Costco Wholesale Corporation

Good afternoon. My name is Vincent, and I'll be a conference operator today. At this time, I would like to welcome everyone to the Q2 earnings call and February sales. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. And if you would like to withdraw a question, press the pound key. Thank you. I will now turn the call over to your speaker today, Mr. Richard Galanti, CFO. Sir, you may begin.

Thank you, Vincent, and good afternoon to everyone. I'll start by stating that these 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 the company does not undertake to update these statements except as required by law. In today's press release, we reported operating results for the second quarter of fiscal 2019. The 12 weeks ended February 17th, as well as February retail sales for the four weeks ended this past Sunday, March 3rd. Note that the first two weeks of February fell into this second fiscal quarter, with weeks three and four of February are the first two weeks of our fiscal third quarter. The reported net income for the quarter came in at $889 million, or $2.01 per share, a 27% increase compared to the $701 million, or $1.59 per share, last year in the quarter. In terms of sales, net sales for the quarter came in at $34.63 billion, a 7.3% increase over the $32.28 billion reported last year in the second quarter. Comparable sales for the second quarter, as shown in the press release, for the 12 weeks on a reported basis, U.S. was 7.4%. Canada was minus 0.3%. Other international, 0.7%. For the total company of 5.4%. As well, e-commerce for the 12 weeks on a reported basis was 20.2%. Excluding gas deflation, the impact of FX and some weakening foreign currencies relative to the dollar, as well as revenue recognition, which is an impact this year, the 7.4% reported in the U.S. would have been a 7.2. The minus 0.3% in Canada would be a plus 6.0%. Other international, instead of being 0.7% reported, would be plus 4.8%. With total company, the 5.4 reported would become a 6.7. And again, e-commerce reported at 20.2. X-Gas, FX, and RevRec, 25.5% plus. In terms of Q2 comp sales metrics, second quarter traffic or shopping frequency increased 4.9% worldwide and 5.2% in the United States. Weakening foreign currencies relative to the U.S. dollar negatively impacts sales by approximately 140 basis points. and gasoline price deflation was another minus 50 basis points of impact. RevRec actually benefited comp sales by about 55 basis points to the positive. These are the three factors that we adjust for and that are presented in today's release as the adjusted column. In addition, weather conditions adversely impacted Q2 sales by around a half a percentage point, and cannibalization weighed in on the comps by about minus 70 basis points. In terms of front-end transaction, or what we call tickets, Average front-end ticket was up 0.4% during the quarter. And excluding the impacts from gas deflation, FX, and RevRec, our average ticket was up approximately 1.8%. Going down the income statement, membership fee income reported came in at $768 million, or 2.22%. That's up $52 million, or 7.3% from a year ago. Again, with weak foreign currencies, if you adjusted for flat FX, That would make the up 52 another $9 million up 61 million year-over-year FX. Reported membership revenue of the plus $52 million amount, that's a little more than half of that, a little more than $20 million of that related to the membership fee increases taken in June of 2017 in the U.S. and Canada. We're now nearing the end of that 23-month cycle to recognize the incremental benefit of the increases, what was known as deferred accounting, into our P&L. The benefit to our P&L will be fully recognized in the next two quarters by the end of the fiscal year, but as with this last couple of quarters, it diminishes each quarter. In Q3, we'll have about half the benefit recorded in Q2, and in Q4, there'll be a very small benefit. In terms of renewal rates in the second quarter, our U.S. and Canada member renewal rates in Q2 came in at 90.7%, up from 90.5% 12 weeks earlier at Q1 end. And worldwide, the rate improved to 88.3%, up from 88.0% at Q1 end. So improvement in our renewal rates. In terms of the number of members at Q2 end, member households and total cardholders, we ended Q1 12 weeks earlier with 52.2 million member households. At Q2 end, it was 52.7 million. And total cardholders increased from 95.4 million at Q1 end to 12 weeks later at Q2 end, 96.3 million. During the quarter, we had one new opening in Carl Springs, Florida, and we also relocated a Miami location. At Q2 end, our paid executive membership base stood right at 20 million. This is an increase during the quarter of 341,000, or about 28,000 per week since Q1 end. Now, this includes the recent introduction of the executive membership in Korea, which is our fifth country offering executive membership. For Q2, Korea contributed a little over half of those increases. Going down to the gross margin line, reported gross margin in the quarter came in at 11.29%, up 31 basis points from last year's Q2 18 of 10.98%. The 31 basis point improvement, X, gas, FX, and REVREC would be plus 30 basis points. I'll give you the chart. There's not a whole lot to it given that the adjustment column is not that different than the reported column. In terms of core merchandise, year-over-year in Q2 was up one basis point on a reported basis as well, X, the gas, deflation, and the REVREC up one basis point. Ancillary businesses up 33 on a reported basis and up 32 on an adjusted basis. 