Costco Wholesale Corp (COST) — Q1 2018 Earnings Call Transcript

Thank you, Christy, and good afternoon to everyone. I'll start by mentioning that these discussions will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that could lead to actual results differing materially from those expressed. The risks and uncertainties include, but are not limited to, those discussed in today's call and other risks detailed in the company's public statements and SEC filings. Forward-looking statements are only valid as of the date made, and the company does not commit to updating these statements except when legally required. In today’s press release, we announced our operating results for the first quarter of fiscal 2018, covering the 12 weeks ended November 26. Our reported net income for the quarter was $640 million or $1.455 per share, which is a 17% increase from last year's first quarter net income of $545 million or $1.24 per share. When comparing year-over-year results, two key items were highlighted in today's release. First, this year’s first quarter saw a $41 million or $0.09 per share tax benefit due to a change in accounting rules for stock-based compensation. Second, last year’s first quarter benefitted from a one-time $51 million legal settlement. That figure accounted for a 19-basis point improvement in gross margin and contributed $0.07 to last year’s first quarter earnings per share. Excluding these two items, the reported 17% increase in earnings would have been approximately 16%. Various factors influenced the year-over-year comparison. On a positive note, gasoline profitability increased year-over-year, along with some contribution from incremental events and our co-branded credit card program. However, these were counterbalanced by costs related to Hurricanes Irma and Maria and a slight rise in the normalized income tax rate, which increased by about 70 basis points. Now looking at our income statement, net sales for the first quarter were $31.12 billion, marking a 13.3% increase from last year's $27.47 billion. This year's 12-week quarter had one less sales day in the U.S. compared to last year due to the Thanksgiving calendar shift. Sales during the pre-Thanksgiving and Black Friday weekend were included in this year's first quarter, whereas they fell into the second quarter last year. Overall, these factors provided an estimated net benefit of 1.5% to this year’s first quarter sales in the U.S. and about 1.3% globally. As mentioned in our release today, our reported U.S. comparable sales increased by 10.3%. Excluding gasoline and foreign exchange effects, that number was 8.7%. In Canada, reported comparable sales were 11.3%, and 4.3% excluding gasoline and foreign exchange. Other International reported a growth of 10.1%, and ex-gas and FX, it was 8.2%. Overall, the total company reported a 10.5% increase and a 7.9% increase after factoring in gas inflation and foreign exchange. E-commerce sales, which we're now reporting monthly, saw comparable sales rise by 43.5% for the 12 weeks and adjusted for foreign exchange, it was up 42.1%. This figure includes the holiday shift associated with Thanksgiving, which impacts online sales differently due to Cyber Monday. We estimate the benefit from that shift to be between 5% and 10%, so if normalized, the 42% might be somewhat lower but still represents strong performance. For Q1 sales metrics, overall traffic was up 5.9% globally and 6.6% in the U.S., enhanced by the Thanksgiving holiday shift mentioned earlier. Foreign exchange negatively affected total sales by about 110 basis points, while gasoline inflation contributed another 142 basis points. Together, gas and FX impacts totaled about 2.5 percentage points, or 250 basis points. Additionally, cannibalization affected comparable sales by approximately minus 105 basis points, which has been more pronounced in recent quarters due to an increase in reloads. Our average transaction or ticket was up 4.3%, benefiting slightly from gas and FX, resulting in a normalized transaction increase of just over 2%. Moving down the income statement, membership fees in Q1 were reported at $692 million, reflecting a year-over-year increase of $62 million or 9.8%. This $62 million increase includes approximately $24 million attributed to membership fee increases, largely driven by adjustments in the U.S. and Canada effective June 1, 2017. After factoring out the $24 million increase, membership fees still showed a growth of 6%, and would be in the low-to-mid 5% range once foreign exchange impacts are excluded. We anticipate that the effects of the fee increase will continue to show a more positive year-over-year growth in the coming quarters. Our renewal rates stood at 90.0% in the U.S. and Canada, with a worldwide rate of 87.2%. These figures remained consistent with the previous fiscal quarter's results. At the close of Q1, we reported a total of 49.9 million households, an increase of about 1% from 49.4 million households at the end of Q4. Total cardholders rose from 90.3 million to 91.5 million over the same period. We also increased our Executive Members to 18.8 million, with an addition of about 246,000 over the past 12 weeks, averaging about 21,000 new Executive Members each week during the quarter. Regarding the gross margin, our reported gross margin in the first quarter was down 33 basis points year-over-year. For clarity in understanding the numbers, it's important to note key figures reported for Q1 '18 and those without gas inflation. Merchandise core was down 12 basis points reported, but flat without gas inflation. Ancillary businesses grew by 600 basis points reported and by 9 without gas inflation. Reward reduced by one basis point and by two without gas inflation, while 'Other' declined by 26 basis points in both cases. In total, on a reported basis, gross margin was down by three basis points, and down by 19 excluding gas inflation. Overall, it was lower year-over-year by 14 basis points and flat excluding gas inflation. The core merchandise component margin was down by 12 as highlighted, but remained flat when excluding gas inflation for the quarter. Within subcategories, food, sundries, and soft lines merchandise saw year-over-year growth, while hard lines and fresh foods experienced