好市多 (COST) 2014 Q3 法說會逐字稿

Good morning, my name is Bridget and I will be your conference operator today.

At this time, I would like to welcome everyone to the quarter-three earnings conference call.

(Operator Instructions)

Now I would like to turn the call over to Richard Galanti, CFO.

Mr. Galanti, you may begin your conference.

Thank you, Bridget.

Good morning to everyone.

This morning's press release reviews our third-quarter operating results for the 12-week period ended May 11.

The discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and 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.

To begin with our 12-week third-quarter results, operating results.

For the quarter, our reported earnings per share came in at $1.07 per share compared to last year's third-quarter earnings per share of $1.04.

As I go through the line item detail on the income statement, I will point out a few factors that impacted earnings both up a little and down a little.

One item that I will point out up front, of course, is the FX impact to the entire income statement.

The FX impact of weaker foreign exchange rates year-over-year when reporting profits from our international operations, that represented a little over $17 million pretax, or between $0.025 and $0.03 a share impact to the P&L to the negative.

As an example, year-over-year in the third quarter the Canadian exchange rate, the Canada dollar relative to the US dollar was down about 8%.

Japan yen down about 6% year-over-year.

Offsetting a little bit from strengthening foreign currencies for the UK and Korea and a couple of others, but dwarfed, of course, by Canada.

In terms of sales for the quarter, total sales were up 7% and our 12-week reported comparable sales figure was up 4%.

For the quarter, sales were negatively impacted by gas price deflation, which was about a 25 basis point impact, and by weaker foreign currencies relative to the US dollar year-over-year, which in the aggregate impacted sales by about 140 basis points to the negative.

Excluding gas, the reported 5% US comp sales increase in Q3 would have been a 6% and the reported plus 3% international comp figure, excluding gas and FX, would have been plus 8%.

Such that the total company comp, which we reported a plus 4% for the quarter, excluding gas and FX, would have been plus 6% for the whole company.

In terms of new openings, after opening 16 new locations in the first half of fiscal 2014 and the closing of our Acapulco location earlier in this fiscal year due to the hurricane damage, we opened four new locations in Q3: two in the US, one in Louisiana, and one in Texas; and one each in Japan and Korea.

All told, that puts our 2014 fiscal year openings through the third-quarter end at 20.

Since the third-quarter end, on May 15 we opened our first Costco in Spain in Seville and this week we are opening our sixth location in Australia in Brisbane, our 11th Korea location, and our 20th Costco in Japan.

So three openings outside of the US this week.

By week end we will be operating 657 locations worldwide and after that, and through the end of the fiscal 2014 on August 31, we expect to open six more locations, four in the US and one each in Canada and the UK.

Such that we will most likely end the fiscal year with 30 new openings, less the one closing in Acapulco, or 663 Costcos worldwide as of August 31.

This morning I will review with you our e-commerce activity, our membership trends and renewal rates, recent common stock repurchase activities, and of course, a discussion about the various line items of the income statement.

So on to the results.

As I mentioned, actually total sales for the quarter came in at $25.2 billion, up 7% from last year's $23.5 billion.

On a reported comp basis, Q3 comps again were 4% for the quarter on a reported basis, 6% excluding gas and FX.

Now looking at the 4% reported comp sales figure, it was a combination of an average transaction increase of 0.2% up.

Of course that was on a reported basis.

Excluding gas and FX, the average transaction was up just under 2%.

And an average frequency increase of up 4.3%, which by the way, is the same number year-to-date through the third quarter.

In terms of sales comparisons by geography, within the US the Southeast and Midwest were the strongest, in the high-single digits.

Internationally in local currencies Australia was the weakest due to cannibalization on a relatively small base of existing units, with Korea, Taiwan, Mexico, and Canada all coming in in local currency in the plus 8% to plus 10% range.

In terms of merchandise categories, sales results for the quarter -- for the third quarter, within food and sundries, overall in the mid-single digits.

Frozen food, candy, and meat deli were relative standouts.

Hardlines, which overall was just above flat, about 0.5% up.

Departments with the strongest results were office and automotive.

Consumer electronic sales were down in the low to mid singles.

Within the mid to high single-digit softline comps, small electrics, domestics, and apparel were standouts.

And in fresh foods, comp sales were up 8% with produce and meat being strongest.

A little inflation on the meat side.

Moving down the income statement, membership fees came in at $561 million, up 6% or about $30 million year-over-year and down 3 basis points as a percent of sales.

Again FX, that $30 million increase would've been $38 million assuming flat year-over-year currency exchange rates.

In terms of membership, we continue to enjoy strong renewal rates, continue to tick up a little bit.

US and Canada for the quarter was up -- the renewal rate through the quarter end was at 90.6%, so first time averaging -- rounding upward, and 87.3% worldwide.

Again, we see continued increased penetration of the executive membership and I will speak about that in a minute.

Overall, new member sign-ups in Q3 were up about 1%.

A lot of that -- sometimes it's up a little, sometimes it's down a little.

It really is impacted by, particularly by some of the Asia opening schedules where we hit outsized new member sign-ups.

In terms of members at year-end, at year-end --- I'm sorry, at Q3 end, at the end of the third quarter Gold Star members totaled 30.6 million, up from 30.1 million 12 weeks earlier.

Primary business 6.8 million, up from 6.7 million 12 weeks ago, and business add-on was steady at 3.5 million.

So all-told, member households 40.9 million at Q3 end, up from 40.3 million at the end of second quarter.

And including the add-on cards, the extra card, total cards outstanding 74.6 million at Q3 end, up from 73.4 million 12 weeks earlier.

At May 11, Q3 end, paid Executive memberships were just shy of 14.4 million, representing an increase during the quarter of a little over 300,000 new Executive members or about 26,000 per week increase in the quarter.

Executive members continue to be a little over a third of our member base and a little over two-thirds of our sales.

As I mentioned earlier, our renewal rates have continued to tick up.

Business members at Q3 end were at 94.4%, up from 94.3% renewal rate 12 weeks earlier.

Gold Star 89.7%, up from 89.6%.

So all-told 90.6% versus 90.4%.

And worldwide I mentioned the 87.3% number.

That was up from 86.8% 12 weeks earlier at the end of Q2.

