好市多 (COST) 2018 Q3 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Q3 earnings conference call.

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

Thank you, Josh, and good afternoon to everyone.

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

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

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

In today's press release, we reported our operating results for the third quarter of fiscal 2018, the 12 weeks that ended on May 13.

Net income for the quarter was $750 million or $1.70 per share.

That compared to $700 million or $1.59 per share last year in the third quarter.

Now last year, in the third quarter, our net income was positively impacted by the $82 million or a plus $0.19 per share tax benefit, and that was in connection with the $7 per share special cash dividend that we had done at the time.

I'll start by reviewing our third quarter operating results and then allow some time, of course, for Q&A.

In terms of sales, net sales for the quarter came in at $31.62 billion or 12.1% increase over last year's third quarter sales of $28.22 billion.

Net sales for the first 36 weeks of fiscal '18 increased 12.0% to $95.02 billion, up from $84.82 billion from last year-to-date -- last year for the first 3 quarters year-to-date.

In terms of comparable sales, which we reported in the press release, for the 12-week period, U.S. was 9.7%.

Excluding the impact of gas inflation, it was 7.7%; Canada on a reported basis for the 12 weeks' comps were 11.3 and, ex gas inflation and FX impact, was up 4.8%; Other International reported at 11.8%, ex gas inflation and FX, 5.8%.

So all told, total company at 10.2% comp and, ex gas inflation and FX, up 7.0%.

E-commerce, which we, of course, separate out here, is 36.8% for the 12 weeks and 35.5% ex FX, so that continued strong.

Similar statistics in the press release for the 36 weeks year-to-date.

In terms of third quarter sales metrics, third quarter traffic or shopping frequency was up 5.1%, both worldwide and within the U.S. Strengthening foreign currencies relative to the U.S. dollar impacted sales by approximately 145 basis points to the positive.

And gasoline inflation added an additional 170 basis points.

Cannibalization weighed on the comp to the tune of minus 60 basis points.

Our average front-end transaction or front-end ticket was up 4.9%.

And again, excluding the benefits from both gas inflation and FX, that average ticket would have been up somewhere in the mid- to high single digits, about 1.7%, 1.8% up.

Next, on the income statement.

Membership fee income reported in the quarter, $737 million, up $93 million from $644 million during Q3 of last year or up 14.4%.

The benefit of strong foreign currencies was about $9 million of that $93 million increase.

So ex that, it would have been up $84 million.

Now of the $93 million increase year-over-year, a little over half related to the membership fee increases that we have taken in the last year, 1.5 years, the majority of which came from the $5 and $10 annual fee increases taken last June 1 in the U.S. and Canada and the small balance of that from the fee increases taken, Other International operations starting back in September of 2016.

We will continue, by the way, to see membership fee based on the deferred accounting, the June 1 of '17 increases in the U.S. and Canada last year will continue to see the benefit of that year-over-year increase in the membership fee line.

It will peak in Q4 this coming quarter, the 16-week quarter, and then still year-over-year increases, but in all or at least 3, maybe 4 of the -- all of next year in fiscal '19 as well.

In terms of membership fee renewal rates.

Our U.S. and Canada member renewal rates at Q3-end came in at -- were 90.1%, similar to what they -- where they stood a quarter earlier at 90.1%, a slight uptick but still rounding to the 90.1%.

Worldwide rates improved from 87.5% up -- improved to 87.5%, up from 87.3% 12 weeks ago at Q2-end, with the uptick in renewal rates and Other International operations led by Asia, both Taiwan, Japan and Korea.

In terms of number of members at Q3-end.

In terms of total member households at the end of Q2, it stood at 50.4 million and 12 weeks later, at the end of Q3, it is now -- it then stood at 50.9 million.

Total cardholders, 92.2 million a quarter ago, 12 weeks ago and, at Q3-end, 93.0 million.

During the fiscal quarter, we had 2 new openings.

Also at Q3-end, as of Q3-end, our paid Executive Member base stood at 19.0 million households.

That's an increase of 199,000 households from 12 weeks earlier, about 17,000 new Gold Star members per week.

Related to the benefit from last year's fee increases, that year-over-year quarterly fee increase, as I mentioned, will continue to benefit both Q4 and into several quarters next year but on a diminished amount each year-over-year quarter.

Going down to the gross margin line.

Our reported gross margin third quarter was lower year-over-year by 46 basis points, coming in at 11.05% during third quarter of fiscal '18 compared to 11.51%.

Now that minus 46 basis point figure year-over-year on a reported basis, excluding gas inflation, it was minus -- it would have been minus 28%.

And let me again ask you, as I usually do, to jot down just a couple of columns for Q3 '18.

The first one would be as-reported and the second one would be excluding the impact of gas inflation.

The 5 line items would -- first one would be merchandise core.

In Q3 '18, on a reported basis, that was down year-over-year by 33 basis points and, ex gas inflation, down by 17 basis points.

Ancillary businesses.

Reported, minus 10 basis points year-over-year, minus 6% ex gas inflation.

2% Reward plus 2 as-reported and flat without gas inflation.

Other, minus 5 and minus 5. And I'll talk about that in a second.

So total, if you add up those 2 columns, on a reported basis, again, gross margin was lower by 46 basis points, ex gas inflation, lower by 28 basis points.

Now the core -- as I mentioned, looking at the core merchandise categories in relation to their own sales, so core-on-core, if you will, margins year-over-year in Q3 were lower actually by minus 4 basis points.

Subcategories within core gross margin year-over-year in Q3, food and sundries was up slightly.

And hardlines, softlines and fresh foods, the other 3 components of core, were down just slightly.

The slightly year-over-year core-on-core gross margins in the third quarter resulted from our continuing investment in price to drive sales and widening the value gap between us and our competition.

Ancillary and other businesses gross margin were reported down 10 and down 6 ex gas.

Some of that is increased gas sales penetration, which is a much lower-margin business, the other parts of it is -- some of the other ancillary business were down a little bit as well.

2% Reward was flat ex gas, as I mentioned.