declines. Gross margins from ancillary and other businesses increased by 6 basis points reported and by 9 without gas inflation, with contributions from gas and hearing aids offset by decreases in pharmacy, e-commerce, and food court margins. The impact of the 2% Reward slightly decreased the margin, reflecting a higher sales penetration from Executive Members. Lastly, we saw a positive non-recurring legal settlement benefit year-over-year, contributing 19 basis points, while most other costs involved incremental expenses related to a new centralized return facility. This facility previously underwent testing in one region and has since been rolled out nationwide, incurring modest incremental costs that will continue to impact margins over the next quarters. Looking at SG&A, our SG&A percentage in Q1 improved by 34 basis points year-over-year and was also lower by 20 basis points when adjusted for gas inflation. On a reported basis, it was at 10.36%. In breaking down the details further, core operations improved by 24 basis points and by 12 excluding gas inflation; central expenses were down by 8 basis points and 7 without gas, while stock compensation improved by 2 basis points reported and by 1 without gas. Observing all these figures, we see that stronger sales results largely drive lower SG&A rates. Moving back to our income statement, preopening costs were down $5 million year-over-year at $17 million this quarter, reflecting our opening schedule differences. This quarter, we opened seven locations—five new and two reloads—all in North America. Last year, we opened nine locations, with eight being new. Reported operating income for Q1 reached $951 million, an increase of $102 million or 12% year-over-year. Adjusting for the legal settlement, the increase would have been $153 million, representing a 19% rise without that benefit. Below operating income, interest expenses rose by $8 million year-over-year to $37 million due to our debt offering in May, which included a special dividend. Interest income fell by $4 million year-over-year, although actual interest income increased by $5 million, offset by approximately $9 million in negative impacts from foreign exchange-related items. Overall, pretax income rose by 11% or $90 million in the quarter, totaling $936 million, which was a rise of $141 million or 18% when excluding last year’s $51 million legal settlement. Our tax rate for Q1 2018 was 30.4%, down from 34.4% last year. On a normalized basis, last year’s tax rate, minus unusual items, would have been 34.1%, which is 70 basis points lower than this year’s normalized rate of 34.8%, once again accounting for the previous year's adjustments. As previously mentioned, we had some positive discrete tax items this year. Reported net income was up 17%, reaching $640 million compared to last year's $545 million. Excluding the two noted items, net income would have been 16% higher. Before we move to Q&A, a few additional points: capital expenditures totaled $820 million, and we anticipate staying in the mid-to-high 2s for the year, with depreciation at $335 million. Regarding warehouse expansions, we plan to open between 20 and 25 new locations, over half of which will be in the U.S., alongside three in Canada, two in Korea, and one each in Australia and Mexico. We also intend to relocate six warehouses this year—four in the U.S. and two in Canada—compared to two or three in recent years. As of the end of Q1, total warehouse space amounted to 108 million square feet. In terms of stock buybacks during fiscal 2017, we invested $473 million to repurchase nearly 3 million shares at an average price of $157.87. In Q1, we bought back 734,000 shares for $119 million at an average price of $162.51, with purchases primarily occurring earlier in the fiscal quarter. Before I hand it back to Christy for questions, I'd like to provide a brief update on e-commerce and our credit card partnership with Citi Visa. Worldwide, e-commerce sales for the first quarter of 2018 reached $1.3 billion, reflecting a 40% year-over-year increase, with a 5% to 10% benefit attributed to the holiday shift. We are continuously enhancing our offerings and improving the member experience with better sales processes, checkout, and return options. Our site traffic conversion rates and overall traffic showed positive year-over-year growth, particularly noticeable during the Thanksgiving, Black Friday, and Cyber Monday periods, with the latter falling into Q2 this fiscal year. Our warehouses are now supporting Costco.com with signage that aids in search and purchase, and members can buy select items for online purchase through their local warehouses. In terms of online grocery offerings, we introduced two new delivery options on Costco.com: a two-day dry grocery delivery and same-day fresh delivery through Instacart, both of which were positively received since their rollout in early October. We also enhanced the Executive Membership value by allowing members to earn a 2% reward on travel purchases made through Costco travel, which, combined with using their Citi Visa, offers an additional 3% back, totaling a 5% reward. We've also embraced a buy online, pickup in store option for select items like jewelry and laptops, which has seen customers shopping while picking up their orders. Overall, these initiatives are positively impacting both our online and in-store businesses, driving greater sales momentum and increasing awareness of our digital presence. Additionally, we are leveraging online channels to stimulate traffic in our warehouses. Since the conversion to Citi Visa occurred in June 2016, we initially had 11.4 million co-branded cards or 7.4 million accounts. As of the end of Q1, we have now issued 2.1 million new approved member accounts, totaling 2.8 million new cards, including around 263,000 new accounts opened in this quarter. Adoption and usage of the card has been favorable, benefiting both us and our partners. Lastly, for our fiscal 2018 second quarter, the scheduled earnings release date for the 12-week period ending February 18 will be after the market closes on Wednesday, March 7, with the earnings call scheduled for that afternoon at 2 PM. Now, I'd like to open it up for questions. Back to you, Christy.