Continuing down the income statement to gross margin, gross margin year-over-year in the third quarter came in at 10.62% of sales, down 5 basis points from last year's 10.67%.

If we jot down the following little matrix, then I will explain it; I will walk through it.

There will be four columns and six line items.

The line items would be core merchandising, second line item would be ancillary businesses, third line item would be 2% reward, fourth line item LIFO, fifth line item would be other, and then the total would be the sixth line item total.

The four columns would be reported in Q2 2014, the second column would be without gas deflation in Q2 2014.

And then columns three and four would be for Q3 2014 both columns and again reported and without gas deflation.

So again, going across those four columns: core merchandising was minus -- was plus 1 basis point in Q2 2014 on a reported basis year-over-year, without gas was minus 1, for Q3 it was plus 9 and plus 7. Ancillary businesses were, again reading across the four columns: zero, zero, plus 1, and zero.

2% reward, minus 1 and minus 1. And then for Q3 2014, both recorded and without, would be zero and zero.

LIFO minus 6 and minus 6, and for the Q3 2014, minus 8 and minus 8. Other zero and zero, and Q3 2014 would be minus 7 and minus 7. So all-told it was minus 6 basis points year-over-year in Q2 2014 on a reported basis point -- on a reported basis.

In Q2 2014 without gas deflation it was minus 8 basis points total and then in Q3 2014 recorded and without would be minus 5 and minus 8 basis points, respectively.

So as you can see, the overall reported gross margin was lower year-over-year by 5 basis points, minus 8 without gas deflation.

However, our core merchandise gross margin was up year-over-year both with and without gas deflation of 9 and 7 basis points, respectively.

For the third quarter on the merchandise categories on sales, food and sundries gross margins were up about 20 basis points -- were up in the 20 basis point range year-over-year, while hardlines and softlines were in the high single-digit basis points increase range year-over-year.

Fresh foods gross margins was just slightly lower year-over-year, less than 5 basis points delta, which is actually an improved -- a relative improvement from recent quarterly performance in that area.

LIFO, in the third quarter we recorded a $12 million, or 5 basis point, minus pretax charge in the quarter.

That compared last year Q3 of an $8 million or plus 3 basis point pretax credit due to deflation a year ago.

So year-over-year it was a $20 million swing or about $0.03 a share.

In terms of inflation, LIFO if I looked at just -- as one representative factor in that data point in that, if I looked at our US inventories looking at the LIFO calculations Q2 end versus Q3 end, in the 12 weeks there was about a 0.25 percentage point delta in the LIFO index.

With foods, not food sundries but canned goods and the like, it was up a little over 1% during those 12 weeks.

Lastly, Other.

Last year in the quarter gross margin benefited from a non-recurring legal settlement received last year in Q3.

This accounted for about a 7 basis point minus swing year-over-year, both with and without gas.

There was a little over a $17 million pretax benefit last year in Q3, again related to this legal settlement, which was about right around $0.025 a share.

Moving down to the SG&A, our SG&A percentages were higher by 4 basis points year-over-year, coming in at 9.86% of sales this year compared to a 9.82% a year ago.

As I did with gross margin, I will ask you to do the four columns.

First two columns are Q2 2014 and Q2 2014, both reported and without gas deflation, and then Q3 2014 and Q3 2014 reported and without gas deflation.

The five line items would be operations, then central, then RSUs or stock compensation, then quarterly adjustments, and then total.

Again, going across operations, the first number would be minus 12 basis points, meaning that in Q2 2014 year-over-year the core represented a 12 basis point increase year-over-year in SG&A.

Then a minus 9 and then in Q3 2014 those two columns will be a plus 3 and a plus 5, or the core operations was improved by 3 and 5 basis points, respectively.

Central, going across the four columns, zero and zero and then minus 2 and minus 2, meaning a little higher year-over-year.

RSUs minus 1 and minus 1, and then in Q3 minus 5 and minus 4. There were no quarterly adjustments, so in that fourth line item it would be zeros across.

And then the final column, the total -- the final row, the total, minus 13 and minus 10.

And in Q3 2014 reported SG&A again was higher year-over-year by 4, so minus 4 there.

Without gas a minus 1.

In terms of a little editorial on these numbers, the operations component of SG&A again was 3 basis points better year-over-year in Q3 and 5 better, excluding gas deflation.

Within warehouse operations, our payroll as a percent of sales was lower year-over-year or an improvement by about 5 basis points.

Total payroll dollars increased a little over 5% in Q3 compared to that 7% total sales increase.

Benefits of workers comp hit SG&A by about 3 basis points year-over-year, so that was a little bit of an offset to that improvement.

Our central expense, it was higher year-over-year in Q3 by 2 basis points, which is actually the same number as related to the ongoing IT modernization.

Incremental modernization cost, that was about a 2 basis point hit to the quarter.

There are a couple other things that went both ways, but those were -- that would be the one thing I would point out there.

Next on the income statement is preopening expense.

Preopening expense was up $6 million from $10 million last year in Q3 to $16 million this year.

We actually had one more opening last year, five last year versus four this year, although that timing of that relates to both things after the quarter as well.

I might also point out, of course, for the opening of Spain you always have a significant preopening expense related to the opening of the country itself in that first warehouse.

That was about $4 million of that $16 million number for Q3 this year.

All told, operating income in Q3 2014 came in at $737 million, higher by $15 million from last year's $722 million.

Below operating income, interest expense came in at $25 million in both this year's and last year's fiscal third quarter.

Over 95% of it relates to the interest expense related to the 10-year maturing $1.1 billion debt we have that matures in 2017, and the $3.5 billion of debt that matures over the next two to six years that we did back in December of 2012.

Interest income and other was lower year-over-year by $3 million, so coming in at $15 million last year relative to this year or this quarter of $12 million positive.

Actual interest income for the quarter was higher by $2 million.

The other component of interest income and other amounted to a $1 million positive this year versus a $6 million positive last year, so a minus $5 million swing.

The majority of this negative variance relates to the negative impact of mark-to-market adjustments on forward FX contracts used to source US goods in certain foreign operations.

Swings are caused by changes in the US dollar relative to local currencies, local currency in certain foreign locations as compared to the prior year.