And Other, which was a -- excuse me, Other, which was a minus 5 year-over-year comparison, 5 basis points.

Last year, we're incurring some incremental costs.

Well, we have been -- as I mentioned in the last 2 quarters, we've been incurring some incremental costs primarily related to the rollout of our new centralized returns facilities.

This will continue to impact us for one more quarter in Q4.

In each of the prior 2 quarters I had mentioned on a -- kind of a sequential basis on a year-over-year, Q1, it was -- we estimated it was about 7 basis point negative impact in Q2, minus 6; and in Q3, minus 5. And again, there'll be some small detriment, I assume, in Q4, and then we'll have anniversaried that.

Moving to SG&A.

Our SG&A percentage in Q3 year-over-year was lower or better by 32 basis points on a reported basis and, ex gas inflation, better or lower by 16 basis points, coming in at 9.98% of sales this year reported compared to 10.30% last year.

Like with gross margin, I'll ask you to take the 2 columns.

First one, as reported Q3 '18, and the second column would be excluding the impact of gas inflation for Q3 '18.

First one, operations, better or plus 26 basis points on a reported basis and plus 13 basis points or lower ex gas; central, minus one and minus 3; stock compensation, plus 2 and plus 1; other, plus 5 and plus 5. So if you add those 2 columns up, the first column would add up to the reported 32 basis point improvement in SG&A.

And again, ex gas inflation, it would be plus 16 basis points.

Basically, it's all about sales.

Core operations, lower, better, strong top line sales led to improvement in payroll, benefits and other variable and fixed costs generally speaking.

Central expense was higher year-over-year, as you can see on the little chart we just made, by 1 basis point on a reported basis and 3 without gas, primarily related to our continuing IT efforts.

Stock compensation, again, lower by a little.

Again, strong sales helped that.

Other, better by 5. That really is nothing this year.

Last year, we pointed out that there were 2 nonrecurring legal items in Q3 last year totaling $14 million or 5 basis points.

And we didn't have any detriment related to that this year.

Next on the income statement is preopening.

Preopening this year came in at $8 million, lower by $7 million from last year's $15 million.

This year in Q3, as I mentioned, we had 2 openings, one in Mexico and one in Korea.

Last year, we had 3 openings, one each in the U.S., Canada and Mexico.

Last year -- and the number was -- we also had some additional spend in Q3 relating to the fourth quarter openings last year in France and Iceland.

Upcoming in Q4 this year, we had 15 total openings, 13 net new units plus 2 relocations.

That compares to 12 gross and net locations last year in the quarter.

All told, reporting operating income in Q3 came in at $1,067,000,000 or up $99 million or 10% higher than -- year-over-year than last year's $968 million.

Below the operating income line, reported interest expense came in at $16 million, higher year-over-year at $37 million this year.

That compares to $21 million a year ago.

That's mostly a result of last May's $3.8 billion debt offering that we did in conjunction with our special dividend.

Interest income and other was higher or better year-over-year by $23 million in the quarter.

Actual interest income and most of the interest income for the quarter is better or higher by $6 million.

We also benefited year-over-year comparison by various FX items to the tune of $17 million.

That's the number that fluctuates both ways.

Generally speaking, it's in the 0 to $15 million range.

For this one, it was plus $17 million.

Overall, pretax income was higher by 11% or $106 million in the quarter coming in at $1,071,000,000 compared to last year's $965 million.

In terms of income taxes, our tax rate in the third quarter of this year came in at 28.8% compared to last year's reported tax rate of 26.8%.

Now last year, of course, on a normalized basis -- because I mentioned that we had an $82 million tax benefit related to the perpetual dividend, last year's normalized rate was 35.3%.

For fiscal '19, based on our current estimates, which, of course, are always subject to change, we anticipate our effective total company tax rate for the entire year, with the change in U.S. tax rates benefiting the entire year, the tax rate to be approximately 28% as we'll have the full fiscal year under the new U.S. federal rates.

Before I leave the subject of tax law changes, I'll make a couple of comments on that in terms of what our plans are vis-à-vis the savings.

As I had mentioned last quarter-end, we don't -- really don't expect any major changes to our capital allocation plans.

We generate good cash and pretty much do the things that we want to do in terms of expansion and in terms of regular dividend and in terms of stock buybacks as well.

As mentioned on last year's earnings call, we would -- where I said we would use some of the income tax savings in the U.S. to benefit our U.S. employees and that there'll be increases in their hourly wage rates, effective June 11, our U.S. starting wages will increase from $13 and $13.50 an hour to $14 and $14.50 an hour, so $1 an hour for entry level, with all other hourly warehouse employees receiving hourly increase of anywhere from $0.25 to $0.50 per hour.

The estimated annualized cost of these increases that will impact about 130-plus thousand employees in the United States will be $110 million to $120 million pretax, with Q4 being impacted by a little more than $25 million pretax.

We have been investing, second, next, we have been investing, and we'll continue to invest some of the savings to drive our business.

And this will certainly include investing in price as well as other activities.

Some of the tax savings will -- needless to say, some of the tax savings this way will fall to the bottom line indirectly by investing in driving value and sales.

And then some of the tax savings will go straight to the bottom line.

A few other items of note.

In terms of expansion, I mentioned we have 15 total openings scheduled for the upcoming 16-week fiscal fourth quarter, which include 2 relos, so we'll have 13 net openings.

That would put us at 21 net new openings for the fiscal year, 25 total, less 4 relos.

In Q1, we opened 7 locations, net of 5. In Q2, we opened 1. In Q3 as, I mentioned, we opened 2. And for all of fiscal '18 again, the 21 net new.

Of those 21 net new, a little under 2/3 of them will be in the U.S. Additionally, for fiscal '18, we'll relocate the 4. All of those in the U.S., and those are relocated to better and larger facilities.

As of Q3-end, total warehouse square footage stood at 108 million square feet.

In terms of stock buybacks, in Q3, $55 million was expended.

So Q3 year-to-date for the 36 weeks, we repurchased $233 million worth of stock or 1.337 million shares at an average price of $174.30 per share.