Richard, is membership for the club at a sustainable growth level now? Were any unit promotions a factor in the growth you experienced during the quarter?

I believe the main factor to consider is that a few quarters ago, the average membership numbers declined slightly due to three key reasons: first, the number of new openings which vary each quarter and year; second, we've seen significant membership sign-ups in new markets, particularly in Australia, Asia, and Iceland, compared to the U.S. and Canada where we have been established for a long time; and third, when we introduce new units in an existing market, as I mentioned last time, that can be impactful. For instance, we might have 65,000 members per warehouse in areas like east Seattle or San Jose. Opening a new unit can generate around $120 million to $130 million in additional sales but may only increase the member count by a few thousand because it allows existing members to shop more frequently due to proximity. This pattern will continue. The timing of openings will fluctuate, but overall, our metrics have improved year-over-year for the first time in the last two quarters, and we're expanding into new markets which will further support this growth. If we calculate the average membership by dividing the total number of warehouses by the total locations, it should stay in the low 60s with slight variations. If the average drops a bit, it could be due to fewer year-over-year openings in some international markets. We're optimistic about our renewal rates and so far, the transition related to credit cards and auto bill has been going well.

In the past, you've given a little bit more detail on renewal rate by Gold Star Primary Business that was your cohort. Is there any reason why you decided not to give that detail?

I believe the main reason, after 20 or 25 years in this business, is that we've become so detailed that it can be distracting. I want to assure you that we will keep you informed about anything significant. Ultimately, what's crucial are the total membership numbers, growth, and renewal rates. Over the years, we've faced challenges, especially in the beginning, where wholesale members needed a valid business license and were genuine small business owners. This evolved into a mentorship model with business add-ons, many of which were not solely for business purposes, as small businesses with 10 employees would purchase memberships for their staff. Additionally, with the introduction of the Executive Membership, some members transitioned from the primary membership to their own. Therefore, we have a clearer understanding of our business members compared to others, based on their purchasing behavior.

And then my follow-up question this on the potential for tax reform. Would you treat any savings that you might get from potential tax reform as any other windfall that you get and reinvest that back in the business in the form of lower prices?

Well, first, we have to wait and see what actually happens. I know in the first year, what we're reading about today, there's still some onetime offset to that for earnings overseas, historical earnings overseas to the extent that cash hasn't come back. That will be a partial offset, I believe, to what we currently read today. Look, going forward, we're going to do what's long-term right for our stockholders quarter's valuation. And for us, that includes all of the things you've heard about historically. But we'll have to wait and see and talk about it more when you get there.

Just on the gross margins, I think you said the quarter-on-quarter was flat. I was wondering if you could shed some color there on the Visa benefit? And then also what the total core was as a percentage of their own sales? If you could just amplify on any of the category color on direction that you gave earlier.

Yes, regarding the earlier question about granularity, the primary benefits were realized in the first year. There were some additional benefits afterward, but moving forward, we won't be detailing this further. To be clear, the incremental benefits have been significantly less than the substantial gains we achieved in the first 12 months, which continue to grow as a percentage of sales. For core encore, I believe it decreased slightly, although I don't have the specific numbers at hand. I recognize this was a key question last quarter compared to previous ones. There are many variables involved. What I can share is that we are confident in our margins. Much of what we have done, and will continue to do, is proactive rather than reactive, and we believe we are seeing results that are as favorable, if not better, than we initially expected.