We just pointed it out as part of that impact; sometimes it's a little positive, sometimes it's a little negative.

Overall pretax income with higher year-over-year by $12 million in the third quarter coming in last year at $712 million and this year up $12 million to $724 million.

In terms of income taxes, our tax rate this quarter came in a little better or lower at 33.9% versus 34.8% last year.

This was primarily due to the higher year-over-year penetration of profits coming from our foreign operations, which overall have lower tax rates than in the US.

Overall reported net income of $459 million last year compared to the $473 million of net income this year in third quarter.

For a quick rundown of other topics, again the balance sheet is included in this morning's press release, but I will point out a couple of balance sheet info items.

Depreciation and amortization for the quarter was $237 million and so year-to-date $708 million.

AP as a percent of inventories came down 2 to 3 percentage points.

On a reported basis it showed last year 102% accounts payable as a percent of inventories.

This year 99%.

If you look at just merchandise payables, not other types of payables like construction payables, last year in Q3 that 102% was a 91% and this year 91% comes -- went from -- is an 89%, so still down a couple percentage points year-over-year.

Average inventory per warehouse was up about 7% on a per warehouse basis, coming in at $13.0 million this year, up from $12.2 million last year.

The increase was pretty much spread over many departments.

Apparel was probably the biggest delta, the men's, women's, and children's apparel was up year-over-year about a little under $200,000, and foods and candy was up about $150,000.

Overall, though, we feel our inventory is in good shape and not a whole lot to talk about there.

In terms of CapEx, in first quarter we spent $574 million, in the second quarter of this year we spent $447 million, and in the third quarter just ended we spent $405 million.

So Q3 year-to-date we are just a little over $1.4 billion.

Our estimate for the year for CapEx will come in at about $2.2 billion compared to last year's expenditures for the whole year of $2.1 billion, so up slightly from last year.

In terms of Costco Online, we continue to operate Costco Online in the four countries that I've mentioned in prior quarter: US, Canada, UK, and Mexico.

UK and Mexico, of course, being much newer than the US and Canada operations.

For Q3, sales and profits are up.

Sales were up 16% year-over-year in the quarter, a little impact from again the weak Canadian dollar, but overall 16% on a reported basis.

I have talked about the various things we have done in the last year, year-and-a-half in terms of re-platforming and adding mobile apps and combining some of the e-commerce merchandising buying efforts with some of our line efforts.

We've added a few categories like apparel, some limited apparel items and some limited health and beauty items.

We've started to ship out of more than one depot to improve timing of shipments on some of the bigger ticket items as well.

Outside of e-commerce there's a couple things that in the Internet area or things that we are testing.

I mentioned before the Google test, Google Shopping Express in the Bay Area.

More recently in the last several weeks it's being tested in Los Angeles with several retailers, not just us, but in Los Angeles at our Culver City location and in Manhattan at our Manhattan location.

Those are -- both those two cities are just in the last four to six weeks.

Also, we've tested a few from a membership sign-up standpoint, a couple of social media areas -- social media initiatives with LivingSocial and Zulily.

Next on the discussion list in terms of expansion, again through Q3 end we've opened 20 units and had the current closing of the Acapulco location earlier this year because of the hurricane.

Q4 in total including the few that we have already opened, we would expect to open 10.

So again, 30 openings, less the Acapulco location would be 29 net increase for the year.

So looking back over the last year, year-and-a-half, in fiscal 2013 for the entire year we added 26 units on a base of 608, so about 4.5% square footage growth.

This year, assuming the 30 net new units, it would be a 4.5% to 5% square footage growth.

Again, of the 30 openings this year, 17 would be in the US, three in Canada, one in the UK, two in Korea, and two in Japan, three in Australia, and one each in Mexico and Spain.

As of Q3 end, total square footage stood at 93.7 million square feet.

Next item stock repurchases.

As mentioned on the call, I guess about 12 weeks ago, that we would -- we anticipated we would begin buying back some stock.

We began our recent repurchase activities on March 7. I think that was the day after our second-quarter earnings results were released.

For those nine weeks since then through the end of the third quarter we purchased 1.6 -- a little over 1.6 million shares at an average price of $113.14 for total dollars expended during those nine weeks of $183.6 million.

In terms of dividends, our quarterly dividend per share increased with an A dividend payment from $0.31 a share on a quarterly basis to $0.355, so about a 14.5% increase.

This $1.42 per share annualized dividend represents a total cost to the Company of about $625 million a year.

Lastly, our fourth-quarter scheduled earnings release will be Thursday, October 9. That will be for the 16-week fiscal quarter -- fiscal fourth quarter ending on August 31.

With that I will open it up for Q&A and turn it back to Bridget.

Bridget?

(Operator Instructions) Charles Grom, Sterne Agee.

Richard, good morning.

Just on the core up 7 and then the fresh foods being down slightly year-over-year, just wondering if you could remind us how that fresh foods margin has trended over the past couple of quarters.

And given the inflation that we are seeing today, what is kind of your expectation for that over the next 16 weeks?

I can't give you a whole lot of information about the expectations.

I can tell you a little bit about what's happened the quarter and year-to-date.

If I look year-to-date at those components, fresh foods year-to-date -- do I have that here?

I don't know.

Hold on, I'm looking at the wrong sheet here.

Total consolidated; fresh foods year-to-date was down about 22 basis points and that includes up the -- down the 4 or 5 or sub-5 this quarter.

So for the first half of the year it would have been more than that minus 22.

Okay, so what's the change?

What has changed as part of that?

Is it a little bit of better relief on the pricing front or is it something different?

I think the one thing that I pointed out last is certainly I mentioned historically that we have kept the rotisserie chicken the same price for the last two years, when costs dramatically increased.

We've seen some relief there in the last quarter and so a little of it is that probably.

But that's one item and that's a huge item in terms of this factor.

But beyond that I mean it's a conscious effort to -- we want to be ever-competitive, but we were also trying to show a little margin improvement.

So that's the only thing I could point out.

In general, as it relates to inflation, we tend to be the laggard when there's inflationary pressure.

My guess is that when I looked at the core components of the food and sundries up, but that's where there was some more inflation, there's also some LIFO charge related to that.

