yes, it over-indexes the other way towards younger people relative to our existing base, which you'd expect.

And then my last question for you on the LIFO credit based on what you know today about deflation storewide, are you expecting additional LIFO credits as we get into the back half of the year?

If it were today, I'd say yes. But you never know. Keep in mind when we have a LIFO credit, your markup is probably impacted a little the other way. When you have a LIFO charge, it's because there's inflation. You've raised your prices a little bit. Sometimes there's a little bit of a gap there. So it's part of margin. But yes, I think all things we see today, it would be a LIFO credit, a little bit of that extra LIFO credit.

Good morning. Thanks a lot for taking my question. On the wage increases, is the increase that you are giving this year consistent with what you've done in the past? And when you've done this in the past, have you noticed any change in your sales trajectory? So employee satisfaction goes up and that leads to a better membership experience or it coincides with broader wage inflation and some people have more money to spend and they spend it at the warehouses?

Yeah, well, somebody once said it's like chicken soup, it can't hurt. I think at the end of the day, at top of the scale we've done every year for as long as I can remember. When you've got somebody that's reached top of scale, they want to know what they're going to get a year hence. And we've always erred to the high side on that. I think over the last three years, top of scale in the U.S. is in the $23 range, $22.50 or something just top of scale. And so if you – and I think it was a $0.50 or $0.60 increase, so let's say $0.55 on $23.00 would be about a 2.5%, a little under 2.5% increase. I believe the current increases are similar to that kind of percentage. What we haven't done every year is bottom of scale. We like to be – and by the way, I want to also say is that the amount of cumulative hours it takes for somebody to get from bottom of scale to top of scale on a full-time basis, not that people will always start at full-time, they don't. But on a full-time basis it takes about four-and-a-half years which is very, very short period of time. So our employees get it. But we think this will help, and it's important to do. We want to be the premium at all levels. We're a huge premium at the top of scale. That's as others raise their rates at the bottom. And frankly in some markets, this is a physically challenging job. You're on your feet, you're lifting cases, you're pushing carts at these entry level jobs. And so we thought it was time to do it. So that is incremental. And that's when I mentioned earlier on the call that the $0.01 a share in Q3, thank you. And the $0.02 a share in each of the next three quarters because there are four quarters, that's that incremental piece that I'm talking about. Now I would like to think that we're not going to have less shrink or employee shrink because of it, or they're going to be better service providers to our members. I think it reinforces what they already feel. And that's what we're all about.

Hi, Richard. I just have a couple of questions I think. The first one is on the membership fee income growth, what would it have been without the impact of no American Express sign-ups?

We don't measure it. On the margin we think somebody's coming to sign up because of us first and the co-brand card second. A distant second. Whether it's Amex or Citi Visa or anybody. They come in to be a member of Costco. I don't think they come to the desk and say never mind and walk away. So I think – now, because part of our relationship with our former partner and our upcoming new partner – current and soon-to-be-former partner and our upcoming new partner – is they do some marketing for us. They do some things to get people to come in also. So there's probably a little bit but we don't try to measure that, we just know it's zero right now.

Got it. Okay. And then in your softlines business, there has been some – the private label component I think has increased and I was just wondering if you could talk through a little bit on the impact that weather has played in that segment of your business both from like a markdown perspective but also in terms of what you are really seeing as buying opportunities throughout the last few months in the current market?

Well, the only thing that was impactful is I believe there was a relatively warm – there was more men's outer wear markdowns this last few months than we had historically but it was completely weather-related. And I didn't even point it out on the call. That's probably a little bit of softline's impacts. That was one of the reasons that the softline's margins I mentioned year-over-year was a little down. Beyond that, at the last budget meeting when we were looking at the – some of the apparel buyers came and talked about some of the new seasonal things, we keep getting a few more brands. I can't think of any off the top of my head right now. But I think it's a consistent – we've enjoyed the apparel business with comps in the 10% to 15% range compound for a couple years now. And we're still seeing decent growth in those areas. So it's a good category for us. I think we're trying a couple of men's athletic items. We've been very successful with the three pieces, the bottom, the top of the jacket. KS, I know we're bringing in a few other items on the men's pant. Not just the fancy wool pant but the khakis and the gabardines.

Hi. Thanks for taking my question. Richard, just wanted to go back to the credit card transition. You've talked in the past about kind of reinvesting some of the savings but I think you just also mentioned maybe keeping a little bit of it. I'm just curious, is that a change, are you considering letting some more of that flow through – I mean you have had a lot of expense on the IT front now with the wage increase FX has been a headwind? So just curious if there is any change in how you are thinking about the savings there? And now that we are kind of very close to it, any comment on what those savings could be in terms of magnitude?

Well, no comments until we get there. So it really is going to be probably not until early October when we report our year-end and fourth quarter numbers. Since early June would be the beginning of the first – about three weeks into our fourth quarter. So I can't really tell you anything about it. We've made no change in what piece of this bucket we're thinking of saving. If anything, as we went through the final negotiations several months ago of what the rewards structure would be, Craig pushed it further towards the customer, towards the member who would get this card. We want it to be a great card, and so if anything, we went the other way a little bit. I just mentioned – perhaps I didn't mention it that when I talk to people, as people have talked to me, my standard line has been like anything we do, when we save a buck on a piece of merchandise, we can buy better, and we're going to give, as a rule of thumb, the majority of it maybe 80% even 90% back to the customer. We're going to do the same thing here, we're going to give most of it back to the member. That being said, again, in the throes of final figuring out what exactly do we want the reward structure to be, and because we want that card to be top-of-wallet, as we do with our current co-brand. Top-of-wallet and be used not only at Costco but outside of Costco and to be used at Costco as much as possible. We – Craig pushed the envelope with us and with the third parties to make sure that that value proposition is geared more towards them than us. So there's been no change in terms of that.