Okay, great. And then just any early readings with Instacart? I know when you did Google Express that most of the purchases were falling trips and were therefore complimentary. I was just curious what your early takes are with that effort.

Look, all the members are great partly because they expanded themselves in terms of the number of locations over the last 12 months. Two, it's front and center now on our website. But one of the things I mentioned here, we both have chosen for the first two-three months for this thing to basically have a soft opening, if you will, to make sure that we don't screw it up. And when I say we don't screw it up, it's growing very nicely. But clearly, when we market it, we think it will take off even more. But so far, so good.

Okay. So then when you look at the acceleration in digital sales in November, that was really just your core Costco.com business?

The thought of starting with jewelry and PCs, what sort of drove that? How far can you take that operationally? Right, if you think about other products like big bulky stuff, papers and beverage, can you do that operationally? And then is that what your customers want? Are you hearing from numbers that they want more bulk items?

We haven't received feedback from many members, and we haven't asked them specifically, but we do see strong performance in our numbers, especially in-store. While our online presence is impressive, in-store sales represent only about 5% of our business. We're still contemplating whether to adopt practices similar to those of other retailers, not just other warehouse clubs, as there are significant costs associated with that. So far, we haven't found a compelling reason to change our approach. In certain categories, we've identified that some customers are reluctant to purchase items because they can't have them shipped to their workplace or don't want them left at their doorstep. This has created an opportunity for them to buy in a way that's convenient. Additionally, since we won't be delivering grocery items to refrigerate or freeze, customers can simply pick them up. Notably, over half of the customers came in and shopped before picking up their laptops or jewelry. We appreciate this trend and will continue to evolve our offerings as we move forward; this is just the beginning.

When considering the tenure of openings, do you believe we are currently at the lower end of that 20 to 25 range? Additionally, since we haven't had many openings in Asia recently, does that reflect the timing of real estate opportunities? Should we expect a surge in overseas openings in the next 18 months? Also, are you planning to open just one business center this year?

We have already opened the San Francisco location, and we also have one in Minnesota. So, we're expecting at least two openings this year, with the possibility of a third depending on timing. I believe this will be prioritized right after the fiscal year. A lot of this is influenced by timing. Historically, when we consider the 20 to 25 openings, we tend to be at the lower end of that range. The main factors include whether we can push certain projects forward, manage the timeline effectively, and if we have favorable weather conditions while dealing with permits and other obstacles.

Lastly, could you clarify the impact of the gas benefit? Was it minimal or significant?

We're trying to assess the situation, and while it's challenging to provide specifics, when you look at the overall impact, it has been significant for our bottom line. Overall, gas performance has been solid, and if you analyze the last several quarters, it has contributed more than a penny per share on some occasions, potentially reaching up to five cents. The results can vary, but overall, the performance has been positive.

First, just a housekeeping question. What was the inflation in the quarter? Could you give that?

No, we didn't. Overall, excluding gas, it was up a couple of percentage points. We don't really monitor LIFO anymore. We used to have it, but we don’t pay attention to it now. In terms of our guests, if there was anything, it was a slight increase in inflation excluding gas, but that was mainly on the cost side. Considering the investments in pricing and the competition from other retailers, I would estimate that there is probably minimal or no inflation.

Okay, so that was unclear. PPI has clearly been high and elevated, while TTI has been much more subdued. I'm curious how much that impacted your margins or how we should consider that in relation to the quarter.

I really don't think that impacted it, Karen. It's really us looking at what happens when we get hot on pricing or hotter and recognizing we have these benefits from credit cards and from membership. And that's what we do.

Okay. And then I guess, in terms of grocery delivery and then Instacart, I guess, you didn't give an update. Are you still at the 500 SKUs for grocery delivery and 1,700 on Instacart? And then anything to indicate on that component of the business, whether or not this is drawing a customer who has kind of been dormant? Now you're seeing incremental trips; anything it could point to because obviously the concern is that there will be cannibalization with this offering.

We really haven't. Even though there are significant increases in their activities before we go back in early October, it was minimal compared to our company's size. We will wait six months and then reassess.

Okay. And then lastly, how many units on focus right now?

I'm sorry, how many units? Are on the buy online, pick up in store for those smaller items? Very limited. Hold on, hold on. All warehouses are doing jewelry and laptops in the U.S.

Richard, can you discuss the success of the promotions you ran this quarter and how they compared to previous ones? Also, is the competitive landscape for club membership any different now than it has been before?