Overall, when prices are going up quickly, ultimately we have to raise some of them but we are probably going to be slower than others.

So again that is on a general basis.

Overall, beyond that, I don't think there's a whole lot to talk about in terms of trend there.

Okay.

And then I know you will probably disclose this in your Q, but if you could you shed a little bit of light on your operating margin performance internationally and then also in the US and how that compared to last year.

I think we are still crosschecking those numbers and want to -- that will be out in the Q. Generally speaking, the trends that you have seen continue.

FX doesn't play into those numbers from the standpoint of percentages because FX hits every line item on a Canadian P&L, as an example.

But Canada continues to be more profitable that as a percent of sales than the US, and other international overall tends to be in that direction.

It's skewed a little bit on a smaller base of total units when you open in Spain or you cannibalize some units in a country, but overall I think that it's fair to say that columns 2 and 3, with column 1 being in the US, are more profitable as a percent of sales than the US.

Okay.

Then just last question; in April you called out the state of California as improving, the entire state.

Just wondering if you could elaborate on that improvement.

Do you think it sustainable and I guess what do you think was driving it?

I don't know -- it's sustainable so far.

I don't know in the future.

When I called out just geographically some of the numbers, I think California -- again the ones that were -- I called out were Southeast and Midwest.

California actually was a little better than the Northeast and the Northwest, pretty close to the total for the Company.

So overall I would say California continues to do a little better than -- given its maturity and size.

I can't tell you why, though.

All right.

Good, thanks.

John Heinbockel, Guggenheim Securities.

Richard, just a quick follow-up on the inflation question.

A number of companies have said in the last four to six weeks they have seen a sea change in some items; it's all perishable.

Have you seen anything like that or what you are seeing is more gradual?

Well, when I look at just again the various LIFO pools for US inventories, which is one indication -- the LIFO pools of course are the cost pools, back-like items year-over-year.

And again, you start the new year at a cost of 100.00 for everything.

If I look at what I will call the foods pool -- this is not fresh foods but it's canned goods, cereal, all types of food items like that -- that's up a little over 2.5% from the beginning of the fiscal year.

And the last quarter and the last 12 weeks of these 36 weeks it is about 1.2%, so almost half of that delta.

Yes, that's into the sea change.

I haven't looked at that closely in fairness.

When I look across items in terms of inflationary items -- again I'm just shooting down the list, looking at the top 25 most impactful items to our LIFO calculation -- there's several nuts on there -- almonds, pistachios, walnuts -- all in the high teens to low 30s.

There's some seafood items.

There's -- generally speaking, those are the types of items.

There is some -- few produce items.

That tends to be item-based not all produce-based based on where a drought or a freeze or a rain was.

On the deflationary side, it's the usual suspects, a bunch of electronics.

Not a whole -- that's a lot of the items.

A couple of small apparel items.

Okay.

Again, I guess beef in total would be a bigger -- is that a bigger sales item in total than your chicken products?

Sure.

Yes, beef overall I think in the last -- beef prices are up 10%-plus in the last quarter on a year-over-year basis.

So, yes, clearly there's more inflation in that.

I think on the poultry side there has been some inflation, but we were successful in locking in some stuff as well a little earlier.

Another topic on payrolls, you said up 5% dollars.

What has the trendline been on that?

It actually seems like a pretty good performance for you.

Are you doing anything different process-wise in the clubs to try to tweak that a little bit?

I don't have it in front of me, but I think the last few quarters, when I pointed out payroll, that has generally been a slight benefit basis point wise, which would indicate the dollars increase a shade less than sales, total sales increase.

I think, first and foremost, it's sales driving the top line is our biggest benefit.

Beyond that, there continues to be a focus on things like overtime hours, lots of little things like that.

I don't know if there's any giant process changes in the warehouse of late that I can think of.

Because that is the total number, right?

If you looked at payroll and comp clubs it would be up less than that, right?

I'm sorry, what was that?

The 5% is a total number.

If you looked at it on a comparable basis it would be less than that.

So when you think about at least on a labor [percent] what comp do you need to get leverage, you can get leverage on a lesser comp than you have been getting.

Fair?

Yes, probably a little higher than some other retailers, but that is a little lower than it has been historically for us.

We also probably get little benefit from increasing penetration overseas, where as a percent of sales it is a lower labor percent.

Okay, then just one last thing.

Monthly coupon book performance, just curious; you have been doing a much better job in the clubs signing in the club what items are in that coupon book.

Has that done anything to performance of the items in the book or, no, not really?

I would like to find out how you concluded that, first.

Look, they keep working it.

It's a challenge.

We have done it for a lot of years.

I think we have, first of all, gotten better at timing and such that they are easier to manage, both by the buyers and having it essentially -- usually like a week in between them to give the warehouses time to move out what remnants are left than the old MDM and being able to bring in the new stuff.

Again, overall every time you do an MDM you have more experience about something that maybe has petered out little bit because we have been running it every year or every six months.

And other things that did surprisingly well, but perhaps even on a regional basis that we want to push everywhere.

So, as you might expect, we work with our vendors on that, figuring out how to best spend that money to both ultimately drive sales.

Yes, my comment was just that on the shelf itself I'm seeing more this item is in our coupon book this month, which I hadn't seen going back a few months.

Fair enough and you're right for that.

I agree.

Dan Binder, Jefferies.

Good morning.

Just had a few questions for you, first on inventory.

You have seen inventory tracking a decent amount above sales the last four quarters or so.

The clubs look clean, at least the ones I visit.

I'm just curious what the driver is.

Is it the new clubs?

Is it dot-com?

Maybe a little bit of color on that.

And then also I know you had an amazing turnout for job applications and staying curious what the early days are looking like in that club.

And then, finally, on the IT spending I imagine you probably have a pretty good idea of what that looks like for Q4, so should we expect a similar set of 2 basis point incremental impact there?

On inventories is the question related to where are the increases coming from?

Yes.

I think clearly we have -- yes, we do have more inventory in e-commerce because we are now shipping out of more than one location, but that is relatively small to the total when I look at the total average per location.

Again, the big areas was a conscious effort on our part in apparel.