Got it. That's helpful. And then just on the transition, will you have any grace period for a member that say doesn't have the cobranded card but tends to use their AmEx at the store and didn't get a new card in the mail obviously but gets up to the register and goes to pay and you are not taking AmEx anymore or will they just have to find a debit card or have you thought about how to treat that situation?

Well, first of all, there's going to be a lot of communication several times by us to our members about timing and everything. Contractually, there's a lot of things we can't do until near the end. There will be plenty of information provided. We're still going to upset a few members when they come in. We did it with gas pumps years ago when we stopped accepting certain things. And – but at the end of the day, there will be plenty of opportunities. The fact is that there will be some members that have an existing Visa card in their wallet while we would prefer them to have ours. There will be cannibalization that way. Frankly, there will be some cannibalization. Look, whether it's American Express, Citi or any other big credit card issuer, they're the bank that determines credit eligibility for somebody signing up. Now that doesn't impact the portfolio people, all the people that have the current co-brand. They're going to get a new card similar in terms of credit capacity and things from their existing co-brand relationship. But somebody who has to sign up, there are millions of people that never got an Amex card because they couldn't. They have resorted to debit, cash or check. There are some of those people that haven't – will be thrilled. There's some debit cardholders that will do this. But when you add it all up, we think that it's a net – we know that it's a net positive certainly in terms of what we've negotiated, and we'll see where it goes from there.

Got it. That's helpful and then if I could just ask one more on online. A lot of retailers are spending a lot of money investing in their online business. It has kind of pressured the margins for them there. I believe your e-commerce business is higher margin. Just curious how you think about spending there going forward and is that higher margin structure sustainable?

Well, first of all, our gross margins online are a little lower. Its operating margin is quite a bit higher because you have a substantially lower SG&A. Now the fact that we're not spending hundreds of millions of dollars online perhaps is part of that. But at the end of the day, we certainly make more when that dollar is sold online than it is in-store. And notwithstanding the fact that our gross margin, what we charge the member is lower online than it is in-store.

Hey, guys. Thanks for letting it go so long. I just wanted to poke at the environment that almost everyone seems to be operating in right now. I mean I think you talked about traffic and I assume February traffic is in that kind of 2 to 2.5 range too. Talked about the deflation outlook. We talked about wages going up. I guess as you kind of move forward here and this is not just a Costco question, I guess this is from an analyst perspective that covers a lot of retail, it seems like everybody is facing a lot of the same challenges. I mean, do you see a light at the end of the tunnel? We had deflation now minus 1 maybe, we have wage inflation, we have traffic that has kind of come down a little bit. Not a great environment and so it seems again that maybe something has to give here. Is the wage inflation going to finally pick up demand? Where does this in your opinion kind of end? Even Costco which is probably one of the best retailers in the world domestically is feeling the pressure. And I'm just trying to understand what is the end game here generally and I don't know if you have any thoughts on that? That's my question.

I don't know if this will give you comfort or anxiety. We're going to keep doing what we do. In bad times, we probably have the benefit of being more aggressive to drive stuff. And if anything, I think we're doing it from a stronger position now than we've ever been in. We're going out there driving prices down. We see our competitive moat actually even relative to traditional brick and mortars, not only our direct competitors but other forms of – and not just clubs but other forms of category diamond retailers. That moat has widened a little bit of late – of late being the last year or two. And the answer around here is well, can we get a little more margin? And the answer is, of course no, if we could drive more business so we could make it tougher on everybody. So I think – and then again, I think some of the things we're doing in terms of our strength with our vendors and our global sourcing, all that stuff, that helps. We've got a – we're doing a lot of good things.

Thanks. I have two questions, Richard. What drove the acceleration in membership fee income growth besides the Living Social program?

Well, Living Social had virtually no impact because it's deferred accounting. Even if we had a little bump in that first week, or last week of Q2, when the Living Social thing was happening, virtually none of it hits the income statement. Because for a new member, that $55 or $110 goes into the P&L over the next 12 months. And my guess is it's probably some strength a year earlier that we're not getting the full benefit of that.

Okay.

It might even be strong membership.

Got it. If I could also focus on sales for a second question, so I guess the difference really between January and February in the U.S. if you knock out the weather and Super Bowl, et cetera, it is actually seems to be at least in the overall number seems to be less about traffic and more about ticket. I know that there is a component of ticket that is obviously deflation. Is the decel in ticket ex-gas and FX in the past couple of months entirely about deflation or is there any change in basket size or units per basket, et cetera?

Well, it's basket size related to deflation.

Great. All right. Good luck.

Hi. Good morning. So just following up on the Living Social deal, understanding that the deferred accounting doesn't really impact it but how did that impact the total membership numbers for the quarter? And then also how was the retention rate really on the one that you had about 18 months ago?

I aggregate number of members, we signed up a few more than we did the last time. And I think the 4% increase would be lower and it would be somewhere north of zero and south of 4%.

Okay. But the mechanics of the program when somebody buys that deal, they automatically they get it done. They don't have to take it to the warehouse to get activated?

They buy the coupon or whatever online. They print it out. They go to the warehouse where they sign up for a membership.

Okay. So you don't get those...

It's that latter take that when we represent, when we recognize it as a member and when we start our deferred accounting. Which will be small in the first year because you have offsets, you have a value proposition to that purchaser.

Okay. So there could be more people that are signing up in the current quarter that we are in now that have purchased that deal?

There will be. Yeah. Thank you, everyone. Have a good day.