好市多 (COST) 2014 Q4 法說會逐字稿

Good morning.

My name is Brandi and I will be your conference operator today.

At this time I would like to welcome everyone to the Costco fourth-quarter earnings conference call and year-end conference call.

(Operator Instructions) Mr. Richard Galanti, CFO, you may begin your conference, sir.

Thank you, Brandi.

Good morning to everyone.

This morning we reported our 16-week fourth quarter and 52-week fiscal year 2014 operating results, both which ended on August 31.

These results are compared to the similar 16-week and 52-week periods in the prior fiscal year 2013, which ended last year on September 1.

In addition, we are reporting this morning our September sales results for the five weeks ended this past Sunday, October 5.

I will start by stating that the discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and that these statements involve risks and uncertainties that may cause actual events, results, and/or performance to differ materially from those indicated by such statements.

The risks and uncertainties include, but are not limited to, those outlined in today's call as well as other risks identified from time to time in the Company's public statements and reports filed with the SEC.

To begin with, our fourth-quarter earnings results.

For the 16-week fourth quarter earnings came in at $1.58 a share, up $0.18, or up 13%, from last year's fourth-quarter earnings of $1.40.

In terms of sales for the fourth quarter, total sales were up 9%.

Comp sales were up 6% on a reported basis and, excluding gas and FX impacts, were up 7%.

For the quarter, gas prices year-over-year were essentially flat, so no impact on the 6% US comp figure.

However, foreign currencies overall weakened relative to the US dollar year-over-year in the fourth quarter, with the biggest impact in Canada, such that our reported 6% international comp figure, assuming flat year-over-year FX rates, would have been up 8%.

In terms of sales for the five-week September period, total sales increased 7% year-over-year and reported comp sales increased 4%.

Again, excluding both gas and FX impacts, comp sales would've been up 6%.

In terms of comparing our $1.58 earnings figure for the fourth quarter of this fiscal year to last year's fourth quarter of $1.40, there are five items I would like to point out.

First, FX.

In the fourth quarter year-over-year, currencies in the foreign countries where we operate on an overall basis weakened versus the US dollar, resulting in our reported foreign earnings in Q4 when converted into US dollars being lower by about $14 million pretax, or $0.02 a share, than these earnings would have been had FX exchange rates been flat year-over-year.

Second point, LIFO.

Last year in the quarter we recorded an $8 million pretax LIFO credit or a pickup of a little over $0.01 a share.

This year in the fourth quarter we had a LIFO charge of almost $11 million, or about $0.02 a share charge.

A third point, income taxes.

Our income taxes this year in Q4 included several discrete items that in the aggregate increased our income tax line by about $8 million.

The $8 million of additional taxes included a few positive items that benefited or lowered our taxes by about $7 million in total.

However, these positive items in total were more than offset by a $15 million income tax charge related to our decision to repatriate from Canada back to the United States about $1.2 billion or CAD1.3 billion of our Canadian cash operations cash balances in the near future.

In all, the $8 million net income tax increase from these discrete items a negative impact to earnings of about $0.02 a share.

Fourth item, our company bonus accrual.

I discussed in last year's earnings call that our fourth-quarter 2013 quarter results benefited by reversing or bringing back a portion of the Company's bonus accrual as our fiscal 2013 results caused us to pay bonuses at a lower level than we had accrued throughout the year.

This year in the fourth quarter our accrual for the year-end bonuses was not reduced in the fourth quarter as it was -- as it had been last year.

Overall, this represented a $0.04 a share negative swing year-over-year to our bottom line.

Mind you that the bonus program impacts a little more than 4,000 people who participate in it throughout the Company.

Last item I will point out is gas profits.

This year our gas profits in Q4 were quite strong, representing an additional $0.05 a share to earnings year-over-year.

Overall, $1.58 earnings figure for the year's fourth quarter was reached despite several discrete items representing $0.05 or $0.06 shares in the aggregate that did not go our way.

Now to the subject of new openings, for all of fiscal 2014 we opened 30 new locations: 17 new in the US, three each in Canada and Australia, two each in Japan and Korea, and one each in the UK, Mexico, and Spain, that being our first unit opening in Spain.

We ended fiscal 2014 with 663 locations operating worldwide.

For the current fiscal year, fiscal 2015, our plans are to open 31 new warehouses and also relocate four existing locations.

19 of the planned 31 new locations will be in the United States with the remaining in international markets.

Inevitably, up to a few of these will get delayed so I would estimate that the number of new units in fiscal 2015 will most likely be either in the very high 20s or up to 30, plus the four relos.

During the first four months of fiscal 2015, basically September through this coming calendar year-end, we plan to open eight of our fiscal 2015 locations -- six in the US and one each Australia and Mexico.

As well, we will complete one warehouse relo in Wayne, New Jersey.

This will occur two weeks from tomorrow on the 23rd.

This morning I will also review with you our membership trends and other activities, our e-commerce activities, additional discussion about margins and SG&A, our stock repurchase activities during the quarter.

I will also comment on recent switch in Canada of our co-branded credit card offering that's going on right now.

Okay, for the fourth-quarter results sales again for the 16-week fourth quarter were up 9% to $34.8 billion, up $3 billion from $31.8 billion a year ago in the fourth quarter.

On a reported comp basis, Q4 comp sales were up 6%.

For the quarter our 6% reported comp was a combination of an average transaction increase of a little under 2% for the quarter and this included an FX detriment of about 0.5% and average frequency increase of 4.2%.

In terms of sales comparisons by geographic region, in the US with a 6% fourth-quarter comp overall most US regions registered in the mid-single-digit comp increases with Midwest and Southeast being even stronger.