2% reward, minus 3 and minus 3 basis points year-over-year. And then total, up 31 basis points, as I just mentioned, on a reported basis, and up 30 basis points, X, gas, deflation, and rev rec. The core merchandise component, again, was higher by one basis point here. Looking at the core merchandise categories in relation to their own sales, what we call core-on-core, margins year-over-year were higher by eight basis points. Within the four key subcategories, both food and sundries and fresh foods were up a little, and soft lines and hard lines were down a little. But the net of the four departments on their own sales was up eight basis points. Ancillary and other business gross margin was up 33 basis points, up 32, ex-gas, deflation, and rev rec, primarily driven by gas and also benefiting somewhat from e-comm and a few other things. Moving to SG&A, our SG&A percentage Q2 over Q2 was lower or better by two basis points, both with and without the adjustments, coming in at 10.0% of sales this year compared to 10.02 last year. In the chart that I normally give out, there really is not a whole lot to tell you. Operations was an improvement of two basis points in both columns. The other two line items that we usually point out, central and stock compensation expense, were zero and zero. So the total remained at two basis points, so overall two basis points better. In terms of that two basis points better, we feel it was a pretty good result given that we're still facing the headwinds from the U.S. wage increases to our hourly employees that went into effect last June 11th of 2018. As mentioned in the past couple of fiscal quarters, those wage increases negatively impacted SG&A by about seven to eight basis points during Q2 year over year. And it will continue to impact SG&A comparisons through Q3, which ends May 12th, and into the first month of our 16-week fiscal fourth quarter to anniversary on that June 11th. Additionally, this past Monday, we began our new three-year employee agreement. With the new agreement, we announced that we're taking our starting wages from $14 and $14.50 up to $15 and $15.50 per hour in both the U.S. and Canada. In addition, we're also increasing wages for supervisors and also introduced paid bonding leave for all hourly employees. These items are incremental to the usual annual top-of-scale wage increases that are typically done each March. Collectively, these additional items will add about three to four basis points to SG&A over the next four quarters. Now, again, this is on top of that seven-day basis point impact I just mentioned that will impact SG&A through this coming mid-June. Otherwise, pretty comparable year over year in terms of central and stock comp and other various SG&A expense line items. Next on the income statement is pre-opening. Pre-opening expenses were actually lower by $3 million, coming in this year at $9 million compared to $12 million last year. This year, again, we had two openings, one net opening and one relocation. Last year, we actually just had one opening. There's other activities that relate to pre-opening as well. Year-over-year, primarily the difference was due to the $4 million in Q2 last year related to our opening of our new meat plant in Morris, Illinois, slightly offset by higher warehouse pre-opening this year due to the additional opening. All told, reported operating income in Q2-19 was up 18.4%, coming in at $1,203,000,000 this year, compared to $1,016,000,000 last year. Below the operating income line, reported interest expense was $3 million lower or better year-over-year, coming in at $34 million this year and Q2 as compared to $37 million last year. The actual interest expense quarter over quarter each year is about the same, a little delta in improvement in capitalized interest amounts. Interest income and other for the quarter was better by $39 million year over year. Interest income itself was higher by $17 million year over year in the quarter, a combination of higher interest rates being realized and also higher invested cash balances. also benefiting year-over-year comparison with the various FX items in the amount of $22 million. Recognize that much of this is essentially an offset to the lower reported operating income and earnings in our foreign operations due to the strength of the U.S. dollar versus many of the foreign currencies in the countries where we operate compared to last year. Overall, pre-tax income in Q2 is up 23%, coming in at $1,215,000,000 this year compared to last year, $986,000,000. In terms of income taxes, our income tax rate was a little better than we had anticipated. It came in at 25.8% effective tax rate during Q2 2019 compared to 27.7% in Q2 last year. For all of fiscal 19, based on our current estimates, which, again, are subject to change, we anticipate that our effective total company tax rate for this fiscal year to be approximately 26 to 26.5%. This figure is about a half a percentage point lower or better than we had previously estimated a quarter ago. This is primarily due to a Q2 tax rate that now includes a one-time benefit for certain foreign tax credits. This one-time tax benefit will continue through the end of this fiscal year, but we do not anticipate a similar type of benefit beyond fiscal 19. A few other items of note. Again, we opened a net one unit during Q2, opened two including a re-roll. In Q3, we have three new openings planned and no reloads. We actually opened this morning in Bayonne, New Jersey. In late April, we plan to open our 16th location in Korea, and in early May, our 11th location in Australia. The big expansion quarter for us this year is Q4. We plan to open a net of 12 units, 14 openings, including two reloads, including our first opening in China, in Shanghai, in the city of Munhong. and also our third unit in Spain, which would be our second in the Madrid area. Any of these could slip a little bit, but our current best guess right now is 14 openings, including two reloads, so a net of 12. As of Q2N, total warehouse square footage stood at 112 million square feet. I might also add that in terms of CapEx, we continue to allocate more CapEx to grow and support our operations. including, as you know, over the last year, year and a half, we'd opened a second meat plant, the first one in California many years ago and then in March, Illinois. Also, a little while ago, our Canadian bakery commissary in Canada. We are under construction with the big chicken plant in Nebraska. We plan to start initial processing and production later this year. Depot expansion, we're doing that in many areas around the world. Also, we just – Just a month ago, I believe, we started up our first what we'll call fulfillment automation operation next to our – as part of our Mira Loma depot. This is for small packages for e-commerce, and we plan to do two more of those this year at other depots. In terms of two-day grocery, which, as you