In terms of our e-commerce activities.

E-commerce, we currently operate e-commerce sites in the U.S., Canada, U.K., Mexico, Korea and Taiwan.

Total e-commerce sales for the third quarter were up 37% year-over-year.

And again, that was Q3 of 36.8%; year-to-date, 36.1%.

And for the 4 weeks of April, which we have previously reported, it was up 43.1%.

We continue improving and slightly expanding our offerings.

We've been helped, of course, by improved member service and better search and checkout and returns processes.

But first and foremost, we're delivering greater value to members and more people are actually looking at it, opening their e-mails and transacting.

This stuff works, and we'll continue to see -- we believe to see some good results there.

In the third quarter, our site traffic conversion rates and orders were continuing to improve year-over-year.

And again, we would expect that to continue at least in the near term.

Online grocery, both our dry grocery 2-day delivery and our same-day fresh delivery through Instacart, both of these were rolled out last October and continue to grow nicely.

Still a small percentage of the total company but growing, and we're seeing good things from it both in existing markets plus, in some cases, in markets where an existing Costco might be a little further away.

We continue to improve the online merchandise and services offerings with hot buys in Buyer's Picks with buy online and pick-up in the store; some limited big-ticket items like jewelry, tablets and laptops and, most recently, handbags.

One other additional comment on that is we're seeing that plus or minus -- about half, a little under and a little over, of those people will come in and shop as well before they pick up the item.

Another example of how we're seeing some of the stuff benefit us, as I've given you examples in the past, the most recent probably good example is household furniture.

Historically, this was -- it was only in the warehouse and, generally, for 8 or so weeks per year.

Now it's online all 52 weeks, and we're seeing good increases in sales there, incremental sales similar to our success in selling appliances that I've discussed in the past.

Overall, all these efforts are positively impacting our business, both online and in warehouse, and are helping our sales momentum and increasing member awareness of our digital presence at the same time.

We're seeing good traffic increases and, hopefully, we can continue these types of activities.

Overall, omnichannel is certainly working to enhance and increase our business.

One last example, we now have in 220 of our roughly 520 U.S. locations what I'll call e-commerce product showcases and online ordering capabilities.

All U.S. locations will have something in -- in fact, in place by this year's upcoming fall holiday season.

In terms of upcoming releases, we will announce our May sales results for the 4 weeks ending June 3 next year on June 6, and our fiscal '18 fourth quarter scheduled earnings release date for the 16-week fourth quarter ending September 2. This will be after the market closes on Thursday, October 4, with the earnings call that afternoon at 2:00 p.m.

Pacific Time.

I do want to point out that last year, fiscal fourth quarter was 17 weeks.

This year, it's 16 weeks.

So keep that in mind as you plan your numbers.

As a reminder, last year's fourth quarter was 17 weeks, as I mentioned.

With that, I'll open it up for Q&A.

And Josh, I'll turn it back over to you for that.

(Operator Instructions) Your first question comes from Simeon Gutman with Morgan Stanley.

My first question is on the gross margin.

The core-on-core has been roughly flattish to down a little bit low single digits.

I think you said down 4. I know you don't guide to it, but I wanted to ask if that's roughly the ballpark that we should think about.

Or is that a consequence of just how the margins of the business and the sales play out?

Starting with -- the first part of that question was I know you don't want to comment on it.

Look, at the end of the day, there's lots of moving parts to it.

All I can tell you is we've been fortunate to have a few different buckets of monies to be able to do a lot of things starting with the credit card transition, continuing with membership fee increase, continuing with the income tax and even add a little to that some of the Sam's closings, all these things we're able to do.

We feel very good about what we're doing.

And the other thing is, as you've all heard over the years, when things are -- when costs are going up, we want to be the last to go up.

And when prices are going down, the costs are going down, we want to be the first to go down.

When you look at some of the things that have happened, whether it's inflationary freight cost, those things generally are now in there, but we pride ourselves on holding off on some of those things.

So I can't really tell you where we'll go with this other than we feel good about what we're doing.

Keep in mind also that some of this has to do with not just core-on-core but some of the penetration, sales penetration of things like low margin gas.

We feel really good about where we are pricing-wise and where -- what we're doing with it in driving our business.

And the $110 million to $120 million of pretax wage investments, do you think about investment in price any differently or the 2 are unrelated in the way you manage the business?

Well, the 2 -- and keep in mind, given that the income tax changes were unique and don't happen every day, we certainly felt the right thing to do was to allow it certainly to help our employees as well as drive our business and improve it, the member value.

I look at how we've done it.

We feel pretty good about what we've done and where we're going with it.

And we don't -- but we don't look at it, let's take 1/3, 1/3 and 1/3, it's just how we're doing it.

And we want to -- we recognize that there's a lot of things to be able to do with it.

And if you go back years ago, when I look at my comment on some are going to fall to the bottom line, we view that as part of the process here, too.

Your next question comes from Michael Lasser with UBS.

So when you look at the e-comm transactions, how are those impacting your profitability, both just the e-commerce transaction itself and then those that are being picked up in store?

Could you say that half of those include shops and visits to the warehouse as well?

Well, first of all, the buy online and shop in stores is some limited high-ticket, small-sized items where, in many cases, we find members who would love to buy it but didn't want to -- couldn't have it delivered to where they work and didn't want to leave it on their doorstep.

And what we found is, which we were a little surprised by, is when they do come in, a lot of them come in and shop first and then pick it up and shopped quite a bit, frankly.

It's a small piece of the business.

We're not looking to have people come and have to refrigerate stuff while -- order online, and then we got to have refrigerators and freezers filled waiting for them to come.

These are limited areas where we think we can do -- drive business and provide that member service.

And is it having an impact in your margin structure at this point?

No, not really.

I mean keep in mind, Mike, a lot of companies out there were doing a lot of things.

If you think about what we're doing with the 2 delivery things.

There's some inefficiencies of starting it up, ramping it up and buying equipment for box-making, whatever else.

And we are not really talking about all these little things but there are things there.

