好市多 (COST) 2016 Q1 法說會逐字稿

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

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

All lines have been placed on mute to prevent any background noise.

(Operator Instructions)

Mr. Richard Galanti, CFO, Sir, you may begin your conference.

Thank you, Brandy, and good morning, to everyone.

This morning's press release reviews our first quarter of FY16 operating results for the 12 weeks ended November 22.

Before I begin, please note that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements address risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements.

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

Forward-looking statements speak only as of the date they are made and we do not undertake to update these statements except as required by law.

To begin with, our 12-week first quarter of FY16, for the quarter our reported earnings per share came in at $1.09, $0.03 below last year's reported figure of $1.12.

There are several items of note, six to be exact, that impacted this year-over-year comparison of Q1 earnings.

First, FX, in first quarter the foreign currencies where we operate were weaker year over year versus the US dollar, primarily in Canada, Mexico and Korea.

Such that foreign earnings in Q1, when converted into US dollars for reporting purposes, were lower by approximately $42 million or $0.10 a share than those earnings would've been had FX exchange rates been flat, year over year.

The big weaknesses started about a year ago.

While I certainly don't know what's going to happen tomorrow and there's been continued weakness, certainly the biggest impacts look like the last four quarters.

One of the benefits, of course, is it has made purchasing land and building units in some of these countries a little cheaper over the last year.

Number two, stock compensation expense was $36 million higher year over year in the first quarter, or $0.05 a share.

We have over 4,600 people who received restricted stock units.

For many of them, it is a significant part of their annual compensation.

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

While these grants typically vest over a five-year period, accelerated vesting occurs when a recipient reaches 25, 30 and 35 years of employment with the Company.

So, factors driving this $36 million increase included additional levels of accelerated vesting given the rising number of employees achieving long tenure with the Company.

This by the way is most impactful each Q1, given our October, our issue grant cycle.

Two, appreciation in our stock price and of course the larger number of employees in the plans.

I would like to note that because of the significant price appreciation in our stock this past year, this year's annual RSU grant which occurred in late October, was reduced by an average of 12%.

That is the number of RSUs granted to each recipient.

So while there was a $36 million year-over-year increase in Q1, in the upcoming second, third and fourth quarters of this fiscal year, the anticipated year-over-year increases are estimated to be about one-third of this dollar amount in each of the fiscal quarters.

So, $0.01 to $0.02 earnings year-over-year impact each quarter in second, third and fourth quarters, versus the $0.05 a share impact in Q1.

Third point I'd like to note, there are two SG&A items that together, negatively impacted this year's Q1 earnings.

In the first quarter, we recorded a $22 million charge related to two nonrecurring legal and regulatory matters.

The $22 million figure represented an 8 basis point hit to SG&A and impacted our first quarter earnings per share by $0.04.

Point number four, IT modernization.

As discussed in each of the past many quarters over a couple years now, our major IT modernization efforts continue to impact our SG&A expense percentages, especially as new systems are placed into service and depreciation begins.

In the first quarter on an incremental year-over-year basis, these costs impacted SG&A by an estimated $20 million pretax or 7 basis points, 6 basis points without gas deflation, which was about a $0.03 hit to earnings in the quarter versus last year.

Point number five, last year in the first quarter we did call out that we had a $17 million benefit to gross margin related to a nonrecurring legal settlement.

So that benefited last year's first quarter by $0.03 a share.

And lastly, point number six, our co-branded credit card transition in the US.

As you know, we'll be transitioning to a new co-branded credit card relationship in the US next year.

As we wind down our current relationship, new co-brand sign-ups have greatly slowed and in fact, are now, have now ceased.

The short-term negative impact relates to monies we earned for new co-brand sign-ups.

Year over year in Q1, this represented a $15 million or $0.02 per share hit to our earnings.

This will continue to be a small, negative impact to earnings in Q2 and Q3 and possibly into Q4 based on timing.

At which time I'll be able to better outline how the new relationship should directionally impact our future results and the future rewards to our members under the new co-branded credit card program.

I look forward to sharing more information at that time.

So, six items of note.

I added it up, it's about $0.27 an impact to our year-over-year earnings comparison.

I know many of these things you may have in your numbers.

I know some of them you don't.

Turning to our first quarter sales, in terms of sales for the quarter, our 12-week reported comp sales figure for Q1 showed a minus 1% decrease, plus 2% in US, minus 9% in Canada and minus 5% in other international.

As we stated in our release, if you take out the two big impacts of gas price deflation year over year and the impact of negative FX, the plus 2% reported US comp would've been a plus 6% for the first quarter, the minus 9% in Canada would have been a plus 9%, and the minus 5% other international would've been a plus 7%, such that the minus 1% reported comp would've been a plus 6%.

And, as we reported last Wednesday in our November sales results for the four-week month ended November 29, our comp sales increase, excluding the impact of FX and gas, was similar to the 12-week first fiscal quarter, with total Company comp increase of 6% and again, ex gas and FX, in the US a plus 6%, in Canada, a plus 8% and other international, a plus 7%.

In terms of opening activities and plans, we opened 13 new locations in Q1, including two relos for a net of 11 new warehouses during the quarter, which ended November 22.

That included seven in the US, one in Canada; one in Australia, our eighth in that country; one in Japan, our 24th in Japan; and our second in Spain, just outside of Madrid in Getafe.

That's our second unit in Spain.

Two relocated locations were in Woodland Hills, California and Teterboro, New Jersey.

In the second quarter, we had two new business centers planned to open.

One each in Westminster, California, and in Hackensack, New Jersey.

And for all of FY16, we have a current plan to open up 32 net new locations.

That could come down a little bit based on timing as we get into the second half of the year, a few may be delayed, but that is our current plan.

Of those, assuming we were able to do all 32, 22 of them would be in the US, three in Canada, two each in Japan and Australia and one each in the UK, Taiwan and Spain.

Later in the call, I'll review with you our e-commerce activities, our membership trends, additional discussion about gross margin and SG&A in Q1, and recent stock purchase activities.

Again, very briefly, sales for the quarter reported were up 1.3% to $26.6 billion, up from $26.3 billion a year ago.

Again, on a comp basis, reported number was down 1% but ex gas and FX was up 6%.

For the quarter, our minus 1% reported comp sales results were a combination of an average transaction size down 4% for the quarter.

Again, taking out gas and FX, it would be up 3% excluding those items.

And an average shopping frequency of about 3.5% for the quarter.

In terms of sales comparisons by geography, geographically for Q1, the better operating performing regions in the US were all three regions in California and the Midwest as well.

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

In terms of merchandise categories for the quarter, during the quarter, we look at September, October and November, excluding FX and gas, within food and sundries, which were up in the mid single-digits year over year, sundries, meat deli, and spirits were the relative standouts.

Our hard line sales were up in the mid to high single-digits for the quarter.

Majors were electronic came in positive for the quarter in the low double-digit range.

In addition to electronics, better performing departments included hardware and garden patio.

Within the mid single-digit soft line comps at domestics, women's apparel and home furnishings were standouts.

And in fresh foods where our comp sales were in the mid to high single-digits, produce was at the top of the four sub categories.

Moving down the line items of the income statement, membership fees.

In the first quarter, membership fees were up 2% and 2 basis points or up $11 million, coming in at $593 million versus $582 million a year ago.

Again, without FX, the dollars would've been up 6%.

I noticed in several of the preliminary notes from some of the sale side analysts out there, they'd expressed some questions about the strength in membership.