know, we started in October about a year and a half ago, we did that out of 10 or 11 of our business centers around the country, We're in the process of moving these operations out of the 10 to 11 business centers to six of our depots over the next several months. I think we've done our first one, and we've got several more planned right around the end of spring, beginning of summer. In terms of stock buybacks, in Q2, we expended $117 million to repurchase 561,000 shares at an average price of $208.72. The $117 million, of course, is significantly higher than the Q1 purchases of $35 million. In terms of e-commerce, overall, again, e-commerce sales increased during the quarter on a reported basis 20.2% and FX and RevRec up 25.5%. Continued increases in e-commerce in terms of orders and sales and profits and other metrics. Top growth categories in the quarter, quite a few actually. Grocery, consumer electronics, what we call majors. Hardware. health and beauty aids, tire automotive, toys seasonal, and apparel. We've now passed our one-year anniversary on the grocery launch, which was, again, a year ago, October. Same-day grocery delivery is now available to members within a short drive of 99% of our U.S. locations. Two-day grocery is available anywhere throughout the continental United States. And while still these are small pieces of our total business operation, they're growing nicely. We now have grocery shipments to all 50 states. In terms of e-commerce, in terms of new brands and items online during the quarter, we're now offering a much broader selection of Apple products, including the recent addition of MacBooks and iMacs. And, yes, you'd expect good values to our members. Also, the first of what we expect, several products from Sony. They've just started to arrive. In terms of health and beauty aids, new names like Living Proof Shampoo and Conditioner, Mirad Skin Care, and Kate Somerville items. On the exercise front, NordicTrack is a new name. And finally, I had to point out the now somewhat famous 180-serving, 23-pound, 20-year shelf life macaroni and cheese for $89.99. If interested, you can find that online under emergency supplies and in a few of the Costco locations. We continue to improve our online and in-line cross-market initiatives, and we think that's continuing to drive our business. In terms of buying online and pickup in-store, In the quarter, we expanded our selection within the same categories, jewelry, some electronics, and handbags, and continue to test pickup lockers in 10 locations for this program. Lastly, this calendar year, we will begin e-commerce operations in Japan early summer, likely, and in Australia late summer, early fall. Finally, I'll turn to our February sales results. The four weeks ended March 3, 2019, compared to the same period a year ago. As reported in our release, net sales for the month came in at $10.72 billion, an increase of 5.0% from $10.21 billion the year earlier. In terms of comparable sales, U.S., on a reported basis for the four weeks, was 6.0%. X, gas, FX, and RevRec, that 6.0 would be 5.7%. Canada, on a reported basis, 0. X, gas, FX, and RevRec, plus 4.8%. Other international, reported minus 5.9%. and again adjusted with X those things, minus 1.2, such that total company came in at a 3.5 reported and a 4.6 X those items. In terms of e-commerce, reported for the four weeks, 24.2%, and X those adjustments, appropriate adjustments, 21.6% up. February sales were negatively impacted by weather throughout the U.S. and Canada in a big way. We estimate that negative impact on the total company was approximately 1%. and a little more than the 1% figure in the U.S. and Canada. In addition, Lunar New Year, Chinese New Year, occurred in February, the same as last year, however, 11 days earlier this year. This is an important holiday in terms of sales strength. The holiday shift negatively impacted February's other international sales by, we estimate, 450 basis points or 4.5 percentage points, and total company sales by about a half a percentage point. Looking at January and February combined, effectively eliminating the impact of that holiday shift. The comp for other international for the eight weeks was 0.2% reported and plus 4.9% FX gas deflation and rev rec. U.S. regions with the strongest results in February were Midwest, Northeast, and Southeast, and internationally the strongest results were Mexico, Japan, U.K., and Spain. Spain, of course, is relatively new with two locations. Foreign currencies year-over-year relative to the U.S. dollar hurt Fed comp sales. by February comp sales in Canada by approximately 460 basis points, other international also by about the same number of basis points, about 4.5 percentage points, and total company by an estimated 130 basis points. The negative impact of cannibalization was about 50 basis points to the negative in the U.S., 80 in Canada, and 120 in other international for total company of minus 70. Within ancillary businesses, Hearing aids, optical, and food court had the best comp sales in February. Gas price deflation negatively impacted total reported comps by about 75 basis points. The average selling price during the four-week month compared to a year earlier was down 6.3% year over year. The average gallon a year ago we sold for $2.74. This year, $2.56 a gallon. Including the adverse impact of weather and the holiday shift in Asia, Our comp traffic or frequency for February, even after taking those into effect, taking those impacts into effect, for February was up 2.7% worldwide and plus 3.2% in the U.S. For February, the average transaction was up 0.8% for the month. Again, this includes combined impacts from FX, gas deflation, and rev rec. So that's about it in terms of our prepared notes. Lastly, in terms of upcoming releases, we will announce our March sales results for the five weeks ending Sunday, April 7th, on April 10th, after the market closes. With that, I'll open up to Q&A and turn it back over to Vincent. Thank you.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone keypad. Again, that will be star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. We have your first question comes from the line of Christopher Horvath from J.P. Morgan. Your line is now open.