Well, first of all, I'm not sure what we did this first quarter. During Q4, we did the Groupon/mini social. That went fine but I'm not sure of anything we did this quarter.

Okay, what about the environment? Is it any different as far as competitors being promotional for new members? Is there anything to call out versus what it was like in the past?

I don't think they're more promotional, but our direct competitors have been very promotional one more than the other. But whether it's a monthly one or a certain amount of dollars off to try it out, and so we haven't really seen any dramatic differences to that. It's been that way for a while.

Okay. My follow-up is on the online sale. You gave it a bit of color, I don't know if you talked about categories that are out comping the house average. Are there any gross margin implications of the categories? I realize there is still a range even within a pretty tight band, but curious, just thinking about the products that are growing faster than the house online versus others, if that's doing anything for the gross margin?

Yes, while we are experiencing significant growth, it is still relatively small, making up less than 5% of our company, so its overall impact is limited. However, electronics sales are likely to have a more considerable effect, especially since we have found success in online electronics sales. We hope members are aware that executive members with a co-brand card will receive an additional 5% off and a four-year warranty that applies when using the card. These factors can contribute to driving the business, and we need to ensure everyone is informed. Apparel sales have been performing well, partly due to our increased online apparel offerings. We're also improving our targeted email strategies for members to enhance engagement with these products.

So first question was on the Visa cardholder. I was just curious, you're over a year now. Do you have any comparative data on how that cardholder spending in the club versus the MX holder previously?

The main aspect I would focus on is that in many instances, it tends to be the same figure. We believe that your spending is higher due to improved rewards and promotions. The acceptance of Visa in more locations means that if it’s your primary card—whether it’s an older rewards card or a co-branded card—it was my main card, and now the new Citi Visa has taken that place. There are significantly more locations where I can use my new card, which has led to an increase in overall spending. Additionally, co-branded programs with major companies, such as airlines, retailers, hotels, and travel companies, often involve some level of revenue sharing. Those are the metrics we analyze. We also offer double rewards on Costco purchases; while gas does not earn double, other purchases that previously earned one point now earn two. All these factors are contributing to a positive trend.

And then with regard to renewal rates, you highlighted that the renewal rate was the same as where we were at the end of the fourth quarter. I know last quarter, you were talking about the trajectory and how you think it will follow your experience in Canada. Do you think that next quarter, we could see the first tick-up in renewal rates?

I believe a quarter ago, we mentioned a timeline of one or two quarters. We have one more quarter of flat performance, with changes expected to be minor, averaging out to just tenths of a percentage point. We're being cautious here, but we are confident in our view. Although we have one more quarter of grace, we were encouraged by our results in Q1 compared to the end of Q4.

And then lastly, do you have any numbers around membership growth in comp stores?

No, we don't. Only because we did that last quarter because we know there were a lot of concerns around it, we thought that was a data point. And I'm sorry, we just don't have that.

So on the core margin being flat ex-gas, usually when you're going to these periods of intimate piece of the renewal, the membership fee increase. It tends to invest in gross margin, and I think most expected it to be down. So going back to a prior question, is mix helping you? The price environment is pretty promotional out there, solid just trying to understand why that came in flat versus through the historical experience of how you would invest and to the fee increase period.

Our philosophy is to invest in these opportunities while being pragmatic. There is a lot available, but we also have an advantage. Given our limited resources and the number of products we offer, we can make strategic purchases on a small number of standout items that can generate an additional $10 million or $20 million in sales within a week or two. This approach seems effective for us, and we feel confident in taking an offensive stance as we evaluate our options.

And then in terms of the following up on the tax question, you talked about doing what's right for the shareholders, the valuation of the stock, and historically, I think your motto is customer, employee, vendor, shareholder. So is that the way how we should think about that potential tax flow through?

We got crazy a little bit, sure, I mean, yes, we're going to keep doing what's right. And again, I'm not trying to be cute. First of all, we don't know what the tax plan is going to do, and we don't know the impact on the first year of it based on some offsets. But you can rest assured that we'll do the right thing, and we'll drive the business the way we do it that helps of those stakeholders.

And then lastly, just a couple of quick follow-ups. This in the calendar, this the 53rd-week end up being a point on headwind for this upcoming quarter? And the other line, we think, gross margins, I think you said 26 basis points. When you say some of that is going to stick around for the next three quarters, is that 26 basis points or something like that?

