好市多 (COST) 2015 Q1 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Q1 earnings conference call.

(Operator Instructions)

Thank you.

And I would now like to turn the call over to Mr. Richard Galanti, CFO.

Mr. Galanti, you may begin your conference.

Thank you, Erica.

Good morning to everyone.

This morning's press release reviews our first quarter of FY15 operating results for the 12 weeks ended November 23.

I'll start by stating that the discussions we're 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 first [collobrary] results for the quarter -- as you saw, our reported earnings came in at $1.12 a share, up 17% or $0.16 per share over last year's first-quarter earnings of $0.96 a share.

A few items of note, in terms of looking at the comparison.

Within gross margin, which was higher year over year in the first quarter by 22 basis points, we benefited from strong margins in our gasoline business, which I'll speak to more when I discuss our gross margin results.

And we also had a $17 million pretax nonrecurring lawsuit recovery.

This latter $17 million amount represented about 6 basis points of margin improvement, or about $0.03 to our per-share earnings.

Interest income and other, you'll note, was higher year over year in the first quarter by $17 million pretax, or about $0.03 a share.

This increase primarily related to several of our foreign operations using FX contracts to lock in US dollar-denominated merchandise payables.

Under GAAP, the mark-to-market gains or losses -- in this case, of course, gains -- are recorded on the interest income and other income statement line.

I really look at this as part of merchandising gross margin, in the sense that our foreign operations buyers lock in exchange rates at amounts which they're comfortable they'll be able to price their merchandise at.

Third, FX.

In the first quarter, as you probably are aware, the foreign currencies where we operate, overall weakened versus the US dollar, primarily in Canada and Japan.

Resulting in our foreign earnings in the first quarter, when converted into US dollars, being lower by about $22 million pretax or $0.03 a share than those earnings would have been had FX exchange rates been flat year over year.

Fourth item, stock expense.

That was higher year over year the first quarter by $38 million or $0.06 a share.

As I mentioned before, we have over 4,000 of our assistant managers and above who receive our restricted stock units as a significant part of their annual compensation.

These grants are made annually each October, or in the first fiscal quarter.

These RSU grants then typically vest over a 5-year period, with accelerated vesting when the recipient reaches 25, 30 or 35 years of employment with the Company.

Factors driving this increase include, of course, the appreciation of our stock price, additional levels of accelerated investing, given some employees' long tenure with the Company, and large number of employees in the plan.

I should note that last October, our issue grants were reduced by an average of 15%.

That is the number of RSUs granted to each recipient.

Fifth, IT modernization costs.

As discussed in each of the past eight or so fiscal quarters -- earnings calls, our major IT modernization efforts continue to negatively impact our SG&A expense percentages through 2015, and into probably the first half of 2016.

Especially as these new systems are placed into service, and depreciation begins.

In the first quarter, on an incremental year-over-year basis, these incremental costs impacted SG&A by $12 million on estimated 3 basis points, or $0.02 a share.

Turning to our first-quarter sales, in terms of sales for the quarter, our 12-week reported comp sales figures for Q1 showed a 5% increase on a reported basis, 6% in the US and 1% internationally.

As indicated in our release, excluding gas price deflation and the impact of FX, the 6% US would have been a 7%.

The 1% international would also have been a 7%, and therefore the 5% for the total Company reported on a normalized basis would have been a 7%.

And as reported last Thursday, our November sales results for the four-week month ended November 30 -- our comp sales increase, excluding, again, the impact of FX and gas, were even a bit stronger than these 12 weeks figures.

With total Company comps on net normalized basis increase of 8%, which included a 9% in US and a 7% international, ex gas and FX.

Other topics of interest are opening activities and plans.

We opened eight new locations during the fourth quarter, which ended November 23 -- six in the US, our seventh location in Australia and our second location in the Leon, Mexico.

During the first quarter, we also relocated one location in Wayne, New Jersey, to an expanded location.

Also during the quarter, about six weeks prior, we had experienced a severe hurricane around our Cabo San Lucas, Mexico, location.

That has since been reopened.

We have no openings planned for Q2.

For all of FY15, however, we have a current plan of 31 new locations, 18 of which will be in the US, 3 each in Japan and Mexico, 2 each in Australia and Korea, and 1 each in Canada, UK and Taiwan.

Also this morning I'll review with you our e-commerce activities, our membership trends, additional discussion about gross margin SG&A in the quarter, and just a few other topics of interest.

Now, on to the discussion of our quarterly results.

Again, total sales were up 7.4% to $26.3 billion.

Again, on a comp basis, reported a 5%; ex gas and FX, it would have been a 7%.

For the quarter, our reported 5% comp was through combination of an average transaction size of just over flat for the quarter.

Ex gas and FX, it would have been up about 2.5%, an average frequency increase of about 4.5% in the quarter.

In terms of comparisons by geographic region, geographically for the quarter, the Midwest and Southeast were the strongest, with Northeast close behind.

Internationally and local currencies, the better performing countries were Canada, Taiwan and Mexico.

In terms of merchandise categories for the quarter, for the first quarter within food and sundries -- which was up in the mid-single digits -- candy, deli and spirits were up, with relative standouts.

Within hardlines, they were also up in the mid single-digits for the quarter.

Majors were -- electronics came in positive for the quarter, actually in the high-single digits range.

And in addition, better-performing departments within hardlines was hardware, sporting goods and tires.

Within mid-single digit softline, domestics, apparel and home furnishings were the standouts.

And fresh foods, where our comps were in the high-singles, with meat department being the standout there.

Moving to the line items on the income statement.

The first quarter, membership fees were up 6% or $33 million, to $582 million.

Given the sales strength, that was about a 3 basis points decline.

Again, ex FX, that 6% dollar increase, assuming flat year-over-year, FX would have been up 8%.

In terms of membership, we continue to benefit from strong sign-ups at existing and new warehouses, continued increasing penetration of the executive member, and strong renewal rates, both in the US and Canada, as well as worldwide, in newer markets.

Our new membership sign-ups in Q1 year over year, Company-wide, were up 4% year over year in the quarter, even though there were fewer locations opened.

We opened 9 locations in Q1 this year versus 13 last year.

That, of course, includes all member sign-ups -- new member sign-ups throughout the Company.

In terms of new number of members at Q1 end, we began the fiscal year or ended last fiscal year with 31.6 million Gold Star members.

We now had at this quarter-end 32.1 million, so up about 0.5 million.

Primary business remained at 6.9 million, add-on business remained at 3.5 million.

So all told, we went from 42 million member households to 42.5 million.

And including additional card holders, went from 76.4 million at fiscal year-end to 77.5 million at the end of the first quarter.

Also at Q1 end, paid executive memberships totaled $15.2 million, which was an increase during the 12 weeks of about 420,000, or about 35,000 a week increase in the quarter.

Executive members, as you know, represent more than a third of our membership base, and over two-thirds of our sales and operation.

In terms of renewal rates, they continue strong.

At the end of the fourth quarter, business memberships renewed at 94.4%.

At Q1 2015 -- so 12 weeks later -- at 94.5%, so up a tick.

Gold Star remained at 89.8%.

Total 90.6% at fiscal year-end and 90.7% at Q1 end.