And I might point out a couple of things.

In addition to being up 6% FX, on a cash basis, there was about another percentage point higher than these numbers.

As well anecdotally, a year ago, we did a couple of things outside with social media in which we didn't do.

Small impact year-over-year, but something versus nothing.

In terms of membership, we continue to benefit from good sign-ups in existing and new locations, continued increasing penetration of our $110 a year executive membership and strong renewal rates, a 91% averaging up to 91% in the US and Canada and averaging up to 88% worldwide.

Our new membership sign-ups in Q1 year over year, company-wide were up 7%.

In terms of members at Q1 end, gold star came in at the quarter end at 34.7 million, up from 34.0 million at year end.

Primary business, 7.2 million at quarter end versus 7.1 million a quarter ago.

Business add-on remained at 3.5 million.

So total memberships 45.4 million at quarter end, up from 44.6 million, and including extra cards, 82.7 million cards out there versus 81.3 million, 12 weeks earlier.

At Q1 end, paid executive memberships came in at 16.4 million which was an increase of 307,000 or 26,000 new executive members increased each week in the 12-week fiscal first quarter.

As you know, executive members are over one-third of our member base and over two-thirds of our sales in those countries where executive membership is available.

In terms of renewal rates, in the US and Canada, at quarter end we were at 90.6%.

It rounded up to 90.6%, rounded down to 90.5% at the end of Q1.

The impact that I mentioned a quarter ago in Canada with having to re-sign up the members with the new credit card program, at the nova program, that was a small impact.

I think there was little impact in the US perhaps based on what I said earlier.

Total worldwide remained at 87.8% at quarter end and at fiscal year end.

Going down the gross margin line, our reported gross margin in the quarter was up 26 basis points coming in at 11.29% up from 11.03%.

As you know, gas deflation is a big impact to these figures, so I will give you a couple numbers.

I'll ask you to write down the normal four columns for all of FY15, columns 1 and 2 would be reported and then without gas deflation, two columns for Q1 2016 reported and without gas deflation.

Of course these basis points figures are the year-over-year change from a year ago.

Merchandise core was reported was plus 11 basis points for all of FY15, but without gas deflation was minus 12 year over year.

For Q1, it was plus 24 and minus 3. Ancillary businesses for the year, plus 29 and plus 23.

For the quarter, plus 11 and plus 4. 2% (sic - see press release ) super [cent] reward, minus 4 and minus 2 and for the quarter, minus 3 and minus 1. LIFO for all of last year was a 5 basis point pickup for both reported and without deflation and for the quarter it was plus 1 and plus 1. Other, for the whole all of last year, plus 2 reported and plus 1 without gas deflation.

And this year, that nonrecurring legal settlement impacted gross margin, that benefited gross margin a year ago, such that it was minus 7 basis points reported and minus 7 without gas deflation.

You add up those columns for all of FY15, reported gross margin was up 43 basis points but up 15 ex gas deflation.

This year Q1 reported up 26, but without gas deflation minus 6, with minus 7 of that minus 6 being the one-time benefit a year ago.

So again, overall those are the numbers.

In terms of core gross margins, which is the core business food and sundries, hard lines, soft lines and fresh foods, as a percent of their own sales, they were positive year over year in Q1 by 13 basis points and they were higher year over year across all four of these merchandise categories.

With both hard lines and soft lines showing stronger year-over-year improvement than the year-over-year improvement in food and sundries and fresh foods.

But nonetheless, all four were positive year over year.

Ancillary and other business gross margin was up 11 on a reported basis, up 4 without gas deflation through the quarter.

Many of these businesses, gas, pharmacy, food court, hearing aids, and mini labs, all showed higher year-over-year gross margins as a percent of their own sales.

Offsetting this a little was slightly lower e-commerce gross margins but overall, net positive there.

The 2% reward was higher year over year due to higher sales penetrations for executive members.

This impacted gross margin in Q1 by 3 basis points to the negative, 1 basis point to the negative ex gas.

LIFO, last year in Q1, we had a $2 million credit representing slight deflation in the US inventory pools and a credit of $5 million this year, also relatively small but a net pickup of 1 basis point year over year in terms of that recovery.

Lastly, I mentioned the quarterly adjustment, a 7 basis point hit in terms of the comparison benefiting a nonrecurring benefit last year versus nothing this year.

So overall, gross margins excluding gas were down 6 basis points year over year, but up 1 basis point excluding that one year charge, that nonrecurring benefit from last year.

Moving on to SG&A.

Our SG&A percentages Q1 over Q1 were higher by 28 basis points coming in at 10.54 this year versus 10.26 last year.

But excluding gas deflation, were lower or better by 2 basis points.

I'll go into some detail and you'll see that the core expense components of that actually were pretty good.

So again four columns, columns 1 and 2 would be FY15 for the year reported and without gas deflation and then, columns 3 and 4 would be Q1 2016 reported and without gas deflation.

First line item, core operations, minus 6 reported and plus 16 without deflation for all of last year on a year-over-year basis.

In Q1, 0 and plus 26; central, minus 7 and minus 5 for the year; and minus 8 and minus 6 for the quarter.

Stock compensation minus 5 and minus 4 for the year and minus 12 and minus 10 for the quarter.

Quarterly adjustments, nothing last year in columns 1 and 2. This year, a minus 8 and minus 8. That represents that $22 million item that I mentioned early on.

So total, last year for the year over year, we reported SG&A up or minus 18 basis points.

And without gas deflation, better or lower, so plus 7 basis points.

This year, higher by 28 so minus 28 basis points for the quarter reported and without deflation, plus 2.

Within operations, again without deflation, showed plus 26 or lower by 26.

Within that, our core warehouse payroll was better year over year in the mid to high single-digits.

Benefits were lower, or better in the high single-digits and the combination of other expenses, a variety of them, were better or lower by 10 basis points year over year.

So again, kind of a core controlled or operating expenses were all in pretty good shape this quarter.

Central expense was higher year over year by minus 8 or minus 6 basis points without gas.

As I mentioned earlier in the call, increased IT spending related to modernization showed higher year-over-year costs of 7 basis points, 6 without gas deflation.

I already mentioned earlier the stock compensation which was 12 basis points or 10 basis points without deflation.

I also mentioned that again, because of certainly the stock price increase but also importantly, the fact that there is more and more employees hitting 25, and in some cases 30, and even in a few cases 35, because they started back at Price Club, the total impact for the year, more than half of it based on our estimates, is the impact in Q1 with about one-third or less of that amount in each of the upcoming three quarters year over year.

So still going to be higher year over year, but not as high as that increase was in Q1.

Finally, quarterly adjustments, again related to the $22 million nonrecurring legal and regulatory items that I discussed.

So overall good expense control, other plenty of things hopefully I've been able to elaborate and shed some light on the onus of that.

Moving down the income statement, pre-opening expense was higher by $11 million or 4 basis points higher.

We had nine openings last year, including one relocation, 13 this year including two.

There's other pre-opening items in terms of countries and some other things, but overall, no big surprises there.

All told, reporting operating income in Q1, reported operating income in Q1 was down $3 million from $770 million last year to $767 million this year.

Below operating income, reported interest expense in Q1 came in at $33 million versus $26 million a year ago.

Interest income, I'm sorry, lower by $7 million.

Interest income itself was lower year over year by about $4 million and the other component was lower by $3 million year over year.

That's primarily related to various FX related transactions.

Sometime that's a positive, sometimes that's a negative.