No, no. Within the 26 is 19 of that 26 was that $51 million legal settlement benefit to gross margin in Q1 of '17 a year ago. So year-over-year was minus 19 basis points. So we're talking about is the other 7, and the other seven has primarily do with a major switch we did and how we hand over, return and dispose of salvaged merchandise. And we tested it for a couple of years in one of two regions, one region than another. And then just the last six or seven months we rolled it out through the United States to selling all 12 depots that do this for us that can handle the entire United States. And needless to say, we did because it works, since it's positive. There's the start-up cost, if you will, of getting it rolled out and done in the efficiencies that we look for over time. That seven hopefully will be 6, 5, 4, 3; but a year from now it will be zero in theory and then go the other way a little bit. But at the end of the day, we wanted to point it out because it is a little unusual, and we recognize that you guys are very sensitive to these basis points of margin.

And then 1.5 point sale shift?

That's for Q2.

That is a headwind?

Yes, that will be a headwind, yes. And it will be a bigger headwind for e-commerce because we don't know if it's 5% or 10% probably in the high singles; that's a guess.

Can I just ask about traffic; it wasn't that long ago, I guess, that traffic slipped to kind of 2% or so, and we were also thinking maybe this is the new norm. Obviously, you have seen dramatically better traffic growth this year. I guess, looking back, was there something unusual about that period of 2016? And then as we think about things going forward, is there anything really that would cause things to revert to that kind of level again given the levers you now have to pull in this business, whether it's the fee increase or tax or whatever it might be?

I believe part of the issue can be attributed to the transition to the credit card that took place leading up to June 2016. For about nine months before that, we didn’t onboard any new members since American Express decided not to sign up new customers for a card that would soon be discontinued. This likely created some negative effects and confusion, which may have carried on into the initial weeks after the launch of the new card, as the transition was abrupt. While this situation certainly didn’t help, I suspect its impact was relatively minor. When we noticed the decline in numbers, we speculated it might just be part of a normal cycle; we felt confident in our business. In response, we worked on ways to invigorate our offerings, including adjusting pricing. Additionally, we experienced some challenges with traffic due to the multi-vendor mailers. On the positive side, they offered premium items with higher sales than our usual model. However, the downside was that we may have overextended with fewer mailer days throughout the year. This effect was observed from December 2016 to early 2017, particularly during the second quarter of fiscal 2017. As mentioned in our Q2 call, which was disappointing, we resolved to revert those changes by adding more mailer days while maintaining the fewer, higher-value items. This strategy has been effective, and although we’ve had slightly fewer days, the impact has not been significant.

Just a follow-up on tax reform. I know it is a difficult question to ask, but maybe we think about it in like bigger picture sense of investment and how you think about driving sales. And as you think about sort of like where you'd like to spend money particularly if you were to potentially get some windfall, everyone sort of thinks about price, but are there other things that sort of like would really like to have but are expensive? Or an earnings headwind currently that makes the return calculation a little different, whether it's the enhanced digital or fulfillment or something on labor. Just figure out, are there other areas of the business besides just price you should be thinking about that you would like to invest if you had the opportunity?

First of all, I think we would be doing those things anyway. We have strong cash flow and generate more than enough to cover our capital expenditures while consistently increasing the regular dividend. We have provided special dividends a few times and have returned enough to cover what over 5,000 employees receive as part of their compensation. I believe we will not just sit around considering what to do with our available funds; rather, we are focused on our proven strategies. This includes merchandising, driving business, taking care of our employees, and looking out for our shareholders. While I’m not trying to be evasive, we have yet to determine exactly what we will do, as we first need to assess what possibilities are realistically available.

A couple of follow-ups; one on the calendar shift, can you talk about whether it was a particularly profitable 1.5 of sales? Clearly, you're going to do a lot more sales per day and probably per employee hour. I'm not sure what the margin profile that you generate on that week so any impact on operating margin rate from that shift and presumably whatever it was would reverse in the following quarter.

I'm speaking candidly here. When there are particularly strong sales in a warehouse on that day, the profitability as a percentage of pretax income tends to be higher because labor costs are already accounted for, and the pace is busier. We are hopeful that our budgeting is accurate on the other side, so any potential offset shouldn’t be significant. However, we are only discussing a few weeks here and there, so I don’t see it being a major issue either way.

Okay. And then another question, you asked on e-commerce about profitability related to category shift. If you think about the growth of the business, you think about some of the accommodations you're making and the incremental offers that you are providing, can you talk a bit about the gross margin profile of e-commerce in total? I think you addressed them briefly, I think, as part of the gross margin discussion. Any sense as to the direction, and they also know it's small, you made that point as well. Just as it gets bigger, is the direction you're taking it in and moving to gross margin category with the other through that channel, just, is what I should say?