And when I say total, that's US and Canada, recognizing newer markets start out at lower rates and build over the first several years.

Worldwide, we remained at 87.3% in the fourth quarter, and at Q1-end, still a nice increase from a year earlier at the end of the first quarter last year at 87.3%; what we ended the quarter with now, was at 86.5% worldwide.

As I touched on in last quarter's conference call, we continue to try new things to drive sales and membership sign-ups.

I did mention in this fiscal quarter, on the last call in early September, for eight days, we ran a nationwide promotion for new members on LivingSocial.

It was a good value, and we felt worked pretty well.

But we'll continue to look and see what we want to do going forward; no plans at this point.

Going on to the gross margin line, gross margins, as you saw, were quite strong, up 22 basis points to 11.03%.

Again, I'll ask you to jot down a few numbers.

Four columns, The first two columns are for the entire FY14, both reported and without gas deflation.

And then first-quarter 2015 would be columns three and four, reported and without gas deflation.

Moving across those columns, core merchandise for the year was 6 basis points on a reported basis, and up 3 basis points ex gas deflation.

For the quarter, it was down 6 basis points, and down 13 basis points without gas deflation.

Ancillary, plus 6 and plus 6 in columns one and two, for all of last fiscal year.

In Q1 2015: reported, plus 22; and without gas deflation, plus 20.

2% Reward minus 1s across the four columns.

LIFO, year over year for all of last fiscal year was a minus 5 and a minus 5. We actually had a very small LIFO credit this year, versus a very small LIFO charge last year in the quarter, so it's a plus 1 and a plus 1.

Lastly, other or adjustments, minus 2 and minus 2 in all of FY4.

And plus 6 and plus 7 without gas deflation for Q1.

That's that one-time, that nonrecurring lawsuit recovery that I mentioned earlier.

So total reported was up 22 for the quarter, and up 14 without gas deflation.

Now, the core merchandise I mentioned is, again, on a reported basis, was down 6, and down 13, ex gas.

A lot of that, again, is driven by this -- particularly this success in the gas business, both in volume, as well as margin contribution -- when the gas margins were up, when gas prices go down, typically.

Core gross margins as a percent of their own sales were slightly negative, a couple of basis points down year over year.

With food and sundries and softlines showing year-over-year improvement, and hardlines and fresh foods gross margins being lower year over year in the quarter.

Pretty much as what we planned, what we continue to see in the fresh foods area, with some of the raw material cost going up.

Ancillary and other business gross margins, as I mentioned, was up 22 and up 20, without gas deflation.

With the exception of slightly lower year-over-year pharmacy margins, most of the other ancillary businesses -- starting with gasoline, of course, but optical, hearing aid, travel, business centers -- all showed higher margins year over year in the quarter.

2% Reward again increasing penetration, represented 1-basis point hit to margin.

And as I mentioned, LIFO was a 1-basis point swing.

We had $1 million LIFO charge last year in the quarter, and a small LIFO credit of about $2 million this year.

Moving into SG&A, our SG&A percentage year over year in the quarter was higher by 4 basis points, coming in at 10.26 this year, compared to a 10.22 last year in the quarter.

Again, will do the same four columns for all of FY14, both reported and without gas deflation.

Columns three and four, the first quarter, both reported without deflation.

Going across these line items, operations were minus 2 and a plus 1 for the year, and a plus 8 and plus 16 for the quarter.

Remember, pluses means lower year-over-year SG&A.

Central, minus 3 and minus 3 in the year, and minus 1 and minus 1 in the quarter.

Stock compensation, minus 2 and minus 2 for the year, and minus 11 and minus 11 for the quarter.

And total would be, again, for reported for all of FY14, SG&A was higher year over year by 7 basis points, without gas deflation higher 4 basis points.

This year in the first quarter it was higher by 4 basis points reported and better or lower by 4 basis points without gas deflation.

And a little elaboration on this that.

Core operations SG&A, again, was lower by 8, but lower by 16 ex gas impact.

Within operations and without gas, our payroll SG&A percentage was 9 basis points better year over year -- particularly good showing, and certainly a reflection of strong sales, as well as strong gas sales which have lower SG&A, while benefits and workers comp-related expenses were about 4 basis points worse year over year.

Central expense was slightly higher year over year in the quarter by 1 basis point.

Increased IT spending, as we continue to modernize, as I mentioned -- within this number, that was about minus 3 basis points.

And that will continue in those types of increments, we think.

The increase was partially offset, of course, by improved payroll in central, as well as by 2 basis points.

Finally, SG&A expense-related stock compensation was higher year over year by 11.

I should point out that the year-over-year basis points variance for this expense item will be quite a bit less in Q2 and Q3, and higher year over year in Q4, but not as big a negative as variance as we've seen in Q1.

Again, if you think about it, with most of the RSUs vesting over five years, you take out the one that finally vested.

So you take out an expense back when the stock was in the 50s, and you add one when the stock was in the 125, 130s, when we did the one in October this year.

Last thing, on the income statement pre-opening expense -- $24 million last year.

It was lower or better improvement by $9 million; so $15 million this year.

Again, we opened 9 units this year, compared to 13 last year.

So all told, reported operating income for the quarter total $668 million last year, and $770 million this year.

Or an increase of 15%, or up $102 million for the quarter.

Below the operating income line, reported interest expense was about the same year over year, with Q1 2015 coming in at $26 million versus $27 million last year in the quarter.

Interest income and others, I mentioned earlier, was quite a bit higher year over year -- $18 million last year versus $35 million this year, or up $17 million.

Actual interest income component for the quarter was slightly up; I think it was a little less than $1 million.

The other component of equity and earnings within this line item was higher by 16.

This, again, relates to the marking-to-market the gains on FX contracts used to source US merchandise -- principally our US merchandise -- in our international operations.

Overall, pretax income was up 18% versus last year's quarter, from 659 last year to 779 this year.

In terms of tax rates, our effective tax rate this quarter came in a little higher than last year.

It came in at a 35.2, compared to last year's first-quarter rate of 34.6.

The increase was mostly due to a few net discreet items that benefited last year by about $5 million, and a couple of negative discrete items which totaled about a -- an increase in taxes of about $1 million this year.

Overall net income was up 17% versus last year's first quarter, from $425 million last year to $486 million this year.

A quick rundown of a couple of other topics.

Balance sheet depreciation and amortization for the quarter came in at $254 million.

In terms of accounts payable as a percent of inventories, you have the balance sheet attached to the press release.

Now, on that, it showed a reported number this year of 101% payables to inventories, up about 2 percentage points from 99% last year.

That, of course, includes construction payables and other payables, not just merchandise.

If you took out everything and just had merchandise payables as a percent of inventory, last year Q1 -- and it was 89%, up 3 percentage points to 92% this year.

Again, a reflection of that inventory control, but also strong sales.

Average inventory per warehouse last year in the first quarter ended at $14.453 million.

This year, in came in slightly lower, at $14.372 million, or about $81,000 lower.

If you take out FX -- FX was about a minus $250,000 to that number.

So if you take out FX, we were actually up average inventory per warehouse about $169 million -- still a very small increase, 1.2% on that normalized basis, compared to the 7%-plus sales increase.