But know, when we're doing some of the things, hot buys, some of that is our vendors and some of that is some of the monies that we have to be able to use.

As I've mentioned before, I think that for every dollar that we have to use, we feel we get kind of a bigger bang for that buck than others simply because of limited targeted items.

And my follow-up question is this year's third quarter ended a week later into May and began a week later in February, so you probably got a higher volume week and gave up a lower volume week.

Does that calendar shift effect have any impact in your sales and profitability in the third quarter?

Not for the quarter, no.

Your next question comes from Chuck Grom with Gordon Haskett.

On the digital front, any learnings so far from CostcoGrocery?

In particular, are you seeing a new shopper or an existing shop that's making incremental purchase?

And then, separately, can you remind us of the SKU count online today and where you see it going forward?

On the last question, the SKU count, I think it's approaching 10,000.

We don't see it getting a heck of a lot bigger.

But keep in mind, over the last couple of years, we've added lots of, what I'll call, velocity items, food and sundries items, health and beauty aid items, some apparel items, which is getting people to open their e-mails, if you will, and think about coming back more often to take a look without us having to remind them.

And so all those things, I think, we'll continue to see.

And I'm sorry, the first part of the question?

Just on the central shoppers?

And so what we're seeing -- I do -- it's really still too early to tell.

We clearly are getting some customers -- in the case of the 2-day, which is dry and covers the entire Continental United States, we are picking up some members that we never had before because we were 50 miles and 100 miles away from the nearest physical Costco.

And we're really just -- I talked, the last time, in the last quarter, about there's really been very limited marketing of this as we're just getting it up and running and rolling it out.

We -- and it's too early to tell what impact, if any, it has in terms of same-day grocery.

Historically, we saw, in some early cases, back in like the Bay Area, which didn't offer fresh, by the way, you saw perhaps somebody, an existing member, shop a few less times that year or shop several times online, in some cases, as fill-ins, and they're still coming in.

And the sum of the 2 is still better, a little better, than it was before.

I think we'll have to see.

As you might expect, we're going to figure out how to do it so it's not -- it benefits us in some ways that -- I think we're fortunate that some traditional retailers don't have that same benefit.

Okay.

And then just on -- it's been a while since you've updated us on your long-term club goals, just curious where you see saturation.

Where do you think you could see the club base looking out maybe 5 to 10 years?

Well, again, we'll have to see.

I mean 21 this year is probably a few less than what we had thought we're going to be able to get done.

Some of that is a couple of delays, some of it's international which takes a little longer.

Some of it is (inaudible), particularly in some of the newer countries.

We want to grow people there.

And as you know, if you look back at Japan, I think we got to 6 over in the first 5 years.

And fast forward several years, we're in the mid- to high 20s.

We got to 3 over 2.5 years or 3 years, 2.5-plus years in Australia.

So I think you'll see those numbers go up.

If I had to guess and it's an honest educated guess, somewhere in the mid-20s over the next 5 years, probably a couple of years in business centers, 2 to 3, who knows?

And in terms of U.S., on a base of [5.20], today in the U.S., it's somewhere in the 15-ish range for the next few years.

And logic would say maybe it comes down a little bit, maybe it's helped a little by business centers, we'll have to see.

We still -- we keep finding and surprising ourselves as it relates to the ability to put another unit in.

And even getting somebody to cut their drive time, if you will, to the nearest Costco from 30 to 15 minutes can be very meaningful as we've seen in places like San Jose and Redmond and other places, so we'll see.

Great.

Then my last question just on the grosses.

You said the core-on-core, down 4. Anything unusual in the quarter?

Was there any mix pressure or any inventory issues given some of the weather?

And it sounds like most of the price investments have been proactive.

Just wondering if you guys have done a deeper dive look into elasticity on some of those price investments.

Elasticity is not a word we will ever use or think about.

We -- we're merchants, and we're constantly driving value.

I think you've heard us say before, this is all about us -- who's our toughest competitor?

It's us.

And I think there's a little sales penetration detriment in the number that was part of that.

But again, there's lots of moving parts and pieces not just the core-on-core but other ancillary businesses.

And we -- again, I got to tell you, we feel pretty good about our pricing ability and our ability to drive the bottom line through good sales and the like.

Your next question comes from John Heinbockel with Guggenheim Securities.

So Richard, a couple of things, maybe along the lines of convenience.

When you think about bulk that's inside the box, there's been much thought about doing more items and maybe bulkier items that take up space, kind of get them out of the cart, pick them up on your way out.

And if so, would that -- do you guys think that would lead to more items per shopping trip if people were kind of buying paper and beverage not in the box but on the way out or in the lot?

The short answer is no.

I mean, will there be some other things added to the buy online and pick up in store?

I'm sure there'll be a few other things, but it's not like we're saying, hey, what else can we do there.

We're doing a little of that because the few things that we've done have worked.

But also, it takes something as simple as bulk paper goods and bulk water.

It's kind of like where is that located in the warehouse?

It's in the back corner.

What does it make you do?

It makes you go through the whole warehouse.

It's not unlike having the fresh foods at a supermarket in the back, as we do as well.

So I think there's lots of different ways you can skin that cat, and I don't see us doing a lot of that.

I'm sure it will change and increase somewhat over time.

Okay.

And then, secondly, you think about -- I think, in the past, maybe the topic of smaller box size comes up, but you've always liked the economics of the large club.

So if you think about maybe a box that's half as big, more convenient, playing in the what's for dinner tonight space to a greater degree, does it ever become an attractive option for you or not just because the economics don't match the big box?

Well, never say never, but it's not on the plate right now.

I mean it's not even on the second page of the plate.

So we feel we've got plenty going on in terms of regular-sized boxes and big-sized boxes, in terms of business centers, in terms of some vertical things that we're doing like in the fresh and the protein area, some more things going on in the private label and with delivery.

I mean we've got a lot of good -- in our view, good things going on and pretty happy that there's plenty of regular-sized box opportunities.

Your next question comes from the line of Karen Short with Barclays.

A couple of questions.

I just want to clarify, I guess, in terms of the tax dollars, you did say dollars would go to investing in price.

