好市多 (COST) 2016 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the Q2 earnings call and February sales conference call.

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

After the speakers' remarks, there will be a question-and-answer session, (Operator Instructions).

Thank you.

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

Thank you, Brittany and good morning to everyone.

I will start by stating that our discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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.

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.

So last night's press release reported our second-quarter and first half fiscal 2016 operating results for the 12- and 24-week periods ended February 14, as well as our monthly sales results for the four-week reporting month of February which ended this past Sunday, February 28.

For the quarter, reported earnings came in at $1.24 a share compared to last year's second-quarter earnings per share of $1.35.

Note that last year's earnings were positively impacted by two discrete income tax items that together benefited last year's second quarter earnings by $43 million or $0.10 a share and that excluding these two items, earnings for the second quarter last year would have been $1.25 a share.

Among the factors that impacted our second-quarter year-over-year earnings comparison, foreign exchange, FX as compared to a year ago.

During the quarter, the foreign currencies where we operate continue to weaken versus the US dollar in all countries but primarily in Canada, Mexico and Korea resulting in our foreign earnings in the second quarter when converted into US dollars being lower by about $32 million or $0.07 a share than if exchange rates had been flat year-over-year.

The second item of comparison is our cobranded credit card transition in the US that relates to that.

As you know we are transitioning to a new cobranded credit card relationship in the US this year.

As we wind down our current relationship, new cobranded credit card sign-ups stopped several months ago.

The short-term negative earnings impact to the loss cobranded credit card sign-ups was $18 million pretax or a $0.03 per share hit to the second quarter.

Recall that the earnings impact was $15 million pretax or $0.02 a share last fiscal year and it will continue to impact earnings in Q3 and a little even into the first month of Q4.

As of today, we expect to have the new cobranded Visa cards in the hands of our members in May with a go live transition date in June.

While I can't give you any specifics regarding the new card, contractually I can't do that yet, I do look forward to sharing more details with you at that time.

Third item, IT modernization; our major IT modernization efforts continue to impact SG&A expense percentages especially as depreciation begins on the new systems that are now being placed into service.

In the second quarter on an incremental year-over-year basis, these costs impacted SG&A by about $10 million or an estimated 3 basis points, 2 basis points without the gas deflation which was about a penny a share.

There is a light at the end of this tunnel with SG&A headwinds.

Based on our current estimates, we would expect the year-over-year basis point impact to SG&A is likely to be just a couple of additional basis points in fiscal year 2017 and then flatten out hopefully a little better than flattening out over the next couple of years after that.

Stock compensation expense was higher year-over-year second quarter by $14 million or $0.02 a share.

And lastly in terms of the year-over-year comparison LIFO, last year the second quarter we recorded a pretax LIFO credit of $4 million.

This year in the second quarter with deflation being a little bit more impactful than in the past couple of months we had a LIFO pretax credit of $15 million resulting in a year-over-year delta of $11 million or $0.02 per share.

Now turning to our second-quarter sales, reported sales were up 3% and our 12-week reported comp sales figure was up 1%.

For the quarter, sales negatively impacted by gasoline price deflation to the tune of 80 basis points and by weakening foreign currencies relative to the US dollar by minus 340 basis points such that excluding gas deflation, the reported plus 3% US comp for the second quarter would have been a plus 4%.

The reported Canadian comp of a minus 7% in the second quarter would be a plus 10%, excluding both gas deflation and assuming flat FX rates year-over-year.

And the reported minus 3% international comp figure for the quarter excluding gas and FX would have been a plus 6%.

Total comps again reported 1% for the quarter and excluding gas and FX would have been up 5%.

For the four-week month of February which again ended this past Sunday, reported comps came in flat at 0% and that consisted of a plus 2 comp on a reported basis in the US, a minus 2 reported in Canada and a minus 8% other international.

As we discussed last month, the calendar shift of Super Bowl moved sales out of January reporting period into February.

We estimated that this shift benefited our US sales for the month of February by about 0.75% and the total Company by about 0.5%.

Sales were negatively impacted by again gas deflation which started to head down again during the month, about 180 basis point negative impact to the number and also by weakening FX, foreign currencies relative to the US dollar to the tune of 250 basis points.

Excluding gas deflation in the US, the reported plus 2% US comp for February would have been a plus 4%.

Excluding gas deflation and FX in February a minus 2% comp in Canada would have been a plus 10% and the reported minus 8% international comp would have been flat year-over-year ex-gas and FX.

Total Company comps reported again zero for the month, would have been a plus 4% excluding gas and FX.

I might mention that the other international normalized number in other words ex-gas and FX of zero mostly relates to the timing of the Chinese Lunar New Year holidays.

We don't think that will be an issue after the timing of that.

Final comment on deflation.

Beyond gasoline price deflation that we have always pointed out each month, we have seen a little additional deflation across many merchandising categories such that sales have been impacted a bit a little bit more in the past couple of months.

In terms of new openings, our opening activities and plans, we opened 13 units, new units in Q1 including two relocations so a net of 11 new locations in the first quarter.

In Q2, we opened one new business center in Westminster, California.

For all of fiscal 2016, we are still on target to do 30 net new locations, 21 of which will be in the US, three in Canada, two in Japan and one each in the UK, Taiwan, Australia and Spain.

Also this morning I will review with you our e-commerce activities, membership trends and renewal information, additional discussion of course of margins and SG&A and a couple of other items of note.

Okay, in terms of second-quarter results, sales for the quarter were $27.57 billion, up 3% from last year.

On a reported comp basis, Q2 comps were up 1% for the quarter, up 5% gas and FX.

For the quarter, our plus 1% reported comp was a combination of an average transaction decrease of minus 2.5% and an average shopping frequency increase of just over 3%.

Now in terms of the minus 2.5% average transaction decrease again taking FX and gas out of that number, that minus 2.5 would have been a positive number that would be just under plus 2%.

In terms of sales comparisons geographically, in the US, the Midwest Texas and California regions were strongest.

Internationally in Q2 with local currencies better performing countries were Mexico, Canada, Australia and Taiwan.

In terms of merchandising categories for the quarter, for the same quarter within food sundries overall flattish meat, deli and sundries were the leaders.

Tobacco negative in the low double digits as we continue to eliminate tobacco SKUs from various locations.

For hard lines overall in the mid single-digit range.

Departments with the strongest results were consumer electronics which was up in the low to mid teens; sporting goods; lawn and garden and tires.

Within the low to mid single-digit soft lines, domestics and apparel were the standouts.

And in fresh foods, comp sales were in the low single-digit range with produce showing the best results are among the four main fresh foods categories.

Lastly, as we mentioned during the December and January sales calls, in the US we are seeing deflation in the low single-digit range for foods, sundries and fresh foods and now again a little bit more on the nonfood side as well.

In terms of February, traffic was up a little over 3.5% while the average transaction was down a little under 4%, about 3.75%.

Again gas as I mentioned earlier fell again a little more dramatically.

In February, the average sales price year-over-year in gas was down 21% for the month which is a bigger decline year-over-year than we saw in the quarter overall.

In terms of geographic regions again for February, Texas, Southeast and Midwest regions were strongest and internationally in local currencies, Mexico and Canada were at the top.

From a merchandise categories standpoint ex-FX, all categories, food, sundries, hard lines, soft lines, fresh foods were in the mid single-digit range for February reporting period.

Again a little deflation impacting these and it is a little deflation but it is more than we had seen historically of recent history.

Moving down the line items of the income statement, membership fees, we came in for this fiscal year at $603 million up 4% or $21 million from $582 million a year ago and up 2 basis points as a percent of sales.

Again that $21 million increase and 4% dollar increase if you assume flat FX, the $21 million would have been a $40 million increase and a 4% increase ex FX would have been a 7% increase.

In terms of membership, renewal rates remained strong, 91% in the US and Canada and 88% rounded up worldwide.

Continuing increasing penetration and the executive member I think helps that.

New membership sign-ups in Q2 companywide were up 4%.

I will point out last month the early part of February and into the second week of February for 12 days we ran a new membership promotion on Living Social.