No real issues with inventory levels going into the last few weeks before our calendar year-end and Christmas and the holidays; they're in good shape.

In the past couple of months, we have received questions about possible inventory issues due to the work slowdowns and shipping along the West Coast.

I'm sure, like many retailers, we did what we could do to bring in seasonal merchandise a little early, if required and necessary.

Overall, it was not a big issue for November and December, and is not currently a big issue.

Looking ahead, into January and February, it's really not a big issue -- perhaps even a small issue, from seasonal furniture and some other types of items like that.

But talking to the merchants, not big delays, but a little bit of a back-up.

In terms of CapEx, first-quarter 2015 we spent $555 million.

Our FY15 CapEx is estimated to be in the $2.5 billion-plus range; this compares to last year's $2 billion.

So up pretty significantly year over year, with our ramp-up and expansion and all the complementary things that go along with that, with depot expansion.

And of course, the IT expenses that I just mentioned, as well.

In terms of dividends, our quarterly dividend of $0.355 a share or $1.42 annualized, based on shares outstanding, is about $625 million annually.

We did buy a little stock back in Q1, about $18 million, at an average price of $126.43.

In the first, I believe, five weeks of this quarter, we were under blackout from the prior year with -- until we were able to report first quarter.

And so we didn't buy a heck of a lot during the quarter.

Costco online, we are now in four countries -- US, Canada, UK and Mexico.

For the quarter, sales and profit were up over the year.

E-commerce sales were up 20%, up 19% on a comp basis, and up 21% excluding FX.

It still represents about 3% of our total sales -- just under 3%.

We continue to -- from really going back a couple of years ago, when we re-platformed the site, we've gone through a couple of iterations of improving our mobile applications.

As I think I mentioned earlier, we've combined some of our e-commerce merchandise efforts with our in-line efforts.

We think that's been a big help to us.

We've added a few categories, like apparel, health and beauty aids, and a few extra [curriculum] signature items.

We have certainly improved timing of shipment, by shipping what we ship directly, instead of from the manufacturer -- from one depot to a few depots around the country.

Our international markets -- stay tuned.

Maybe one additional country by fiscal year-end 2015.

Certainly, at least one by the end of calendar 2015.

In terms of a few other things that we've talked about in the past, Google Shopping Express is now being offered in six markets in the US.

The Bay Area, which is now geographically expanded from its initial testing about 10 months ago; the Los Angeles area, New York City-Manhattan.

And more recently, in October, the test continued into three new cities -- Chicago, DC and Boston.

Again, it's too early to completely tell, but we're seeing some increased overall spend, and it's been a good partner to work with, with Google.

We continue to increase our offerings and categories in these tests, as well.

Instacart -- it's now in 13 markets.

This is where customers in Instacart order through Instacart; they come in and buy the merchandise and deliver to the customer.

That's continuing to expand, as well.

And Boxed is now in three markets, up from two.

Lastly, I think you saw the release, maybe we talked about it, with Alibaba Tmall being shipped out of our Taiwan operations.

We're shipping -- I think we're up to about 125, 130 items -- mostly various food or sundries or [haba]-related items, about half of them are Kirkland-signiture.

It's great, but it's new and we'll see where it goes from here.

It's certainly -- again, our name known a little bit over there, as well.

In terms of expansion, as I mentioned, we've got a lot going -- nothing going on in Q2.

Just a few in Q3.

We have five openings, although two of them are relocations; so, net of three.

And we've got 20 planned for the 16-week fourth quarter.

Most of those look pretty good at this point.

It's just how they -- the timing of them.

In FY14, for all FY14, which ended of course at the end of August, we added 29 units, or about a 5% unit square-footage growth.

And 2015, assuming we add the 30 to 31 units -- on a base of 663, that would also be about a 5% square-footage growth.

If we get to the 31, it will be 18 in the US, 3 each in Japan and Mexico, 2 each in Australia and Korea, and 1 each in Canada, UK and Taiwan.

Some of you asked for square footage numbers.

As Q1 ends, total square-footage stood at 96,437 million square feet.

With that, I'm going to turn it back over to Erica for any questions.

Thank you.

(Operator Instructions)

John Heinbockel with Guggenheim Securities.

Rich, I wanted to drill down a little bit on gross, by category.

Two were up, two were down.

The two that were down -- fresh food and hardline -- fresh food was solely pass-through of inflation, and was hardline's entirely mix?

Fresh foods was certainly inflation and us holding prices, like you know we do.

I know, again -- sound bite, anecdotal -- butter and milk is way up, and therefore, cheese.

And so you've got those types of items.

On the other side, some of it's electronics -- that's more competitive, and we're part of that.

So, a little of it is mix.

But nothing really out of the ordinary.

When you look at the two that were up -- and I take it they were not up a lot -- is that solely mix?

And where is Kirkland -- Kirkland would have the big impact in food and sundries, that's where it would show up.

Is that primarily driving the better mix?

Honestly, I don't have that level of detail in front of me.

First of all, none of the ups or downs were -- they were in the 10- to 25-basis point range, basically, up or down.

So not a lot of jumping either way.

My guess is, a little of it's mix.

KS helps, but clearly, KS -- the big penetration increase of KS from zero to 25% over the last high-teens or 20 years, those increments are smaller now.

So, yes, it helps, but it doesn't help like the days when you're adding a percentage point or two in a year sometimes.

All right.

And then lastly, you talked about FX and inventory.

Even putting that aside, obviously, inventory is under awfully good control.

Is more of that in-store?

Or is more of that backstage between your vendor and the stores?

Keep in mind, if we're trading on inventories 12-plus times a year, everything is pretty fast-paced.

If you're in Canada or Japan or wherever, and you're buying -- buyers using FX contracts, because they've got, in most cases, US dollar-denominated inventory payables.

They're going to lock in based on what they've got coming in, what they know what they're going to have to pay out in dollars.

At a time when they are comfortable with -- based on that conversion rate, they're comfortable with the price point they're going to sell it in their local currency, in that local country.

So it's pretty straightforward.

In fairness, as you know, some quarters, year over year -- some quarters, it's a $10 million gain, sometimes it's a $10 million loss.

This time was a little better, I think partly a reflection of the weakness in the -- the strength of the dollar, how quickly that strengthened, particularly in a couple countries.

But it's nothing you are doing structurally to take inventory working capital out of the system?

No.

We do that -- that's just kind of one of the mantras that we try to do anyway.

Mind you, I mean, this as an example from 20 years ago in the tobacco business, which is a very high-volume -- not as high a volume as it used to be -- but a very high-volume business, and a very fast-turning business.

I remember years ago, the majors offered -- let's say whatever the terms were -- X% discount if paid within seven days.

And then they came back and said -- we'll give you an extra 0.5 point if you pay one-day EFT or ACH, or whatever it was.

So 0.5% for paying six days early.

Well, it's a no-brainer.

But you take a high-volume item like that, and it goes from probably 100% payable to zero almost.

That's an extreme example.

You've got gas working the other way, where accounts payable is probably 600% or 700%.

Okay, thank you.

Simon Gutman with Morgan Stanley.

This is Joshua [Cyborne] on for Simon Gutman.

Just curious, looking back, how are customers reacting to lower gasoline prices?

And have you seen any trade-up from regular to premium?