So I guess, the first question I have is, and asking about the gross margin a little differently, was that something that maybe did tick up a little bit this quarter because you did mention fresh margins were down this quarter, and I think they were up in the prior quarter?

Or should we kind of expect to see a little bit more pressure on the core gross margin going forward as you do take those tax dollars and invest?

Look, listen, I can't tell you where it'll go in the future.

What I can tell you is that it's not just the tax dollars, it's the credit card, it's the fee increase.

It's -- there's a lot of things going on out there.

And have we been able, as freight costs have skyrocketed in the last year for everybody, to hold that a little bit?

Absolutely.

Ultimately, we've got to catch up on that.

And we feel comfortable holding it and catching it up at some point, as we have.

And so I think we feel -- all I can tell you is we feel quite comfortable as to what we're doing and how we're doing it, and that we feel very comfortable that we are our own toughest competitor and we control those valves a little bit at this point.

We don't know what's going to happen in the future, but I don't think that's changing very quickly as we come up with new things to do.

Okay.

And so I guess, I was also wondering, I mean, obviously, you've had unbelievably strong sales now, going on almost a year.

But more recently, I guess, what I'm wondering is do you think that the strength in sales is just a function of stronger -- not that you weren't executing before but stronger execution and price points?

Or do you think there is some benefit that you're seeing from a consumer perspective from tax dollars or tax reform dollars in their pockets?

Do you have any color on that?

The only color we can give as it relates to tax reform dollars is what we keep -- what you and I and others hear and read in the paper and hear from some economists.

Certainly, we've heard from some of our business partners, whether it's the credit card issuers and networks or other types of third parties, and it seems like there's a little there, but it's hard to really dictate that.

We know that pricing -- investing in price works, and we know that it tends to work generally very well, such that even in working with suppliers, in some cases, we'll partner with them to get to that lower price point and, as it drives more volume, not have to take on any of that ourselves.

So there's lots of different ways to do this.

But I think that one of the things that we've commented on, of course, is also some of the low-hanging fruit and benefits that we have because of things we hadn't done historically.

You look at the examples of appliances and look at the examples of furniture, it used to be if you wanted to buy a household furniture item, if you don't have a truck, you'll get one or call your friend because we don't deliver.

That's changed anyway.

But even so, we're still doing very well in store for those 8 or 10 weeks of this example but, all of a sudden, we've got 40-plus more weeks where we're doing truly incremental business in the hundreds and millions of dollars and growing.

Those are the things that I think that make us additionally -- it's not just price.

Price is in our -- price is at the top of our list.

But beyond that, there's other things that I think are benefiting us, certainly, fresh foods and what we've done there in terms of the quality and the consistency and coming up with new items.

Great, okay.

And then last question from me, just inflation at core and at retail this quarter.

I think on the food and sundries side, it's picked up a little bit.

And again -- and talking to the buyers, a big chunk of that has to do with freight.

And I think one of the analyst reports out there, and the title was called, ["Freightening Changes to Cost."] But at the end of the day, it rains on all of us.

And I think on the food and sundries side, it was up in the 2% to 3% range and probably 2/3 of ex -- it was more related to freight-related costs.

And that's at cost or at retail or both?

That's at cost.

Needless to say, if there's 40 -- 35%, 40% of your business, 200 or more cost basis and core-on-core is down 4, ultimately, you got to pass that on.

And ultimately, we have some additional monies to be able to use towards that to be more competitive, so...

Your next question comes from Peter Benedict with Baird.

The move on wages, is that -- does that effectively pull forward what you might have done or was likely to happen, I guess, next spring when I think you guys are due for your next employment agreement?

If you look back over many, many years, we have a 3-year employee agreement.

The last one was March of '16.

So -- and the one important thing in there, of course, is where do our top of scale hourly employees move each March of '17, '18 and '19 that's prescribed in that March '16 new employee agreement.

And so -- and that's prescribed.

And historically, we've always done something at top of scale.

I don't see that changing.

We have, once or twice, moved the bottom of the scale up.

We'll see where tomorrow brings.

This probably won't be the last time particularly, and so we'll have to see.

But we -- I don't -- we really looked at it independently of that.

Ultimately, if you're going to do something and you're doing something now, it doesn't mean you're not going to do something like on top of that next time.

And again, I'm not trying to be coy.

Expect whatever most people are going to do, we're going to do a little more around employee wages.

No, that makes sense.

A quick question on the competitive tone in the market.

I mean, you just got done saying earlier that you're always your toughest competitor.

But maybe can you comment on what you're seeing as you guys are looking at some of your competitors or the big club or non-club?

With all these tax dollars moving around, are you noticing them being sharper in any areas?

I honestly believe while there's been some -- I think all companies, not just in retail, I'm sure many companies feel that, one, there's a desire to use some of this to help employees, to share that wealth, if you will, to drive their business.

I don't think it's been life-changing for any company in the sense that -- one of the questions we were asked right after the announcement that we said that on an annualized basis next year, if you do simple math, roughly 7 percentage points of our effective rate from the 35-ish to the 28-ish on -- you take the pretax dollars, it's some low $300 million-ish aftertax benefit.

And somebody asked the question, well, does that mean you might do a special dividend.

Well, our special dividends, the 3 we've ever done are the $2 billion to $3 billion cost range.

So this really doesn't change anything there.

We're already generating cash flow to do other things, and maybe we're in the higher quartile than we've been able to position financially.

But I think overall, I think because my gut and from what I've read, does it help the consumer?

Sure, it helps the consumer.

Some of the consumers as employees are benefiting from it, and all that's good.

Certainly, competition in general is benefiting consumers in terms of pricing.

We feel fortunate that, that pricing moat continues to widen to our benefit.

My last question is just around the Executive Membership numbers.

Those were growing, call it, high single digits in the past, even last year.

This year, they're starting to grow more like mid-single, some deceleration there.

Can you just talk about maybe the opportunity to continue to grow Executive Membership here in the U.S.?

And then thoughts on maybe when you could be adding that to some newer markets internationally?