Recall that we also ran a membership promotion with Living Social about 18 months ago.

Like that one it went well and we don't do it too often.

I don't want to get people used to it but it was a good result.

In terms of new members at Q2 end, Goldstar members at Q2 end was 35.4 million, up from 34.7 million at Q1 and 12 weeks earlier.

Business primary remained at 7.2 million, business add-ons remained at 3.5 million so all total at Q2 end, we were at 46.1 million versus 45.4 million at Q1 end and total cardholders would be 84.0 million up from 82.7 million.

As of the end of the second quarter, paid executive memberships totaled 16.6 million of our members, an increase of 214,000 over the 12-week month or about 18,000 a week increase in the quarter.

And as I mentioned before, executive members are a little more than one-third of our membership base and about two-thirds of our sales results.

In terms of renewal rates as I mentioned, they continued strong.

Business in US Canada was at 94.5%, same as it was a quarter ago.

Goldstar was 89.7%, same as a quarter ago.

Total US and Canada 90.5%, same as a quarter ago.

Our worldwide at 87.7% down a tick from 87.8% at Q1 end and a little bit of rounding and then as you know all new markets we generally have in the first year lower renewal rates in that second year and the first year of renewals.

I had mentioned I think in the last couple of months that in Canada when we did the credit card conversion which is a little different than the one we are doing here, it was what was referred to as a de novo thing where everybody had to sign up for a new credit card and apply and what have you.

And so your renewal rates related to auto renewals which by definition are high, it comes down a little.

That will be anniversarying after next quarter so we saw a little tick down in Canada this quarter year-over-year as we had in the last couple of quarters as well.

There should be one more quarter of that again not terribly meaningful but we have been asked.

Going down the gross margin line, our gross margin in the second quarter was higher year-over-year on a reported basis by 17 basis points.

As always we will jot down four columns of numbers with six line items.

The first two columns are Q1 2016 and Q1 2016; the columns would be reported column 1. Column 2 would be without gas deflation and then we would have Q2 2016 two columns reported and without gas deflation.

Reading across, core merchandising Q1 on a reported basis was up 24 basis points, ex gas deflation was down 3 basis points year-over-year.

For Q2 2016, reported was plus 5 basis points and without deflation minus 3 basis points.

Ancillary plus 11 basis points and plus 4 points in the first quarter year-over-year, plus 9 basis points and plus 7 basis points in Q2.

2% reward minus 3 basis points and minus 1 basis points.

Q2 minus 1 basis points and zero.

LIFO plus 1 basis points and plus 1 basis points.

And in Q2 plus 4 basis points and plus 4 basis points.

Other was minus 7 points and minus 7 basis points a year ago and not an issue, zero and zero in Q2, such that total reported year-over-year in Q1 we were up 26 basis points in gross margin.

Without gas deflation, down 6 basis points and in Q2 we were up 17 basis points and up 8 basis points ex gas deflation.

As you can see the core component of gross margin was higher by 5 basis points, 3 basis points excluding gas deflation in the quarter.

Core gross margins, food, sundries, hard lines, soft lines and fresh foods as a percentage of their own sales were positive year-over-year in Q1 by 11 basis points with food, sundries and hard lines showing higher year-over-year gross margins as a percent of their own sales while softlines and fresh foods a little lower year-over-year as a percent of sales.

But again, the net of those four major categories as a percent of their own sales was up year-over-year in the quarter by 11 basis points.

Ancillary and other business gross margins were up 9 basis points, 7 without gas.

Both in terms of ancillary businesses, our gas business, our food courts, our hearing aid centers, our tire shops and our many labs all showed higher gross margins year-over-year as a percentage of their own sales.

Again, executive membership not an issue without deflation, a zero impact year-over-year and again LIFO a 4 basis point benefit to the gross margin year-over-year.

Moving to reported SG&A, our SG&A percentage in Q2 was higher or worse year-over-year by 34 basis points on a reported basis and higher or up by 27 basis points ex deflation.

Let me again give you these tabular numbers and then I will give you some text around those.

Again the four columns would be reported Q1, the first two columns would be Q1 2016, year-over-year reported and without gas and deflation and Q2 reported and without gas.

Those would be the four columns.

First line item, operations would be zero basis points in Q1 reported and plus 26 without gas deflation, a plus meaning lower or better.

In Q2, minus 22 and minus 16.

Central, minus 8 and minus 6; in Q1 and Q2 minus 8 and minus 7. Stock expense minus 12 and minus 10 in Q1, and Q2 minus 4 and minus 4 and quarterly adjustments or unusual items minus 8, minus in Q1 and no usual items to point out zero and zero in Q2.

Such that in Q1 year-over-year on a reported basis, SG&A was minus 28 basis points or higher by 28 basis points.

In Q1 ex gas it was better or lower by 2 basis point so a plus 2. In Q2, it was minus 34 as I mentioned and minus 27 ex gas deflation so by higher by 27.

Now a core operations rations component, the minus 22 again minus 16 ex the impact of gas deflation.

Of that minus 16, payroll was about minus 2, benefits and workers comp were minus 8 with the remaining minus 6 basis point being a variety of items including bank fees, depreciation and various other items.

Again, I think a few of those things relate to a very slight change in sales increases and a couple of things just going a basis point in the wrong direction.

I will also point out that within the benefits of workers' comp, one thing that stood out is just in January we had what was referred to as high cost claims for employee benefits, medical claims.

Typically it averages over the last two years -- this is the US about $6 million or $7 million.

A year ago it was a little lower than that, it was about $3.5 million, this year it was about $13 million.

So nothing unusual other than what we refer to as high cost claims anything over $100,000 but it just spiked and that is a few basis points there but again, that will come and go in both directions.

In terms of central expense, higher year-over-year in Q2 by 8 basis points, 7 without gas.

As I mentioned earlier, IT was 3 basis points of that or 2 without gas deflation.

In addition, we had several one-time items which in total represented about $9 million.

Again, we always have a few one-time things that could go either way.

We had three items that together totaled $9 million but they are what they are and they did impact our SG&A.

Lastly, the stock compensation expense was 4 basis points.

But before I move on from SG&A, I do want to mention one additional expense headwind that is just starting.

In March every three years, we review our pay scales and in fact our entire employee agreement.

We always review top of scale and historically increase the top of scale every year in March where the roughly 60%, 65% of our employees that are at top of the scale already.

In addition this year we are also changing the starting level or entry level hourly wages.

This is the first change to the entry-level wages in nine years.

Since 2007, our entry-level wage in US and Canada was $11.50 or $12 an hour.

Effective this month in the US and Canada, we are increasing our starting wages from $11.50 and $12 to $13 and $13.50.

So up $1.50.

We estimate that this will cost us about $0.01 a share in Q3 year-over-year and about $0.02 a share in each of the next three fiscal quarters.

Again, part of what we do -- there are a few warehouses that we have already started people at a higher level since -- markets like Bay area or some limited markets like that but at the end of the day, it will be about the numbers I mentioned in terms of the impact to our earnings.

Next on the income statement is preopening expense.

Pretty much the same year-over-year at $9 million last year and $10 million this year.

Last year we had no actual openings in the quarter but a lot of that relates to openings that are just getting ready to occur or just occurred as well as one opening this year.

All told, operating income in Q2 came in at $856 million, down 2% from a year ago was $877 million.

Below the operating income line, reported interest expense in Q2 came in at $31 million.

That is up $4 million from last year's $27 million.

The increase is primarily due to interest on the $1 billion debt offering that was completed in Q3 last year related to our one-time special dividend that we did back in February a year ago.

Interest income and other was lower year-over-year by $4 million coming in at $20 million last year and only $16 million this year.

Actual interest income for the quarter was lower year-over-year by about $8 million primarily a factor of less cash on hand this year as compared to a year earlier.

This is a result again of two things, we had a $1.2 billion debt payoff last December as well as we used about $1 billion of our cash towards paying that $5 a share special dividend last February 27, a year ago.

Overall pretax income was lower by 3% or $29 million in Q2 going from $870 million a year ago to $841 million.

In terms of income taxes, we got a little help there.