First of all, gross margins in e-commerce were a bit lower than the warehouse two years ago, but yesterday they were significantly lower. However, the bottom line was much better than the warehouse, acknowledging that this wouldn't be the case if it were in another warehouse. It's all interconnected. Ultimately, what we have discovered, along with others before us, is that if we can effectively communicate with our members about particularly attractive products, it really boosts our business, not just online. I believe we possess considerable flexibility and confidence in our margins. Our margin performance, whether slightly lower or higher, is driven by our own decisions, not by losing ground to competitors. We are fortunate in that sense. Even in a highly competitive space like hydraulics, we tend to focus on higher-end products. While competition exists everywhere, we find that the electronics sector is somewhat less competitive, which works to our advantage. There are numerous areas we can tap into, and I don’t see any significant concerns regarding our structural analysis.

I would like to revisit the conversation on e-commerce. During the last few calls, there were several announcements, including partnerships related to buying online and picking up at Costco grocery. Richard, could you please share your overall mindset and approach to e-commerce and omnichannel strategies? Many of us perceive this as a significant shift in the narrative compared to how you have historically approached the business.

I believe we have stayed true to our approach while continuing to evolve. There are many perspectives out there, including from people on this call, and a variety of opinions. I hope we have conveyed that in our unique way, there are many opportunities and low-hanging fruit that we have yet to address. Perhaps we should have explored some of these earlier, but we seem to be operating effectively across different areas, and our efforts are paying off. This success is evident not just through e-commerce and omnichannel strategies but also in-store, positively impacting our business. We consider ourselves fortunate in that sense. I recall during our last earnings call, we discussed for the first time the two new grocery delivery options on the Costco.com site. Some perceived this as a necessary move, while others thought it was simply a response to competitors. We believe we are successfully enhancing our brick-and-mortar business and acknowledging that some aspects will evolve. We have seen encouraging results, especially with big-ticket items such as furniture and electronics. Many years ago, we noticed a trend online with services related to larger items needing installation or assembly, like patio sets or televisions. Previously, we struggled with our white goods segment, only managing a few items without offering higher-end products available in-store. However, we have now established strong relationships with LG and Samsung, providing significant value, including special rewards for Visa card users. We anticipate that an item that once generated under $100 million in sales could reach $1 billion within a few years. Although that figure is still less than one percent of total sales, it represents considerable growth. There is much we can accomplish in this challenging environment. I also mentioned apparel, where traditional retail has seen flat or declining figures, yet total apparel sales, including online, have increased slightly. Our global apparel business, nearing $7 billion, has grown over 9% in the last three years due to strong signature growth and weaker brick-and-mortar performance, with some manufacturers choosing to sell to us for the first time. Incredible pricing has also contributed, and we plan to continue on this trajectory.

That makes sense. And also in looking at your strong top line over the last few months, it's occurred globally. You spoke a bit about kind of the investments in price on some of the product on the U.S. front. Is that the same story in what's happening in Canada and other places around the world? Or other any kind of unique factors that we would attribute some of these in those regions, too?

It's everywhere. The warehouse club concept is relatively new in some countries, and we're continuing to open more units, including a new one in Seville, Spain. Although it's a smaller market than Madrid, we've engaged with vendors, both international and local, who recognize our size and potential impact. Once we open the second unit, it will positively influence the first one as well. We've observed similar trends in Australia during our early years there. Our presence in the market, with eight locations in Australia, allows us to leverage the purchasing power of a $130 billion retailer, which benefits us significantly. Additionally, our signature items have established themselves as a high-end, low-priced, and high-value brand, further aiding our success.

And lastly, for me quickly, I might have missed it, but from the Visa card, did you outline any particular benefit to gross margins or SG&A in this quarter?

Well, for the first four quarters since it was so large going from the prior program to what this great new program has done for us, we did. Going forward, we aren't. We did say that incrementally, it was a little benefit percentage-wise.

Just curious on the SG&A line, you mentioned some incremental cost to think about over the next few quarters. Can you quantify that at all for us? And in terms of the shift, was there an impact, the calendar shift, to SG&A or membership or any other line items in the quarter?

There are some minor details to consider. Regarding the shift, in response to Matt's earlier question about the extra percentage half, it offers some benefit, but it’s challenging to quantify precisely. This represents a slight change related to holiday pay issues, and I would estimate it affects only a small number of basis points. Your initial question pertained to this topic, and it will persist for the next few quarters as it relates to margins. This change comes from us implementing a more efficient and cost-effective method for handling returns, managed centrally at each of our 12 depots across the country. We began testing this approximately three years ago and expanded from two depots to twelve in the last six months. This expansion contributed significantly to that extra line item, which accounted for 26 basis points, of which 19 were a one-time expense from the previous year. The remaining seven basis points largely stem from this change, translating into a marginal impact that we anticipate will continue for the next two or three quarters. I hope this impact will lessen over time, but that’s the current outlook.