One of, I think, our successes that we talked about for the last several quarters is massing out and making bigger commitments to some items that have done -- what I will call fashion basics, but everything from true basics to seasonal items like shorts and bathing suits.

And KS items.

We've done really well in some of those items, so we have certainly committed more inventory to that area.

By the way, that area tends to be usually in the middle center area where we have shrunk some areas like media over the last few years.

As it relates -- what was the next question was?

Just early days in Spain.

Well, Spain, so far so good.

We are only open for two weeks.

We have had good sign-ups, not like Japan and Korea, but very good in our minds.

And we are pleased with the results so far in terms of sales and it's growing.

You're going to get small baskets when people come in for the first time, but we were pleased with the results.

I really don't want to be cute either way.

It's so far, so good.

And the last question related to IT, if you had asked me before I said minus 2 a couple weeks ago, I would've said it's probably minus 3 just because it tends to be in that 3 to 4 range on average.

It's probably in the minus 2 to minus 3 range next quarter, but we will have to wait and see.

Starting near the end of the quarter and into Q1 of 2015, there will be a couple of projects that go online and because you depreciate -- you capitalize those and then amortize them over typically a five-year period, sometimes a little less, sometimes a little more.

Up to seven and generally no less than 3, but I would say five is a good single-point average.

My guess is they will tweak up a little bit again.

As I've said, our best guesstimate over a three or so year period in terms of incredible impact to SG&A would be 10-plus basis points.

If we look now, I think this is about the seventh fiscal quarter we've talked about it, if I had to average -- you look at all of fiscal 2013, those four numbers and annualized the three quarterly numbers this year, we are probably in the 6 or 7 basis point, 5 to 7 basis point range incremental.

And we probably have another 3 or 4 to go after that.

So this is a guess and a decent estimate, but we will wait to see.

Great, thank you.

Meredith Adler, Barclays.

Actually my question has been asked already.

Thank you.

Matthew Fassler, Goldman Sachs.

Thanks a lot and good morning.

Two questions, the first, Richard, relates to online.

If you could give us a sense as to what your members are asking for more of.

It sounds like you are evolving the mix; are there areas where you would expect to grow the assortments incrementally based on member demand?

I think the areas that we have grown over the last year relative to prior to that have been some limited apparel items, some health and beauty aid items, and perhaps some other replenishable office items.

K-cups, health and beauty aids, but some small office needs.

As you probably are aware, for the first many years many of our items were big ticket and in many cases deliverable, and in some cases white-glove installed items like a big screen TVs and patio furniture and swing sets and the like.

And so certainly some of those -- and furniture.

Some of those are still our biggest categories for, one, they've been on for longer and, two, they are bigger ticket items.

We are, in our own way, looking to see how we can get items on there that are more regular and frequent and get people to come to Costco.com.

I think we are doing better -- a little better with signage even in the warehouse with certain items.

Somebody doesn't want to necessarily have to [shuffle] it home and install it.

They want to -- they are willing to pay for that delivery and certainly our prices are very attractive even on that basis.

Just a follow-up on that.

As you think about the vintage of member that's doing business online, is there a difference between those who've been Costco members for many years and maybe those who are newer to the Company?

Well, generally speaking, newer to the Company means less and less purchases.

Certainly when we get a new sign up online because they are buying online I would say generally they tend to be lower.

I don't have exact numbers there.

When we have done -- when we have looked at the age breakdown of our members based on how long they've been members or throughout the United States, and we look at new member sign-ups through a couple of these social media things that we've done in recent months, it is what you would expect it to be.

You've got a younger member signing up through LivingSocial and through Zulily, so -- and it's a relatively attractive cost of acquisition.

We are not going crazy here.

We are taking baby steps, but some of this stuff works.

That's very helpful.

Thank you so much.

Jason DeRise, UBS.

I wanted to ask a question on the margin decision on some of the food items that you sort of have a fixed price.

I guess I just want to understand the rationale for not changing those.

And the comparison I want to make, whether it's fair or not, is that your fuel prices are not a fixed price and it varies with what's happening in the market.

So why not with rotisserie chicken and hot dogs and things like that?

Well, that's like behind the black curtain here.

Look, at the end of the day -- first of all, I want to make one other point about the previous question as it relates to -- well, I will stop on that.

Let's get to your question first.

In terms of fixed items, in retail there are price points that are hot; the $1.50 hot dog and soda.

We didn't sit down one say and said let's decide that the rotisserie chicken should be it, but as prices changed dramatically and we saw the competition raising the price, it was a hot price.

Let's take a little less margin, take a little less margin, take little or no margin.

And so I think there are a few examples of that extreme.

Gas historically has always been an item that there's some locations where we comp shop the price three or four times a day compared to the locations nearest us.

So it tends -- I think it's just the nature of retail and the nature of what we do.

We don't sit down and try to optimize everything.

We are merchants; there are key price points and that's how we do it.

Okay.

Gas, by the way, is a lot more volatile and a $12 billion or $13 billion business for us, but it's very visual out there.

People -- you go to some of these apps like GasBuddy.com, there's a reason that we are comp something that item in some locations three or four times a day.

Okay.

No, I know it's an unfair comparison but I thought -- I don't know, just help try to understand the thought process between things like that.

I guess as the follow-up on the last question, maybe it will get you continue to follow up on the answer to the last question.

But as you do these -- as you try out social media or the LivingSocial type promotions to get younger members to sign up, how do you manage with the limited number of SKUs to keep both your core boomer shopper happy and then also have enough relevant items for a millennial shopper?

Or do you think that doesn't matter?

Well, we will have to wait and see.

We are not going to keep our head in the sand on it, but extreme value works.

And again, to follow up on the previous question, what I was going to mention was the test that we are doing with Google now in three major markets -- in the Bay Area, LA, and New York City -- arguably those -- if you look at the age breakdown of those, it's younger.

That's a positive.

Now we are never -- I don't think we are ever going to get your one box of Life cereal and one box of Fruity Pebbles and two different types of half gallons of milk delivered to your doorstep at six in the morning, but there's a lot of things that we have.

We have certainly changed and, frankly, expanded the items out of the locations in the Bay Area, and you will continue to see that.

So we are excited to see what the Instacarts and the [boxes] are doing as customers of ours, but they are small, they are new, and there is going to be a lot of things.