Our Company income tax rate this quarter came in right at 34%, up from a little over 30% a year ago in the quarter.

The income tax line on this year's Q2 benefited from a few positive discrete items resulting in a -- in the 34% rate.

Our normalized rate would have been a shade over 35%.

While last year's income tax line benefited from as I mentioned -- we mentioned earlier, a $43 million benefit primarily relating to our $5 special cash dividend.

Overall reported net income of $598 million last year in Q2 compares to $546 million of net income this year in Q2 on a reported basis.

Rundown of a few other items.

Balance sheet is included in this morning's press release.

A couple of things I always point out on this call, depreciation and amortization for Q2 totaled $285 million for the quarter and $556 million year to date.

Our AP ratio, accounts payable as a percentage of payables last year in Q2 on a reported basis, it was 97% and this year 5 percentage points lower at 92%.

That includes construction and other payables so if you just looked at merchandise payables as a percent of inventories it would be 87% a year ago and 4% lower or 83% this year.

Last year being higher by 4% or 5% a year is actually the anomaly.

A couple of factors, part of it was last year's West Coast port slowdowns.

You had a lot less inventory a year ago on some big-ticket low turn items like electronics.

And just that one department was $120 million plus of higher inventory and only a few million dollars of higher accounts payable.

And then gas payables again was $20 million or $30 million to the wrong side of this AP calculation as we tried to keep our tanks a little more full when prices decline.

So again, that is the running the business and nothing per se exceptional there.

In terms of average inventory per warehouse, pretty much flat year-over-year coming in just $6000 higher this year and average inventory per warehouse of $12.761 million from $12.755 million a year ago.

Ex-FX year-over-year inventory levels per warehouse were up more than the $6000, they were up $286,000 or up 2%.

For that again on a normalized basis I think is one of the smaller increases we have seen year-over-year in that.

Overall inventories are in good shape.

Not only are they in good shape, we just completed our midyear fiscal inventories and it is our best shrink results ever by a basis point plus.

So again, I think it is indicative of running a clean shop there.

In terms of CapEx, in Q1 we spent $715 million.

In Q2 we spent approximately $650 million more.

We were still on track this year for a fiscal 2016 CapEx to be in the range of $2.8 billion plus, maybe as high as $3 billion but $2.8 billion to $3 billion.

That compares to $2.4 billion CapEx in fiscal 2015.

Next, Costco e-commerce, Costco online, we are now in six countries having recently opened in three in Taiwan.

We are also of course in the US, Canada, UK and Mexico.

For Q2, sales and profits were up over last year.

Total sales were up 19% in the quarter, up 22% ex-FX and on a comp basis, up 18% reported and up 21% ex-FX.

So continued good results in terms of growing our e-commerce efforts.

In terms of expansion, fiscal 2016 again we opened ahead of 11 units in Q1, one new unit in Q2 so 12 through midyear.

We plan seven net openings in Q3, nine openings including two relocations so seven net.

And in Q4 we are on task to do 11 so that would give us the 30 total for the fiscal year.

If you go back a year ago in fiscal 2015, we added 23 net new units on a base of what was beginning base of 653, so about 3.5% square footage growth.

This year assuming we get to the 30 that would be about 4.5% square footage growth.

Again the new locations by country if we do the 30, 21 in the US, three in Canada, one in the UK, and three in Asia, one in Taiwan and two in Japan, one more in Australia and one more in Spain.

At 2Q end, total square footage stood at 100.7 million square feet.

Next in terms of stock buybacks in Q1 as I mentioned a quarter ago, we spent about $130 million buying 898,000 shares back so an average price of just under $145 a share.

In Q2, we spent $80 million on 531,000 shares so an average price at just over $150 a share.

During the first five weeks of the past quarter, very little stock was repurchased in fact of the total $80 million, $3 million of the $80 million was purchased in the first five weeks and the remainder, the vast majority was in the last seven weeks and that is purely a function of how we do it.

We look at kind of a matrix pricing.

As it goes up a little, we buy a little less and if it comes down a little, we buy a little more.

As long as we feel comfortable about our runway, I think we will continue to do that.

In terms of dividends, our current quarterly dividend stands at $0.40 a share so $1.60 annualized which on an annual basis is about a $700 million number.

That is the quick and dirty of how Q2 went.

I will turn it back to Brittany now and be happy to answer any questions.

Brittany?

(Operator Instructions).

John Heinbockel, Guggenheim Securities.

Richard, I know you have this data.

I don't know if you -- how deeply you dig into it but if you look at traffic in the US by your different customer segments and in particular your most loyal customers, are the most loyal customers generally fresh food customers?

Is that a good part of the basket?

Do you think is it possible that a little bit of the moderation in traffic is are you maxing out with your truly best customers and it is just kind of hard to grow frequency with that group?

I would have to look into it.

I don't know.

My guess would be that our more frequent customers are bimodal, they are the ones that you mentioned that are shopping more frequency as families on a regular basis and certainly food is a meaningful part of that, that is in my view one of the two or three main factors that get people in the door on a more frequent basis.

You also have small business members who are buying a lot of things, not necessarily fresh foods.

Some restaurants come in and will buy some of that.

But in terms of actually -- I have said it before, I continue to be surprised how many more executive members we are getting even among the existing longer tenured members.

So we have to keep what we are doing in terms of being good merchants and constantly improving the value and there is always saturation in everything that you do.

We are pretty good at figuring out ways to offset that.

In the last year or two, certainly organics has helped not only bringing in arguably some newer, perhaps younger members but taking existing members who love Costco but there are certain things that they didn't buy at Costco because they are an organic family.

So I think we will keep coming up with stuff.

But I would bet that logically that makes a little sense but I bet you it is not that big of a factor that concern.

Do you think the -- are your best customers -- do you think they are shopping three, four times a month or more frequently than that?

I am sorry, who?

Your best customers in terms of shopping frequency, do think they are up to three, four times a month or even more?

Yes, I would say three or four times a month.

I think, look, you have some customer shopping twice a week.

A core of those are small business -- I have a friend that shops six times a week.

That is what he tells me and I run into him a lot and I scratch my head -- why?

But jokes aside, I mean arguably when there is a family that is getting to shop four times a week, are they on that curve of incremental frequency increases that it is going to be harder and harder to do.

But again, we are pretty good at figuring out a reason why they need to come back.

And we are getting -- we feel good about the fact that in the last couple of years our average members' age which half a dozen years ago was they were four years older than the US population is now just under two.

So that is going in the right direction for a lot of reasons.

The fact that we keep adding some gas stations is driving frequency.

I remember years ago, I have heard 30 years -- now that this thing is maxing out, fresh foods or gas stations whatever it is, we keep figuring out new things and I feel good about some of the things we are doing in a lot of the non-foods categories.

Fresh foods never ceases to amaze me and we will keep going.

And then just lastly, so you talked about two of the categories were up in gross, two were down.

So just maybe a little more color on the ones that are up versus down, how much is mix a factor?

I guess I thought fresh food might just because of deflation and a little bit of delayed pass-through -- but I guess maybe you pass through that a little more quickly.

Well, we do that.

By the way, one thing that Bobby reminded me of, another issue in terms of the year-over-year comparison or as some of you like to talk, the two-year stack, it was a year ago when gas fell dramatically in a big way and we had a couple of months there, we had a 5.5% frequency for a couple of months.

So look, I think some of it is the deflation that we are seeing now a little bit but some of it is that year-over-year comparison when we had some pretty nice numbers there.

Now I am hopeful -- we will find out in the next couple of months once we -- now that we have anniversaried that.

Okay, thank you.

Simeon Gutman, Morgan Stanley.

This is Joshua (inaudible) on for Simeon.

If gas prices stay low, do you expect you would see traffic slow as that competitive advantage starts to diminish?

Again in theory, it should be less of a factor of helping sales because we are not on the news every night.

We love it every year when Gas Buddy comes out.

Now three or four years in a row since they started it, that we are the lowest price nationally on average.

I think we still get positive feedback from that.