Internationally within the plus 8% local currency comp, Australia and Japan were the weakest, due in large part to cannibalization with Taiwan, Korea, Canada, and Mexico all coming in strong in terms of comp sales increases.

In terms of comp sales by merchandise categories for the quarter, both food and sundries and hard lines comps were both in the mid-single digits range for the quarter and both soft lines and fresh foods comps were in the high single-digits range for the fourth quarter.

Within fresh foods, of course, we are still experiencing inflation in the low to mid single-digit range on average.

For our September sales results, sales for the five-week September month which ended October 5 were $10.57 billion, up 7% from last year's September reporting period.

Again, on a comp basis reported plus 4%.

For September, our plus 4% reported comp sales results were a combination of a slightly positive average transaction, notwithstanding almost 2 percentage points' impact from FX and gas deflation, and average frequency increase of right at 4%.

Cannibalization for the month negatively impacted our sales by just under 0.5 percentage point.

Excluding FX and gas effects, comp sales for the month of September, as I mentioned, were up 6%.

In terms of sales by geographic region, most US regions were in the 4% to 5% comp sales range with the Midwest and Southeast being even stronger.

Internationally in local currencies, Japan and Australia being impacted by cannibalization were the weakest performers, while Canada and Taiwan were the strongest in terms of comp sale increases.

In terms of sales by category for this September, food and sundries and soft lines both enjoyed mid single-digit comps; hard lines low single-digit comps; and fresh foods high single-digit comps, again having a little bit of extra inflation there as well.

In ancillary business comps, overall in the mid single digits led by optical and food courts.

Gas comps were in the mid single-digits range despite average sale price of gasoline during the month being down 4 percentage points year-over-year.

Moving to the line items on the fourth-quarter income statement, membership fees.

We came in at $768 million, or 2.21% of sales.

That is up 7%, or $52 million, year-over-year from $716 million.

It is down 4 basis points as a percent of sales, and again we had strong sales in the quarter.

In terms of membership, we continue to enjoy strong renewal rates coming in at -- rounding up to 91% in the US and Canada and a little over 87% worldwide.

We continue to enjoy strength in our executive member program with continued new sign-ups.

New member sign-ups in Q4 overall, a little over 2 million new sign-ups in the Company.

It was about a 7% increase year-over-year.

This was helped, of course, by strong new sign-ups and a few overseas openings in Australia, Korea, and Spain over the past year.

In terms of members, number of members a Q4 end, last reported number of course was a fiscal quarter ago in mid-May.

We had Gold Star members at the end of Q3 at 30.6 million.

At the end of the fiscal year it was up 1 million to 31.6 million.

Primary Business was up 100,000 from 6.8 to 6.9 million.

Add-ons remained at 3.5 million, so overall total paid member households 40.9 million at Q3 end and up 1.1 million to 42 million even at Q4 end.

Including extra cards, 74.6 million at Q3 end, up 1.8 million to 76.4 million at the end of the fiscal year.

Also at the end of the fiscal year Executive Memberships stood at just under 15 million, an increase of about 450,000 just in the 16-week quarter, or about 28,000 increase per week of new Executive Members.

In terms of membership renewal rates, they too continue strong.

Again, at the end of the third quarter business renewal rates were 94.4%.

They remained there at Q4 end.

Gold Star renewal rates ticked up a little bit from 89.7% to 89.8%.

Overall, we remained at 90.6%, rounding up to a 91% and again worldwide we continued at 87.3%.

Now, as I have touched on the last couple of quarters' conference calls, we continue to try a few things to drive both sales and new member sign-ups.

In early September -- this would be the first couple of weeks of the first quarter of the new fiscal year -- for eight days we ran a nationwide membership promotion for new members on LivingSocial.

With the purchase of a full-priced $55 membership, the new member received a $20 Costco cash card, coupons for three free items.

As you might expect, they include a Kirkland Signature bath tissue, an apple pie, and a rotisserie chicken.

Also a free three-month membership for identity protection and a bonus coupon of $25 off of any Costco.com offer -- purchase of $250 or more.

These types of promotions we believe will allow us to get in front of younger demographics with an appealing offer.

This one worked well and we will keep you posted.

Lastly, I want to mention (inaudible) in Canada.

It was announced last week that the Costco Canada's co-branded credit card offering is being switched from a Costco American Express co-branded card to a new co-branded Costco Capital One Platinum MasterCard.

This will be exclusive to Costco members.

We have already begun to issue the new MasterCards and we will continue to accept all AmEx cards through December 31 of this year.

Our new no annual fee credit card doubles as the membership card and allows our members to earn cash rewards on all purchases made both inside and outside of Costco with no cap on the amount of rewards that can be earned.

Now getting back to the income statement, our gross margin in the fourth quarter was quite strong, coming in up 15 basis points year-over-year from a 10.55 a year ago in the fourth quarter to a 10.70 during the fourth quarter of this past fiscal year.

As usual, I will ask you to jot down a few numbers.

We will do four columns.

This time the four columns -- the first two columns will be for Q4 2014, both as reported and without gas inflation, and then for the entire fiscal year 2014 reported and without gas inflation or deflation.

First line item is core merchandise.

In the fourth quarter we have year-over-year core was up 6 basis points both with and without gas because gas year-over-year was essentially flat.

For the year, plus 6 reported and a plus 3 without gas.

Ancillary and other business a big contributor in Q4, plus 15 basis points in the first two columns there, and for the year plus 6 and plus 6. The 2% reward, no impact in the Q4, both of those two columns, a minus 1 basis point impact in the next two columns.

LIFO, as I mentioned of course, there was a charge this year versus a credit last year, 6 basis points year-over-year both in the fourth-quarter columns and minus 5 basis points year-over-year for the entire fiscal year in both columns.

Other, no additional items in the fourth quarter.