Never that meaningful for the year in its entirety, generally.

Overall, reported pretax income was down 2% versus last year coming in at $762 million down from $779 million pretax a year ago.

Again, several items impacted the year-over-year earnings comparison which I discussed earlier in the call.

In terms of tax rates, our corporate tax rate this quarter was up about 1 percentage point coming in at 36.1% compared to last year's first quarter rate of 35.2%.

The higher tax rate year over year resulted from a few discrete items going to the increasing tax rate not reducing it and to a little extent, lower earnings penetration from our foreign country operations where tax rates are generally lower than in our income tax rates for the United States.

Now for a quick rundown of other topics.

The balance sheet as has been in the recent past is included in today's press release.

I'll point out a couple of items.

Depreciated amortization for Q1 came in at $271 million.

Accounts payable as a percent of inventory on a reported basis was pretty much the same year over year.

Last year was 101%, this year 100%.

Taking out non-merchandise payables, last year, non-merchandise payables as a percent of inventories was 92%.

This year, at quarter end it was 90%.

Average inventory per warehouse on a reported basis was up a little over 3% or $524,000 to $14.9 million.

Again, ex FX it would have been up about 6.5%, up $960,000 assuming flat FX.

About $0.25 million is electronics and what we call majors and about $160,000 is apparel.

Both built up inventory heading into the Thanksgiving week, Black Friday, and Cyber Monday.

As you could have extrapolated from our November reporting, where we reported the four weeks of November, the 12-week first quarter and a 13-week retail reporting calendar of 4-5-4.

The implication there of course was that the last week, which is really the first week of Q2, which is Thanksgiving week, was pretty strong.

The balance in the departments have been selling well like hardware, housewares and toys.

So really no issues of inventory levels going into the last few weeks before calendar year end.

We're in pretty good shape.

In terms of CapEx, in Q1, we spent a little over $700 million and our estimate for the year is to be into and most likely CapEx will be in the high 2's, say $2.8 billion to $3 billion.

This compares to CapEx of last fiscal year of $2.4 billion.

In terms of dividends, our quarterly dividend continues at $0.40 a share or $1.60 annualized.

This represents a total annual cost to the Company of around $700 million.

In terms of stock buybacks in Q1, we bought back a total of 898,000 shares for $130 million, so an average price of $144.88.

Next topic, Costco online.

We're now in five countries having launched Korea, November 10.

We're in the US, Canada, UK, Mexico, and Korea.

For the first quarter, sales and profits were up over last year.

Q1 e-commerce total sales were up 15%.

On a comp basis, a total and comp basis up 19% on a comp basis excluding FX.

And again, it represents a little over 3% of our sales.

We've been asked a lot of how again, the week of Thanksgiving, Black Friday, Cyber Monday, you name it.

E-commerce sales were quite strong, up 28% and up over 30% in local currencies.

New initiatives, again, it was a few years ago that we replatformed the sites.

We've continued to improve our mobile apps and there's room to grow but they're a lot better than they used to be.

Combined total e-commerce initiative efforts (technical difficulties) with our in line efforts.

We've added a few categories like apparel, (inaudible) and KS items.

We've greatly improved timing of shipments by shipping out of more than just one depot across the country.

And again, we'll expect to see e-commerce in other international markets in the future.

In terms of some of the others out there that are buying from us, we continue to provide merchandise for sale on the Google shopping express.

This is now being offered in six markets.

The Bay Area has recently been expanded, LA, Manhattan and more recently, Chicago, DC, and Boston.

We've increased our offerings and categories and currently testing fresh foods available on a limited group in each of the San Francisco and LA markets.

We're also providing merchandise to Instacart now in 16 markets through the West of the United States.

Boxed in three markets and we're also selling, doing some business with jet.com in the three cities where they have their distribution centers.

Outside of here, Alibaba Tea Mall, we currently offer just over 200 skews on the Tea Mall site with a heavy emphasis on Kirkland Signature items.

It's going well and we're certainly building some recognition for the cost in Kirkland Signature names.

We had a very successful singles day on Alibaba Tea Mall receiving over 300,000 orders.

Next on the discussion list, expansion.

Again, last year, we opened net new units of 23.

So it's about 3.5% square footage growth.

This year, again, plans for up to 32 units.

If we achieve that it will be about 5% square footage growth and I already mentioned where those would be.

Also, as of Q1 end, some of you want to know what our square footage is.

At Q1 end, it stood at 100.547 million square feet.

Lastly, our second quarter FY16 scheduled earnings release, that will be for the 12 weeks ended on February 14, will be after the market closes on Wednesday, March 2, with earnings the following morning on Thursday, March 3.

With that, I'll turn it back to Brandy and be happy to open it up for questions.

Thank you.

(Operator Instructions)

Charles Grom, Sterne, Agee.

Hey, Richard.

Thanks for that.

First question, a lot of moving parts with some of the one-time items.

I know you guys don't give guidance anymore, but I'd be curious how the quarter overall performed relative to the expectations that you would have budgeted back in August?

We beat them.

You beat them?

Okay.

Yes.

Second question, when you look at new member sign-ups, how has the trend been by age group?

I'm curious your ability to attract younger customers given the success of Prime and other programs out there.

Have you guys started to look at the sign-ups by age group, et cetera?

We have and I don't have the most current month's detail, but from our monthly budget meeting, we're getting, first of all, the average age of a Costco member has come down.

I think a few years ago we were about four years older than the average in the US.

Now we're a little under two years older.

About one-third of our new sign-ups in recent months have been millennials and I'll make a point to provide a little more color on that at each quarterly earnings release.

Okay.

The last question for me just on the gross margin.

It's the first time in a long time that all four categories have been positive.

Just curious if there's, if you could provide a little color maybe by category what's driving that?

Well I think the one that's historically in the last many quarters that's always the one that's a little volatile and volatile is mostly defined as down year-over-year, is fresh foods.

And that has to do with the fact that as commodity prices have increased, we maintain prices.

No doubt things like rotisserie chickens and the like.

And that's, I think there's been a little bit of deflation in some of those categories and some meat.

But also, our volumes are particularly strong.

When you've got a low double-digit comp in produce as an example, that's going to help you because sales are strong, availability of products is good and spoilage is less.

So those are the types of things that help you in fresh foods.

I think the strength in electronics has probably helped us.

Those are the things that come to mind.

I don't have -- organics is helping.

Organics as I mentioned before, it's kind of a win-win for us.

We get, for us, a fuller margin, a more fair margin within the confines of what we limit ourselves to.

And in our view, creates even a greater, competitive mode given that that's where sometimes retailers will try to make more.

And your organic penetration stands at what at the current time?

Organic -- well, it's $4 billion plus.

It's still growing very strongly.

But I don't have the detail in front of me, sorry.

That's alright.

Okay, great.

Thank you.

One other point, on the soft lines I know our apparel has been pretty strong too in terms of apparel basics.

So that's generally a full margin business.

John Heinbockel, Guggenheim Securities.

Richard, a question on the fresh food deflation as we -- and I guess maybe it behaves a little bit differently by category.

But if you think about meat and dairy in particular, is that less of a benefit to you margin-wise and more of a volume benefit in terms just because you pass the declining prices through more quickly than most of your competitors by design and so it's probably more of a help to volume than margin or no?

Yes it's more of a help to volume.

If anything, we'll bring the price down and we'll always err to the low side.

So if we have a calculated margin that's -- I'm making the numbers up, but $8.15 a pound, it's going to be $7.99.