Sure.

Well, in terms of total membership, we feel again, pretty good about -- it slightly depends on when you're opening and where you're opening.

In the last couple of quarters, we have -- we've opened 3 units, I think, in the last 2 quarters.

We got a bunch coming.

It also depends where your opening.

As you know, and I've given the examples of where we've done an infill in a very strong market like San Jose area or Redmond, Washington area, near Seattle.

We might average in 3 existing locations, 60,000 or 65,000 members per building, add only 3,000 to 5,000 new members in that new building but add, net of cannibalization, $100 million to $120 million in annual sales in the first new year, first 12 months of that new opening.

And so that is all about being close to your customer and driving more business.

I don't -- what was the first part of the question again?

Well, just on thinking how much new opportunity and then internationally.

I'm sorry.

The other thing is, as we've said and you're aware of, in international, we tend to do outsized number of sign-ups.

Again, there hasn't been as many right now.

Lastly, I mean, we've done, I think, in the past 3 or 4 many social or Groupon type activities.

And they worked quite well, so well that we don't want everybody to get used to it, so we don't do it that often.

We actually just started one yesterday for a 2-week period.

And so that will help a little bit this quarter as will opening 13 or whatever number of new units, as will opening a couple more international ones.

And so all those things, we -- when I -- when we look at -- one of the questions we've been asked over the last couple of quarters was membership, new membership growth has slowed a little bit.

When you look at existing warehouses net of cannibalization and take out all the cannibalizing -- the units that were new and the ones that those new ones cannibalize in those markets, we're still seeing a number in terms of member growth per warehouse in the high 3s, mid- to high 3s, I believe, 3.7, 3.8.

I think, it was 4 6 months ago.

So that certainly gives us comfort, and we feel it should give you.

In terms of Executive, I think on a weekly basis, forever it seemed like it was like 20,000 a week, 22,000 a week.

I think there are a couple of quarters where it was in the mid-teens or maybe in the low double digits.

So it's come back from that to 19,000.

In terms of -- some of that is, ultimately, you do saturate it a little bit.

But part of it also in terms of new countries, we currently offer in U.S., Canada, U.K. and Mexico.

And I think if you just looked at simply how many units we have in each of those markets, certainly, Mexico and U.S. is a nonissue.

We're in the low to mid-30s in the U.K. and in the low to mid-30s in Mexico.

And part of that is a unique kind of a critical base because of the services that you offer that also it's not just the 2% Reward, it's the services you offer for it.

I would guess that you'll see it in other countries that will help a little bit in terms of driving that.

But probably more of it will come from us driving the Executive -- the value of it.

We've seen some improvement when people realize that, hey, if I sign up for the Executive Member card and I sign up for the co-brand Citi Visa card, that's not only the 2% from Costco but the 2% from -- on the average of whatever it is from Citi Visa.

And if I buy a TV that way, it's a 4-year warranty, not a 2-year warranty.

So all those things get people to card business.

I mean, last year, we represented over 0.5 million new car sales.

And if you are an Executive Member, in some of those marketing items, you got a cash card that was a few hundred dollars more than if you were a Gold Star member.

You can rest assure that there were people that converted for that reason and once they did, they start to look at the other benefits of it.

So all those things help.

We do a better job when you sign up and getting you to sign up as an Executive as best we can.

Your next question comes from Kate McShane with Citi.

I know this has been asked a couple of times, but I just want to ask it maybe in a little bit different way.

But with the level of cash that is coming from the membership increases and in the tax reform, do you think your price investment is going to result in greater gap historically given the amount that you've been able to invest?

I think they have.

I mean, on a general picture, if you look at just the traditional grocery industry, there's more competition generally out there.

And have others come down in certain pricing?

I think a little.

Have we come down more?

Yes.

This is an old statistic, but I remember looking at traditional grocery markups, and recognizing there's been some product additions that are higher-margin items, specialty items, in the supermarket industry over time.

But over 20 years, this goes back a few years ago, so 5 years ago and 25 years ago or whatever, it seemed like, generally speaking, the grocery industry was going from markups that had been in the very high teens or low 20s to the mid- and high 20s or -- and the big home improvement companies had gone from the high 20s to the mid-30s.

And what has our gross margin and our markup has done?

It's gone up from 10 to 12.

And in fact, it's gone up from 10 to 12 despite the fact that -- and some of that is -- not despite the fact -- some of that is some higher-margin businesses like travel, which has very little cost of sales or some of the ancillary businesses like pharmacy and optical that have very little cost of sales, so relatively speaking.

And higher cost of sales but higher markup, higher markup to cover the cost of pharmacists and optometrists and what have you.

So I think, when all's said and done, in our view, just looking at the pricing gap, we've gotten stronger.

And I think we get a little more kick out of a dollar used in certain ways than perhaps others that we're fortunate in that regard.

Okay, great.

And my second question was just on the international business.

I'm wondering if you could remind us of the time line or your expectation for profitability for France, the newer stores in France and Spain to be profitable?

Yes.

But I think the store level in Spain were there -- were pretty much there or very close.

And mind you, we charge -- we own many of these locations around the world.

We own around 80% of our locations.

We charge it a higher than current market rent factor internally just to have everything and look at all warehouses on the same schedule.

And I'm talking about after that imputed rent factor as well.

But on a store contribution level, yes.

France is brand new.

Iceland is a unique -- brand new in the last couple of years.

Iceland is unique because it's just been a great market for us, so it's done better than planned.

The others are pretty much have been planned.

We -- if I go back again a number of years ago, our original budget in Japan just 20 years ago was to open 5 units in 5 years and be breakeven or start profitability towards the end of year 5 or early 6. We ended up opening 6, and I think we were profitable near the end of -- right before the end of year 4. These are rough numbers.

But at the end of the day, that includes the cost of a central operation that's not going to grow -- as you grow from 2 units to 10 units, the market is going to grow a lot less than fivefold and the preopening cost of a new unit and then the fact that you're also building your business.