So yes, I mean at the end of the day is it better when we had -- is it better than when we had gas was going down a dollar year-over-year or over a couple of months and it is on the news every night?

Sure, that helps us a little more.

But we still find people that are just signing up and can't believe our gas prices.

So again, it is a net positive.

It is less of a positive than it was in the first year and the second year and the third year.

And a follow-up to John's question.

I don't if you have this in front of you but would you be able to compare traffic and ticket growth across demographic groups?

I know that our membership marketing people look at that and I've seen it but I don't know if we want to go that -- I don't have it in front of me so I can't answer that question.

Last one for me then.

If you could talk about the dynamics between the credit card transition and a potential membership price increase in terms of timing?

There is no real dynamic.

I mean it looks like we are on task.

As you know just last week I believe American Express and Citi announced the agreement to purchase the portfolio which I believe we are on track to issue -- Citi is on track to issue cards to the existing millions of members that have the current cobranded card in May with a transition date likely in early June.

But again that can slip a week or two too.

We will see.

In terms of transition, there is not a lot contractual yet we can do.

Until then and of course when the cardholders are being sent those cards by Citi, they will be getting information from Citi and I think that will start that process of making our members aware of what the new card brings to them and then we will go from there.

Look, we are excited about getting it done.

It is a big transition in the sense that there is millions of members that have the current card and they will get the new card in the mail.

We are excited about the value proposition to our members and we think it will be a net positive long-term.

Like anything, when we can save money, we want to give most of it to our members and this will be like that as well.

We will get a little benefit from it.

As it relates to the fee increase, we really haven't made any decisions which would be consistent with the six times we did it in the past.

History has shown if you just dot it out chronologically, it is about every 5.5 years to six years -- five to six years.

The last time we did it was in January of 2012 so five years would be January of 2017 and six years would be a year later.

I can only tell you that logic would dictate we certainly wouldn't do anything during the transition.

We've got going on this year, midyear when we are doing this credit card transition and so all of those align to a possible answer.

At the end of the day, I don't know when we will do it.

I can tell you that we feel as comfortable today as ever about the loyalty of our members and we feel as comfortable as ever today that we feel that we have improved the value on that membership way more than the likely increases that you have seen in the past.

Thanks, Richard.

Christopher Horvers, JPMorgan.

Thanks, good morning.

So I wanted to follow up on the potential membership increase as well.

Last time you raised the executive membership price in addition to Goldstar.

But I believe -- correct me if I'm wrong -- that was the first time you had ever done it.

So can you walk us through how you thought about that last time and maybe reflect on how -- what that could possibly mean for the next potential increase?

I think the big issue is for about I think it is 10 or 12 or so years we had the executive membership out there, the executive membership from its inception was $100 and our view at the time was let's build it.

In theory every time -- if you think about it when we originally did the executive, I think the Goldstar was $45 and so there was a $55 delta if you will and $55 assuming a 2% reward, breakeven if you will between do I stay a regular member, become an executive was an incremental $2750 of annual purchases.

And as the $45 went to $50 and to $55 that delta became less.

So in theory, another bucket of I think it was 2+ million additional members that fell into that bucket of being above breakeven and below breakeven and so we wanted to grow it.

As we decided to raise it almost five years ago, four plus years ago from not only from $50 to $55 but the $100 to $110, I think felt that we gotten a lot of that benefit and certainly there is a lot more benefit incrementally than $10 and so we felt comfortable doing that.

That is how we got there.

How we get to the next one stay tuned.

Understood.

And then just reflecting back on the traffic, I think ex the Super Bowl, still 3+ traffic comp, do you think that much has changed in terms of the behavior of the consumer within the box in terms of maybe are you seeing it in different mix, buying less discretionary items, less trade up within the category or any commentary there that you can talk about the consumer and how they are behaving in the store?

In terms of discretionary, some of our stronger categories are not foods and so that flies in the face of that concern.

Did we see a little bit of -- a little less strong numbers in some of his higher ticket categories in parts of Texas or Canada -- Canada was strong.

Notwithstanding that or I guess North Dakota -- I don't know about North Dakota.

I know Texas was a little different even though Texas overall was fine.

I know that when I talk to our head of international because of the strong dollar, they saw a little bit of -- a little weakening of that strength in the bigger ticket discretionary items.

But overall, we have had our best percentage dollar increases in electronics and statistically in TVs the last couple of months in a few years.

Thanks very much.

Dan Binder, Jefferies.

Good morning, thank you.

My question was around membership as well.

You obviously have a good retention rate and then presumably in existing clubs you have members that sign up to help fill the gap.

I'm just curious if you can give us some metrics around comp membership growth, how that looks in the US and then how that looks on international?

First of all any new market even when we went into New Orleans, where we had been in Louisiana before a couple of years ago, you are going to see a year hence when you have your first class of renewals, it is going to be a number quite a bit lower than our company average.

I think in the US we typically see numbers in that first full year in a new market and there aren't that many new markets anymore but when we do, something in the low 70s perhaps.

Overseas when we first opened in Korea, Taiwan and Japan, and as we have opened new units and new geographic markets in those countries, we might see in the first year renewal rates in the high 50s to low 60s and it grows from there.

So our renewal rates -- and that is why you see that -- we separate US and Canada which is the most mature.

That number is a little higher than the worldwide number for that very reason.

We always see a higher renewal rate among the executive members.

They get it.

They are investing another $55 on top of the main $55 on that upgrade because they get it and they get the value of it.

And we think that works, reward programs works, cobranding credit card rewards works, fresh food and gas works.

So all those things help.

So looking in aggregate, mature clubs and new markets, is the Company actually experiencing a comp store membership growth?

Yes, I am sorry.

Most of our sign-ups are comp sign-ups.

So the answer is yes.

I mean this is a rounded number here but when asked, if you have a 90% or 91% -- we use 90% for this example -- if you have a 90% renewal rate and you had 100 members, what do you have a year hence?

You have about 101 or 102.

You lose 10 and you gain 11 or 12 and that is kind of have how it has been.

And I'm shooting from the hip with this one but that is pretty consistent with my assumption of if overall new member sign-ups are in the 4% range this past quarter.

And you mentioned the Living Social campaign was good.

Can you give us a little color around how many and how many were millennials?

No.

Millennials were -- not in terms of the number.

We were pleased with our results based on our expectations of it but again, we don't want to get people comfortable waiting for that kind of value proposition to sign up.

So that is why we waited 18 months.

And as it relates to millennials, I don't have the chart in front of me but I know the chart that our head of membership marketing showed at the budget meeting, yes, it over indexes the other way towards younger people relative to our existing base which is what you would expect.

And then my last question for you on the LIFO credit based on what you know today about deflation storewide, are you expecting additional LIFO credits as we get into the back half of the year?

If it were today I would say yes but you never know.

Keep in mind when we have a LIFO credit, your markup is probably impacted a little the other way.

When you have a LIFO charge, it is because there is inflation, you raise your prices a little bit, sometimes there is a little bit of a gap there.

So it is part of margin.

But yes, I think all things we see today it would be a LIFO credit, a little bit of an extra LIFO credit.

Great, thank you.

Michael (sic) Lasser, UBS.

Good morning.

Thanks a lot for taking my question.

On the wage increases, is the increase that you are giving this year consistent with what you have done in the past?

And when you have done this in the past, have you noticed any change in your sales trajectory?

So employee satisfaction goes up and that leads to a better membership experience or it coincides with broader wage inflation and some people have more money to spend and they spend it at the warehouses?

Somebody once said it is like chicken soup, it can't hurt.

I think at the end of the day at the top of the scale, we have done every year for as long as I can remember.

When you've got somebody that has reached top of scale, they want to know what they are going to get a year hence.

And we have always erred to the high side on that.

I think over the last three years top of scale in the US is in the $23 range, $22.50 or something just top of scale.

And so if you -- and I think it was a $0.50 or $0.60 increase so let's say $0.55 on $23 would be about a little under 2.5% increase.

I believe the current increases are similar to that kind of percentage.

What we haven't done every year is bottom of scale.