Thanks. Good morning, Richard. So a question on the core margins. You know, the core margins performance this quarter was much better sequentially, I think, and everyone was sort of taken by surprise by the core margins. X gas in the last quarter, and now they're looking much better. So can you put into context, you know, what sort of drove that change and any commentary about how you're thinking about, you know, core margins as you look forward?

You know, honestly, you know, we drive our business by driving sales and Usually that means lowering prices on things, which we continue to do. And we're also buying better all the time. Some of it's mixed. Some of it, you know, the one category that shifted, if you look back to the last few quarters of reports, when we look at core and core, you know, fresh foods has been a little down. And I think the key word there is little. I appreciate the fact that every basis points for us is $14 million plus pre-tax a year on $140 billion. but you're talking about five to ten basis point swings here, and there's lots of things that impact it, whether it's freight, tariffs, some cases not as bad as we thought. I think we've done a great job, and we continue to do a great job, particularly in freshwood organics, where there's a little, I believe there's a little less pricing pressure or competitive pressure, but don't get me wrong, as soon as we have a good quarter, the next quarter will change that. Not that I'm giving any guidance. We know that we keep it pretty steady, and we feel pretty good about it, whether it was up a few basis points or down a few basis points.

Got it. And then just a question about the gas margins industry-wide. I understand there are a few ways that gas impacts margin, but if you just focus on the fact that it seems like the core cents per gallon has improved across the industry in the independence maybe and the integrated is taking a little bit more, and that's giving you some room to take a little bit more. So can you talk about what you're making sort of per gallon, I guess, relative to, say, last year and maybe a couple years before that? And as you think about the upcoming year, is there anything that you're seeing that would suggest that, you know, that core profitability of every gallon sold is all of a sudden going to revert back to what it was, you know, a number of years ago?

I think over the last several years, the new normal is better. If you go back to when gas prices skyrocketed several years ago and as they started coming down, what we saw and what we read, frankly, from others is that as they came down, not all of those savings were passed on to the consumer. That gave us perhaps a little bit bigger window. We're still, I think, If you ask our people in charge of gas operations around here, we're saving the customer a little more today and making a little more because there's just a bigger opportunity gap there. It really comes down to that. It is still a volatile, no pun intended, profitability item. It can swing back and forth based on underlying cost of goods sold that change daily, and but the new normal is better and all those examples, but I'm sure we'll, there'll be quarters. This was a Q2 is a particularly good quarter. Uh, but, uh, as I believe Q2 a year ago was a little better than the other three, but that's not seasonal necessarily. It's just, there's a lot of different factors. What's going on in the news internationally. What's going on with, uh, with inventory levels, you know, world and U S inventory levels. Uh, what's going on with, uh, Inevitably, a refinery shuts down for two weeks for their planned repairs, and it takes four weeks. So any of those things, switching from winter to summer blend and back, all those things impact it. I think we're fortunate in the fact that we turn a lot of gas. We literally turn our inventory about daily. And as you know, we have locations with up to 24 pumps, and they're backed up all the time. It's great. And so I think we're in a fortunate position that overall retailers, whether it's retailers that have gases in their parking lots, like supermarkets and discount stores and ourselves, or full-line independent retailers or the ones with the convenience stores, I think everybody seems to have been taking a little more, and that's given us an ability to do so over the last couple of years. But I guarantee you it will be volatile, and we'll always tell you that it was certainly a little more of a benefit this quarter than normal, but it was a year ago too.