You have all those things working towards that.

But that's what drives --

The price elasticity on that is pretty high?

Well when you have got a hot price on strip steaks or items like that, yes.

When you can hit another $1 a pound if you will lower, or a few dollars a pound on some items, that can drive business.

And needless to say, you've been at a Costco and talked about maxing out big, good-looking stuff, that's fresh foods is where we shine.

You said eCommerce gross was down a little bit.

Is that purely mix?

There's been no comment, nothing that was called out specifically of why that is.

So I assume it's mix.

All right and lastly, the leverage that you've gotten in core operations was better than we've seen in a couple of quarters.

It was pretty broad-based.

Is there anything you're doing differently whether it's managing labor, benefit design that would have -- because comp wasn't that different versus prior quarters.

So is it something you're doing internally to manage those items?

I wish we knew more here, but I mean everything we do everyday and I'm not trying to be cute here, but certainly, we continue to focus on things like basics like overtime hours.

Every four weeks when we have an all hands budget meeting here, each of the 16 or so Senior VPs are country managers of operations get up and talk about things that they've done in their region to be more efficient.

And I think that pays off.

We have focus items that they talk about each month.

They talk about other things, working with buyers to create more seamless movement.

All of those things, we really spend a lot of time on.

One of the things that I think benefited us, our assumptions for healthcare costs, notably US where it's most expensive and it's most inflationary, we've done a little better job of that.

It was over a little over a year ago that we made a few changes in plan in terms of our primary caregivers, primary within the plan and that changed a little behavior.

Not that big of an impact to the employee, but a better management of that.

So I think we're still getting a little benefit of that there.

But it's in the core payroll as well and I think that's a combination of lots of little things like I mentioned.

All right, thank you.

Simeon Gutman, Morgan Stanley.

Thanks.

Thanks, Richard.

Good morning.

Curious if you can help diagnose the consumer?

I know we saw some volatility in your monthly comps and there's been some unevenness in other parts of retail.

You gave us some good color in November, but what do you think is going on?

Does spending appear back to normal?

I don't know if it was just a temporary hiccup?

I mean remember I think it was October when we said one month does not make a trend.

And then the first couple weeks of November weren't terribly exciting and then it got more exciting.

And middle of November and late November was quite a bit stronger than the first part of November.

So again, I think we're really concerned when it was -- when frequency was a 3 instead of a 4 but overall comps continue to be well.

Our markdowns are in good shape even though inventory is a little higher.

So I think we feel cautiously optimistic and certainly confident about what we're doing right now.

I think if you ask me what surprises me in the last month versus the last couple of months, electronic has finally turned and that's a think a function of people coming in.

Pricing keeps coming down.

I think our fresh foods has been great.

The fact that many times I'm explaining that fresh foods year-over-year margins are down a little, they were up a little.

That's all good.

So I think that reflects well on us.

I can't speak to the consumer outside of that though.

Right.

So other than electronics, the complexion of what consumers are spending on looks back to normal, back to the old cadence?

Yes, but that doesn't mean anything for tomorrow.

What's nice is when I look at the November results, which I have in front of me, underlying in the US, which is the big piece here, so as it relates to the FX issue, soft lines was low double-digits, fresh notwithstanding some deflation and the average sale on meat, was good.

And so I hope it will continue.

Stay tuned.

Okay.

And just a follow-up gross margin because I guess the printed number is the highest number since our model goes back to 2003.

And you mentioned the four core categories were good and I think you attributed somewhat to mix.

But big picture, the mix of product, that will probably keep benefiting you.

Can you give us a sense though on the leverage with suppliers?

How much of that side of the coin is helping you as well?

I don't think -- I haven't heard anybody talking about major changes in leverage.

We are -- I think if you ask our suppliers, generally we are typically front and center with them.

When freight rates have come down as you might expect, some suppliers are reluctant to -- they are waiting for us to call them, not offer it up.

And global sourcing I think is helping us competitively a little bit.

So overall, I think we're still tough.

I mean there have been some suggestions out there that some retailers are going back to manufacturers to insist on extra monies.

When we read that and hear that, we hear it from as you might expect, and we have to understand that there's some people out there that sell to all of us and will share things each way, that you're going to find we're going to go back and make sure we get our share of that.

So I think we continue to be tough.

I don't think there's been any change in that.

Okay, thank you.

Michael Lasser, UBS.

Good morning.

Thanks for taking my question.

Can you describe what you're doing to prepare for the transition to VISA?

And as you make that transition, how are you going to inform your existing members and new, potential members of the switch?

Well I'm glad a lot of that's in the operations and membership marketing areas.

There's a lot going on, needless to say, between our Company and the new issuer, Citi, that's going to be coming out.

There is -- Citi and American Express are currently discussing what they need to be doing in terms of that transition.

And again contractually, there's not a lot we can say at this point but rest assured, it's going to take several weeks, that transition.

But the assumption is is that existing members with the existing co-branded card will be getting new cards in the mail on or about the time of the actual transition.

And it will be hopefully as seamless as possible to them.

Once we're allowed to communicate to our members about the new program, which again contractually we can't do that until that time, as you would expect, like anything we do, we're going to let everybody know and put it in big letters.

And should we factor into our models a potential disruption from the transition?

Will there be a period of when you take both VISA and American Express for a period of time?

There may be.

Again, that's still in flux.

There's some possibilities of that.

But whether there's an exact transition, a binary transition or an overlap period of time, I don't really see a lot of disruption on that side.

It's, as you might expect, it's a royal pain to do this but it's like -- it's what we do.

You've got teams of people in operations that are working with our people in membership marketing and they're working with the outside, the new outside provider to make it as seamless as possible to have the communication out there both in-store, via e-mail, via letter.

So I think it's going to go a lot better than one might think.

Is just a lot of work to be done.

Understood.

And coming back to the topic of traffic, three out of the last four months, traffic has been a little slower than the 4% you had been seeing consistently before that period.

Are you just running into a point where there's now either limitations on how frequently some of your members, some of your most loyal members can shop?

Or limitations on the throughput that some of the stores are having based on the level of traffic that you already see in those locations?

I think there's a level of through-put.

We keep doing a better job of that.

We keep in my own calculations keep raising the number of amount of annual volume that a warehouse can do.

Certainly, there will be somebody in line saying God, why did I come on Saturday afternoon?

But at the end of the day, that's not an issue.

I remember in calendar 2009, for calendar 2009, the first year after the bad economy hit, we had a frequency number of around 4. And I was reminding people that if calendar 2010 was 0, that compounded number of plus 2 for those two years would've been better than our average over the prior 20 years.

And now, we've enjoyed seven years, calendar 2009 through calendar 2015, that have been slightly above 4 on average on a compounded basis.

So, at some point it has to come down a little bit.

We feel very good about where it is.

We can't look at any specific factor to say this is why it used to be a 4 and the last couple months it's been a 3.5.

We feel very good about where it is.

Thanks so much and have a good holiday.

You too.

Robbie Ohmes, Bank of America Merrill Lynch.

Thanks for taking my questions.

Richard, I was wondering if you could talk a little bit more about partnering with Instacart and Google and Google and maybe how that's going versus your expectations?

And also, can you remind us how the membership is impacted by that if it were to roll out nationally?

How does membership fee get accounted for in that?

And then I have a follow-up question.

Thanks.

Sure.

Well, each one is a little different.

I believe with Google you have to be a Costco member to go through the Google Shopping Express network.

So, it doesn't impact membership at all.