We like to be -- and by the way, I want to also say that the amount of cumulative hours it takes for somebody to get from bottom of scale to top of scale on a full-time basis, not that people always start full-time, they don't, but on a full-time basis it takes about 4.5 years which is a very, very short period of time.

And so our employees get it but we think this will help and it is important to do.

We want to be the premium at all levels.

We are a huge premium at the top of scale.

That is -- as others raise their rates at the bottom -- and frankly in some markets, this is a physically challenge -- physically challenging job.

You're on your feet and you're lifting cases, you're pushing carts at these entry-level jobs, and so we thought it was time to do it.

So that is incremental and that is when I mentioned earlier in the call, the $0.01 a share in Q3 and the $0.02 a share in each of the next three quarters because there are four quarters; that is that incremental piece that I'm talking about.

Now I would like to think that we are not going to have less shrink or employee shrink because of it, or they are going to be better service providers to our members.

I think it reinforces what they already feel, and that is what we are all about.

And then my second question is on the competitive landscape.

Traffickers remain good on a multiyear basis, but a little bit more volatile just on a one-year basis.

Are you seeing any signs that you are having more interference from competition?

It certainly doesn't look like it from some of your club peers, but maybe some of your online players are peeling off, some members, or peeling off some trips from your member base.

I don't think so.

Again, on the margin are there a few?

I'm sure there is somebody that made one less trip to Costco because they bought something online or somewhere else.

But I think we are still doing a pretty good job of getting them in the door, particularly with fresh foods, with gas, with executive member, with a quality co-brand offer in terms of rewards.

So all of those things help.

I think we have, again -- online is taking a piece, and some of those pieces we are not going to take.

We are not going to take the single-unit items, some small value food and sundry things that are going to be delivered to your door by 7:00 in the morning if you ordered six hours earlier.

That is not us.

We can't do that at 10%, 11% margins.

But we are taking little pieces of other things, and again we still feel pretty good about what is going on.

Awesome.

Thank you so much.

Brian Nagel, Oppenheimer.

Good morning.

Thanks for taking my questions.

I want to go back, and this may be a follow-up from some of the earlier questions.

But in the US comps ex-gas in January and February, so my numbers -- you had a 1% and a 4%.

And you had mentioned before there was some shift between those two months, just given weather and then the timing of the Super Bowl.

I guess the question now, Richard, if you look at those month and then maybe take them in total, is that tracking; are sales in the US tracking where you would expect them to be and if not, is there something we can point to to explain why?

Look, like a teenager, we always want more.

I think when we look at the detail, deflation is probably the biggest factor, and that gives us comfort that fundamentally there has not been a lot of change in our view.

We still -- it bothers us that it tracked a little differently but again, that just makes us look at everything what else can we do?

And we've got a lot of good things going on out there.

Would we like it a little better?

Sure.

And on the deflation point, you probably gave these numbers already, but was deflation a more significant factor here in the first two months of 2016 than it had been say in the second half or latter part of 2015?

Again, there are different ways to measure deflation.

The answer is yes, first of all.

But there's different ways to measure deflation.

If I looked at the first just from a LIFO Index which is US inventories if everything started at a cost, everything we had in our warehouse at a cost of 100.00, that was the baseline, at the end of Q1, so in late November, that LIFO Index was 99.49.

So 0.5% lower on average, that is that inventory LIFO calculation.

In the last eight weeks, the 99.5 has gone to 99.06 so down 4 basis points.

So yes, that has continued so that is where I got -- it is a little lower.

We are seeing a little bit more deflation particularly we are seeing in some of those nonfood categories.

When I look at the 85+% of our goods that go through our depot operations, again this is just one parameter, the number of pounds being shipped through with a dollar value, that dollar value is down a little over 1% year-over-year.

Now year-over-year, not from the beginning of this fiscal year.

So again, that would indicate to me again we are seeing a little bit more deflation.

I could give you crazy numbers on given items.

On a year-over-year basis when you look down -- candy, M&Ms down 10% year-over-year; American single slices of cheese down 15%; bacon down 20%.

But there is also some inflationary items.

But overall I think the LIFO Index and that depot calculation although it is not a perfect calculation would indicate that we are seeing a little bit more deflation than we had overall.

And particularly on the nonfood side you are seeing it.

And I think I mentioned a quarter or two ago when asked about that with oil prices coming down, what about some nonfood items like plastic bags and things that require a lot of petroleum-based products, and the answer I got back and I shared with everybody was yes, you are seeing it but you've got to ask for it more frequently and more strongly.

And even then it took a little longer because sometimes you've vendors that have committed out several months if not a year on raw material prices and we are going to work with them.

We are not going to -- we are going to do what we can but we are not going to create hurt.

So again, we are starting to see a little of that but that is retail.

That is helpful.

Then the second question I had just with respect to the forthcoming shift in credit card and I know it is early but is there anything you are watching as some type of leading indicator as to how your members may or may not react to this shift?

Look.

You've got 11 million or so million members that have a co-brand card, you've got however many high 20 million of member households in the US.

We have had our share of letters both ways, good -- I'm glad you are changing, I never liked whoever.

And then you've got those that say how dare you change.

I got it for this reason and I love my card, my existing card.

Aside from that, we feel comfortable or we wouldn't have done it.

We recognize that -- (inaudible) afterwards.

I think with the reward proposition, with any possible improvement in merchant fee to us, with the fact that the new card will be accepted in more places, there is a lot of reasons why it should be a positive.

We have to get there and see.

Thank you very much.

Appreciate it.

Paul Trussell, Deutsche Bank.

Good morning, Richard.

You spoke about the incremental labor costs that are forthcoming with the $0.01 hit in Q3 and $0.02 thereafter over the next 12 months.

But can you just dig a little bit more into the expense deleverage from the second quarter?

Certainly as you mentioned, there was a little bit lighter sales volume so perhaps that had been impact.

But how should we think about the results in 2Q and the outlook on payroll and benefits and operations central, etc.?

I think first of all, sales drive leverage and I remember years ago when we were always asked the question, what comps sales number do you need to get any leverage at all or to be consistent?

And our guesstimate at the time -- this was a number of years ago -- was something in the 4% or 5% range as an underlying comp.

But my stronger and more confident portion of response was whatever other companies do to be able to better leverage if sales showed a little weakness, we are not going to be as good because we are not going to do some things.

We are going to still clean the bathrooms every hour and we are going to still make sure all the parts are inside and not sitting out there and we are not going to cut labor.

In fact, we will enhance labor.

We have done that at times at the front end to drive more business.

And so I think again, the bottom of the scale increase that is easy, that is quantifiable.

A few of the moves lined up on a few items, I mentioned the high cost claims was 3 or 4 basis points.

I mentioned there were 3 other items that usually 2 of them go one way and one go the other way and so it is a couple of million or a quarter or half a penny impact to the quarter.

This time it was all in one direction.

And so you are always going to have that.

But I guess I too get a little more defensive when we miss the number.

Some of it was is we could have done a little better job.

And so directionally we are going to try to do a better job.

We are going to hope that the moves line up to 2 to 1 to the positive, not 3 to 0 the other way and we know that we are getting a little less hit from IT modernization a year or two in.

Other than that, that is what we do for a living.

I think the other thing is to drive more business and we are pretty good at that.

By the way, then the credit card.

You have heard it before, I have said it before whatever this additional bucket of potential money is, we are going to give most of it to the customer in the form of the cobrand offering.

But we are going to keep a little of it and that helps merchant fees but that is not going to start until the summer and we will go from there.

So that should help us a little.

We've got our fingers crossed.

I appreciate that color.

Certainly we will take a look at the 10-Q when that is out to see some of the margin detail geographically.

But could you maybe just give us a little bit of preview of any changes year-over-year from a US or Canada or international standpoint?

Maybe you can just speak to some of the performances ongoing in those particular markets?

No, I think we will have to wait until the quarter is out.

The only thing that you've seen in the past historically is gas continues to be strong but on a year-over-year basis, there is not a big difference.

Gas is a big thing to the US.

I think you have seen a couple of quarters in the 10-Q in the last two or three quarters where the biggest improvement year-over-year in the segment analysis of operating income as a percent of sales, you had the most improved was the US column which is one of the lower columns.