So then just a quick one on that. So, you know, of the 30-odd basis points in ancillary this quarter, should we assume some portion of that comes out, you know, next year in the second quarter? Is it like anything that you would say is one time that we should put back next year, maybe half of it?

I wouldn't use the word at one time. I'd say unpredictable. I mean, it truly is not predictable. I mean, we know that when demand rises at the beginning of summer, that impacts everything. Gas prices have a little bit more positive pressure on them, and when prices are going up, not only for us, but when I read the profitability of gas and other big retailers, supermarkets and Walmart and the like, it impacts them as well. When prices are going up, we all make a little less. When prices are going down, we make a little more. We, I think, are in the enviable position of being extreme. And as overall the retail environment has chose to make a little more, it gives us an ability to make a little more, a little less than a little more, and still make more but even be a greater savings to our member. I mean, And that's the thing that we focus on. Are we saving our member more than we used to? And we are. Understood. Thanks very much.

Your next question comes from the line of Simeon Gutman from Morgan Stanley. Your line is now open.

Hey, Richard. A follow-up on the gross margin or the core margin. You mentioned mix helped a little. Can you dig in anything about mix that was either seasonal or something that is changing? You say we've always lowered product acquisition costs. Can you remind us when your own chicken plant is coming up? And then one more in that mix, can you tell us the channel mix between physical and digital? Is that sort of embedded gross margin improving as well?

Well, overall, our gross margin online is a little lower than our company overall. Part of it is the product mix itself, and part of it is we're driving that business. But that hasn't changed. That's been that way. We also work on a lower SG&A online, as you might expect. In terms of mix, there's so many different pieces to it, honestly. You know, part of it is, you know, when you walk into a Costco in the U.S., roughly 90% of the goods come through our cross-stock operations. For us, cross-stocks are very profitable. It's the most cost-efficient way to ship stuff. Nobody can do that to the extent that we do it because of how we sell goods in pallet and large case quantities. So, I mean, there's lots of little pieces to it. I think private label and continuing penetration in private label, fresh. But all these are anecdotal. There's no one thing that's driving in a particularly large direction. We think we're pretty good at what we do, and we're constantly buying better. Even, you know, as it related to tariffs, which so far so good in terms of being on hold, but we don't know what's going to happen in the future. I think bigger retailers have an ability to buy better.

Right. And then shifting to SG&A, you know, in the past, I think we've talked about as long as your comps hold up in this single digit, you're leveraging. And that was based on some imputed rate of spending. There was IT. There was technology. Has anything on the spending side changed, any curve that's increasing, decreasing, and that same mantra of about missing a little bit of comp, that should still be enough to give you leverage?

Well, hopefully it will. The word modernization, I think, has finally been retired around here. We're still spending a lot, and we're going to continue to spend a lot. As some of these new things come online, like the chicken plant, like the fulfillment automation, These are $50 to $100-plus million items, chicken plants more, where a bigger chunk of it is things like equipment and software that is appreciated over a shorter period of time than steel buildings. And so all those things are hitting us a little. I think the fact is we've been fortunate with our sales levels. As they go down, that will hurt us a little. You know, we're achieving our current SGA with all the things that we haven't talked about, some of these other items that impacted the other way. There are lots of little things. And we're not terribly worried, though, if some of these things, if sales were to come down a little and some of these things were going to impact it, so be it. We're going to do what we do and drive the top line.

Thanks, Richard.

The next question comes from the line of Chuck Grum. From Gordon Husket, two lines now open.

Hey, good afternoon, Richard. Just on the pricing front, I'm curious how you guys are handling increases in certain categories, including any of those that may be impacted by tariffs. Are you looking to pass along those increases, and do you think that may have helped out the core margins at all here in the second quarter?

I don't think it would have helped the margins. The question is, did it hurt it or not hurt it? It probably hurt it less than one might think, but that, again, gets back to our ability to buy right. And, you know, to the extent there's 10% tariff items in those examples versus 25, that's a big difference. Some cases you've got your vendors along with us eating into that a little bit, sometimes not. But I think it gets back, that's just one piece of what we do. The fact that, you know, organic helps us, the fact that KS helps us, the fact that, you know, We don't talk about it, nor will we plan to a lot. But, you know, all the marketing dollars that are out there now, some of those impact cost of sales.

Okay. I guess just to follow up on Chris's question, you know, you've had three consecutive quarters in a row of the core on core on core being negative, and then this quarter it flips to positive. Is there anything else you could point to?

I wouldn't read a lot. Look, we're happy about it, and hopefully you're happy about it. It's not – it's how we run our business. We didn't sit there and say, hey, let's get it up a little higher. It is a few – it is – I know we're a basis point company, and for you guys who have known us for 30-plus years, we talk basis points. It's some minor switches. It's nothing that we've changed dramatically. And there's so many different moving parts to it, frankly.