So I think there's still a lot of reasons -- not everybody wants to just sit home and type in stuff to have it delivered in the morning.

People like to go out and do stuff.

We are pretty good at getting you in the warehouse, and we will have to evolve over time as well, but there are certain things in our model.

There's a reason that we are able to markup goods on average 11% on arguably buying power that is at the top of the heap in terms of shrink and that all is good.

We are open-minded, but don't expect us to deliver to everybody's doorstep.

If others want to, we will be happy to accommodate and help them do that with our stuff.

I mentioned this last time, and jokes aside, organic is getting bigger.

Not just for us, but for everybody.

But again, just like we wow people in our produce -- members in our produce department with great quality on slightly oversized items for families, that whole organic thing is arguably -- again, I don't think we sat down and strategically thought about it.

We look at what items work well and try some things and when it works, we really go after it.

And we've seen surprisingly good success on organic and produce and fresh meat and fresh ground beef.

The challenge is the supply, frankly.

There's not enough supply, but if we can show great value, we will figure it out.

Okay, and actually that was what I was going to finish up on as an example of something for a younger consumer based on the demographic.

So you think that when you put these items on the shelf like organic compared to conventional, you are getting enough rate of sale that all the economics from your point of view work; or if it's not quite that level, you are willing to stick with it?

Well, first of all, the level of economics are still on an item basis.

As we said, there's less supply.

We just don't put it in all the locations, and we'd love to have twice as much in some locations.

But items live and die around here since the beginning of time, since 30 years ago, and certainly some of these organic are really starting to take off.

I think so far, one of the benefits that we think we have had -- I think I mentioned this before -- not only in some cases -- I think I've used like the fresh ground beef example of organic.

It's a higher price point.

We get a slightly better or full margin, by our definition of full margin because it's not football every day out there at every supermarket chain.

And to our pleasant surprise, 75%, 80% of these sales of this new item was truly incremental.

It was existing members that didn't buy ground beef at Costco because they did buy organic, and so it was incremental.

So now these are all small examples, but they're going to grow over time.

Great, thank you.

Peter Benedict, Robert W. Baird.

Richard, a couple questions.

First, can you talk about the level of new member sign-ups that you guys tend to see when you open up a club internationally versus what you see in the US?

How dramatic is that difference?

Well, I don't have exact numbers in front of us, but when we are in a well-penetrated very successful market like LA, or parts of Virginia and New York, you might have -- what we look at is during the 8 to 12 weeks prior to opening when you've got the parking lot partially done and there's some tabling activities outside where people can come and sign up, you might have as few as 3000 or 4000 new sign-ups through those 8 or 12 weeks.

In a new small market like somewhere in the Southeast like Louisiana, Baton Rouge or New Orleans, or Knoxville a couple of years ago, you might have 8,000 to 12,000 because even though it's a much smaller market, it's new.

We have had some extreme examples during those first many weeks prior to and through opening day of 30,000 to 40,000 members in some of the Asian countries.

It's somewhere in between there for Spain and Australia.

So better than the US, but again the benefit is when you open it up in an LA, Huntington Beach a few years ago or something like that, you may have fewer net new sign-ups but you're getting -- you get existing members that are going to shop more frequently because they've got a unit 10 or 15 minutes from their home instead of 30 minutes.

Okay, that's helpful.

Then there was no gross margin headwind from the Executive reward, 2% reward this quarter.

What's happening in the spending patterns between your Executive members and your regular Gold Star members?

Are the Gold Star members kind of picking up incrementally?

And just remind us where you have the Executive membership being offered and what countries you don't have it, and where you don't have it what are your plans for getting it there?

Thank you.

Theoretically, our plan is to put it wherever we can and it makes sense.

I don't know if I know off the top of my head where else it's going.

Currently we have -- let's see here -- US, Canada, UK, and Mexico.

And I know we are looking at a couple of countries, but I'm not going to say when.

My guess is in the next year or two we will have at least one more country.

Part of it, of course, is based on size and number of warehouses and number of members in that country.

We want to get a handful of offerings going -- to be able to go with a handful of offerings to start with.

I don't think the delta: one, as we've opened -- there's probably a little more sales penetration in some of those new markets.

There is international markets where we don't have it; that probably impacted little bit.

I'm not terribly concerned.

It has generally been in the 1 or 2 basis point delta year-over-year in terms of how that reward impacted it.

This time it was at zero.

I don't know off the top of my head -- I haven't heard anything or seen anything at the monthly budget meetings about any concern about that.

If anything, we are continuing -- my one surprise yesterday or a couple days ago looking at these numbers was the fact that we probably -- the 25,000 or 26,000 new Executive members, new and converted Executive members per week during the quarter is a little higher -- certainly a lot higher than Q2.

I think a little higher on average than the last several quarters on average.

So we are still getting a lot of people to convert and that's good.

That certainly looks like that trend continues to be healthy.

It looks like the Gold Stars are definitely doing better.

Last question, just early thinking on your openings for 2015.

If there's not a number maybe just kind of a geographic split how you are thinking kind of international versus the US, thank you.

I think it will be similar to this year, 30, maybe -- hopefully a little -- 30 plus.

I think I mentioned this year, if we get to the 30, it's going to be 17 in the US, so a little more than half.

I would guess half is -- 45% to 52% or something next year, not 55%.

But overall we still think we've got opportunity in the US and Canada and other markets that are seemingly well penetrated.

But we definitely have the pipeline more filled overseas now.

If I had to guess, it will be a number north of 30 and south of 34.

Okay, thanks very much.

Scott Mushkin, Wolfe Research.

Thanks, Richard.

Thanks for taking my question.

It's actually more of a big picture question kind of going back to some of the e-commerce discussions and just noting that one of your biggest competitor's CEO is on record yesterday saying that, if consumers just don't want stores, maybe we won't have stores, when talking about kind of the trajectory here in the US in e-commerce and whatnot.

Now maybe that is because his stores aren't performing as well as yours.

So I guess one of the things I'm wondering is you could say that's Costco doesn't have as well developed of an e-commerce platform.

You could also say that a lot of stuff you guys carry Amazon has been pretty aggressive in, yet your stores are doing great.