And we mentioned part of that is attributed to gas.

But I know in Q2, there was not a bit -- it was still good but it also was very good a year ago.

So other than that I can't really talk to you about it until it comes out.

Thank you.

Lastly from me and very quickly on e-commerce, you continue to have very solid growth, up I think it was 19% this quarter or 22% ex-FX.

Can you just speak to some of the categories really driving that strength?

Is there any expansion of assortment that we have seen online of late?

Just a quick update on the Google and Instacart partnerships.

Well, we have over the last couple of years expanded some of the categories what we will call the velocity categories, some sundries items, some limited nonperishable food items, some apparel items, socks and underwear, things like that, health and beauty aids.

So yes, that is a little of it but those are small pieces relative to if you could drive sales in furniture and exercise equipment and electronics.

So those things are helping as well.

I think it is a lot of the things we have done, some out there would argue it is about time but we are getting to it and we are driving it and we are starting to do a few new things.

Peter Benedict, Robert Baird.

How has the growth in trips to pump changed as gas prices have dropped here to around $2?

Has that been -- have you seen a noticeable change there?

And remind us what percentage of those fill-up trips correspond with a visit inside the club.

For every 100 people that pump gas during the hours that we are open in the warehouse because we open a couple of hours earlier than the warehouse opens at the gas pump and close an hour later, it is in the low 50s.

And that has improved a little from 50 and 49 but it is in the low 50s.

What was the other part of a question?

Have you seen the growth in trips moderate as gas prices have fallen?

I think whether you measure that by comp gallon growth or what have you?

What we see is when it really spiked a year and a quarter ago, we saw a spike there as well in terms of gallonage comps.

It is still positive and it still beats the US averages out there but it is more muted than when you have those big deltas.

Okay, that is fair.

That makes sense.

By the way, that means we are retaining it.

Understood.

And then just on the organics, can you remind us where your penetration is at this point, what the pace of growth has been and where you think you can take that?

Do you have more room to continue to improve the penetration of organics?

Yes, we are about 4 billion which was I think the last two years it was up 30%-ish and we are on task -- I think our goal this year is on task to have a double-digit number that has a two in front of it and we feel good about it.

We are I think doing as good a job as anybody in terms of sourcing and part of the challenge is availability and the industry is growing needless to say.

There are more farmers and more poultry producers and more bee producers that are committing more to this and we are certainly out there literally in the fields here and abroad getting these growers and processors to do more.

So I think it still has some good opportunities there.

Okay.

And then last question just on D&A was up about 9% year-over-year in the quarter.

Is that a pace that you are comfortable with kind of going forward?

Is that going to accelerate at all as some of these investments come in or I'm just trying to get a sense for how we should be thinking about the growth in D&A going forward?

It is partly going up because of IT modernization.

And because we are opening 30 units instead of 23.

And although this 30, 21 or so are in the US which is a little different than I would have guessed two years ago what it would be by now.

And so I would say that for a couple of years here it has kicked up, we have got at least one more year it will kick up because of IT modernization and then this year and next.

And it probably kicks up a little bit because of just a little more expansion and a little bit more expensive expansion.

So (multiple speakers) take the number.

If sales were growing at X, does D&A grow at X plus 2 or 3?

I would have to look at it but it is probably as good a guess as anybody and I would look at what it has done historically and probably it grows a little faster than that in the next couple of years, couple or three years percentage wise.

Okay, makes sense.

Thank you.

Oliver Chen, Cowen and Company.

Thanks a lot, Richard.

The average transaction increase was impressive at that plus 2% range.

Do you expect that that will be a dynamic that will continue and within consumer electronics, what are the major pluses there given that it had such nice performance?

Richard, as we do model the next year, what is the magnitude of deflation in terms of the impacts to comps?

Is it in the 100 basis point range?

And just I think you mentioned several different categories but is there an overall take on which categories it is applying to most?

Starting with the last question first, again I think the difference now is we are seeing a little bit more deflation on some of the nonfood items, particularly like an example love plastic bags, garbage bags and things like that that require petroleum-based products.

I still think again, you get the sound bites of the things that are down 10% and 20% but overall if deflation as measured by our LIFO Indexes are down, have been down a 0.25% a year and then last year maybe was more than that, this year seems like it is a little more.

It is less than 1%.

Maybe it is 0.5% to 1% instead of 0.25% to 0.5% but I am guessing there.

And then in terms of electronics, I think a couple of things.

I think arguably if we have a higher end member that probably helps.

We certainly over index on bigger TVs.

I know that during the four weeks between Thanksgiving and New Year's, Thanksgiving and Christmas, we had outsized TV sales dollars talking to every major supplier that we buy from relative to everybody else online and off-line.

And I think part of that was that over indexing to 60 and 80 inch TVs.

But we are seeing strength in phones.

TVs is the thing that drives that.

Cameras are better but the cameras are better because they were weaker the last couple of years.

Richard, just remind us as a percentage of total, what is consumer electronics?

I don't have it in front of me but I think Department 24 is four or five -- four plus.

TVs would probably be 40+% of that.

Okay.

And Richard, as you think about Costco for the long-term just for the five-year story of Costco, we know that you don't have the buy online and pick up in store, the BOPUS, but what are customers asking for as you really try to execute to customer desires?

Is there anything on the delivery speed front and mobile that you would highlight as where you are focusing efforts on in terms of your human capital and strategic priorities as you look to bricks and clicks over the long-term?

One of the challenges we have with picking up at the store is we have got an average location that is doing $175 million, $180 million which means we've got a bunch of locations that are doing $200 million to $300 million and several that are doing more than that.

We don't want somebody to come by and necessarily pick it up.

Maybe that would change if we were having minus 3% comps in our lives.

So we want to do everything possible to get them in the store and not just come and pick something up.

So I don't see that as being a strategic focus of ours at least in the near-term.

We also -- part of the thing of trying to get people in the store with treasure hunt items, with fresh foods and with gas.

So we keep driving that.

As we have done, our relationship with like in six markets with Google shopping and I think 16 markets with Instacart, there are people that want things delivered to them and we are selling them.

We are still selling it but we are doing it that way.

And so I think that is what we will continue to do.

We are getting better and again, some out there would say we have gone from an F to a C or an F to a D, some would say that we have gone to a B+.

We would like to think of ourselves -- we still have some things to do but we have improved our mobile apps, we have gotten a little smarter about how we do it.

We know that when you come in store you are going to buy a lot more than when you shop online in general.

And recognizing our average online transaction is actually higher than our in-store visit, that is because we started with just big-ticket items.

It is just recently we have put on some other smaller ticket items.

But we know that compared to an Instacart or a Google experience, the in-store visit is 2.5 to 3 times if not a little more than that.

Now what we are finding is that that customer comes in a little less frequently, does the online several times and the net of the two is an aggregate improvement in their comp.

So that works.

But we are still taking it slowly in terms of -- I don't see us doing pick up at store at least in the next year or two because we've got enough traffic there and we are trying to figure out how to keep driving that.

Richard, you have been experiencing such robust traffic and healthy fundamentals.

What is your take on the health of the consumer because there seems to be different factors going on at different income levels and at the same time, there is definitely stock market volatility?

And a related question is if there is something that keeps you up at night for the next year, what would you highlight as risk factors as you evaluate them and think about them internally?

I think from all of the things I read, first and foremost when we do our competitive price shops, we feel as good if not better than ever.

When we look at our renewal rates and our customer loyalty, we feel as good as ever.

When we look at our employee loyalty and our turnover rates, we feel as good if not better than ever.

We certainly like to read those nice things that everybody says about us and I think it reinforces and we are doing it because we do it and reap the benefit of it.

So I think from that perspective -- now at the same token, my favorite negative phrase out there -- we talked about the volatility and the choppiness.

There is a lot of what somebody referred to not me -- but toxic anxiety out there.

The world is a little different and the dollar strength doesn't help everything.

And even the US economy while good, there is not a big engine driving it necessarily.

So there is a lot going on out there.