Understood. I guess the other bright spot here in the quarter was – The renewal rates are ticking up nicely. If you look back at the cadence in 2018, they were pretty steady. But they're showing a nice uptick both in the U.S. and worldwide. Just wondering if you could comment on that improvement.

Well, we like it. You know, look, we focus on all the things that we feel we should be focusing on, customer service, great products, great services at the best prices. We've been fortunate, notwithstanding the fact that we really don't have a PR department per se, that there's been a lot of good press about us, about Kirkland Signature, about our e-commerce site and customer satisfaction. I think that we've been blessed that some of the weaknesses that traditional brick-and-mortars or traditional formats have had in some ways have helped certain other discounters like ourselves. And hopefully that will continue.

Great. Thanks.

Your next question comes from the line of Edward Kelly from Wells Fargo. Your line is now open.

Yeah, hi. Good afternoon, Richard. I wanted to start with just a follow-up on fuel. If we were thinking about trying to strip out fuel and the impact, do we take the majority of the 33 basis points in order to do that? And then is there any intentional reinvestment to sort of consider as we think about this?

On the latter part of the question, there's no intentional reinvestment. I mean, there's 100 different moving parts to our company all the time, and we do what we feel is right. It was kind of like the question I was asked a year ago. We were asked about would the extra earnings from the lower tax rate, will that change what we're doing with automation, online fulfillment, or whatever else? And the answer was, of course, no. We've got more cash than we spend. This will add to that, and that's all good. But we're constantly figuring out, you know, what other things we can do there. What was the first part of the question?

I'm sorry.

Well, we don't disclose every component. It certainly was the biggest piece of it.

Okay. And the last quarter you mentioned a little bit of competitive pressure, specifically talked about SAMS and FRESH. I'm just curious if you could give us an update on a competitive backdrop, what you're seeing. And then, you know, as part of this, you know, it seems like we're starting to see maybe a little bit of food price inflation. Just curious in your thoughts on pass-through, I guess, and expectations for the year.

Well, I think the key word on price on inflation is little. We're not seeing – other than the tariff impacts on things. But in terms of food and what have you, it is, frankly, very little. And – You know, over time it will go up. You know, our comments over the years have continually been we'll be the last to go up and the first to go down, and I think that holds true as well. In terms of the comment last time on Sam's, you know, that was an interesting comment because I think after the call, the headline in the press was that's why margins were down. And the fact of the matter is we call it out because we're pretty transparent. Sam's had others, but Sam's has been more competitive, as are we. And that's the nature of the business, and it has been for 30 years. We see that continuing, and I think the fact that it's continuing, we still show improvement in some of these things, is a good sign for us.

Great. Thanks, guys.

Next question comes from the line of David Schick from Consumer Edge Research in lines now open. David Schick, your line is now open. The next question comes from the line of Karen Short from Barclays. Your line is now open.

Hey, thanks very much. Sorry to harp on this gas margin question or gas profit question. Is there any way you could just help us get a feel for how much it benefited EPS this quarter? Because the data we saw in gas margins for the quarter throughout your whole market area was just astronomically high gas margins.

We see our area throughout the United States?

Well, we map it by kind of stores by state. Okay.

But we don't disclose that. You know, again, it was – Well, more than half, but not all.

Okay. And then I guess just wondering a little bit in terms of the wage increase that you called out for March, is there anything to think about in terms of the basis point impact as we get into the next quarter?

Yes. I mean, starting March 4th, this past Sunday, I think I indicated on top of the 7th to 8th, that will continue through June 11th, if you will. So all through Q3 and the first four weeks of the 16-week fourth quarter. Effective March 4th, we'll have that addition on top of that, three to four basis points.

Okay.

And that three to four will be March 4th to March 3rd of 2020, if you will.

Three to four basis points. Okay. And then just wondering if you could – call anything out in terms of tax refund data, like in terms of your expectations on driving sales? There's a lot of noise on the timeline of that, but any color, what you're thinking it will do to comps or not do, I guess?

Well, honestly, I haven't heard anybody here talk about that. I've read some of the same things that you've read. It started off, it appeared it was a little lower, and now it appeared it was a little higher. Not a lot higher, but a little higher. Typically, On a macro basis, that impacts retail overall, and on whatever impact it has to that, it's typically a little less to us. That's what we've seen historically, whether it was a change in tax rates or dividend rates or you name it, EBT, food stamps. Whenever there's any kind of macro change that impacts retail across the United States, there's a little bit less of an impact to us. But nobody's really – We've not really seen or even know how to answer that.