In the last two columns for fiscal 2014 at minus 2 basis points year-over-year.

That related to a lawsuit recovery over a year ago that benefited us and, of course, we didn't have any unusual item offsetting that benefit from a year ago.

If you add it up, we reported margins up 15 basis points both with and without gas.

Our reported total for the year was up 4 basis points, but taking out gas it was up 1 basis point.

Again, a good showing overall in fourth quarter in terms of margin improvement.

Now, as I mentioned, the core was up 6 basis points.

Two of the four core categories, food and sundries and fresh foods, showed higher year-over-year gross margin percentages, while year-over-year and Q4 soft lines margins were essentially flat year-over-year and hard lines margins were slightly lower.

Ancillary business gross margins were up over 50 basis points year-over-year in the fourth quarter based on their own sales, with gas, optical, and hearing aids coming in better year-over-year in Q4.

And LIFO.

Again in the fourth quarter we recorded just under an $11 million, or 3 basis point, pretax charge compared to an $8 million, or 3 basis point, pretax credit last year for a 6 basis point year-over-year swing in the fourth quarter.

Next our SG&A percentages.

Year-over-year in the fourth quarter they were lower or better by 2 basis points coming in at 9.73 as a percent of sales, compared to a 9.75 last year.

Again, we will do the same four columns, two for the fourth quarter with and without gas and two for the full fiscal year reported and without gas.

In terms of core operations, we have a plus 7 and a plus 7 for the quarter and a minus 2 and a plus 1 for the fiscal year.

So plus 7, of course, would mean that it was lower or better by that many basis points.

Central was a minus 7 and a minus 7 for the quarter and a minus 3 and a minus 3 for the year.

RSUs a plus 2 and a plus 2 and for the year a minus 2 and a minus 2.

No quarterly adjustments, so total for the quarter, both on a reported basis and without gas, again we were better by 2 basis points so a plus 2 for the year.

We were higher by 7 basis points on a reported basis, so a minus 7, and without gas a minus 4.

Now in terms of our SG&A performance, the core operations again was lower or better by 7 basis points.

Within core, payroll and benefits expenses were lower or better year-over-year by 8 basis points, again helped by leveraging sales strength.

Similarly, other operating expenses as a percent of sales in the quarter were better by 4 basis points, so a total of between those three items really would be 12 basis points.

The change in the bonus accrual year-over-year, as I discussed earlier, hurt the core component by about 5 basis points.

In terms of central, it was higher again by 7 basis points.

About 5 of that SG&A variance is related to the ongoing IT modernization efforts and another 3 is the increased SG&A expense resulting from the year-over-year swing in bonus accrual.

That is split between core and central.

Lastly, our equity compensation, which is now an important component of the compensation again to about 4000 people, this represented an improvement of 2 basis point positive in SG&A, benefiting from both timing of certain vesting provisions when employees hit 25, 30, and 35 years of service, as well as from the strong sales denominator in the fourth quarter.

Next on the income statement line, preopening, not a whole lot to talk about, $17 million last year in the quarter, $15 million of charges this year in the quarter.

Last year, we opened seven units, this year 10; no major surprises there.

All told, operating income in the fourth quarter increased 14% or $137 million year-over-year from $954 million last year in the fourth quarter to almost $1.1 billion, $1.091 billion this year in the fourth quarter.

Below the operating income line, reported interest expense was $1 million lower year-over-year, coming in at $36 million last year and coming in this year at $35 million for the quarter.

Interest income and other, it was lower year-over-year by $6 million, $36 million last year in the fourth quarter compared to $30 million this year.

Actual interest income for the quarter was up $3 million coming in at $17 million compared to $14 million last year.

The other component of interest income and other was lower by $8 million, primarily related to various FX items being marked to market at fiscal quarter-end.

Overall, pretax income was up 14% or $132 million to $1.086 billion this year versus last year's fourth-quarter pretax earnings of $954 million.

In terms of income taxes, our tax rate for the quarter came in at a 35.1%, up 0.3% from a 34.8% tax rate all-in last year, so slightly higher this year.

And as I explained the reasons for that earlier in the call.

Overall net income was up 13%, or $80 million, to $697 million versus last year's fourth quarter of $617 million.

And as I discussed earlier, this figure being achieved notwithstanding several items that in the aggregate did not go our way.

Now for a quick rundown of other usual topics, a condensed balance sheet is included in this morning's press release but a couple of items on the balance sheet and a couple cash flow items I will point out here.

Depreciation and amortization for the quarter totaled $321 million and for the year $1.029 billion.

In terms of accounts payable as a percent of inventory, on a reported basis both last year and this year's fourth quarter it was right at 100%.

Payables, of course, include things other than merchandise payables, like construction payables.

If you look at just merchandise payables as a percent of inventory, in both fiscal quarters we were at 89% year-over-year.

So almost 90% of our inventory is being financed with trade payables.

Average inventory per warehouse last year fourth-quarter end $12.5 million, up a tick this year in the fourth quarter to $12.8 million, or up about $300,000 or 2%.

The $300,000 increase, about 80% of that is in four of our merchandise sub-departments.

Majors was up about $91,000; some of that is the reintroduction of Apple products.

Men's apparel was up about $55,000.

Foods was up $61,000 and meats were up $39,000.

The latter two being somewhat related to inflation.

In terms of CapEx, in the fourth quarter we spent $567 million.

For all of fiscal 2014, total CapEx was right at $2 billion.

Our estimate for fiscal 2015 CapEx is quite a bit higher, probably in the $2.5 billion to $2.7 billion range.

The year-over-year increase in CapEx represents our plans for more openings this year -- that, of course, includes the four relos -- versus last year; increased spending for remodeling activities and expanding ancillary business operations; planned expansion of our cross-stock depot operations; anticipate spending later in the year for some additional openings early in the subsequent fiscal year; and increased level of IT spending for the modernization efforts.