I don't know.

I think we sell more premium anyway.

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

I think the reflection that our shopping frequency and our concept continue strong is probably a reflection of that.

Our view historically has been, on something big like this, whether it was when gas was going crazy-upward toward $4 a gallon in early to mid-2008.

Did it impact us?

It probably impacted us a little bit, but not as much as some of the dollar-type stores or lower-demographic stores.

Similarly, are we getting a little benefit from it?

Yes, but we don't think it's big either way for us.

Okay, so just looking forward -- (multiple speakers) Sorry, what was that?

It's got to help a little.

Okay.

And then, looking forward, if gasoline stays where it's at right now, is there a change in profitability, or have we seen the most of it in Q1?

Well, I'll tell you what I know.

It's a volatile business, as we know.

Generally speaking, when it's declining is the best, in terms of profitability.

It is more profitable at any level than it used to be, a little bit, I think.

Again, it's a profitable business, it's a lower percent of sales profitability than the Company as a whole.

I think one thing that's encouraging for us, though, is more and more people coming to get their gas -- for every 100 people that pump gas during opening hours, a little over 50 of them now come in and shop.

So even if 1 or 2 of those 50 are incremental, that's a positive.

We've been helped two years in a row now with these outside entities like GasBuddy.com, where nationwide on average, we are the lowest price; that's helped.

I know our gallon comps in the first quarter were low-single digits, which is really off the charts, in terms of getting people into our parking lot, and that's good.

Okay, thank you.

If you don't mind, if I could just add one more.

If you could discuss --has there been a mentality or strategic shift on the e-commerce front?

If you feel you you've gotten more aggressive over the past 6 to12 months?

The things that I mentioned has probably been over the past 6 to 18 or 24 months.

But certainly we've added a few SKUs, expanded some categories, trying to get people to think of it not just as the place that I can buy patio furniture or a big TV, but also some regular, higher-velocity items.

So I think it's been more -- if I just looked at year-over-year sales increases on a comp basis, it wasn't but a couple of years ago, it was in the mid-single -- stuck in the mid-single digits.

Last year, it was in the high-teens, and this quarter it continues in that very high-teen, low-20 area.

That's a reflection of the things that we've done.

But nothing new and dramatic in the last six months; it's a continuation of that.

Okay, thank you very much.

Charles Grom with Sterne Agee.

Just to clarify on the gross margin grade, did you say that ex gas, the core was down 13 basis points?

The core is down, but again, it's almost like under the phrase -- no good deed goes unpunished.

Over the years -- and as I've tried to explain this in a little matrix, you almost need a three-dimensional matrix.

Given that gas was strong and gas gross margins were very strong, relative to the very low gross-margin business, that disproportionately weights those two lines in that little matrix.

And that's why I pointed out that if you look at just food and sundries, hardlines, softlines and fresh foods -- those four core areas, which I bet are 80% of our business, those, year over year, were down 2 basis points.

Two of those sub-departments up 10 to 25 basis points, two them down 10 to 25 basis points.

The core business is pretty much flat year over year, but shows on that chart that way because of that high-dollar penetration of gas.

Okay.

So the up 2 basis points would more or less compare to, say, the up 6 or 7 basis points that you posted in the third and fourth quarter?

Yes, but it was down 2, not up.

I'm sorry, down 2, okay.

I get it.

And then, on the CapEx guide, you had a big acceleration from this year versus last year, store growth was pretty consistent.

Just wondering if you could speak to the delta.

Is it IT spend, is it land?

Just what's driving the increase?

Well, it's also four more locations, including [relows].

IT is probably at least 100 of it.

International is more expensive.

We probably are spending more this year on depot-type stuff.

I'm rounding here, but depot is, I bet, year over year, is 100, 150 higher.

So, probably -- but year over year in the prior year, there was probably 75 to 100 on IT.

I'm shooting from the hip here.

And certainly, for the year, that 2.5, 2.6 number, we have an original budget probably a little higher than that.

But, we know that a couple of them will slip, and some of that assumes land banking for the first part of next year.

Clearly, we are spending more on some of these international locations, in a confident way, frankly.

Some of the ones in Asia, as you know, are -- knock on wood -- so far have been relatively no-brainers.

Okay.

Last question, on the balance sheet, roughly $17 per share in cash.

Any updated thoughts on getting a little bit more systematic on the buyback from doing so much each quarter, or so much each year, as opposed to setting up the grid?

And any thoughts on the current dividend?

1% yield is a lot lower than some of your consumer-staple peers.

Our Board discusses it every quarterly board meeting.

Again, I've learned that the matrix works when stocks move slowly either direction.

We have had that high-quality problem that you put your [markers] in place, and then in some cases, we're locked in for five or six weeks due to the blackout.

And then it moves well-above the several dollars of cushion we gave it.

I think we want to be more systematic, but I can't say when it will be.

We'll talk to you next quarter.

But certainly, given that we grant to these 42 or 300 employees annual grants that are just in the high-threes -- 3.6 million, 3.8 million shares or something -- we want to at least cover that, I think, on an ongoing basis.

We certainly did not do that on a quarterly basis this quarter, but the year is still young, and we'll see.

We'll let you know next quarter.

All right, thanks a lot.

Good luck.

As relates to the dividend, again, that's a conversation we continue to have, and we look at all of them.

We recognize that as -- first priority is CapEx, and then tied for second, if you will, are a few of the things that we'll continue to look at.

I'm sure we'll do some things over time, but it will be on a timetable that we feel comfortable with.

Thank you.

Brian Nagel with Oppenheimer.

Nice quarter.

A couple of questions.

First off, on gross margins.

If you look at that -- and you may have discussed it in the prepared remarks, and I apologize.

But the ancillary gross margin benefit we saw again here in Q1, can you discuss the drivers of that?

And how should we think about the sustainability of that over the next few quarters?

Well, the Big Kahuna was gas.

As I mentioned, I think, five of six, or five of seven, or six of seven of our ancillary businesses all had up year-over-year gross margins.

Most particularly was gas.

So is that sustainable?

No, it's never sustainable.

You see where gas prices are now.

So it's continuing, but again, that can be fleeting.

We've been asked the question -- when you get these outsized profits, you're more aggressive in pricing.

We don't sit down and say let's use this many dollars, but certainly we're going to be aggressive, and that's what we do for a living.

So I think that buffers it a little bit, as well.

My next question, I think, Richard, you already answered.

In the marketplace -- if we look at Costco gas right now, it's a bit more of a competitive standpoint, Costco gas versus competitors', and you typically price below.

You're saying with prices doing what they've done, you've essentially kept the competitive relationship the same in the various markets?

No, we've improved the competitive relationship, in our mind.

Okay, thank you.

Dan Binder with Jefferies.

Congrats on a good quarter.

Just on the follow-up on that gas discussion, with all the movement in the gallon comps and pricing, where are we now as a percentage of sales for gas?

I'll have somebody calculate it right now for you.

Hold on a second.

Okay.

And then my other question, if you want to focus on that first, is on consumer-electronics; you talked to a lot of strength there.

Any color you can give us around the breadth of that strength, where you're seeing it, what you're seeing with 4K TV and competitive pricing?

First of all, as you know, we introduced several Apple products over the last year.