Perhaps it gets a few members because there's some people that aren't going to come in but now they can get some things delivered to them.

With respect to Instacart I believe it is the Instacart memberships and of course they by multiple memberships.

That might be a slight decline.

(Technical difficulty).

All trying to grow their businesses.

Starting from the point that many out there were concerned that everything's going to go this way and what's going to happen to all this brick-and-mortar.

In our case, we see some changes and that increase in some of these is that there is a slightly improvement in total comp.

Recognizing you've got a few more visits that are delivered but it's still a very small thing.

Not a lot of knowledge I can give you beyond that.

Thanks just the other question was on with the success in fresh food and organic and everything, are you seeing space allocation grow to that area?

And if so, where is it mostly been coming from and is there a maximum allocation?

(Technical difficulty).

-- of refrigerator and frozen, putting in more vertical stand up coolers versus the coffin coolers in the deli and cheese areas.

So we are getting more out of our space.

We've added space.

My guess is is that there is less incremental space that we can do but we're still doing it to some extent.

The other thing is, that's an area where we can benefit by turning it faster as well.

A lot of our expansion was to enable us to turn it fast -- not only more square footage and more lineal footage of doors, but our more vertical cases, but have more merchandise out there that are presented and easier to grab.

I think we have done a great job in that area.

Lastly, the CapEx I think you're saying is going to be up like $0.5 billion or so versus last year.

Can you remind us what that extra $0.5 billion compared to last year is for?

Sure.

Roughly 8 or 10 more locations.

Roughly a few more expensive locations internationally.

There is all that other stuff I talked about where we are still adding a few gas stations, still adding a few hearing aid centers.

Depots, our infrastructure, which is we think is a big competitive and profitable advantage to us.

84%, 85% of our goods now go through our cross dock operations where the average life of the majority of that inventory is less than half a dozen hours.

So we've got a lot there.

I believe IT is -- hold on.

I've got that number here.

IT is -- I don't have it on here.

I think that will be year-over-year, it's going to be $60 million to $80 million.

I don't have in front of me.

I'm sorry.

But that's a piece of it as well.

Got it.

Thanks very much.

Christopher Horvers, JPMorgan.

Thanks, good morning, guys.

So Richard, I understand your comments on the MFI growth and the underlying trend being very strong.

But as you look at the MFI ex FX, it seemed to have slowed off a strong four quarter trend that you saw through the third quarter of last year.

So how much of this is social media offers?

Are we lapping some big international openings as well?

Basically trying to understand what the right underlying trend in MFI growth is?

I don't see a big concern there.

Some of it is the social media.

Anecdotally, one thing we did was a Living Social thing a year ago which was very good.

We've not done that again at a corresponding time this year.

I've not seen any comments from our membership marketing people when we reviewed the quarter with them of any concerns.

There may be a little timing of openings of international openings, but again, we don't see any big trend there that concerns us.

Trend change.

No trend change?

Okay.

Understood.

And then, can you help us think about the gas?

I know you get this question a lot, but you had some nice gas benefits last year.

In the next quarter, you're going to lap I think what was an even stronger quarter, the second quarter a year ago.

So maybe anything on how much gas was a net benefit or a net detriment on a year-to-year basis, quantitative hopefully, but any qualitative comments just to help as we think about this upcoming quarter?

We'll tell you each quarter but in Q1, again, one would have thought, one includes you guys and me, that gas profitability would have fallen down a little bit.

Still very good, historic relative to our history, but versus very strong numbers Q1 a year ago.

We had pretty good numbers this time.

I think year-over-year it was within $0.01 of profitability, flat to down less than $0.01 year-over-year.

I think we also had very strong Q2 profitability.

That may be tough to match, but we are early in the quarter.

Q1 surprised me.

I can only be surprised there but if it does come in a little bit, we'll certainly share with you if it is more than $0.01 or $0.02 of delta.

Right.

So, a tougher compare but you were surprised to the upside on this case and taking that all into account maybe it is not as bad as people fear out there?

Right.

And again when you say surprised as to the upside, we're still down year-over-year a shade.

But again, last year was pretty strong and Q2 was even stronger.

We'll see how this quarter goes.

The fact that gas prices and oil prices have dripped down a little bit, that generally bodes well for us.

But again, I'm not suggesting it can be as well as last year.

We'll see.

Understood.

And just one last question on the traffic side.

I know you said you'd don't really see a change in the box in the consumer.

Does the fact that November was largely driven in the back half of the month concern you at all?

Or is that just an indication of the consumer continuing to wait for the deals that come around Black Friday?

If I knew, I'd be doing something else.

We actually looked at it as a positive.

We were starting to get a little concerned as it slowed down a little bit.

And I think the fact that we don't put as much emphasis on Black Friday and Cyber Monday, it still did well, but we've got a lot of people coming in earlier that week for crazy numbers of pumpkin pies and the like.

All those things I think help us.

The fact that electronics was as strong was a surprise to us.

So I don't think we look at it that way at all.

Okay.

Understood.

Thanks very much.

Paul Trussell, Deutsche Bank.

Hey, good morning, Richard.

I apologize for any background noise.

I am in the airport.

But I wanted to just go back first to your color that you provided on margins just to make sure that I captured some of the details that you listed out.

When it comes to gross margins to start, I believe you spoke to the actual core of four categories up once again 13 basis points, similar to what we saw in the fourth quarter.

You noted that ex the cycling of the one-time benefit from last year, gross margins would have been up an additional 7 basis points.

And regarding the inventory levels, you stated that you feel pretty comfortable with those levels just given how strong the first week of the second quarter was.

Is that a fair representation of your color on gross margins and how should we think about that going forward?

Yes, but mind you the 7 basis points of a one-time item, that's outside -- the 13 is the core business.

It's not like it's 13 becomes 20.

Correct, on the core.

Absolutely.

Yes, we feel pretty good about that.

And then regarding just SG&A again, just for my clarification, making sure my table is clear.

Stock compensation, you mentioned was up meaningfully year-over-year, $36 million I believe you said.

So about a $0.05 hit or so on a go-forward basis.

That will only be about one-third of the hit in the next few quarters?

What I was trying to convey is that because of timing, our annual grant to everybody is in late October.

Because more and more of the recipients, particularly the recipients like myself who have been here 32 years almost, so you've got accelerated vesting.

So the entire hit is now, not spread over five years.

So really, that's a timing issue.

That's going to help you a little in the future.

But the fact of the matter is, is because it's October, you've got a big hit in October or Q1.

Just taking the math of what -- if you think about it, the actual hit to P&L this year is a function of those grants that would have been made over the last five years, that, then vest ratably one-fifth a year.

Adjusted, when it vests faster than that accelerated, based on tenure.

So not only do have more people on the plan today than you had -- as a piece from five years ago gets fully extinguished, you're adding a new piece.

A, this new piece has many more people from five years ago, it has a stock price per share a lot higher and you've got the vesting.

The vesting in my view being one of the key ones.

So the way it hits just simple math is that $36 million year-over-year change is more than half of our expected year-over-year increase in that line item.

So if it was half, in each of the next three quarters it would be about one-third of 50% in each of those quarters.

Is not quite that, but instead of being 36, it's going to be in the 10 to 13 range, or 8 to 13 range each period.

Got it and then the legal hit, is that fully contained into this particular quarter?

Also, on the IT modernization, what -- how should we think about the cadence of those expenses going forward relative to what we saw in Q1?

In terms of the $22 million, again, it's a couple of items that we're still in the process of.