Why do you think that is?

What is the number one reason you think you are overcoming maybe demographics, e-commerce, and really just putting up some of the best sales in retail?

Well, I think you've mentioned some of them.

It is merchandising, it's quality, it's quantity relative to price, it's extreme value.

Arguably, our demographic is probably -- I don't think you need to be an economist to understand that our demographic has probably been impacted less than the lower demographic retailers.

Clearly, gas brings you to the parking lot and our fresh foods is a signature category.

Fresh foods is something, jokes aside, if you like our rotisserie chicken or our whole-meal replacement items or any of those great fresh food items or organic produce, it's a reason for you to come in.

And if you walk by the sweaters and the batteries and the patio furniture and the activewear, you are going to buy some more stuff.

So we think that, again, delivering small quantities of stuff to home is not free.

Ultimately somebody has got to pay for it, and if we are going to lose sales over time to some of that, we will figure out how to not lose as much and how to drive sales in other ways.

I think we've been pretty good at that.

But starting with an average markup, an average gross margin of 11%, which is incredible -- nobody comes close to that, I think we will be pretty good.

But we are also open.

Without trying to put any fluff in it, we like the fact that it has been exciting to work with a Google to look at -- with opportunities to drive business and to drive business that might go somewhere else.

Some of these other new companies that are doing things and using us as part of their platform to pick up and deliver to members at a small cost, that's great.

So we will keep figuring that out, but hopefully there's also some items that we only have.

Usually that starts with the name Kirkland Signature or some crazy items that we only have that somebody bragged about that they can get at Costco, whether it's some incredible price on a branded handbag or bicycle or a kayak or whatever.

So there's all kinds of reasons to come into Costco.

That's a terrific answer.

When you think about your own e-commerce business, how do you prevent it from basically cannibalizing the heck out of your own stores?

We've used it before, but we've been using most of your e-commerce for like furniture, stuff I would never get at your warehouse.

How do you guys think about it as you grow this business and how it doesn't just cannibalize yourself and take your ROICs down?

Well, I get back to the question is if somebody going to take that business, we would rather take it.

We also recognize that I will call it the good old days when you only had -- there was no such thing as the Internet.

You only had one choice; if you wanted to get that TV or that patio furniture at that price, you either find a friend with a pickup truck or go get a U-Haul and get it home.

You have choices now, and so we do believe that we are selling some of those items that would not be -- would not have been bought in-store.

Not everybody is going to take those big-ticket items home that way.

So we have to change when the time is there, but we also recognize we also have to get you in on increasingly -- hopefully increasingly frequent basis so you pass by all those items that you go wow.

And I think so far we have done pretty well at that.

Indeed.

Thanks for taking my questions.

I appreciate it.

Greg Melich, ISI Group.

Thanks, I wanted to follow up on the membership fee income.

If my math is right, it was up a little over 7% in local currencies and so -- is that right?

[It's up] about 3% per club.

Yes.

Greg Melich Could you help us understand what's driving that 3% per club?

Is it an Executive membership shift?

Is it international?

What is the bulk of that up 3% per club?

Executive membership is a good chunk of it.

On an international basis, again I would have to analyze it a little more.

There's more sign-ups per location, although in some countries converted into dollars it's a little less than 55, and of course, we don't have 110 in some of those countries.

So I think it's probably the fact that we do get more sign-ups internationally is probably the biggest reason.

But you think Executive is still a bigger portion of that than international if you had to --?

(multiple speakers) will follow?

If I had to guess I would probably say half-and-half.

I just don't know.

Fair enough, fair enough.

Given the renewals internationally continue to improve, is there a threshold or how should we think about raising the fee in markets outside the US, given that we sort of know how it works in the US, the five to six-year pattern?

How should we think about either a threshold or renewal rates or members per club where we start to model that in on the international side?

You know, I don't know.

We don't talk about it a lot.

We like the fact that in new markets -- and recognizing these new markets are also much smaller percentages of our total company -- let's work to just drive business and drive sign-ups and we can worry about a little of that later.

And so there's -- we look at it every year or so, but spend all of about 10 minutes looking at it, and we will see in the future.

I mean it; I don't see any current plans that make any major changes out there.

So fair to say the focus internationally is still getting the sign-ups rather than trying to take the fee up?

Yes, I think that's not even on page one of a 25-line page.

The first order of business is opening units and getting them to work right.

Even in very successful countries and even with the support of its parents in the US, us, when you are going from nine to now 20 units in Japan over to a little over two years and going from three to six locations in Australia in a little over a year, a year-and-a-half, there's challenges.

Nothing major, and believe me, I think we have some -- every week there's somebody from one of my departments going over to help out on something somewhere, which is good.

But at the same time, you will always have some growing pains with that kind of stuff.

Great, and then a little bit of a housekeeping.

I think on the SG&A you mentioned workers' comp hurt 3 basis points.

Is that --?

Actually benefits of workers' comp.

I think workers' comp was actually flat to a very slight improvement year-over-year as a percent.

Benefits was the bigger culprit.

Benefits was the culprit; workers' comp helped.

Was there anything -- so that was a net figure, the 3 basis points was benefits and workers' comp?

I think it was like 4 and 1, plus 4 and minus 1. But benefits and workers' comp we kind of always summarize together.

Got it and that benefits trend looks like it's sort of an ongoing thing as opposed to anything (multiple speakers)?

The one thing that helps it; we read about hospital costs becoming less inflationary in the US.

We and I've talked to a few other different types of companies at a recent meeting outside of Costco and we are not seeing the low numbers.

I think maybe on a per charge at a given hospital or a given doctor some things might be lower if it's only through the Medicare system, as an example.

But some of the things that have been added, like the 26 year old, up to 26 year old instead of 18 to 22 based on if your kid is in college or not, your dependents, on mental and medical health parity, on no limits.

All these things have added 1 and 1.5 percentage points to an already large number.

The thing that is, frankly, going to help us more than that, whether inflation is 5% or 10% or 3%, certainly if it comes down in the mid to lower single digits that's a positive for us.

But the bigger thing is the increasing penetration outside of the United States where healthcare cost as a percent of sales, respect to sales in that country is a lot less.