That's a very competitive business for retailers.

For us, as well; we know that, but we want to have that product for our members.

4K TVs are going well.

I believe that on those higher-end TVs, we tend to be the outlier, in terms of driving sales of those.

But it's still small relative to the entire category -- that component.

Phone business is very strong.

You can see what we've done with our kiosks out there.

And not only phone business has been strong, added to that, we've added the Apple brand there, as well.

And then, the various tablets.

So there's a lot of different things in that area that are helping the sales strength.

Again, I think it tends to be a little more competitive.

Apple is part of that.

That's pretty much it.

Nothing out of the ordinary.

These things fluctuate up and down a little bit.

We're pleased at the strength of the comps in that area.

By the way, in terms of the question about gas penetration, for the quarter, it was about 10.5%.

And just a quick question on the cannibalization rate.

I know it hasn't really changed much.

I think it was like 50 basis points in any given month on the comp.

I was just curious, can you give us an idea of what you're seeing on the bounce-back of those clubs once you cannibalize it?

Does it come back to historical volumes within a year, two years?

Has that been changing at all as you've been doing more fill-ins?

Generally, it's a year or maybe slightly over a year.

Generally, when we cannibalize our own units, you might take anywhere -- as much as 10% or 15% from nearby unit or units.

And a year, year-and-a-half later, you're pretty much back.

Going forward, not looking back at the past year, of course.

And again, it varies.

But, overall, it's been pretty predictable for us.

Based on ZIP code analysis of where the members are shopping from, we generally know -- and what we find is, the benefit really is -- do we pick up a few extra members?

Yes.

Not a lot.

We pick up a lot in frequency.

If you have a loyal member that is shopping -- I'm making these numbers up -- but once a month, because they're a 30-minute drive away from a Costco, and then all of a sudden, they're a 10-minute drive away, and it becomes a significantly more regular shopping frequency.

Great, thanks.

Meredith Alder with Barclays.

I was wondering -- I'm still somewhat new to the Costco story -- if you could talk about where you see the most potential growth?

Obviously, you don't have a lot of locations in continental Europe.

And yet, it's tough to open warehouses there.

When you look at Asia, do you feel like you've still got a lot more growth in those markets?

And what about the US?

Well, if you'd asked me five years ago where we would expect to be now, I would say our goal was to get up to about 30 locations a year by this time.

And probably be right at that middle point of trending from the majority in the US to less than half in the US.

If you look at this year and next, it's roughly 30 a year.

Still a little over half in the US, I think,16 or so last year.

I think I mentioned, 18 out of 31 this year.

And that's, by the way, a function that we've continued to be successful in, in lots of what I'll call newer markets, meaning the markets over the last 10 to 15 years.

And while we'll still get another unit open in the Puget Sound or perhaps in the Portland area one day, or hopefully, every year or two get another LA unit in Greater LA market of 45 or 50 units.

But there are precision points now where -- locations where we need to go.

But we're finding in a lot of these cities -- again, whether it's Chicago and Dallas and Atlanta, or smaller cities in Florida, in the Carolinas, or new markets like Baton Rouge and New Orleans last year.

So that's probably up to our expectation, a little bit about our opportunities here in the US.

Outside of the US, we've got 10 or 11, I believe, in each of Korea and Taiwan -- maybe 12.

We think that we can go into the mid-to high-20s there over time.

But again, it may take some time to get done.

And where Japan is certainly a bigger market for us -- we've got 23, I believe, 22 or 23 -- we should have a lot more than that.

But we went from 9 to 21 or something in a little over two years.

So we're doing well there.

And we just, as I mentioned, opened our seventh in Australia.

While Australia is what, two thirds of the size, population-wise, as Canada, where we have 90 or so units, we have seven in Australia.

I am not suggesting we're going to have 45 in Australia any time soon, but certainly, we'll get more than 7.

Western Europe, all of Europe, is certainly an opportunity for us.

It is tough to get in, even in the worst of economies.

We've been successful, with about four years of effort, getting one unit open in Spain, with a second coming towards the middle to the end of next calendar year.

And we're still fighting to get our first unit open in France.

So it takes some time, but we're persistent and we'll be around.

Okay, great.

Thank you very much.

Mark Miller with William Blair.

Slightly different question on gas prices.

My historical recollection is that when gas prices are high, more consumers might go out of their way to drive to Costco, and that, that was viewed as a historical benefit to traffic.

But the inverse does not appear to be happening.

Wondering what, in your view, has changed?

Or do you think there is a risk if gas prices stay lower, that you may not get quite as much a lift, in terms of traffic to the store, as in the past?

I think when gas prices were skyrocketing back in 2008, going up towards $4 for the first time, we were on the news every night somewhere, whether it was a small town in Montana or Los Angeles -- where's the best place to buy gas?

And so that certainly was a positive.

Theoretically, the argument is, is that people, as prices fall, that'll be less of an incentive.

I think it's a greater membership value proposition.

When a GasBuddy.com comes out and says 40 million-plus inputs from drivers out there, saying that we're the best, lowest-priced nationally by $0.14 or $0.16, that resonates.

The fresh food, second to none, in our view -- we're biased.

But that drives a lot of business.

The pharmacy, frankly, I think deserves credit we get for that, in terms of pricing.

We're proud of the fact that we take care of our employees.

All those things are positives.

I think once you've come to Costco for gas, and we got you into the warehouse, there's reasons why you want to come back.

I think we're starting to appreciate the fact that it's all the above, it's some of the crazy KS items that are KS items -- where you going to buy them?

You've got to buy them at Costco.

Oh, there are a few other places now you can buy them, but we're selling them to those people.

Your traffic just continues to amaze.

My other question is on China.

I understand it's very early with Alibaba, but I wanted to ask, is there any change in your long-term thinking on China?

You did say that there's a benefit of getting your name known there.

Historically, you've had some reservations.

But are you -- should we be thinking that club growth is in the future there?

And what might inform that?

Thanks.

I think it's in the future, but if you'd asked me that same question 10 years ago, I would say I think it's in the future.

And not being cute about it.

Every couple three years, senior management, both international senior management and corporate senior management, goes over there and looks around, and we continue to do that.

We recognize -- look, it's a giant market.

We're confident about what we do.

We're also very hands-on.

And we've got a lot of things going on in a lot of directions, and we know that everybody says -- well, somebody's getting their first.

Well, people have gotten to other places first, and when we come in, we do just fine.

So it will be at some point, and I don't know when.

If you said, what's the likelihood in the next 5 to 10 years?

Sure.

Next two to five years?

Maybe.

Next Thursday?

We're not ready yet.

Okay.

Thanks, Richard.

Chris Horvers with JPMorgan.

I wanted to follow up on the acceleration and the core comps over the past year.

It seems like most of the acceleration is seen in the hardlines category.

Would you agree with that?

Or have there been movements towards the high-end of the ranges that you provide in softlines and fresh foods, and so forth?

And within CE, is that TV turning positive, plus the addition of Apple, driving the hardlines rebound?

That's one of the things I think I mentioned.

Tires have been good this year.

Automotive, lawn and garden, have been good -- we're out of season for that now.

Apparel has continued to be strong.