That's our best guess of the impact.

We don't think there will any big surprises there.

If anything, you try to be reasonable and conservative.

Outside of that, in terms of IT modernization, it's a little bit of a broken record here.

But there is a light at the end of this tunnel incrementally and I'm hopeful that sometime next year, we'll see that flatten out and come down.

But we've got a lot going on there.

And again, it's part of our operations.

It will come down as a percent of sales at some point in the future or come down certainly relative to the types of increases we've seen.

But it's necessary and we're starting to see some deliverables finally.

Thanks, Richard I appreciate that clarification.

Last for me is just on the international side.

The Canada and international segment have been able to have a reasonable spread versus the US in margins.

I believe some of that's due to a little bit maybe less competition, maybe a little bit less labor costs.

As you continue to grow the business and expand into new markets, how do you think about the margins in those segments going forward?

Can it maintain a little bit of a reasonable spread versus the US?

I think all things being equal, Canada is going to continue to be more profitable than the US and some of these other countries are going to continue to be even more profitable than that.

Not all of them, but some of them.

We have no illusion that some of the ones that are really outsized profit will come down a little over time.

But Canada is mature.

Still growing a little in terms of new units.

Still growing nicely in terms of local currency comps and it's nice that we're the only club in town.

That being said, we're still our own toughest competitor.

We have a little extra margin there, not a lot.

We have a lot lower healthcare cost as a percent of sales.

So there's other things that help us up there, not just a little extra gross margin.

Thank you.

Brian Nagel, Oppenheimer.

Hi, good morning.

Thank you for all the color at the beginning of the call on the kind of one-time items impacting in the quarter.

The question I have, Richard, you called out electronics as a point of strength.

Could you comment specifically on the TV category?

And to what extent some of the new innovations in TVs are helping drive better electronic sales?

And a follow-on to that is, as the holiday season has gotten underway, what type of price promotions you've seen throughout the sector on TVs?

I don't have the quarter in front of me but for the four weeks of November reporting, which would be through the Sunday after Thanksgiving, those four weeks ended then.

Within majors which was up again, ex FX, in the mid-teens for the month.

I think I said it was in the low double-digits for the quarter.

TVs for the month were up both in dollars and sales in the mid-20s, so it's quite strong.

Now that may be because last year was a little weak.

I don't know.

I don't have that in front of me.

But it certainly was strong.

I think there is a little bit more promotions.

Cell phones are strong, tablets are strong -- I'm sorry, tablets have come down a little bit.

But phones are strong and those are the big things.

Video games are strong.

Again, all those other strongs or a little weakers are dwarfed by television sales within electronics.

And speak then on TVs.

I think new technology, the 4K, is helping but the prices are coming down as well.

I was there across the street yesterday and you've got smaller flat screens with great quality, less than $200.

You've got bigger TVs less than $1,000.

You've got as well the giant HD 4K whatever, under $3,000 and under $2,000 depending on the size and the item and some of the new technology.

So I think all those things are helping us a little bit on that category.

I point it out also because it's one of those that we continue to get asked about as dot com continues to take market share of electronics and the impacts to other brick and mortars over the last few years.

I think Best Buy has been a little better on TVs as well but certainly, this has been a standout for us of late.

Got it.

That's helpful.

And one follow-up question.

I know you addressed this in your prepared comments too but the inventory growth in the quarter, so if you look at it on a sequential, year-on-year sequential basis, it did tick higher here in fiscal Q1.

What explains that?

The two biggest components of that $900,000 ex FX number year-over-year, is electronics which is about $0.25 million and that's planned and doing fine as expressed in these sales numbers.

And apparel, and again, we are out there en masse and these are basics.

We're not going to be left over with a lot of red and green Christmas dresses because that's not what we sell.

I mean you're going -- we're during fine.

We feel we have no concerns about our inventories, our markdowns.

Something I know we learned years ago, the cheapest markdown is the first markdown and the quicker you get rid of stuff that had problems.

And our markdowns overall have been nothing to be concerned about.

Thanks a lot.

Matthew Fassler, Goldman Sachs.

Thanks a lot.

Good morning, Richard.

Thanks for taking my question.

My first question just wants to get a little more clarity around this transitional period as you have to cease sign-ups for the card.

You talked about it in terms of EPS impact on the quarter that you just reported and some residual impact over the next couple quarters.

As we think about where this shows up in the P&L, is there any discernible impact on the top line?

And if you could kind of dimensionalize the impact on the member fees as well, just to understand where we would model for that to happen?

Well, we don't have any new co-branded cards being signed up right now, so that's impactful a little bit to the membership line.

Not a lot.

99% -- that's going to go to sales.

You've got everybody who has a co-brand cards currently is still using it so there is no impact there.

Again, what I try to do recognizing that the $1.09 reported figure was going to raise some questions, we just looked at what are the things that we can really look at?

We have not, given that our sales continue to be strong, we're not really looking at that line to see how much sales do we estimate we're losing.

I assume we're losing, in theory you're losing a sale for somebody that signed up as a member that can't sign up for the co-brand card.

They are still buying from us.

They don't have the co-brand card.

They don't have that reward.

They're probably using some other AmEx reward card.

Recognizing at its current strength, AmEx is about 40% of our sales.

There is still 60% of the people that aren't using AmEx, whether they are using debit or a very limited of an old house card, we don't own it, from years ago, or another AmEx card.

We don't see a big impact from that.

Is it greater than 0, the negative impact?

Of course.

But again, given where our sales numbers have been, this is something that there's specific pieces that are monies earned for new sign-ups in the equation and so we pointed that out.

Got it.

Second question, you talked about the seasonality of stock comp expense and the bulge you saw this quarter.

Just to confirm what you talked about we saw this past Q1 and what you talked about for the rest of the year.

It seems to be seasonally a lot like what you had last year even though it's a bit different from what you had over the prior few years.

Is that an accurate way to think about it?

Yes.

By the way, comp is -- it is part of our comp and it is part of SG&A.

We have always prided ourselves -- for many years, we never changed the number of shares.

So as the stock compounded at 19% a year, that piece of 3,000 or 4,000 people's compensation improved dramatically.

As you may recall, a couple of years ago we reduced the number per recipient at whatever level that was by I think 15%.

And again, we just did it again in the grant that just happened.

Notwithstanding, you're still seeing this big increase because of just how that works.

Great, and just another quick follow-up on the demographic piece.

You give us a couple of interesting numbers.

A couple different ways to come at that question I guess, is the average age of a new member changing for you?

Has that been moving in one direction?

You talked about it relative to the national average and presumably that couldn't happen without the average age coming down.

But without knowing what the national average has done at our fingertips, kind of hard to know.

And then also, members in multifamily dwellings versus single family, if you think about millennials staying in that kind of environment and multifamily in general gaining share from single family.

I'm not sure if you're able to look at it that way.

Any sense of how you're faring with that cohort?

Well I've never -- I haven't and I haven't seen any figures presented to me that way.

I've said a couple times in the last many months when people talk about millennials, I think the good news is we're getting more of them and things like organic certainly help.

Social media helps a little bit.

Millennials is going to be an issue for the total pie in general if people move home after college for a period of time, if they move into a smaller place, if they get married later, if they have fewer kids.

It's going to rain on all of us.

So we certainly having increasing the share that we get of those people will help, but we're going to keep driving value and given the flexibility of the types of things we can continue to sell and we'll see where it goes.

We have not looked at that.

If we start looking at that, I'd be scared.