When you start with a slow-volume building as expected in some new countries, not all new countries, you're pricing your fresh foods as if you're doing a lot more business and you know you're going to have, in some cases, very low or negative gross margins sometimes on those.

So I think the time line, we're patient.

We're also not going into any market, trying to get 10 or 20 openings in 1 year or 2 years.

And so I think we've done a decent job of balancing that process.

Your next question comes from Dan Binder with Jefferies.

I have a couple of questions.

First was on -- can you hear me?

Yes, I can hear you.

Your next question comes from Chuck Cerankosky from Northcoast Research.

Josh?

Can you hear me, Josh?

Josh?

Richard, I can hear you.

This is Chuck Cerankosky.

Okay.

Your next question comes from Laura Champine from Loop Capital.

Somebody call him.

Hold on, we're having a problem with the third-party here.

(technical difficulty)

Sir, I can hear you now.

Josh, why don't we go back.

There are a few people that had -- Chuck Cerankosky and Dan.

I think Dan Binder was the first one that did not -- Dan Binder is the first one that you couldn't hear but we could hear.

So can we go back?

Sir, we just have to get them to requeue up, and I'll promote them again.

Okay, thank you.

So go ahead.

I'm sorry, this is Kelly Bania from BMO Capital.

Just wanted to first ask on -- quickly on gas.

Did you clarify the impact from just the mix of higher gas prices versus the actual gas margins?

We didn't.

Margins -- in terms of dollars, margins were down, and we made it up in volume.

And so profitability was pretty even year-over-year.

Got it, okay.

And then just also wanted to go back to the comments on the food and sundries inflation.

The cost inflation, I guess, that's freight-driven.

Are you seeing any acceleration in that?

Are you not quite passing all of that along?

Do you see your competitors passing along?

Do you see that kind of accelerating as more of these vendors that maybe are feeling it are starting to push that through?

Well, I think a general comment would be is whenever input cost, input item is inflationary, we're going to hold off longer than others.

But ultimately, you've got to do it.

And we, like any other retailer, will push back with a vendor and try to figure out smarter ways to do things.

And -- but overall, it's a small delay.

Don't -- we're noble, but we're not crazy.

I guess, do you think -- I mean do you think this could result in just some broader food inflation over the next several quarters?

That was -- just we haven't seen in a long time.

I think you'll see that generally.

I mean, if costs are up 2% to 3%, input cost on the food and sundries side, a big chunk of that is freight-related.

Ultimately, that's going to compel.

Now some of that will also compel to private label, in some cases.

In our case, we generally see this as a positive because we can be a little tougher on pricing in terms of being -- and being more competitive.

Got it.

And then just one more on the online grocery, the nonperishables offering.

Hold on.

Can I really interrupt you for one second.

Josh?

We had a couple of calls externally here, people in our office, that are -- they cannot hear the call all of a sudden.

So while we continue here, can you check and see what's going on there?

Certainly.

Not a problem, I'll look into that for you.

Okay, thank you.

Go ahead, I'm sorry.

Okay.

I'll ask one more maybe while others are getting back in queue.

Just on the nonperishables offering, how do you feel about the process of fulfilling those and scaling that over time?

Do you think you need any more -- any sort of automation technology to fulfill those orders and make that profitable longer term?

Or are you happy with the way that, that process is working?

Well, first of all, the stuff is profitable.

It's small, it's growing nicely.

But it's -- we have capacity within our business centers, which are already set up to do buy online and actually deliver.

This way, it's just you had to buy some box-making machinery.

And the good news for us is that we feel that, a, that yes, ultimately, God willing, we'll have to build new facilities or additional facilities for this.

Just like when we started, we had one e-commerce fulfillment facility in Mira Loma that covered the whole country years ago, and so there's a tradeoff.

But I think that, a, we feel very good about how we're doing it that we can be profitable almost from the start, other than things that we're doing to invest and driving the business, marketing it and things.

And it will be fine.

Again, I think we're fortunate in that regard with so few items, it's a lot easier to do these things.

Your next question comes from Dan Binder with Jefferies.

It's Dan Binder.

I had 2 questions.

First was on the benefit that you're seeing in the clubs where you've had competitor closings.

Obviously, there were a lot.

So I'm just curious what you're seeing in terms of the comps benefit and the membership benefit.

And then my second question was around price investment, a little bit different angle.

Just trying to understand a more about couponing versus everyday low price.

I think it was probably a year or so, maybe a little over a year ago where you had backed off, I think, on the vendor item a little bit and that hurt the comps and then you kind of brought it back.

I'm just curious, as you think about price investment going forward, will it be more through the vendor mailer or more through EDLP?

Well, first of all, if we go back -- just to clarify one thing, if we go back to -- it was Q2 of last year when it was a little disappointing, and a lot of it had to do with the stuff that we did to change the MVM and take some items and test with vendors everyday low pricing or in some greater values but still be at the table in the MVM, maybe a few hot picks as well.

More of the offsets of that, that we didn't anticipate from a negative standpoint was fewer MVM days.

So if you went down, I think it was the 4-week reporting month of February of '17, 28 days, we had 8 less MVM days.

The MVM items themselves did as expected, more lift more value to the member and less gross margin per item but more gross margins dollars to us.

So that worked nice.

But by having some of those significantly fewer days of having something that is a promotional thing that gets members in the door, and we changed that.

It took us too much to change that.

And since then, it's been fine.

And of course, it's gotten better than that since then.

I don't think there's any magic.

If there were an exact formula that we knew, we wouldn't tell anybody.

But at the end of the day, we keep trying different things with different vendors and see what works and doesn't.

I think we have kind of settled on a mix that includes all of the above, and we'll keep then trying to figure out how to drive that in different ways.

So again, I don't see there's a big shift.

The shift was over a couple of years, perhaps leading up to February of '18 or in the late calendar '16, it was -- over 20 years, some of the stuff gets -- some of the sales lifts of an item gets less, people are waiting for that regular thing every -- twice a year for 3 weeks, waiting and so, a, the values have to be greater to drive more lift and, b, you got to shake it up a little bit.

