Costco Wholesale Corporation

Good afternoon, ladies and gentlemen. My name is Jerome, and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask questions during this time, simply press R, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Now, it's my pleasure to hand it over to Mr. Richard Galanti, Chief Financial Officer. The floor is yours.

Thank you, Jerome, and good afternoon to everyone. I will 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 cross actual events, results, and 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 third quarter of fiscal 2019. The 12 weeks ended May 12. Reported net income for the quarter came in at $906 million or $2.05 per share, as compared to $750 million or $1.70 per share last year. As mentioned in the release, this year's third quarter benefited from a non-recurring tax item of $73 million or $0.16 per share. Excluding this item, earnings for the fiscal third quarter were up 11% year over year. Net sales for the quarter came in at $33.96 billion, a .4% increase over the $31.62 billion sales figure last year in the quarter. Comparable sales for the third quarter were as follows. For the 12 weeks on a reported basis, U.S. was 7.0%, excluding gas inflation, FX, and REVREC, it would have been a 5.5. Canada reported at a 1.3, X those items a 5.1 positive. Other International reported 1.7, X those items a 6.9 to the positive. So total company, we reported a .5% comp sales figure for the 12 weeks, excluding those three items almost negated each other, coming in at a 5.6, excluding those items. E-commerce was 22% for the quarter on a reported basis and .5% X those items. In terms of Q3 comp sales, our third quarter traffic or shopping frequency increased by .7% worldwide and up .4% in the U.S. In terms of the impacts of the items of gas, FX, and REVREC, weakening foreign currencies relative to the U.S. dollar negatively impacted sales by about 130 basis points. Gasoline price inflation impacted sales by a small amount plus 10 basis points. And REVREC benefited comp sales by about 110 basis points. So the net of the three about a minus 10 basis point. Our average front end transaction or ticket was up .8% during the third quarter. And excluding the impacts from gas, FX, and REVREC, our average ticket was up approximately 1.9%. Next on the income statement, membership fee income. We reported membership income in the third quarter of $776 million or .29% of sales. This is up $39 million or .3% from last year's $737 million. FX had a negative impact on that number. That impacted that $39 million increase. It would have been about just under $10 million higher than that FX. Our reported membership fee revenue again was up to $39 million or 5.3%. In addition to FX impacting that to the negative, it does have the benefit of the fee increases we took almost two years ago. Really the last fiscal quarter of that. Those are increases that we took in June of 2017 in the U.S. and Canada. We now have effectively completed that 23-month cycle it takes to recognize the incremental benefit from the fee increases. The benefit to our P&L and Q4 will be very small, less than $1 million. In terms of renewal rates, at Q3 end, our membership renewal rates remain strong. In the U.S. and Canada, membership renewal rates came in at 90.7%, the same as it was a quarter ago. Worldwide the rate was 88.3%. That figure also the same as of Q2 end. In terms of number of members, at Q3 end, the number of member households we had was 53.1 million at Q3 end. That's up from 52.7 million 12 weeks earlier. In terms of total cardholders, we came in at 97.2 million, up from 96.3 million 12 weeks earlier at Q2 end. During the quarter, we opened three new warehouses, one each in the United States, Korea, and Australia. At Q3 end, in terms of paid executive members, they stood at 20.4 million, which was an increase of 406,000 during the quarter, or 34,000 per week. Korea was actually a very small piece of that increase, so we've had good continued increases in executive member penetration in other countries as well, most notably U.S. and Canada. Going down the gross margin line, our reported gross margin in the quarter was lower year over six basis points, coming in at .99% versus last year's 11.05%. Now excluding the items that I've excluded before, FX, RevRec, and the like, the six basis point lower number would be actually plus five basis points excluding gas, inflation, and RevRec. If I'd ask you to jot down a couple of numbers here, two columns, both reported, and then X, gas, inflation, and revenue recognition for the third quarter of 2019 as compared to a year earlier. The first line item here would be core merchandise on a reported basis year over year in the quarter. It was reported one basis point lower. X, gas, and RevRec, it was nine basis points positive. Ancillary businesses, minus three and minus one basis point. Two percent reward, minus two and minus three. Summing all those up, you'd have the reported number six basis points lower, and X, gas, and RevRec, five basis points higher. One thing I'll note compared to the second quarter, in the second quarter we had a big increase in ancillary business margin as we pointed out last quarter's earnings release. The core merchandise component here, again, lower by one basis point. If you look at the core merchandise categories in relation to their own sales, core on core, if you will, margins year over year were higher in Q3 year over year by 21 basis points. The subcategories within the core, all four main subcategories, food and sundries, hard lines, soft lines, and fresh foods, were all up year over year in the third quarter on their own sales. And that's a trend that we've seen last quarter, it was up less than that amount in Q1 down a little bit year over year. Ancillary and other business gross margin, again, lower by one basis point on the X, gas, and RevRec. Nothing really to speak of in terms of things there. Moving to SG&A, our SG&A percentage, Q3 over Q3 was lower, or better, by six basis points, coming in at .92% of sales this year, as compared to .98% reported last year. X, gas, inflation, and RevRec, it was higher or slightly worse by five basis points. Again, to jot down a few numbers here, the two columns, reported, and the second column, without gas, inflation, and RevRec. Core operations on a reported basis was better by seven basis points, so plus seven. X, RevRec, minus two. Central, minus one and minus two basis points. Stock compensation, zero and minus one. Summing up those two columns, again, on a reported basis, SG&A was lower or better by plus six basis points, and X, those other items, worse by five basis points. Now, the key thing here is within the seven basis points of improvement, or rather, the minus two basis points, X, gas, and RevRec, that's notwithstanding the fact that we're employees that went into effect in June of 2018, as well as additional wage increases implemented in March of 2019. Both of these wage increases negatively impacted SG&A during the quarter, represented about 10 to 12 basis points of the year over year variance. In Q4, the estimated impact will be about minus five to six basis points, which is the residual impact from June of 18 plus the March 2019 increases. And then we'll tick down to three to four basis points of detriment, we estimate in Q1 of 2020. Central, nothing to speak of there. It was higher by two basis points on X, gas, and RevRec basis. Stock compensation, flat year over year, and then again, minus one. Next on the income statement is pre-opening expense. Pre-opening expense came in at $14 million this year in Q3, up $6 million from a year ago. We had one additional opening, three openings this year versus two last year. There was also about $2 million of pre-opening expense in the number related to the chicken plant that we planned to start the beginning of production in later this summer. Additionally, some of this quarter's expense relates to our higher number of openings we have in Q4. In Qs one through