In terms of Costco Online, we are currently operated in four countries: US, Canada, UK, and Mexico.

We would expect to be in at least one, probably two, additional countries by the end of calendar 2015.

For the fiscal year, total e-commerce sales came in just under $3 billion.

For both fiscal fourth quarter and the fiscal year, sales and profits were up.

Sales in e-commerce were up in the high teens for both the fourth quarter and the fiscal year and comp sales in e-commerce were up in the 18% to 19% range for both the fourth quarter and the fiscal year.

Over the past two years, as I mentioned, we re-platformed our site.

We've introduced new apps.

We've combined some e-commerce merchandising efforts with in-line efforts.

We've added new categories including areas like apparel, health and beauty aids, and some sundries.

And we have improved distribution and delivery time.

In addition, outside of e-commerce, as you know, we have continued over the last -- much of this past calendar year testing Google Shopping Express.

That continues with a great partner with Google.

The trending is positive in terms of member spending and also signing up some new members, but again it's still a test.

We continue to add items to that delivery process.

Currently it's in three geographic areas -- the Bay Area, Los Angeles, and New York -- and more to come I'm sure.

Next discussion in terms of expansion.

Again, for fiscal 2014 that ended we opened 30.

Acapulco was closed due to weather-related destruction so ended up a net of increase last year of 29.

This year, assuming we open the planned 31 -- we open 35 but four of those are relos, so a planned net new of 31 -- eight would be in the first quarter, none in the second quarter, two in the third quarter, and 21 in the fourth quarter.

We've got a lot going on.

I think that again we will probably see at least a couple, one or two of those perhaps speed up a little bit, but a few be pushed into the next -- early into next fiscal year.

So in fiscal 2014 we added 29 on a base of 634, or about 5% square footage growth.

In fiscal 2015, assuming 31, that would be about 4.5% to 5% square footage growth.

In terms of the 31 this year, if we get all of those open, 19 would be in the US, one each in Canada and the UK; in Asia overall six, three in Korea, two in Japan, and one in Taiwan; one additional in Australia, that would be our seventh in Australia; two more in Mexico; and one more in Spain.

As of Q4 end, total square footage stood at 95.3 million square feet.

One last comment regarding openings and operations in Cabo San Lucas, Mexico.

Costco, like many other businesses, was a victim of the recent hurricane on September 14 and the subsequent looting that took place and we are currently closed.

We plan to be back up and operating by early November.

In terms of common stock repurchases, we began our recent repurchase activities on March 7, the day after our second-quarter earnings release was released.

In Q3 we purchased 1.6 million shares at an average price of $113.14 for a total expended of just under $184 million.

During the fourth quarter we purchased 1.3 million shares at an average price of $116.11 or a total dollar amount of about $150 million.

In terms of dividends, our current quarterly dividend stands at $0.355 a share or annualized at $1.42.

That is up 14.5% from the previous year's dividend rate.

This $1.42 per share dividend represents an annual cost to the Company of about $625 million.

Lastly, our fiscal 2015 first-quarter scheduled earnings release date will be Thursday, December 11.

For that will be for the 12-week fiscal first quarter ending on November 23.

With that, I will turn it over to Brandi for Q&A.

Brandi?

(Operator Instructions) John Heinbockel, Guggenheim Securities.

Richard, a few things.

The gross margin being up in the food categories, is that cost of product to you?

I know you talk about inflation, but is that cost-of-product driven, is that mix driven?

Where is that coming from?

Without looking at the detail, I would guess most of it is cost-of-product driven.

The examples, of course, would be -- I mentioned before poultry prices to us have come down a little bit as we locked in versus where they had been.

We didn't change the price, needless to say, of those items upward.

I think we have had a little bit of hit in the food court, similarly, for that reason.

Do you think -- as Kirkland gets bigger and gets more scaled, do you think there is -- can that move the needle on gross margin, either in terms of margin on the product or mix?

I think it does a couple of things.

Generally the answer is yes.

It also, as a KS product, takes share from a branded product.

It generally moves the branded product to come down in price to us, which again gives us even more competitive loyalty with our members.

So there's a lot of good things there.

Certainly the needle -- the low-hanging fruit occurred many years ago.

You have heard the examples of whether it's toilet paper or disposable diapers where you have items that are very, very competitive, branded items.

We can come in with a great value, great quality item and make a fairer margin to us, but still a great savings to the customer.

So it works, but it moves the needle slightly.

All right.

One of the countries you didn't talk about, good or bad, was the UK.

Obviously there's a lot going on there.

Just generally speaking, how do you find you are performing in the UK top and bottom line today?

Two things, to finish something I thought about after I finished the first answer, the other benefit, of course, is not just KS but the increase in organic sales.

That's something I think that competitively gives us a leg up because it's where more margin historically has been made in retail and organic.

We can provide better savings and it has other positive attributes in terms of the type of member that shops for that stuff.

In terms of the UK, it was still positive.

It was at the lower end, low single digits.

Actually UK has shown some improvement.

And --.

(multiple speakers) You mentioned organic.

Two things.

What is happening to assortment there?

And then secondly, it does look like on a variety of levels in terms of just product placement, marketing, you are trying to drive that significantly.

So that has got to be still one of the -- still one of fastest-growing departments in food.

Do you think that -- is at helping you much with the Millennials or is that yet to come?

Well, it's helping.

It's probably a bigger percentage now because it's on a small base.

You look at I think a couple quarters ago I talked about like fresh ground beef, organic ground beef.

It is an infinite percentage increase from zero to 25-or-so-million that first year.