Okay. And then just last question. I know that you don't want to have people get in the habit of assuming that there will be a special dividend on a regular basis, but any thoughts on your philosophy on that as it relates to the timing within this year because we're at the two-year mark?

Yeah. I mean, our thoughts continue as they have been. The three we did were about two and a quarter years apart. But that doesn't mean anything going forward. It's still a topic on the table, and we need to talk about it along with other things. So really not a whole lot of news to tell you about.

Okay. Thank you. Yeah.

Thank you. Next question comes from the line of John Heinpacher from Guggenheim Securities. The line is now open.

So, Richard, what are you guys seeing with regard to inbound freight? Is that a slight directional drag? And then if anything, what are you doing to mitigate that?

I'm shooting from the hip a little on this one, but I believe while it's been up a little bit because of new restrictions on how many hours long haulers can drive and just capacity and truck capacity out there, it's gone up for everybody. I believe we internally look at it in our freight department as a freight factor, a premium factor, or fuel factor, whatever we call it. I forget. And it's up a little less than it was a couple of months ago, but it's still up. And it's come down a little bit from where it was, but it's still up from a year ago is my guess.

Okay. All right. You know, and you've had the adjustment item, right, in gross margin related to some supply chain investments, not there now. Is that now gone for the duration, or does that come back with other supply chain investments that you might make, whether it's the chicken plant or other depots?

One of the things was the return centers we talked about for a few quarters. I think there's more things happening that impact us a little bit negatively to start. We opened a new meat plant, major capital expenditure. First, it takes a few things out of our Tracy meat plant that goes to the East Coast. With Tracy, we couldn't accommodate all our needs just from that plant. And then you've got a new plant that's starting with its own, even though we know how to run one, It has its innate inefficiencies when you first start, and it's low, you know, not full capacity. Same thing with the commissary, which was more of a learning experience two years ago over the last two years up in Canada. I think all these things will impact us. A comment I made earlier is we're not going to point out each one of these, but in the aggregate, my guess is still a little bit of a drag, which is offset by other things, most particularly sales.

All right, and then lastly, there was a period there where you'd stepped up growth of business centers for a period of time. What's the philosophy now on, you know, where they go, U.S. or internationally, as part of your expansion over the next couple of years?

I think right now we have one in Canada and, what, 16, I believe, or 16 in the U.S. I would expect one or two a year for the next couple of years, which is not really a change of what we thought. The change was several years ago when we went from zero to eight over a million years over a long period of time, and then we started opening a couple of years. And so we'll continue to open a few, but we're not – it's part of the plan, but our focus is regular warehouses and, quite frankly, a lot of the infrastructure things that we're doing now. All right. We're continuing to do it in a bigger way. Thanks.

The next question comes from the line of Scott Ciccarelli from RBC Capital. Your lines are open.

Hi, guys. Scott Ciccarelli. Richard, with your first opening in China coming up, what is the best way to think about U.S. versus international store openings over the next, call it, two to three years? And then related to that, any reason why we should see international profitability levels decline as you start to move into some of these new markets like China?

I think – well, first of all, you know, if you had asked us five, six, seven years ago, by now, what percentage of our units would be outside of the U.S. and Canada? I include Canada as part of the original mature, you know, fully grown-out area – that by now we'd probably be 50-50 international outside of the U.S. and Canada, and we're not. It's probably, well, it's 65-35, 70-30 U.S.-Canada still. Part of that is the opportunities that we've had in the U.S. and Canada, and part of it is the pipeline's taking a little longer elsewhere. I think you'll continue to see that change in the directions toward more international, but I can't sit here and tell you that it'll be 50-50 three years from now or five years from now, but clearly we've got more things going on. Now, as it relates, whenever we go into a new country, it's almost by definition you're going to lose money for the first few years, even if that first location or two contributes a small amount of profitability, if it does, because you still have the central expense and the whole full thing, the infrastructure. I look back at Japan. When we first went to Japan, we opened six units in the first five years. And the goal was to be at break-even at the end of year five, and I think we beat it by about 10 months. By the end of the day, fast forward another 10, 12 years past those five years, and we now have in the high 20s, and we'll grow from there faster and more profitable than it was in that midterm when we were opening several units on a small base, but it takes time. And as we go into France, as we went into Spain, you know, by definition, those are going to, add more to the bottom line sales in that calculation of return on sales, and sometimes even subtract a little at the top. The key is balancing a little of that, and I think we're big enough now that even if we overdo it a little bit on some of that new stuff, it's okay. We'll let you know if it costs us an extra basis or two.

Got it. Okay. Thanks, guys.

Why don't we have two more questions?

Next question comes from the line of Mike Baker from Deutsche Bank. Your lines are open.