Thank you so much.

Oliver Chen, Cowen and Company.

Yes, good morning.

This is Steven Zaccone on for Oliver Chen.

Thanks for taking our questions.

Just two quick questions.

As you look to the remainder of 2016, are there any areas of the assortment that you have an opportunity for improvement in your view?

And then secondly, we just had a quick question regarding the E. coli situation.

Have you seen any traffic disruption from the headlines?

It does appear that you have the situation contained but just curious have you seen any traffic disruptions?

Thanks very much, Richard.

On the latter, no.

It was contained pretty quickly and the information was communicated pretty quickly.

And I believe that the last possible episode related to Costco of someone falling ill was November 1. So we're kind of past that.

Thankfully, nobody was extremely hurt.

There were a couple, there was a few that did go to the hospital and I understand that they are all doing better now.

So, nothing new as it relates to that.

I'm sorry, in terms of the other question in terms of what's new?

Again, it's more of the same.

I can't give you anything specific that's at top of mind.

Organics continues.

And [KS], we're doing a few more things but that's kind of steady as we go.

Great, thanks.

Kelly Bania, BMO Capital Markets.

Hi, thanks for taking my questions.

Just wanted to ask another question on the transition to Citi.

As we get closer to that transition in the spring, just curious how you feel about it?

Sounds like there is a lot of preparations involved.

And maybe you can just remind us what's different about this in the US versus what you did in Canada a couple years ago?

And maybe what you learned in that transition process?

Well, it just takes time.

I think the big difference is in Canada, the new issuer was not able, did not purchase the portfolio from American Express.

And therefore, it's what's referred to as a de novo program where customers, members have to sign up and re-apply for credit.

So that's a little more disruptive.

It impacts -- now it's a MasterCard up there, so there are many people up there that have a MasterCard in his or her wallet already so they still have something to use.

And then in terms of auto renewals, part of our renewal rate is the fact that you have some members that do auto renewal, which as you might expect, statistically has a slightly higher renewal rate because it is auto.

And the assumption here in the US is that the portfolio will be, the transition will include the purchase of the portfolio.

And I think the language we've used in the past is that is what we anticipate because there's always a chance that something can happen.

But we're working towards that end as you'd expect the issuers out there.

So again, recognizing that Canada is 10% of our Company and the US is 70%.

So these are bigger numbers.

I would guess that if you look at the $15 million I pointed out as related to just revenues we get for signing up new co-brand cards, even if the same percentages occurred up there, it wouldn't even be worth calling out in terms of the Company as a whole.

So it's just going to take some time.

I'm just trying to share with you what I can at this point.

Nothing big is going to happen.

We'll get through it and we're very excited about the next many years under a great program.

That's helpful.

Any color you can provide on what percent of members do use the auto renewal and anything else we should think about just modeling?

I don't have that at my fingertips, but I probably -- we wouldn't share that.

As many as possible would be the answer.

It makes it easier for the customer and certainly it gives them a reason to more likely renew.

Got it.

And then, just another question.

You mentioned I think two new business centers planned for this year.

I was just curious if you could talk about how those are working?

Any relative profitability versus a typical club and just what you think about that format going forward?

First and foremost, we're opening regular warehouse clubs.

For a number of years, we had anywhere from I think six to eight business centers that were doing okay, slightly profitable but not setting the world on fire.

There were a lot of changes that were made to it a couple of years ago and they are growing nicely.

They are more profitable than they had been.

It's another avenue.

It's going to be a lot smaller footprint in terms of how many units we have than a regular warehouse, than a regular Costco warehouse is.

But we'll keep adding -- we're doing this just like we've done everything, pretty methodically.

On a base of 10 or so, we're going to open a couple.

So it's not like we've discovered something that we're going to go from 10 to 20 overnight in one year.

So it's good.

It's a positive business for us.

It certainly is a focus on the business member.

We also will from time to time identify items in the business center that makes sense to sell in all of our locations.

So we think it's a positive.

Some of the examples also, is where we've taken an old Costco which is smaller footprint, perhaps not as well located for our general population member, where as we are relocating an old unit, we will convert that other one in that city into a business center.

So that's been helpful to us as well.

We did that in South Atlanta.

We did that in Chicago I think in Bedford Park.

I believe the New Jersey location is a relocation where Hackensack went to Teterboro.

I mentioned that we opened a new one in Teterboro that is a reloc from Hackensack which now over that several month period is being converted into a business center.

We think it's good.

When asked what's driving our earnings growth and what's driving our whatever, I've always said it's a lot of little things and this would be one of them.

Great, thank you.

Meredith Adler, Barclays.

Thanks.

I have one quick question.

Can you just remind me of the timing of the new credit card?

Well our current relationship expires March 31, and there's a window of a few months in there post that, that this could extend.

So it will be sometime between April and December is my best guess at this point.

Great.

And then you guys are still working very hard on your technology modernization.

Can you talk about whether you've been pleased with the timing of everything and whether all the new systems have been rolled out smoothly?

Technology is notoriously late, but how is it going for you guys?

Smoothly would be an overstatement.

I think in the beginning of time when we talked about this starting about three or four years ago, we said this is our best guess.

And I half jokingly said, whatever you think it's going to do, it's going to take twice as long and cost twice as much.

Anybody that has gone through it I think generally experiences that.

We are experiencing some level of that as well.

That being said, we've got everybody's supportive of it.

The deliverables that we have had sometimes they have taken longer, they've cost more.

We've learned from what we didn't know and as we find out, we do a better job on the next thing.

So again overall, I think again, it's costing a little more than we thought.

It's taking a little longer but we're getting some deliverables over the last year like a new membership system, a new point-of-sale system, a big rollout of really the foundation of our accounting system will be at the beginning of the new fiscal year.

So we've got a lot going on but we're getting through it and I wouldn't -- I certainly wouldn't gloat about it because we know it's tough and it takes a long time.

We're getting there.

Great, thank you very much.

Chuck Cerankosky, Northcoast Research.

Good morning, everyone.

Richard, can you give us a little bit of color or some range on how many stores might be open this year?

You said 32 on the top end.

How low could that be and where would you expect some of the shortfalls to be?

32 is my best guess.

If I had to guess what's the low end, 27 or 28.

That just simply means that under 27 example, that means five in the latter half of the year and the original budget would have been skewed out a little bit.

Right now, I'm looking we've got seven new units coming in Q3 in this plan and 15 in Q4, with about half of those, probably eight of those, in August.

So I'm sure a few those are going to slip.

Some of those have slipped back because the December was 35.

So I'm guessing, so 28 to 32.

Again, it's fluid number.

I don't think we've lost any.

But I know in a couple of them we've already delayed.

Might be a year of delay for zoning issues.

One example again, we found some things underground that original core testings didn't find.

So you're always going to find some things out there like that.

Okay.

Can you talk a little bit about a competitive behavior that you're seeing out there whether it's a reaction of a more conventional stores to what you been doing?

There's not many retailers out their showing the comps that Costco is.

Are you seeing any reaction in your channel and outside your channel and especially as you enter some new countries?

Overall, no.

We are, and I've said it many times, we are our own toughest competitor and I mean that.

In our industry, notably Sam's and to a little extent BJ's, certainly many locations where we compete head to head, we're in their locations literally every week.

And I would assume they're in our locations every week.

And we feel good about the competitive posture there.

I think it helps that our average volumes are dramatically higher and that allows you to do a lot of things.

The nature of our member.