As I mentioned earlier, what we are finding a lot of these items is that it's incremental sales because it was loyal members that didn't buy ground beef from us before.

Now they are.

This year organic ground beef sales were up dramatically because the supply is up dramatically.

So, yes, again they are big numbers on -- it's one of those good things but it's lots of little things.

Okay, thank you.

Peter Benedict, Robert Baird.

Richard, a couple questions.

First, just the membership promos you are doing with LivingSocial, how are those funded?

Are the vendors contributing any of that or are you guys funding all that?

Well, I think an example of -- I think we are doing most of the funding of that.

Certainly to the extent there is the identity protection, we have some vendor support I'm sure.

I don't know that that is exactly, but I would best -- I'm sure we do.

The other item on the food items, there are items -- KS bath tissue, a rotisserie chicken.

I'm not sure if there's a little support from the manufacturers, but I would assume it is part of the member procurement costs on our side.

Okay, then the plans for the Canadian cash that you are bringing in?

It's really just moving it down here.

As we read about every day in the paper, money is stuck at multinational companies outside of the US.

We had the ability -- based on when the monies were earned over the last 20 years, years ago basically the marginal federal corporate tax rate in Canada versus the US was a lot closer than I think the roughly 13 percentage points difference now.

Roughly 26% versus 39%.

These first billion dollars, if you will, $1.2 billion as I think I mentioned translated into US dollars, is at an effective rate of about 1.25% tax rate.

So we opted to move it.

Canada, of course, is very profitable.

It has its own column in the segment analysis.

You can kind of figure that out.

While we are still adding two or three units, our CapEx is dwarfed by our earnings up there and so we will continue to make money.

We saw this as an opportune time to be able to start that process.

Okay, perfect.

Then last question.

Just how do you guys think about the timing of introducing the executive membership option into new markets?

What are the main considerations and how should we think about that for getting in some of these markets where you are not in?

I'm thinking of Asia.

I think there's two things.

One is how big is the country in terms of how many units we have.

Secondly, can we get a --?

I guess there's three things; that was the first one.

Second would be putting a menu of services together that we can do and, of course, as we get bigger, relatively bigger in a given country, that buying power allows us to do that.

Then what else we have going on.

Using Japan as an example, we have gone from, what, nine to 23 or 24 units in about 2.5 years.

So I think our -- we like it.

We like the Executive Member program and long-term we would like to see it in other countries.

But those are the types of factors.

Okay, great.

Thanks very much.

Scott Mushkin, Wolfe Research.

This is actually Mike Otway in for Scott.

Thanks for taking the questions.

Richard, in terms of SG&A, you know you've laid out the buckets.

As we think about next year, is there any -- are there any buckets that are likely to move SG&A a bit higher than this year or perhaps a little lower?

I know you mentioned you are spending a bit more on IT modernization.

How does that flow through the P&L?

Any color there would be great.

First and foremost, it's sales growth.

If we can get good sales growth, that helps a lot of things.

Certainly increased penetration in some of our overseas markets actually helps quite a bit because of various things.

Healthcare expenses as a percent of sales are much lower in virtually every other country than the United States.

Labor costs are different and generally lower in other countries as a percent of sales, so I think those things will probably help us.

In terms of IT modernization, as I have kind of laid out over the last couple of years each quarter, incrementally we would expect that to be in the low to mid -- low to low mid-teens incremental over three or four years.

I think we are probably up to 10 or 11 basis points or maybe 9 or 10 basis points over the last couple of years, and we will continue to see that this year.

I don't think it's going to help us anytime soon.

It probably is a slight impact certainly in fiscal 2015, maybe a little in fiscal 2016 before it flattens out and hopefully starts to go the other way little bit.

Beyond that, healthcare is always an unknown in the US.

Again, as I mentioned, I think to the extent that the healthcare continues to be -- the inflationary aspects of healthcare in the US -- as you know, we haven't and aren't going to make major changes like cutting a bunch of people out of it -- that is an expensive cost to us and we are proud of the ability to be able to do that.

Notwithstanding that, even if that continues and it's slightly greater than top-line sales rate of growth, increasing penetration of healthcare costs outside of the US will help mitigate any damage there.

So I don't think there's anything new to add to this process than those kinds of things.

Okay, that's helpful.

Then just in terms of the consumer, have you seen any real change there in the last few months?

Then specifically with your business in the Midwest and the Southeast, what you're seeing in those regions relative to -- it's clearly strong -- what's going on there versus some other places in the country.

Well, I think the Midwest certainly it's a newer region, relatively speaking.

We are getting -- we seem to have I think are hitting our sweet spots in some of those cities.

Same in the Southeast.

We have opened in areas like Louisiana and Alabama and Georgia and Florida some additional units, and South Carolina.

They are generally tending to do pretty well, so I think a few extra years there have helped us, frankly.

I can't tell you much more than that in terms of a little color on the consumer.

Some of the usual suspects, good suspects if you will, in terms of merchandise categories, some of the non-food soft lines and hardliners categories like apparel and housewares and domestics, those have all done well.

In part, because of our commitment to them.

Our increasing commitment in the apparel area would be one example.

Clearly, having the demographic or a member I think helps.

Having strength in gas.

Gas sales were up I think I mentioned up 4% notwithstanding -- 3% or 4% notwithstanding a 4% or so decline in the average sales price per gallon.

So gallons are up nicely and that's driving, no pun intended, but driving people into the Costco parking lots.

Great.

Thanks, Richard.

Appreciate the color.

Meredith Adler, Barclays.

Thanks for taking my question.

I would just like to talk a little bit about, as you think about international growth, I noticed that you didn't mention opening anything in France I think in this coming year.

Are you looking just to continue to fill out the markets where you already operate, or are you considering moving into another new market?