Thank you. A couple of clarifications. One, to Karen Short's question, you said that gas was about half of it or a little more than half or a little less than half of it. Half of what? Was that the year-over-year increase in earnings or operating profit dollars?

No. First of all, I said it was more than half. I didn't say it was a little over half. It's substantial, but we try not to be that specific. Clearly, There's a lot of things that helped our earnings this quarter, year over year, as evidenced by even the improvement in core on core. And the fact is evidenced by there's things that hurt you a little bit that we don't pick out each one. Gas certainly helped, but, again, I think Karen had mentioned she's done some studies in terms of profitability, and it's a good piece of it, but it's not entirely. There's other things that benefited and other things that hurt it a little, too.

It being the growth in earnings?

Well, gross margin and earnings, ultimately.

Okay. Thank you. Understood. One other question. I thought that you said that the ancillary margins were helped mostly by gas. We get that. But you also said helped by e-commerce. So are your e-commerce margins getting better year over year? And if so, why is that? Okay.

I believe the e-commerce bottom line margin improved a little, but also the sales are stronger than the rest of the company. So it's penetration as well.

Okay. Understood. Last, real quick, Snap, anything, any benefit from the pull forward in Snap? I don't know how much of it is your customer, but it's helped others.

We really don't see any of that. Very little of it. Those kind of things don't really impact us.

Understood. Appreciate the clarifications. Thank you.

Thank you. Last question comes from the line of Scott Muskin from Research Alliance. I'll open.

Hey, Richard. Thanks for taking my questions. So I just want to go back to e-commerce. I know you touched on it in the quarter that it was a little helpful, the margins. But you're putting a lot of money into it, it sounds like, the two-day, one-day grocery. I was wondering if you could walk us forward on e-commerce and where you think it's going to do the margins as you go forward.

Well, you know, every company – allocates things or puts things in different silos. In our e-commerce, the one-day grocery is not part of e-commerce. Even though you go online to order, it's really the Instacart engine, and it's in warehouse. They come into our warehouses, they shop, they deliver the same day. And so that's not part of the e-commerce numbers. That and a couple of other things would actually increase the percentage increases a little bit, but it's still so small, it wouldn't have that much of an impact.

And then the rest of the e-commerce business, as you – I think you said you're building out some fulfillment for e-commerce, I think for more consumables. How are you guys thinking about margins on that business as we move forward? Because the mix is going to shift, I think.

Well, it has shifted. As you know, a few years ago, the average ticket was $400 or something because we sold big-ticket items. We didn't have lots of little things or things that got you back to the site more frequently and more regularly. some of that's just starting. As I talked about, the first of three planned fulfillment, what we were calling fulfillment automation centers, we have our first one in Southern California. It's literally open less than eight weeks, I believe. It's over $100 million investment. First one is the most expensive because you developed all the systems and everything as well. We have two other planned for depots in other parts of the country. I would hope that that's something that's going to hit our number a little bit because it means we're doing well in it and we're growing it. We're going to see the cost of picking an item dramatically reduced because we've done it not quite manually, but less automated than we can well do over time. But that's going to be an ebb and flow over time. We'll just see how it goes. I think in the scheme of things, recognizing e-commerce in its entirety is still, what, 5% to 6% of our business, 5% plus percent of our business? even as we hope and assume that it's going to grow at a higher rate than the rest of the company, it's still going to be in the single digits for a while. So those impacts. And even with the first one, you know, you're talking about, you know, the inefficiencies of getting something open and running and building it up over the first six to 12 months, and then the associated depreciation and like. Those things in the scheme of things are not huge. As we do three and four and five of them, it's a little bigger. So is one chicken plant. So is one, new concept bakery commissary a few years ago. So all these things will be – I would think these are the things we'll hope to balance some of them, but if they're a little dragged, that's a positive.

All right, and then last, and I guess the last question, but February sales and traffic, anything to read there? It seems like it was a little slower than we've been seeing. Any thoughts there?

Well, look, I think we more than anybody hate to use the word weather. as a reason. And, you know, you see it every day. Clearly, whether it was rain, snow, cold, you name it, that impacts things like patio furniture, spring wear. But I think if you X out the things we try to, as I pointed out on the call, if you X the weather, which we assume, I think I said it was 1% in the month. from the full company, a little more, therefore, in the U.S. and Canada. We try to err to the conservative assumption on that. I mean, it's not a lot more than that, but we feel comfortable in talking to the operators of the impact. And if you add that back in, you add the holiday shift in Asia, you take those things out, we're a little lower, not a lot lower, than we've been enjoying for the last several months. I guess we'll have to wait and see how much it is.

You see how much is exactly. All right. Well, thank you so much. Take care.

Thank you. Thank you, Vincent. We'll be around to answer questions. Thank you.

This concludes today's conference call. You may now disconnect.