I think I am comforted by our consistency even if it has come down a little bit in the last couple of months.

And again I can explain some of that with the strength in frequency a year ago.

But look, we would still like in extra half a point or a point there.

In terms of what keeps me up at night, what do we as a Company or what does Craig, our CEO get, what am Bob and I and Jeff asked about, a lot of it centers around dot-com and what are you going to do?

And we try to not of avoid it or be arrogant about it but also recognize we try not to freak out about it.

I think in my older age I am -- I lose sleep for age-related issues, not Company related issues.

I really feel pretty good fundamentally about our Company and what we've got going on, what we are doing in terms of global sourcing, what we are doing in terms of the strength of our current signature brands.

And things could change but we will keep trying to do a few things on the Internet more but we are going to take it steady.

Are you still selling tons of diamonds?

Have your diamond luxury sales been really good?

Yes, I know in fiscal 2015 they were up percentage wise up to like 150,000+ carats which is up 15% or so.

Yes.

Thank you.

Best regards.

Meredith Adler, Barclays.

Matthew Fassler, Goldman Sachs.

Thanks so much and good afternoon at this point.

My first question relates to the US versus international traffic and ticket mix.

When the numbers were quite similar in terms of total sales or comp growth ex gas and FX for US international, I guess we were a bit less curious about how the traffic trends you are seeing that you report which I believe are our global -- correct me if I am wrong -- were different so any sense as to how different the traffic number is in the US particularly over the past few months?

No, I mean again, the biggest factor was a year ago with the gas, our view is it was gas related.

We had a couple of months of mid-5s which was an anomaly the other way and so we are just finishing comparing to that.

What surprises me in Canada, the underlying comp there is surprisingly strong given that oil prices are down.

When I looked at for Q2 in terms of kind of front end transaction growth which is shopping frequency that is how we measure it, overall we were again in the low 3s, the mid-3s.

The US was the mid-2s although that impacted again by -- more impacted than anybody by gas, by the gas a year ago the shopping frequency.

When I look internationally, it ranges from flat to up 14% and no rhyme or reason to it.

A little of it is in the Asian countries Q2 was a little flatter because of opening new units as well.

Got it.

If I could also focus on sales for a second question, so I guess the difference really between January and February in the US if you knock out the weather and Super Bowl, etc., it is actually seems to be at least in the overall number seems to be less about traffic and more about ticket.

I know there is a component of ticket that is obviously deflation.

Is the deceleration in ticket ex gas and FX in the past couple of months entirely about deflation or is there any change in basket size or units per basket, etc.?

Well, it is basket size related to deflation.

So deflation pure and simple rather than any kind of -- store transaction?

A month ago, we don't do this all the time, but a month ago, Bob had everybody look at -- the last two months, we looked at the basket size and the actual number of items in the basket, the number of items in the basket was up less than 1% but 0.25% and the average basket dollar amount was a little down.

So that would imply again a little deflation but (inaudible) slightly more things than a year ago, slightly.

Understood.

And then finally on SG&A and the forward guide on wages just to be clear is what is different over the upcoming four quarters or so, simply the change in the entry-level hourly wage rather than the increases you would give your experienced team members or does that increase also flow through at a greater than usual rate to the (multiple speakers)?

Top of scale close to the same rate but again if you have 60+% of your employees who currently are making $22 or $23 whatever that top of scale is and every March they got a $0.55 to $0.60 an hour increase, we have experienced that through all times for 30 years, which percentage-wise is pretty similar.

The unique thing this time is the bottom of the scale which just taking what would it be without it and what would it be with it and it affects not only the entry-level, it affects the first couple of increases.

If we were at $11.50 and $12 currently prior to now, three months or however many cumulative hours later, somebody goes from $11.50 to $11.75 and then $11.75 to $12 or $12.25.

Well, everybody below $13 an hour is not going to $13.

But what is the incremental cost all things thing equal?

The incremental cost is about $0.08 a share over the course of a year.

It is a penny this quarter because it is a partial quarter and then it is more -- it is about $0.02 a quarter and then it will anniversary next time next year at this time.

Got it.

Thank you and thanks for the transparency today.

Bob Drbul, Nomura Securities.

I just have a couple of questions I think.

The first one is on the membership fee income growth, what would it have been without the impact of no American Express sign-ups?

Higher.

We don't measure it.

On the margin, we think somebody is coming to sign up because of us first and the program cart second, a distant second whether it is AmEx or Citi Visa or anybody.

They come in to be a member of Costco.

So I don't think they come to the desk and say never mind and walk away.

So I think now -- because part of our relationship with our former partner and our upcoming new partner current and soon-to-be former partner and our upcoming new partner is they do some marketing for us, they do some things to get people to come in also.

So I think there's probably a little bit but we don't try to measure it.

We just know it is zero right now.

In your softlines business, there has been -- the private label component I think has increased and I was just wondering if you could talk through a little bit on the impact that weather has played in that segment of your business both from like a markdown perspective but also in terms of what you are really seeing as buying opportunities throughout the last few months in the current market?

The only thing that was impactful was I believe there was a relatively warm -- there is more men's outerwear markdowns this last few months than we had historically.

It was just completely weather related.

I didn't even point it out in the call.

That is probably a little bit of a softline impact.

That is one of the reasons that the softline's margins I mentioned year-over-year was a little down.

Beyond that at the last budget meeting when we were looking at some of the apparel buyers came in and talked about some of their new seasonal things, we keep getting a few more brands.

I can't think of any of the top of my head right now.

But I think it is a consistent -- we have enjoyed apparel business with comps in the 10% to 15% range compounded for a couple of years now and we are still seeing some decent growth in those areas.

So it is a good category for us.

I know we are committing -- I think we are trying a couple of men's athletic items.

We have been very successful with the two or three, the three pieces, the bottom, the top and the jacket.

I know we are bringing in a few other items on the men's pants not just a fancy wool pant but the khakis and the gabardines.

Okay, great.

Thank you very much.

Kelly Bania, BMO Capital Markets.

Thanks for taking my question.

Richard, just wanted to go back to the credit card transition.

You have talked in the past about kind of reinvesting some of the savings but I think you just also mentioned maybe keeping a little bit of it.

I'm just curious, is that a change, are you considering letting some more of that flow through -- I mean you have had a lot of expense on the IT front now with the wage increase FX has been a headwind?

So just curious if there is any change in how you are thinking about the savings there?

And now that we are kind of very close to it, any comment on what those savings could be in terms of magnitude?

No comments until we get there so it really is going to be probably not until early October when we report our yearend and fourth-quarter numbers since early June would be the beginning -- about three weeks into our fourth-quarter.

Actually I can't really tell you anything about it.

We have made no change in what piece of this bucket we are thinking of saving.

If anything as we went through the final negotiation several months ago of what the reward structure would be, Craig pushed it further towards the customer, towards the member who would get his card.

We want it to be a great card and so if anything, we went the other way a little bit.

I just mentioned and perhaps I didn't mention it that when I talk to people as people talk to me, my standard line has been anything we do when we save a dollar on a piece of merchandise, we can buy better, we are going to give as a rule of thumb the majority of it, maybe 80%, even 90% back to the customer.

We are going to do the same thing here.

We are going to give most of it back to the member.

That being said, again in the throes of the final figuring out of what exactly do we want the reward structure to be because we want that card to be top of wallet as we do with our current program, top of wallet and to be used not only at Costco but outside of Costco and to be used at Costco as much as possible.

Craig pushed the envelope with us and with the third parties to make sure that that value proposition is geared more towards them than us so there has been no change in terms of that.

Got it.

That is helpful.

And then just on the transition, will you have any grace period for a member that say doesn't have the cobranded card but tends to use their AmEx at the store and didn't get a new card in the mail obviously but gets up to the register and goes to pay and you are not taking AmEx any more or will they just have to find a debit card or have you thought about how to treat that situation?

First of all, there is going to be a lot of communication several times by us to our members about timing and everything.

Contractually there is a lot of things we can't do until near the end.

There will be plenty of information provided.

We are still going to upset a few members when they come in.