We enjoyed a couple of years on a compounded basis, apparel comps, probably increases in the mid-to high-teens.

So that, of course, at some point, has got to come down a little bit.

But the organics is helping.

I think in the last two years, we've a little more than doubled organic sales from the low-billions to closing in on $3 billion currently.

So all those things help.

Within the hardlines category, is that TV and Apple, essentially, that's driven that acceleration?

Within the major --

I would say TV and Apple are probably the top two, without looking at the detail.

Phones are probably in there, too.

Phones could be first or second.

I don't think that phones are first, but phones, TV and the reintroduction of some of the Apple items.

When you didn't sell, let's say, iPads, were you selling iPhones in the wireless kiosks?

Yes, we are.

By the way, as a comment was made here in my office, those are the big-volume categories.

But white goods are up; not that we do a big white goods business.

Audio is up.

Again, a smaller business.

And that's not just headphones; it's sound systems and all kinds of stuff.

But the big volume areas are those three that I mentioned.

And was Apple a point in time and back to the store base overall?

Or did that start in, let's say, June, and then ramp up over the past five months?

I think that's right.

But it's a piece of it, it's not be driving piece.

Understood.

And then on depreciation, can you give us some color how to think about the depreciation?

I don't believe you historically guide to it, but with the incremental CapEx over the past couple of years, it would seem like dollars per week, or dollars per quarter, that continue to rise for, I think, the next couple years.

So any color there --

I hope it continues to rise forever.

Probably the simplest way to do it is, look at what it's done for each of the last several years, year over year, in dollars.

My guess is somewhere around 10%-ish, and that's probably as good a guess -- maybe if you want to add a little bit for IT modernization.

When, as you know, over a four- to five-year period, on an incremental basis, we're probably spending close to $0.5 billion dollars that generally -- once these different modules and components are put into operation, they then get amortized over five years to seven years.

So maybe that adds a little bit to that billion dollar-plus number.

Where does that depreciation show up, in terms of the margin buckets?

I know you talked about central.

Is that core, as well?

It's all SG&A.

Virtually, all SG&A.

Okay, understood.

Thanks very much, Richard.

Bob Grbul with Nomura Securities.

This is Kevin Heenan on for Bob Drbul.

You had called out apparel as being strong within softlines.

I was just wondering if there were any particular categories or brands within apparel that were particularly strong in the quarter?

It's really all of the above.

We have made a conscious effort over the last couple of years to -- both with brands and with Kirkland Signature -- go bigger and deeper, massing out big quantities of the stuff.

So it really is all over the board, names you've come to know, like Dockers and Levi's and Cole Haan, and just a variety of ones.

But also, the JF, whether it's women's active-wear or what was the men's wool pants.

Certainly the 5 million-plus KS men's dress shirts that we sell a year.

It's a lot of things.

Cool, thanks.

My last question.

We noticed you guys have handheld scanners now in-store, as you are checking out.

We were wondering how that test was going, and any information around that.

I think the handheld -- there's two things we use the handheld scanner.

We give some level of autonomy to the operators on that.

Some regions embrace it a little more than others.

Generally, what we find -- and I'd say there's two uses.

One use is, if lines are backing up and an employee with one of those handheld scanners can go in and essentially scan -- if it's a smaller basket.

Needless to say, if it's top-full and you have things under other things, you can't do it.

But they can help speed up the front end by scanning.

In the case of a limited number of items, those items give that member a little printout with a barcode on it.

When the member gets up to the cash register, the cashier can simply scan that barcode.

It prints out and tenders the full transaction, with all the details.

So that's one way of speeding up.

The other thing it's used for is, in terms of informing people when it would make sense for them to convert from a regular member to an executive member, based on their prior 12 months of purchases.

So if lines are backed up a little bit and we can ask a member if we can scan their card, and we can let them know that, based on their prior year's purchases, they would pay, an example, in the US, of an extra $55 -- $110 versus $55.

And they would have earned well-more than that.

So it's used for that.

But we don't do that all the time because, as we've increased shopping frequency, the member who said no, doesn't want to have say no every week-and-a-half.

So we do that on a periodic basis.

Got you.

All right, thanks a lot for the information.

Oliver Chen with Cowen and Company.

Congrats on the performance, and thanks for the details.

Regarding a bigger-picture question, online, where do you think the mix should go over time?

Will it remain a little bit more modest as a percentage of total?

As you look at your gas and the customers, which factors do people want to see you guys implement over time?

And I just wanted to ask about food and protein and fresh food.

What's your outlook for the inflation there?

And will your pricing under-price the inflation?

And how you see that dynamic evolving?

Well, let's start with the last question.

Our fresh foods people view some continuation on prices like cheese and milk and butter.

A lot of that has to do with some shortages in China, and so increased demand from China, that has pushed that out a little bit.

There's still some inflation in meat.

I believe he said that pork expectation was coming back a little.

And cheese is finally coming down a little bit.

So the expectation is, yes, but not probably as severe -- like, meat had been up 8% to 10% prices; they don't expect that level of additional inflation going forward, but still some.

In terms of pricing, generally, we're going to try to take price increases as late as possible and take price decreases as soon as possible.

Using the famous rotisserie chicken example, we maintained the price while costs were going up, for two years.

When the input cost started going down, we didn't change the price, because we had never raised it.

But overall, we're going to lag a little bit, because we want to be competitive.

And getting back to the first question, it was on Costco.com and mix changes.

Yes, it should continue to inch up.

When we started, it was all big-ticket, and in many cases, hard to take home yourself, or hard to install, or hard-to-put-together items, whether it was big-screen TVs or furniture, or swing sets, you name it.

We certainly want it to be more than just that.

And I think again, we have seen some success in there.

We keep trying things.

What we don't see ourselves, as being the entity that's going to deliver two different boxes of kids' cereals to your doorstep at 7:00 in the morning.

Now, we hope and look forward to some of these other entities that are doing those types of quick home deliveries, for us to be their supplier.

Which we seem to be successful in doing, as well.

Overall, we want our site to be thought of on a more regular basis as well, for our members.

And some of those health and beauty items, some of those sundries items, will certainly help towards that too.

I've used the mobile app.

Do you feel like the mobile app is going to be a key part of traffic online for you as it evolves?

It's continuing, and when we look at our -- when Ginnie Roeglin presents each month at the budget meeting about Costco.com, we have higher and higher percentages of mobile app use.

Not nearly as much as some of the e-commerce entities out there, but it's growing in that direction.

So yes, we'll keep getting better.

Like everything at Costco, while our site is greatly improved from the original mobile apps that we did, there's room for improvement there, and we know that.

Our last question, on the higher-end strength.

Have you seen customer response very positive to higher price points or your assortment, as we see a healthier, high-end customer, as well as your products assortment, being very appealing?

Well, that's what we do.

Since the beginning of time, we've constantly tried to trade customers up to better quality.

We're still a merchant; we want to sell a lot of stuff, and higher-end stuff.

And frankly, we can show great savings in that.

If you go into our warehouses right now -- it is partly for the holiday time -- I've seen some $3,000 and $5,000 and $7,000 wine and spirits pricings, which are great values at those price points.

Certainly our jewelry are higher-end.

Certainly the fact that we do a great penetration in the bigger-sized televisions.