Obviously Spain is still very new, but --.

Sure.

Both Spain and France, I think we probably started talking about those two countries three years ago and at the time we felt that it could be three or more years based on the permitting and appeal processes in various not only countries but cities and communities.

And that is certainly why we keep at this point pushing out France.

We will continue to look at that.

Again, we will have our second opening in Spain later in calendar 2015.

We haven't mentioned any other countries beyond that.

If I was a betting person, absolutely in the next few years but not in the next year, year-and-a-half.

Maybe you could just comment a little bit about real estate in the US.

Are you finding any changes in the environment, harder to find locations, working with developers, anything different?

I don't know if it is anything different.

In some markets it becomes -- it's ever increasingly more difficult.

In Greater LA where we've got 40 or 50 units, many, many units, we feel that over the next 10 years we could open another 10 or 15, but they are all very pinpointed locations based on where other locations, other Costco locations are.

And it is densely populated and it's difficult, but that's what we do.

We've got a lot more of people in the real estate area over the last few years and we've got a lot more in the pipeline and we think we will get there.

I think also -- and we are fortunate in the sense that many of the markets, be it Texas, Midwest, Southeast, some of the markets that we are newer in over the last 10 years, not the last 30 years, we're able to go into, and given our demographic, we're able to find locations.

Certainly we also get some calls, as you might expect, from developers.

But it's probably an increasingly difficult effort and that is why we have added more infrastructure to pursue that.

Overseas every country is a little different.

I think, as I mentioned, in Asia this coming year we have I think six planned: three, two, and one.

Of course, we've opened a bunch in Japan just in the last two years already.

And so, again, it takes a lot longer but we've got a lot in the pipeline, too, and so we will continue to see some growth there.

Okay, great.

Thank you.

Simeon Gutman, Morgan Stanley.

Good morning, it's Joshua Siber on for Simeon Gutman.

I'm curious if you guys are seeing areas of the store where customers are more or less sensitive to price increases and how much room you have to further pass through greater costs in these categories.

Well, we are most sensitive to us.

We haven't seen any major change in level of competition out there.

Everybody is tough and we are pretty tough ourselves, so, no, I don't think so.

I think it is continuing as it goes.

I think we are -- some of our margin improvement of late has become -- as we have not raised prices but some of the underlying costs have come down and some of that hurt is behind us, but tomorrow is another day.

(multiple speakers) We're thinking -- the list of price increases is not a big list around here, relatively speaking.

Okay, that's helpful.

Sure, for the members that you picked up on LivingSocial, do these customers shop online more frequently and is there a noticeable difference in basket in terms of pricing or content?

They are so new I can't really tell you.

This most recent program was early -- about three weeks ago.

The process is they redeem their coupon, then they come in, and a lot of them are coming in.

But I would guess, generally speaking, compared to the first test we did on a regional basis with LivingSocial a few months earlier, you do have a higher percentage of Millennials and --.

But like any new member, Millennials or otherwise, when a new member first starts to shop they are generally shopping smaller basket sizes and a little bit more food-oriented to start with.

And that has been historically a typical pattern, so it's too early to tell.

Okay.

Then just one more, housekeeping question.

Is the $150 million buyback that you guys spent in fourth quarter a good run rate to go forward?

I can't really respond to that.

I can tell you that we -- historically when we have bought back we have bought through blackout periods using 10b5-1s.

Our longest blackout period of the year, which is six or seven weeks long, stretching from early -- I guess from late July/early August all the way to today, you have to basically put in place something.

Well, if you go back that many weeks, the stock at the time was in the mid to high, like $115, $117.

So we hadn't bought for the last few weeks of the quarter.

But that would imply a little longer, bigger runway, but it will go up and down a little bit.

I think that we are intent on buying some stock back.

Okay.

Thanks for the color, guys.

David Schick, Stifel.

Good morning.

You talked in the call about the high teens growth of online and you talked about the success of the Google partnership, and you said profit growth was I think at a similar pace.

But going back to what you said; if you could just give any more details on how the profitability or the growth thereof is trending in online that would be helpful.

Thanks.

The profitability is very good.

We don't -- I don't think we really give out profit growth numbers there in that 3% piece of our business.

The good news, it's growing and it is more profitable.

E-commerce is definitely quite a bit more profitable than the rest of the Company.

And so 3% of sales implies a greater percent increase of earnings.

Is it more profitable on a flow-through basis than it was at this time last year?

Let me correct that.

3% of sales, a higher percent of sales profitability than the Company overall.

So every time we can grow those sales, you will see earnings grow nicely, too.

Then is the operating margin of it -- if you don't want to detail that that's fine, but is it growing beyond the revenue?

Is it levering or is it expanding the total loaded margin?

The problem you have is we've opened recently in a couple of new countries in the last year and half and so we are spending a lot of money on that.

We spent a lot of money on apps, on upgrading and so --.

I don't have the numbers in front of me, but I know it's growing and it's profitable and we are continuing to pursue it.

Thank you.

Greg Melich, ISI Group.

Thanks, Richard, a couple questions.

Love to start on membership fee income, so it was up 7%.

What was it in local currencies?

And in terms of membership growth, how much of that you think is driven by the new clubs?

Let me answer the first question.

It was up 8% without FX in dollars.

And what was the other question?

I think you said memberships were up 7%.

I was trying to get a sense of how much of that was driven by the new openings, particularly in these markets where you have been very successful and you've had huge membership growth with some of the new clubs.

I don't have it in front of me.

I'm sure that made it healthy.

I can remember over the years when sometimes it's a little down year-over-year it's because a year ago we had some foreign operations with those outsized new sign-ups and fewer international the next year.

I don't know off the top of my head.

All right.

But use 8% as the local currency number?