We did it with gas pumps years ago when we stopped accepting certain things.

But at the end of the day, there will be plenty of opportunities.

The fact is there will be some members that have an existing Visa card in their wallet.

While we would prefer them to have ours, there will be cannibalization that way.

Frankly there will be some -- look, whether it is American Express or Citi or any other big credit card issuer, they are the bank that determines credit eligibility for somebody signing up.

Now that doesn't impact the portfolio people, all the people that have the current cobrand.

They are going to get a new card similar in terms of credit capacity and things from their existing co-brand relationship.

But somebody who has to sign up, there are millions of people that never got an AmEx card because they couldn't.

They have resorted to debit or cash or check.

There are some of those people that will be thrilled, there are some debit cardholders that will do this.

But when you add it all up, we think that -- we know that it is in that positive certainly in terms of what we have negotiated and we will see where it goes from there.

Got it.

That is helpful and then if I could just ask one more on online.

A lot of retailers are spending a lot of money investing in their online business.

It has kind of pressured the margins for them there.

I believe your e-commerce business is higher margin.

Just curious how you think about spending there going forward and is that higher-margin structure sustainable?

I'm sorry, could you repeat that?

In terms of online, just a lot of retailers have been talking about how much they are investing in their online business and that pressuring their margins for that side of the business.

I believe Costco's margins online are higher margin and I am just curious how you think about spending there and if that higher-margin structure for e-commerce is sustainable?

First of all, our gross margins online are a little lower.

It is operating margins quite a bit higher because you have a substantially lower SG&A.

Now the fact that we are not spending hundreds of millions of dollars online perhaps is part of that but at the end of the day, we certainly make more when that dollar is sold online than it is in the store.

Notwithstanding the fact that our gross margin what we charge the member is lower online than it is in store.

I guess the question is do you see that as sustainable?

I do.

Because the SG&A portion is so low and because we are so extreme.

Great, thank you.

Scott Mushkin, Wolfe Research.

Thanks for letting it go so long.

I just wanted to poke at the environment that almost everyone seems to be operating in right now.

I mean I think you talked about traffic and I assume February traffic is in that kind of 2 to 2.5 range too.

Talked about the deflation outlook.

We talked about wages going up.

I guess as you kind of move forward here and this is not just a Costco question, I guess this is from an analyst perspective that covers a lot of retail, it seems like everybody is facing a lot of the same challenges.

Do you see a light at the end of the tunnel?

We had deflation now minus 1 maybe, we have wage inflation, we have traffic that has kind of come down a little bit.

Not a great environment and so it seems again that maybe something has to give here.

Is the wage inflation going to finally pick up demand?

Where does this in your opinion kind of end?

Even Costco which is probably one of the best retailers in the world domestically is feeling the pressure.

And I'm just trying to understand what is the end game here generally and I don't if you have any thoughts on that?

That is my question.

I don't if this will give you comfort or anxiety.

We are going to keep doing what we do.

In bad times, we probably have the benefit of being more aggressive to drive stuff and if anything, I think we are doing it from a stronger position now than we have ever been in.

We are going out there driving prices down, we see our competitive moat actually even relative to traditional brick-and-mortars not only our direct competitors but other forms of -- not just clubs but other forms of category diamond retailers.

That moat has widened a little bit of late, of late being the last year or two.

And the answer around here is can we get a little more margin and the answer is of course not.

No.

We can drive more business so we can make it tougher on everybody.

So I think -- and then again, I think some of the things we are doing in terms of our strength with our vendors and our global sourcing all of that stuff, that helps.

We are doing a lot of good things.

So do you have concern though given the slow wind down that we are seeing, Richard, a little bit on the components I mentioned, higher costs yet deflation and the traffic?

I mean does -- I think someone asked what do you stay up at night?

I mean I guess it is hard to stay up because you're getting old but generally does that get you a little nervous as you look at the business and is the broader economy that something is just a little off?

Well, I use the word earlier and I quoted from some economist about toxic anxiety.

The world is filled with it.

Our economy is darn good compared to a lot of them out there and the fact that wages are increasing and unemployment has improved, all of that is positive and frankly higher wages at the lowest wage levels in my view is a positive.

I think we have just got our head down and doing a lot of good things.

I think that what we are doing again on some of the global sourcing stuff is something that very few could touch.

And the strength of our KS brand name and we are going to figure out how to create more value.

So other than everybody in the world never wanting to leave their house and only typing stuff to order and getting it at the front door, other than that risk, I think that the strength of our merchandising, the strength of our competitiveness, the fact that we are able to be successful in other countries.

I come to every four-week budget meeting and listen to merchants and some of the things they are doing and I go out and feel better about what we have got going on.

So in terms of -- I think by the way when it is tougher for everybody else, everybody else does it less extreme than us.

They figure out ways to cut costs that aren't necessarily long-term the right way or as right of a way in our view.

And maybe we are righteous and we are standing on our own pedestal here but it seems to have worked for us through good and bad economies.

Perfect.

Thank you for taking my question.

We are going to take two more questions.

Greg Melich, Evercore ISI.

I have two questions, Richard.

What drove the acceleration in membership fee income growth besides the Living Social program?

Living Social had virtually no impact because it is deferred accounting.

Even if we had a little bump in that first week of -- last week of Q2 when the Living Social thing was happening, virtually none of it hits the income statement because for a new member that $55 or $110 goes into the P&L over the next 12 months.

And my guess is it is probably some strength a year earlier that we are not getting the full benefit of that.

Might even be strong membership.

That is the best reason.

So I guess the second question then is on the ancillary business because I know these have been growing a lot and you gave us a few numbers I think last quarter.

Is there any way to sort of pull those together and say what percentage of your members are doing a car rental or a travel program or car buying or one of these things that -- is it 5% of the transactions if you think of it that way?

(multiple speakers)

Some of those services it is 1% or less.

I think one number that we have seen and presented in some of our PowerPoint presentations, I think last year we had car rentals of about 2.5 million car rentals.

Let's assume 2.5 million car rentals weren't to 2.5 million mutually exclusive customers but maybe it was 2 million members.

I don't if it is 1.5 million or 2 million but if it was even 2 million members that would be less than 10%, probably 7% or 8%.

So my guess is less than that so maybe 5%.

Not everybody needs a [mortgage], not everybody is doing forms and check printing but on some of the items like as a percentage of our total membership base it is low but there's a lot of room for it to grow.

So basically that nice tailwind to gross margin that could be there for a while if we continue to get (multiple speakers)?

I think it is.

Absolutely.

It probably over time moves the needle a little.

It definitely moves the needle a little positively.

Good luck.

Sean Naughton, Piper Jaffray.

So just following up on the Living Social deal, understanding that the deferred accounting doesn't really impact it but how did that impact the total membership numbers for the quarter?

And then also how was the retention rate really on the one that you had about 18 months ago?

I think in terms of aggregate number of members we signed up a few more than we did the last time and I think the 4% increase would be lower and would be somewhere north of zero and south of 4%.

But the mechanics of the program when somebody buys that deal, they automatically they get it done.

They don't have to take it to the warehouse to get activated?

No, they buy the coupon or whatever online, they print it out, they go to the warehouse where they sign up for a membership.

Okay, so you don't get those regulate?

It is that latter take that when we represent, when we recognize it as a member and we start our deferred accounting which will be small in the first year because you have the offsets, the value proposition to that purchaser.

Okay.

So there could be more people that are signing up in the current quarter that we are in now that have purchased that deal?

There will be, yes.

And then I guess the second question would be just around -- you didn't talk much about the other international business being flat in February.

You did say something that the Chinese New Year but is there something going on in the Japan business?

You haven't called it out in the monthly for a long time as being a real positive contributor to comps.

Just any comment you can elaborate on for February for other international and then also specifically in Japan?

I think in Japan, the last couple of years we have had probably a little more cannibalization and their economy is soft.

I know of late again as it relates to the strong dollar in all countries where the dollar is much stronger, there is a little weakness in some of the bigger ticket items.

Okay, thank you, Richard.

Thank you everyone.

Have a good day.

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

You may now disconnect.