So that's something.

Anecdotally, remember also, at the end of calendar 2008 and into calendar 2009, when the economy went south fast, I remember -- and of course at the end of 2008 and into early 2009 when we took some extraordinary mark-downs on things like patio furniture in January and February.

Because the economy just hit, and people weren't buying that much stuff, those big-ticket discretionary items.

I remember as we entered June and July, as the buyers were getting ready to commit for the upcoming end of 2009 into 2010 season, our CEO -- Jim at the time -- and our Head of Merchandising were reminding the buyers -- don't start bringing the price points down.

If you want to cut back on a little volume quantity, fine.

But we've traded our members up, and our members expect higher-end goods.

Let's keep that going, because that's one of the things that helps us stand out, in our view.

Thanks for the comments on the luxury goods and that experience.

Best regards for the holidays.

Thank you.

Matthew Fassler with Goldman Sachs.

Thanks for keeping the call going here.

My one question at this stage relates to IT modernization, Richard.

If you could just talk about qualitatively what you've gotten done, and what is still on the common.

And then how you would expect those additional investments to further enable the online and e-commerce effort?

Thank you.

First of all, for those of you that have known us a long time, it's going to keep us alive and growing.

Our view is, is that we were at the top of our game, in terms of keeping old legacy systems as long and as cheaply as possible.

And the recognition is, is that we did have to modernize.

We knew that, and we started that, really, in earnest about 2, 2.5 years ago, getting ready to start that process.

Our goal, of course is, is to take us -- over the next 10 years, to double our Company.

I'm not trying to -- we don't have 10-year budgets.

But certainly, at a reasonable growth factor, that should be what we want to do.

We need systems to do that, particularly as we go into other countries and expand in existing, smaller countries right now that we're in -- smaller number of units, and as we global-source more.

So all those things are imperative.

And as you know, we've done very little historically with member data.

Don't expect big things from us, but expect any little thing is still low-hanging fruit for us.

So we'll be able to do a little more of that.

First order of business is to get it done.

What has been installed so far are, we've redone the front-end membership system.

Right now, if you want to change your address or phone number, you have two ways to do it.

You call an 800 number or go by the membership desk.

Well, if a million or 2 million of you do something every year, it's one time each for 2 million people, it's 2 million times for us.

So some simple things like that will start early next year, early to mid-next year.

But there's certainly a lot more to do with that stuff, even some basics.

We also re-did the point-of-sale system, and that's in.

That's making -- and when I say that's in, it's just in.

For the last two months of the calendar year, we have a written rule.

You can't -- don't do anything to screw up the systems in the warehouse.

So while we've now installed it in a number of locations and it's well-beyond pilot and the operators want it, they like it, and it will save scheduling and a few other things, that will be into earnest until -- during half of calendar 2015.

There was one other thing that -- payroll.

We just re-did the payroll system.

That's for the US only, to start with, which is 70% of our Company.

That's, again, something that's making life a little easier in the warehouses, and there's some small benefits to that there.

The big benefits are when we complete the things that you've got to put these things, including the accounting systems, in place first.

Our accounting systems are planned to be installed as of this fiscal year-end -- so the end of this August, fingers crossed.

That would be the best time to do it, at a fiscal year-end.

Currently, we're on task, but we'll tell you tomorrow how we're on task tomorrow.

Beyond that, the big things the users are excited about, if we look at our depot and truck fleet operation, there's some real savings and efficiencies in our depot operations that they're anxious to get in place.

That's still going to be, I'll say 6 to 18 months out, because these are all overlapped -- these modules overlap each other somewhat.

The challenge is going to be as buyers who are used to doing things one way have to do things a little different.

We learned a lot of lessons when we went to Spain.

We started with basically the new SAP-oriented system.

And as you might expect, there are a few Costco people that are over there.

We've learned a lot, including pain-in-the-behind things.

So I think that we know what the expenses are, and we know incrementally we've still got another year, year-and-a-half of that.

By its own size, it will level off.

Again, I think, looking to two to five years out is when we're going to -- we've got to get over that hump.

There'll be, I'm sure, some growing pains when we make those conversions.

But we've gotten a lot better not just doing something and then letting everybody -- all the users figure it out.

We're using 10s and 20s and 30s of additions of people to certain departments, focused -- taking existing people that know our current systems, and putting them on these SAP modernization projects.

So we've done a much better job of bringing good people in, and committing to two or three years, in some cases, those people in that area.

We'll continue.

Great, thank you.

Chuck Cerankosky with Northcoast Research.

Richard, you may have said it, but I'll double-check on this, regarding the gas.

What was the year-over-year decrease in the gas price?

And can you talk about gas gallons on a comp basis increase?

The average price per gallon was down 7.3%.

And the comps were -- the gallon comps were, I think, 11% -- I know it was low double-digit.

10.5%.

10.5%?

Yes.

Okay, thank you.

And I'm curious about having merchandise shipped a little bit ahead of sales plan because of some of the slowdowns in the ports.

Where is the extra merchandise being stored?

Is it in the clubs?

Is it in your depots?

Or even off-site?

No, it's not off-site.

It's mostly in depots or in the clubs.

We were stacked tall, but we turned it pretty fast too.

It wasn't a huge issue.

It was an issue in terms of logistics of handling it.

But basically, the depots had a little bit more for a few weeks.

Okay.

So if it's selling, it's there.

It just gets it there ahead of time.

All right, thanks.

Scott Mushkin with Wolfe Research.

This is Mike [Ottwilliam] for Scott.

Thanks for taking the questions.

I think first, Richard, you had said that outside of pharmacy, that all the other ancillary businesses saw their gross margin rates up in the quarter.

Outside of gas, which is obviously transitory, how should we think about your ability to get some slight margin improvement on these other businesses over the course of the year?

On the ancillary?

Well, most of them were up year over year.

A lot of this, particularly in some of the businesses like optometry and hearing aid, the actual markup on the goods is higher than our range.

Because we include in our own cost of sales calculation the impact of the hearing tech, aid techs, or the optometrist and things like that.

But when volume is driven, its operating leverage is certainly, in my view, better than the warehouse as a whole.

We keep looking to -- as you've heard it before -- bring prices down.

Over the last couple of years, when we introduced -- I forget what the -- it's 5.0 or 6.0, whatever the next level of state-of-the-art hearing aids under our brand.

We lowered the price point by close to $2,000 on a high-quality Kirkland Signature item made by well-known, high-end people.

And we really drove that business.

We saved the customer, we made fewer gross margin dollars, but a lot more units.

Fewer dollars per unit, but a lot more units.

Okay, that's helpful, thank you.

Switching gears on the international side, you guys obviously continue to fare pretty well, given the headwinds.

Just looking at profitability of the other international business outside of Canada and stepping back, over the last few years, you saw EBIT margins come down slightly in that portion of the business, versus in the middle part of last decade, that they were moving up.

What's changed?

As you add more stores in this segment internationally outside of Canada, what are your expectations for getting profit to move up slightly every year?

I know some of that is new-store driven and everything like that.

Any thought there would be great.

I think Craig, our CEO, has said -- look, if the goal is to first, get to three pretax, and we'll see where we go from there.

First and foremost, we're going to drive our business.