three in the first 36 weeks of this year, we will have opened a total of 10 new locations. In Q4, we have 11 planned. There was some remnants of the beginning of some of the pre-opening there. All told, reported operating income in Q3 was up 5%, coming in at $1,122 million this year compared to ,000,000 last year. Below the operating income line, reported interest expense was $2 million lower or better year over year, coming in at $35 versus $37. That's just a slight difference in capitalized interest amounts. Interest income and other for the quarter was lower by $5 million year over year. Interest income itself was actually higher by $11 million year over year. However, various FX items in the amount of a minus $16 million negatively impacted the year over year comparison. Overall, pre-tax income in Q3 was also up 5%, coming in at ,000,000 this year versus ,000,000 last year. In terms of income taxes, our reported tax rate in Q3, fiscal 19, was .5% compared to $28.8 in Q3 last year. As was mentioned in today's release, this quarter's earnings and our tax rate benefited from a non-recurring $73 million item. Excluding the $73 million item, our third quarter tax rate would have been 24.9%. We estimate that our effective total company tax rate for Q4, fiscal 19, to be more in the .5% to 27% range. A few other items of note. In terms of expansion, as I mentioned, we've opened through the third quarter to date a total of – actually, we've opened 12 units – I'm sorry, we've opened 13 units, but that includes three relocations, so a net of 10. In Q4, we'll open 13 locations, which includes two relos, so a net of 11, which would put us at terms of net new openings for the fiscal year at 21, the same number that we had in fiscal 18. About three quarters of the openings this year are in the U.S. and about a quarter internationally. This also includes our anticipation of opening our first Costco in China and Shanghai, tentatively scheduled to open on August 27th, right before the fiscal year ends. As of Q3N, total warehouse square footage stood at 112 million square feet. In terms of CapEx, while our new warehouse openings remains in the low 20s, the CapEx spend is in line with prior years. Excuse me. It's in line with prior years. We've got a lot of money being spent on fulfillment, both e-commerce and grocery, expansion and automation, the chicken plant, which is what we mentioned, as well as ongoing expansion and depot and infrastructure, as well as IT modernization. In terms of stock buybacks in Q3, during the third quarter, we expended $44 million, repurchasing 192,000 shares at an average price of $226.57. To date, we've expended $195 million for 903,000 shares at about a $216 per share price. As a reminder, at the last board meeting, the board approved a reauthorization of a stock repurchase program and authorized a new $4 billion program that will remain in effect through April 2023. In terms of e-commerce, overall, our e-commerce sales increased, as we mentioned, on a comp basis, 19.5%, reported 22%, 19.5%, XFX, and yes. I might point out, by the way, that these numbers do not include the increases that we're seeing with Instacart. Instacart comes into our warehouses and purchases, and that goes into warehouse sales. The top growth categories in the quarter were electronics, health and beauty aids, furniture, small appliances, automotive and optical. New brands and items online during the quarter include high-end televisions from Sony and Samsung, as well as the latest generation Apple products from AirPods to iMacs and the like. Other things would include things like bare minerals, beauty, cosmetics. Sales highlights during the quarter included some significant diamond ring purchases, one in the $400,000 range, and big-ticket items like golf simulators that sold for $14,000 each, which we sold during a five-day period. We also continue to improve our online and inline cross-marketing initiatives, a lot of push notifications for start and end of warehouse promotions, emails featuring hot items and suggestions for Mother's Day and other holidays like Cinco de Mayo. During the quarter, we also completed the rollout of six regional grocery distribution centers located within our existing depots. You'll recall that previously we had fulfilled since late 2017 when we began the two-day grocery. We did that through our business centers. As it expands, we've pushed it into our depot operations, and we'll also have, in those cases, regional assortments. An update on terms of our buy online and pickup in store. In the quarter, we began rolling out additional pickup lockers. Over the last several months, we've had 10 locations, but we're in the process of rolling that out to an additional 100 locations over the next four or five months before the September through December holiday season. Continued growth in the Costco app, use among our members. We continue to experience that with new features recently added like pharmacy orders and pickup notifications, easier shopping ability on member savings events, photo center and push notifications, and expect several additional new features are planned for July and the upcoming months thereafter. We continue to focus on getting merchandise to customers faster. Some of that has to do with where we locate the merchandise in these depot and other ancillary operations. As discussed last quarter, we will begin e-commerce operations in Japan later this summer and Australia late summer, early fall. The next thing I want to touch on for a minute is the whole question of tariffs. I'm sure we'll be getting some questions on that, so a few comments. As we indicated a couple of quarters ago in our earnings release, there continue to be a lot of moving parts, although some of the moving parts are getting bigger, but it is still pretty fluid. The actions that we took then and we continue to take where we were able to, not in a big way, we're accelerating shipments before certain tariffs would go into effect or would be increased in the percentage of the tariff, although there's limited ability to do that. We've worked with suppliers. We've gone to essentially every supplier on every item, as you might expect, to see what we can do to both reduce costs and figure out how to do that. In some cases, we've reduced order commitments on certain items. We've looked at alternative country sourcing where possible and feasible, although again, there's a limited amount of the ability to do that. And we've taken advantage of lower pricing on certain US items that have been impacted the other way. In summary, we'll continue to see how customers and competitors react to this. What's interesting is, as you know, this list three, which is the biggest of the three lists of potential tariff items, those were listed back in September of 18 at 10% tariffs and were going to go to 25% as of December 31st. Of 2018. That date has continued to move, although it's now moved and it's in fact at 25% for items that I believe are that are on that are exported after May 10th. So we're just starting to see some of those impacts. As you might expect, it's all over the board in terms of every item and every vendor is different. In some cases, it's being passed on. In some cases, we're able to work to figure out how to move merchandise. And then the impact of when the price increase does go through, it has a different impact of how it affects sales. We think that we're in a good position in terms of our size and our ability and our relationships with our vendors. And we'll keep you posted how it goes. This last piece again includes it's the biggest list of the three lists and includes things like furniture, luggage, bikes, vacuums, grills and more items like that. That's pretty much it on our side. Lastly, in terms of upcoming releases, we will announce our May sales results for the four weeks ending this Sunday, June 2nd, next Wednesday, June 5th after the market closes. And with that, I will open it up for Q&A and turn it back to Jerome. Thank you.