Great. Regarding the acceleration in online grocery, I'm curious about your observations so far, which have shown a lot of success even with a soft launch. You mentioned increasing the use of email and targeted emails. What additional developments can we anticipate from online? Do you have plans to introduce an auto replenishment feature? Any information you can share on that would be appreciated.

First of all, regarding delivery, we haven't made any marketing efforts, so it's really been a soft opening for us and for Instacart on the same-day grocery front; we want to ensure we do it right. The percentage growth is significant, but it's still a small part of our overall business. Even with my earlier comments about laptops and jewelry, that's part of our testing phase. We've been frequently asked about online order pick-up in-store and have considered it, but our locations are considerably busier than others. It doesn't seem to make sense, and we haven't heard many member inquiries about it. However, we are exploring some areas where it could work, such as tires, which have been quite successful over the past year and a half. Customers can order tires online and have them installed at their chosen location, and this has contributed positively to our tire sales.

We talked a lot about digital and what you're trying digitally. My question is what you're seeing digitally in e-commerce, is that causing any merchandising decisions, pushed anything back to the club? Are you noticing anything in those trends that could change your merchandising? Thank you.

We've improved our email outreach to encourage customers to visit the warehouse. For instance, if someone purchases a baby seat or a car seat, they will see promotions for popular items in their email, and similarly for those who buy tires, they will receive offers related to automotive or garage products. Some of these deals are available online, while others can only be found in-store. Currently, we're celebrating the success of these strategies, as they are effectively increasing both in-store and online business.

Could you provide an update on the wage outlook? You've been proactive and transparent about it. I'm interested in discussing the current wage outlook now that it has been 90 days since your last quarter.

No, we feel good about that. We've increased wages, using the U.S. as a baseline. About a year and a half ago, in March of '16, we began offering higher starting wages in several markets where it's necessary. In some areas of the Bay Area and parts of New York, there are a few cities like Seattle and San Francisco where the minimum is 15. However, we will continue to stay ahead of the curve.

So a couple housekeeping items and then a question. I don't think we've talked about much about inflation, or if we did, I missed it, and I wonder what the inflation would look like in the quarter, what's your outlook?

Yes, we did talk briefly about it. Look, we think it's up a little, but it's muted by the fact that driving better value. And so really not a big issue either way. Next question.

The cost of hurricanes was mentioned, but I didn’t catch what the specific amount was.

We try to be a little less granular because if there are some offsetting things of there. The two together were a couple of $0.03 in total, but that's the difference. I'm learning not to tell you stuff.

My real question is, when you take a step back and consider e-commerce and the impact of Amazon, you've traditionally stated that you prefer having customers in your stores, expressing skepticism about online sales and services like buy online and pick up in-store. You want customers to visit your physical locations or warehouses. Given that your sales are incredibly strong, why are you moving forward aggressively with these e-commerce trials and rollouts? It seems that over time, this strategy could be detrimental to retaining customers in your warehouses. I would like to understand from a philosophical standpoint what prompted your change in approach and the reasoning behind this decision.

First of all, we want to be responsive and flexible, but we also want to maintain our own approach. We feel confident that there are strategies we can implement to boost our overall sales and profitability without compromising our values. With approximately 3,800 items in-store and possibly double that online, we believe this is a pivotal year for everyone regarding product offerings. Therefore, we need to determine the best way to proceed while preserving our value. We've also found ways to do this without investing enormous amounts of money. Our initiative for two-day grocery delivery, targeting a select number of our depots spanning the entire United States, is cost-effective since we already enable business members to operate not just from depots but also business centers, allowing them to purchase online for delivery. We've introduced just under 500 items that are more consumable in nature. Our perspective is that these are relatively low-cost methods to experiment and they are proving effective. We need to assess our progress, especially as we want grocery orders placed online to be filled, without deterring in-store visits, even if customers may shop less frequently throughout the year. We recognize that some customers live 30 to 60 minutes away, and this geographical consideration has influenced our strategy. Additionally, the market has evolved concerning large items that require installation and disposal of old products, such as mattresses or refrigerators. We have confidence that we can showcase the best value in premium products within these categories, and overall, things are progressing better than we initially anticipated.

I appreciate the answer and I want to acknowledge that tire program; it's actually quite good. Have a great holiday.