Yes.

Okay.

And then second, I wanted to understand a little bit more about the gross margin in ancillary.

I guess that was up -- you said up 50 bps in ancillary, which was 50 (multiple speakers).

If you totaled ancillary gross margin divided by total ancillary business sales, it was up a little over 50 basis points.

Different ancillary businesses were up or down differently.

That, in addition to strong sales in those areas, so a combination of increasing penetration and increasing margins was at a higher level benefit to the total company gross margin.

Gas being the outsized one there.

How should we think about the sustainability of that on gas?

Are we now at what would be a normal run rate there?

Also is dot-com -- where does that show up in your nice little bridge you do?

Well, dot-com is in the core.

It's not ancillary, is it?

Dot-com?

No.

In terms of sustainability of gas profits, I only wish.

We've probably been on a little longer run of good gas profitability the last several months.

Generally speaking, when gas prices are -- year-over-year are flat or declining, as they are now, that's good news.

We save the customer more and we make more.

When they are going up fast, we save the Company -- the customer a little less and we make less.

And so we have been blessed by having a positive run here for several months, but it's a volatile area.

Now that is just looking with blinds on of just gas operation.

That doesn't take into account the fact that every time we can get somebody to come in and get gas that is incrementally a potential positive shop in the warehouse as well.

And so that we, of course, don't consider as part of it.

Is it fair to say that the 15 bps that you cited that gas was half of that?

I think you listed it first when you talked about optical and hearing aids and gas.

I don't know off the top of my head.

I bet it's half or more.

It's not all.

Got it.

Then lastly just on the inventory increase, it sounded like you gave those four areas which is all very clear.

Was there anything unusual about that other than restocking Apple that you wouldn't use that as sort of a trend going forward in those categories?

Actually the trend, this is I think probably the lowest year-over-year average increase in merchandise inventories.

For a few years there we have been running up 5%, 6%, 7%, 8% year-over-year in the inventory levels.

In the last couple of quarters on a year-over-year basis we've been down in the 2% or 3% range, so actually it has come in better in my view.

Whatever a 3% increase in inventories on a -- 2% increase in inventories on a 7% or 8% or 9% increase in total sales.

I think the anomaly there would be adding some product on that side and the anomaly, of course, with inflation and fresh foods.

But that's going to fluctuate as well.

So I think overall probably this is -- we looked at this as being a little bit better level of increase in average inventories per warehouse than --.

And it sounds like you think it's sustainable at this rate.

At this point, sure.

Great, thanks a lot.

That could change tomorrow, you never know.

I know.

Thanks a lot.

Matthew Fassler, Goldman Sachs.

Thanks a lot and good morning.

A couple of quick ones here.

First of all, I know that you essentially mark to market for LIFO at the end of any given quarter so your expectation is that you are probably going to be clean as you go into next year.

That being said, with the trends that you're seeing in pricing in key categories, what is your initial thinking on the direction that might move in in 2015 relative to this past year?

It's hard to know.

The only person I've actually talked to is in the area of fresh foods and there is anticipation of continuing overall inflationary trends there, although some of it when it's deflationary, it's because -- I think butter had skyrocketed and now it's coming down a little.

I might be wrong on the commodity there.

But probably still a little bit of inflation.

Okay, a quick second question here.

You mentioned in your gross margin discussion that hard lines was down a bit year-on-year.

Just interested in any color in terms of the drivers there.

Yes, I think for the quarter it was flat and was it -- nothing really stood out.

Majors, which is electronics, was up slightly.

Nothing really stands out there.

Okay.

Then finally, you had a question earlier about some of the membership deals that you are running, for example, the one with LivingSocial, about really who bore the economic costs.

And I guess my question is, and I know that this is pretty small potatoes for the moment, how do you account for those subsidies?

Does it reduce the membership fee income or does it show up in some other line item?

It's allocated between sales and membership, but it's mostly membership.

Okay, so for the year -- sorry, go ahead.

That's over the year.

And it's amortized over the year.

It is -- I will have to find out.

It's so small; it's less than a rounding error.

Fair enough.

Okay, I appreciate it.

Thank you.

Charles Grom, Sterne Agee.

Thanks.

Good morning, Richard.

Nice quarter.

Just wanted to see if you could talk a little bit about Google Express and what is the ultimate goal of that program?

Is it to drive increased memberships?

Is it for you to get younger?

And I guess what's holding you guys back on rolling it out to more than just the few regions where it's being tested today?

First of all, we talk about us and Google partnering on this; they are partnering with a number of other retailers as well.

You can go to Google Shopping Express in each of those three geographic markets and see what other retailers.

We are certainly, I think, a big component of it, but we are a big component of anything we do.

And it has been good so far.

I think you really have to ask them that.

I would assume they are looking at additional markets, but as they are announced you will find out as well.

Generally speaking, ultimately we are always asked about all the concerns with delivery and e-commerce, all that stuff.

We recognize we're not going to be the guy that drops off Fruity Pebbles cereal and a quart of milk before your kid wakes up in the morning for breakfast if you ordered it before 10 PM the night before.

But we are -- and we started our business being a wholesale supplier.

In this case it's kind of, hopefully, a win-win, not only for Google Shopping Express but for us.

We are seeing incremental business from it, but again there's a lot of nuances to it.

So far so good, but again it's -- and the biggest test, it's been around for seven or eight or nine months I guess, since January, in the Bay Area, and a lot fewer months in LA and in New York.

We like it because it's our member and there's that positive aspect of it.

You can't get Costco items through Google Express unless you are a Costco member and we have seen incremental sign-ups because of that.

Look, we appreciate the fact that it's a way to sell merchandise.

As well, it's a way to get some members over time.