We want to see improved profitability every year.

And there's lots of moving parts.

Some of these ancillary businesses help.

Costco Travel -- it's little, but it's growing nicely.

We've got new people over the last couple of years in our business centers went from what I'll call the 10-plus year test.

We have them moving in the right direction.

We've got eight of them, and we'll put a few more.

So there's lots of things out there.

The global sourcing initiatives does two things.

It's generally limited resource commodity-type items, in some cases -- and in our view, what sets us apart in terms of quality and value.

And that drives other business.

I think we are less looking at saying -- do we want to grow -- first and foremost, we want to grow comps.

And again, take out inflation and everything else, can we get comps in that mid-single digit, to a little higher?

If we can do that, then how do we get top-line sales a little higher?

And then how do we leverage that?

We'll keep doing what we're doing, and we're not as concerned about one quarter or one year being a little less.

I know we've gone up and down, but certainly we feel comfortable that we've got the things in place to keep driving bottom line, hopefully, a little better than top line.

But there will be fluctuations in that.

Okay, great.

I appreciate it.

Thanks again.

Robbie Ohmes with Bank of America Merrill Lynch.

Richrd, another gas question.

I know you love these.

From history -- or maybe the question being, when historically you've moved into a lower gas-price environment, big declines year over year at the pump like we are seeing and could see more of, what do you guys tell the buyers to do then?

What categories tend to do better when you're having pretty dramatically falling gas-pump prices?

Thanks.

I don't think we're smart enough to sit around and say -- with this extra profit, what are we going to do?

I talk to Doug Schutt, the head of US Merchandising, the other day, and his view was is -- but, we're doing everything we're doing anyway.

This help some.

Do we do a little more?

Sure.

But it gives us a little bit more umbrella.

We are going to keep doing it.

All right, thanks.

Greg Melich with Evercore.

Thanks, Rich.

I can't believe I've got a couple of questions left here.

Could you update us on inflation across the store, both in COGS and at the retail level?

Yes.

Basically, again, very slight deflation for the first 12 weeks.

Food and sundries is very slight inflation.

Sundries is very slight inflation, like less than 10 basis points.

Apparel is very slight inflation, also less than 10 basis points.

That's through the end of our fiscal year.

And food, of course, for all of FY13, was up about 3.5 percentage points, on a cost of goods basis.

Again, for the first 12 weeks of this month, it's ever so slightly up.

Computers and appliances and things like that are down about 1 point.

Gas, of course, is down, as you know, a little bit.

Those are pretty much the pools, and it all adds up to being down less than 0.5 a percentage point since the beginning of our fiscal year.

That's versus being up 0.5 a percentage point all of last year, from the beginning of the prior fiscal year.

That's helpful.

And that's at the COGS level, and the same with retail?

Yes, I would say it's in the same retail -- if it's inflation, maybe it's a little tick under that because of our leg.

But overall, it's pretty close.

Great.

The second question was -- I think it was in September, you switched your -- interchanged your card partner in Canada.

Could you help us understand how that changes the dynamics, either in sales or profits, in the business?

Also, remind us when your AmEx deal expires, or when that's due in the US?

Sure.

We basically had long-term agreements in Canada, and we have one here.

We don't really talk about our current contracts.

We'll let you know when and if anything happens.

But any ongoing contracts and anything, we really don't talk about.

But in Canada, again, we made the switch.

Currently, for I think about a three-month period ending the end of this month, we accept both.

We started accepting MasterCard a couple of months ago.

And we'll continue to accept, as well, American Express in Canada through the end of the calendar year.

Look, we wouldn't have done it if it wasn't the most attractive deal for us and our member.

And I would probably reverse the order, if this was a 10-K, for our member and us, long-term.

Because we're going to continue to drive value.

So we think the transition is always a little bit of a hassle, but we've worked well with both our former partner and our new partner.

Everybody acts professionally in this thing, and these things happen.

And we have a good relationship currently in the US.

So we'll see where that goes in the future.

As relates to Canada, I think we're now up to -- and it's not required yet.

As of last month, we were in the 30%s, in terms of the percentage of people using MasterCard, recognizing 40%-plus of our transactions in Canada, before anything else, is a debit.

As you might expect, MasterCard has a higher penetration of card holders in Canada.

We want to get that rewards-based card out there, because affinity programs drive sales not only at Costco, but drive reward-based programs, when we get that member using that card, that co-brand card.

And the same held true with the American Express co-brand.

When they use it elsewhere, it changes and improves the economics for us, which allows us to, again, provide a better solution to our member and continue to be more aggressive out there.

It's going as expected -- fine.

And stay tuned in the US, what we may or may not do in the future.

That's great.

Thanks a lot.

(Operator Instructions)

Joe Feldman with Telsey Advisor Group.

Thanks for taking the question.

Most have been asked, but I wanted to ask something related to the food side of the business.

I know in the past, we've spoken about opportunities within food, like new products, maybe organic, natural.

And I know you've made strides with some of that.

But any update on where you stand with organic and natural, and how much you could you there?

Look, I think we can do a lot more.

The supply chain is improving and increasing every day, not just for us.

Again, I think in two years, we've gone in the US from about $1.4 billion to close to $3 billion in organic.

And that's with supply constraints.

Our view is -- there's a couple of positives, from our view.

One is, it's not always a substitute sale.

I gave the example -- perhaps as an extreme example, but -- for the first $25 million of fresh organic ground beef we did a year-and-a-half or so ago, on a multi-$100 billion fresh ground beef program.

But again, $25 million -- that first $25 million organic, 80% of it was to existing members that historically didn't buy ground beef from us because they buy organic.

That was added sales in that way.

The other positive is, is generally in the retail business, organic is -- well, it's always a higher price point.

But it's also generally the higher-margin items.

It's kind of like the sale item you see on white goods is the refrigerator without ice-maker, and with a small freezer compartment.

But then you go in, you want the bigger one with all the extra whistles and bells.

Same thing with this.

We can generally make a little bit better margin and save the customer more and have a higher price point item.

Again, it's growing.

It's a $3 billion business.

I can't tell you how quickly it will grow, but it's growing certainly faster than our top line, overall.

Got it, thank you.

Also wanted to follow up with the -- you've mentioned the LivingSocial deal couple of times this quarter, last quarter.

Should we expect more on that front?

Or more things like that to come?

Well, it's a Catch-22.

It works, recognizing we don't do a lot of it.

But we also don't want our members to get comfortable waiting -- our people comfortable waiting for the next deal.

So we're going to do things on a sporadic basis, on an irregular basis.

But we at least are -- as Craig said, too -- our head's in merchandising, e-commerce and membership marketing -- try some things.

And so we're trying some things.

We're letting you know that the things that we try generally work.

But it's not like we want to change our methodology.

We want to also make sure that the value of the membership is the value of the membership.

But we'll keep trying some things.

Got it, thanks.

And good luck with this quarter, guys.

Thank you.

Why don't we take two more questions, and I'm sure you guys are tired of listening to me.

(Operator Instructions)

And there are no more audio questions at this time.

Okay.

Well, thank you, everyone, and have a good day.

Thank you, ladies and gentlemen, for joining today's conference call.

This does conclude today's conference call.

You may now disconnect your line.