I don't think we've seen any big changes there other than we keep doing pretty good.

As it relates to traditional competitors, regionally, we look at all kinds of things.

In the Northeast, we look at companies like Wegmans which is a great supermarket retailer and they're opening more units.

That's in our view our customer, a high-end customer particularly in the quality of fresh foods.

Although our fresh foods are pretty good.

I think we're during a pretty good job.

We're helping by the fact that we can choose to do things like women's athletic wear, activewear, where we can literally create $100 million of sales on full margin items that didn't exist a few years ago.

And I think our global sourcing initiatives and things gives us we believe and edge on things like produce.

But you can't do it if you don't do the kinds of volumes we do.

I think we've got some good advantages out there and we are, I think, one of the best and not resting on our laurels.

In terms of dot com, again we're pretty methodical about it.

Some of the things we're doing are helping albeit from a (technical difficulty) in a lot of ways and I think we're getting better at that too.

All right, thank you, Richard.

Scott Mushkin, Wolfe Research.

Hey guys, I'll be quick.

I know the call is going long.

I just wanted Richard to get your thoughts here and maybe have the numbers even, what the penetration rate for eCommerce and services like rental cars and travel services and that type, insurance services, what the penetration rate is among your members?

And if you have, has it been growing?

They're growing nicely.

We do not give out that information.

They're all pretty good businesses.

They've all grown slowly over time.

Travel is doing very well.

Things like car rentals.

I can tell you I visited some shareholders recently on some proxy issues and during that, I was just giving an example though of our rental car business, which has grown dramatically in the last year to well over 2 million rentals a year.

A lot of that is on line.

And in two different meetings, individuals who prided themselves on knowing how to get the best deal on car rentals went online during the meeting and were able to save on the same car from the same third (technical difficulty) go try it and we got to do a better job of communicating that.

Those businesses are growing.

They're all generally small percentages of the total so I think that creates more opportunity for us.

I think I read recently where if we were a car dealer, we'd be the second-largest car dealer in the country based on number of new cars purchased by our members through the Costco auto program.

All of those are additional reasons to be a member.

They are all very profitable and growing.

If they're very profitable, it means we're going to keep getting even better values.

So it's all good.

And your eCommerce penetration rate?

Do you have that or is that something you don't want to talk about either?

E-commerce in terms of -- what do you mean penetration?

What percentage of the members are using your eCommerce offer?

I don't have that in front of me.

It's probably not as much as it should be and it will keep growing.

I'm not trying to be cute, I just to have that number in front of me.

That's fine.

And when we're looking at these things and we're looking at frequency, I would guess that these are outside your frequency?

They don't get counted?

Is that true?

Correct.

Our frequency is front end transactions at the warehouse.

It doesn't include gas, pharmacy, optical.

If you shop the front end, now matter where else you shop, it's just one transaction.

If you shop just at the gas station, it's not a transaction in terms of our shopping frequency.

And the eCommerce is not ringing up as transactions either?

Frequency?

It's transactions but not frequency.

E-commerce is like a warehouse.

So that it is adding up.

But it's 3% of our business.

So even if it's growing at three times at 20% plus versus 7%, it's de minimis that number.

All right, perfect.

That's it for me.

Thanks, guys.

Why don't we take two more questions?

Hello?

Bob Drbul.

Hi, Richard.

I had two quick questions.

On the credit card, the $0.02 hit this quarter, is that expected to be something similar over the next few quarters in terms of the impact?

I guess the question is when you start to get to the new relationship, will there be additional marketing expense that you would also incur in addition to what is impacting the business today?

In terms of the first piece of that question, yes.

I mean I don't know if it around to $0.01 or to $0.03, if we call it, $0.02 is a guess and it's a guess.

At the time of transition, there are monies baked into the deal.

So I don't see any big impact to that, anything in our numbers.

And you mentioned the Alibaba singles day.

Can you just give us any insight in how you're looking at China and essentially what you're learning so far from that relationship?

We've been asked about China for 20 years and about every two or three years -- it used to be Jeff and Jim and our head of international Jim Murphy, and now of course, it's Craig and Jeff in our international Jim Murphy and a few others in real estate.

We keep looking.

At some point we'll probably open a couple of units but we haven't pulled that trigger yet to actually go forth.

I would say it's probable in the next five years but we got a lot going on.

For 20 years we've never been terribly concerned about we've got to get there now.

So this gets our name known a little bit, but it's not like we've strategically sat down and said hey lets get our name known for a few years and then go.

The Alibaba team, the whole thing happened because they came to us and we did not appreciate how many Kirkland Signature items we're selling on their site before we sold them directly and at a better value.

Thank you, Rich.

Dan Binder, Jefferies.

I got the last one.

I'll try and be quick.

You mentioned earlier in the call, there was some of these one-time items that we were aware of.

Some that we were not.

Just in terms of things like legal and regulatory, is there anything that we should anticipate in Q2 based on what you know today that we should be factoring in?

No.

You mentioned a little contribution from international which contributed to the tax rate difference.

I was just curious, is that related to start up costs in areas like Spain?

Just higher losses associated with that or is it something --?

No, not at all.

What I was talking about is if you have $100 in Canada earned and year-over-year in the quarter, the Canadian dollar relative to the US dollar is down 15%.

We bring it down at $85 of income, not $100 of income.

So it's just -- and in Canada, the marginal tax rate like federal tax rate I believe is 26% currently versus, I could be off a little bit, versus 39% in the US.

In some other countries, it's actually a little lower or higher but generally speaking, I believe the US versus in the nine countries you are, our affected US tax rate on earnings in the US is quite a bit higher than anywhere else.

So as the penetration of foreign earnings to total earnings, it's that simple.

Got you.

So we had an opportunity to visit your Getafe club in Spain.

It was pretty impressive.

I think one of the areas that was surprising was the amount of local sourcing you're doing especially in areas like fresh and we heard about some of the export activities with local vendors.

I was just curious if you could expand a little bit on what that opportunity looks like when you -- not just for Spain, but other countries you're operating in.

How much you're doing in terms of cross-border type sourcing for other clubs and whether it's the US or Japan, et cetera?

It seemed like it was growing.

First and foremost, the big thing is, on multinational vendors getting the -- and a lot of times with multinational vendors you've got two or three or four geographic world regions.

I remember when we went into Australia, and now we have eight units instead of one or two or three a few years ago.

Still with only eight, there's some divisions of even multinationals that aren't prepared quite to sell us, make available certain things and certainly sell us at a global pricing.

That can only change when they get us involved.

And again, since we have that meeting here every four weeks, the budget meeting, that is when that happens.

So I think a focus on that has helped us.

As it relates to going into these markets, to the extent there are items in those countries that helps us both ways.

I think that's, if you will, I think we do a good job of that.

Those are all small little things that help long-term.

I give you an example back in Japan a few years ago, I forget the name of the -- there's a very well-known, what's considered a very premium tea that's a Japanese branded product.

That they initially were reluctant to sell us when we entered Japan.

Even as we had ten or so units.

Once we worked with them to provide a co-branded Kirkland Signature by that brand name, not only in Japan, but it sells very well in Eastern Canada and along the West Coast in California.

All those things are net positive.

It not only afforded us an ability to have a premium item with a decent margin and a new item in these other markets where we're strong, that market potential allowed us I think to procure items faster in some of those countries.

So, it's a win-win.

But these are small.

Again, another small example.

Great, thank you.

Okay, well thank you very much.

We're around today if you have any further questions.

Have a good day.