As well, it's a way, in our view, to have -- ultimately we want to get you into the store or into warehouses more frequently also and we think there's avenues to do that.

But it's really too early to know other than as it is likely rolled out to other cities, we will be part of that at this point in time.

Okay.

So another initiative you guys have to get younger is this organic offering.

I'm just wondering if you could just put things into the context of where you guys are today, either number of SKUs or percentage of sales, to where you were a couple of years ago.

Organic was about $3 billion I'm told by one of the many people in my office right now last year and growing dramatically.

Part of that is supply and part of that is us pushing it more.

I don't think we sat around a number of years ago and said let's do organic to get Millenials.

I think what happened is we sell items and as those items grow and we see that it's got great attributes for us, one that we didn't even realize until we saw it.

We can generally provide a better savings than others because other retailers sometimes will use it as an ability to get more margin, so we can show greater savings.

It's a higher price point item than the substitute item.

And again the added benefit was, in some instances, I've used the ground beef example, we had existing loyal members that -- 80% I know in that first year, I assume it could be a little lower now, but a large percentage of those were incremental sales because those were existing members that didn't buy their ground beef at Costco.

So to the extent that you have, be it Millennial or otherwise, but to the extent you have somebody that is an organic buyer, they may love Costco but if we don't have an organic alternative they are going to shop elsewhere for that item.

So that helps hopefully get them in more frequently to Costco, but we are doing it because we are selling those items.

And as it increases -- we have had organic milk for a number of years and certainly we are able to use our buying power and our sourcing to continue to drive that.

Just switching gears a little bit, it's been a while since I've heard you guys articulate a longer-term store goal and I'm just wondering if you are willing to share one now.

And as a follow-up to that, 19 clubs in the US this year out of, say, roughly 31.

When does the pendulum shift to more international locations where you are doing 19 international, say, as opposed to 19 in the US for this year?

I think you're going to -- over the next five year.

If you look back a year ago I think we talked about the fact that over a five-year period we would expect to open roughly 30 a year, maybe starting at 28 or 29 and ending up at 33 or 35.

And we are kind of in that, I guess year two or two-and-a-half of that five years.

I think the fact that we are opening a few more; if you asked me three years ago I would've guessed it might be more evenly split right now.

I think that is simply a function of availability and speed at which you get things done here.

When you are looking in a 20 million population city in Asia, there's all kinds of issues.

And again, as I mentioned, we've got more people and real estate on the ground in each of these countries compared to very few on the ground five years ago.

So the pipeline is definitely more filled.

I guess from -- looking at it in a positive way, the question of when are you going to slow down in the US because of anticipated saturation, I am happy to report that that's not happening yet.

It will happen at some point, but if anything, that pendulum has probably swung the other way a little bit in the last couple of years.

In part because of some of the strength in those markets where we've been in 10 to 15 years or less, not 25 and 30 years.

Interesting.

Any thoughts on a longer-term store goal that you guys have?

Other than more?

I think if you asked Jeff and Craig and the heads of operations, if it were this current -- my, as I've defined it, five-year period it's a little over 30 a year, I think we would like to get up to 35 a year in the next five years, maybe a little more.

So we will continue to try to push that little bit.

We feel we have the capabilities to do that.

That depends, of course, on continued success in these markets.

Then the last question just on the margins as a follow-up to I believe Matt's question.

Just wondering if you could speak to the degree of improvement on food and sundries and fresh relative to the third quarter, which I believe your food and sundries was up 20 and then fresh was down a couple of basis points.

I know you said it was positive, just wondering if you could give us the degree of improvement.

I think it's in the -- I don't have it right in front of me, but it was less than up 50 and more than up 10.

I don't have it in front of me.

I'm sorry, could you repeat that?

Less than up 50 and more than up 10 basis points.

I think somewhere in the high teens or 20s.

I could be off a little bit, but there wasn't -- one of them wasn't up 1 basis point and the other up 80.

They were both up.

Okay, great.

Thanks, again.

Michael Exstein, Credit Suisse.

It's Charlene Wong on for Michael Exstein.

What is your initial experience in Spain been like?

I'm sorry, what was the question?

What has your initial experience in Spain been like?

Well, so far it's fine.

Our member sign-ups are strong and continuing.

As we expect when we go into a completely new country, you generally see smaller baskets to start with.

We haven't -- needless to say, we have only been there for three or four months so we haven't anniversaried anything in terms of seeing any type of renewal rates, but we are pushing forward.

We are working on our site in Spain.

So no major differences of expectations.

Got you, thank you.

Bob Drbul, Nomura Securities.

Just got a couple of questions for you, though.

On the fourth quarter what was the percentage of sales to the total?

And I'm not sure if you gave it, but can you talk a little bit about in September the impact on gas and FX were to the month of September sales?

Yes, I can.

Gas was -- FX was 120 drag and gas was about 0.5 points, just 48 basis points.

Okay, great.

Then just the last question that I have is on the openings for the next fiscal year are you -- the timing of them, why are they so back-half weighted?

Well, the big reason is we try to open everything as soon as we can other than when there's some craziness because if it's up in Minnesota and it's in the snow and the ground is frozen, you might lose four months if you can't get the foundation -- the ground dug and the foundation set.

But it's just timing of when they are.

We would love to push a few of them sooner.

That is generally our best guess of where we are.

It's really -- the impact is, and I'm sure by Q3 as we know more specifics about how many will open we will have a little color on preopening expense, but other than that it is a manageable process.

Great, thanks very much.

There are no additional questions at this time.

Thank you very much.

Bob and Jeff and I will be in the second day of our budget meeting for a couple hours, but feel free to leave a message and we will get back to you after noon.

Thank you.

Thank you.

Ladies and gentlemen, this does conclude today's conference call.

You may now disconnect your lines.