And I think it's -- the good news is work with vendors, we're not just forcing vendors to try something, try one thing versus another.

We're working with our vendors.

Hopefully, that do well for both of us and to even partner with them when there's a little indigestion on how much additional savings until we can show them the type of unit lift that will generate.

And sometimes, that works, and sometimes, it doesn't.

And then as regard to the benefit you're seeing in membership in comps for neighboring clubs where there was a competitor closing?

A little bit.

I think -- our estimate was -- and when people ask, with the Sam's Club closing, how that impacted us.

First of all, some of those closings were a couple or 3 Sam's closing in the existing Sam's market.

So they were just adding a lot of those sales to other units they already had.

Our view was we'd get 10% to 20% of it, and we have of what we guess their sales would be.

Some of it is not our member, some of it's -- we're too far away from that member, maybe that was on the other -- 10 miles from the other side of the existing Sam's Club, and we're 10 miles the other way, so now it's 20 miles, it's just too far.

And in some cases, the business went to another existing Sam's in the market.

We definitely saw some benefit in membership, the number of members.

Again, not huge, but certainly helps and...

Your next question comes from Chuck Cerankosky with Northcoast Research.

Just want a little update on the food manufacturing projects you have underway, the construction where is that at, and then I want to ask another question about the online.

I'm sorry.

Can you ask that first question again?

Sure.

What -- you've got a couple of food plants under construction.

Where are we at on those and the expected opening dates?

Well, the bakery commissary in Canada is open and running.

Needless to say, it will take a year-plus to get it to increase capacity and everything.

But that's going as planned.

Our chicken plant in Nebraska is 1.5 years away, a year-plus, it's under construction.

But it's -- and it's on plan is a relative term.

We know it's going to take 1 year-plus to get there, but it's doing fine.

Anything else, guys?

We opened outside of Chicago in Morris, Illinois, a second meat plant, basically, a sister plant, if you will, of the one in Tracy, California that we've had forever.

And the good news there is the Tracy one, along with the added capacity at the hot dog plant at the same property location, we're at capacity basically, and we've been able to push that over.

Okay.

And you mentioned before you got 10,000 SKUs online.

Is that the count all the time?

And then when you look at how you remerchandise the online assortment over the course of the year, how often are you changing that?

It seems like the e-mail and promotional activities picked up.

But what is the cadence to refresh the mix and assortment that you have?

Well, look, I think it's -- a, it's not unlike in warehouse.

The exception is, of course, online, we want to be a little resistant, just climbing because virtual and it's easy because it still adds cost.

We've added velocity items.

We've added sundries and some shelf-stable items to the delivery.

That's another avenue as well.

I think it'll ebb and flow.

Don't expect any great change to what you're seeing now other than a constant evolution of that.

The other thing is, in some cases, there's products and vendors that will sell us online that weren't prepared to sell us certain things in store.

And sometimes, you'll have to be a member to get to the price online at Costco, which is fine.

Our member understands that, and they're going to go see it.

I'm going to take 2 more questions.

Our next question comes from Laura Champine from Loop Capital.

It's on the private label business.

I mean, obviously, a lot of clubs have been streamlining the number of brands they offer.

Kirkland is used almost throughout Costco, but there are some other brands like the Charisma and some of the textiles.

Why not go for Kirkland across the board?

And do you have goals on how much of your sales you'd like to drive through that private label brand?

Unfortunately, our head merchant is traveling to an opening today in California -- or is that an opening today in California?

I'm not sure -- in my mind, Kirkland Signature is it.

To the extent there's a bland called Charisma -- but it's not our brand -- I don't -- in a way it's not our brand.

Maybe, it's a brand that's not as well noticed as others, but that's not our brand.

Kirkland Signature is the only brand you're going to see at Costco.

As it relates to how much, gas is under the Kirkland Signature label, but excluding that, which is 10-plus percent of our sales, it's about 25% -- 24-plus percent of our sales.

Where we want it to go, I don't know where we want it to go.

Will it increase?

Yes.

Years ago, I said, well, you'll never see it on this, and then now it's on that.

But at the end of the day, we still want brands, and we still covet it, and our members certainly value brand as well and, in our view, it enhances our brand value.

But yes, there's the 24%, keep increasing to the 25% and 26% and 27%, I'm sure it will, but I can't tell you how long it will take.

Your last question comes from Brian Nagel with Oppenheimer.

Richard, it's David Bellinger on.

Just a couple of quick questions.

Can you talk about regional performance in the quarter?

Any weather impact on traffic that you can call out specifically?

And was there any improvement towards the end of the quarter?

There weren't a lot of weather-related comments or the budget being -- hold on, we're just looking real quick.

It really wasn't that impactful to us.

And I'll just follow up on margins as well.

It seems that the major drag came from the higher gas prices this quarter.

But can you help us frame what percentage of sales gas represented this quarter?

I know you just mentioned it was, on an annual basis, it's like above 10%.

But if you don't want to get too specific, can you just give us some indication on how that's changed over the past few quarters and how that impacted here in Q3?

Yes.

We really don't go into that level of detail.

Generally speaking, when gas prices go up, we make a little less margin.

When they go down, we make more margin.

Happy that they went down yesterday a little bit.

But at the end of the day, it's been a good business for us in its own right as well as driving business into our warehouses.

It's about -- by the way, it's about 10% to 12% of our business.

And the thing that we like to see is when you have total U.S. gallon gas consumption as a country, everywhere would be up in the very, very low single digits, our gallon increases are in the very, very high single digits or very, very low double digits.

And so that's meaningful.

It means that more people are coming into our place.

And when about half of them come in to shop, you don't need more than 1 or 2 of those 50 out of every 100 to be somewhat of an incremental shop to be meaningful to our company on an ongoing basis, aside from the business itself having a little -- strong [somewhat gliding] based on the volatility sometime day-to-day and week-to-week but -- for profitability.

But overall, it's been a good business in its own right.

Thank you.

We'll all around, guys.

And feel free to call with any additional questions, and we'll be here tomorrow as well.

Thank you.

This concludes today's conference call.

You may now disconnect.