Got it.

Then, lastly, on the gross margin.

I think last quarter you talked about some of the gross margin, about half of the hurt was self-inflicted or something you decided to do.

It sounds like this was a quarter where you didn't -- you felt that there was -- you didn't need to decide to do that again.

Am I summarizing that correctly?

Again, I used the extreme example of the chicken.

Again, we went from two years of an item that arguably represents several hundred million in sales of having very little if any margin to indicating that as underlying costs have come down a little we didn't change the price, but we improved the margin a little bit.

It's one item, but it's one item that probably impacted us incrementally by 3 or more basis points over the last couple of years and is now helping.

Some of that is reversing; not all of it.

And we, again, a little increasing penetration overseas helps you a little bit.

All right.

Thanks, Richard.

We don't try to get lower margin.

We try to get lower prices, but we still look to see where we can get a little.

Thanks.

Chuck Cerankosky, Northcoast Research.

Good morning, Richard.

If we are looking at what proteins are doing, especially some of the strong inflation we are seeing in certain categories, how are you seeing your members switching between those?

And what is that doing to your gross profit margin in the edible protein category?

I think from the last budget meeting there was some switch from beef to poultry, as you might expect, with the rising prices in beef.

I don't have an exact number on it.

I look at overall fresh foods margins.

Again, like with beef are down but dollars are up because of the price.

I don't know off the top of my head, Chuck, that detail.

All right.

And then just a quick follow-up with regards to Spain, anything worth pointing out there with regard to the product mix as you open up that's unique to Spain?

The pictures that I saw, there are certainly some unique local items to Spain and Europe, but generally speaking, many of the pictures that I saw looked a lot like a Costco that you would see.

As you might expect, like any opening, and certainly like a new opening in a new country, there are probably a lot of hot non-food items where we were able to procure merchandise and really show great value of exciting stuff.

But I'm shooting from the hip with this answer.

Got you.

We both need to get over there.

Fair enough.

Well, there's Madrid coming up.

Thank you.

Chris Horvers, JPMorgan.

Thanks, couple quick model questions.

So by the nature of the LIFO calculation, you had a 7 basis point benefit last year in the fourth quarter.

Just by the fact that you have a benefit, does that end up being a negative this year in the fourth quarter?

No, that negative related to how it was versus the year before that, but we would now start with that base of cost, if you will, a year ago.

Really just start with the basis at the beginning of this fiscal year.

And so how do prices trend?

Again, using an index of 100.00 at the beginning of -- times zero at the beginning of the fiscal year and let's say through the end of the third quarter -- I mentioned as an example like what I will call the food and sundries pool, or what we call the foods pool, which is canned goods and cereals and things like that, from the beginning of fiscal year it was up 2.6%.

It may go up or down a little in Q4 from that 102.6% number.

It might be -- if it went down a tenth it would be a LIFO credit in the quarter, even though that was a small offsets to the big LIFO charge year-to-date through the first three quarters.

So it's really -- if you think about it, what's going to happen in Q4 is what the index was for all the pools at Q3 end and what it will be 16 weeks in.

But you mentioned that it was -- I understand, so sequential.

You also mentioned that price has accelerated in the back half of the quarter, so it sounds like it's more likely to be a negative.

You know, it could be, but -- it probably will be, but I just don't know.

Okay.

Then on the buybacks, you bought back 1.6 million shares.

The share count ticked down 0.1 sequentially.

So just curious, was that more based on the timing of the buyback during the quarter or was that -- was there more of a big impact from the stock option exercising?

There's not a whole lot of stock option exercises.

In fact, they are using the Treasury stock method, that's kind of implicit in the number anyway, for options.

If you have a big in-the-money option, which our remaining small amount of options that we were granted in 2005 I believe, so they expire in 2015 -- 2004 and 2005 so they expire this year and next year, we are down to a very few left.

But if you had -- making the math simple, if you had a $40 exercise price on $120 stock price, for every option out there you would exercise three of them and then buy one share back so there would be a net increase of two shares.

So that kind of number is not a big number.

We have bought stock during the quarter, relatively speaking, proportional during the course of the period.

So if it was 1.6 million shares my guess is that the rough subtraction to the total shares outstanding would be about half that number, about $800,000.

We said the calculation only went down $100,000; it would be some additional vesting since then on our issues.

And to a very, very small extent, to the extent the stock price was a little higher versus a quarter ago -- and I don't know if it was or wasn't -- that would maybe impacted (inaudible).

But the big things would be roughly adding 800 and then subtracting -- I mean subtracting 800 and then adding some due to just ongoing vesting of previous grants.

I got you.

Then last quarter you talked about your intent to buy back more stock.

Any thoughts on going forward here?

No, other than we have started.

Again, I don't want to be cute or coy.

We continue to buy a little, but we are not suggesting that -- if you took the exact -- those nine weeks times those shares, I think you get to a number in the $900 million a year range.

I don't know if it will be less or more than that next quarter on an annualized basis, but it could be a little less.

We will just see.

It probably is either a little bit less or a little bit more, but not a whole lot different.

We will see.

Okay.

Then last one, just in terms of you had the Spain pressure and the preopening, as you look forward is sort of pre-open per store normalized back down to levels that we've seen historically?

Say that again?

I'm sorry.

The pre-open, if I look at pre-opening expense, it ticked up partly because of Spain.

As you look going forward, does the pre-opening dollars per store go back down to more normalized levels?

Yes, generally because it was clearly skewed because of Spain.

To the extent that we opened more international, they tend to be a little higher, but assuming we open France next year -- and again we don't know when that I will happen -- there will be another little tick upward in that quarter.

Understood.

Thanks very much.

Paul Trussell, Deutsche Bank.

It's actually [Matt] for Paul.

A lot of our questions have been answered, but I was just curious on online, with some of the newer countries you are entering, do you have a different plan in terms of the rollout of your online platform relative to the stores that you kind of done historically?

Thanks.

Well, I know we are looking at other countries to open in, countries where we operate, but I don't know if there's any -- we haven't stated anything about when.

Thanks.

There are no further questions at this time.

Thank you, everyone, and thank you for joining us.

Thank you.

This does conclude today's conference call.

You may now disconnect your lines.