Ladies and gentlemen, at this time, if you would like to ask questions, simply press star, send a number one on your telephone keypad. And if you would like to withdraw your question, press the pound key. Now our first question comes from the line of Michael Lassar from UBS. Michael, you are now live.

Good evening. Thanks a lot for taking my question. Richard, how are you going to comp the $400,000 diamond ring? It's going to be tough next year.

Well, do you have an anniversary coming up?

Even if I did, I can't afford it. My question relates to the comp. The traffic's been moderating a bit. Should we think about this as just more reversion to the mean or do you think that there's something else going on?

Well, look, every time it reminds me of a few years ago when we saw slight moderation in traffic and it was, oh my God, this is the new normal. And our answer then was we don't know if it is or it isn't. What we know is we've got a lot of exciting things going on in buying. We certainly, the different buckets of money we've talked about over the last few years, whether it's the fee income from membership fee increases, the credit card switch, the tax reform, all those things don't go away. They, in fact, grow each year a little bit. And so I think that we feel that we're in a good position to keep driving it. As it relates to where it goes from here, we'll have to see. We think relatively speaking, our value proposition is as strong, if not stronger, than it's ever been out there and we'll have to see where it goes. Now, what are some of the headwinds? Recent headwinds included the weather and other things that started back in February. Certainly, this new word with a capital T called tariff, there's questions out there that we read about every day and we'll see. Again, we feel whatever the impact is, we feel that in the earlier tariffs last year, recognizing many of them were in the 10% range, not the 25% range, we actually felt we picked up a little market share in some cases. We don't know what will happen tomorrow, but we feel we're in a good position from a buying power standpoint and certainly have the ability to drive sales the way we know how to do it with good value.

My follow-up question is your -on-core gross margin expanded rate that accelerated quite a bit from the last couple of quarters. Is that because of what you are doing proactively or is it just that the market is becoming a little less competitive and as a result, you're able to earn a little bit more on your sales?

I think it's a little of everything. I think some of its internal controls, we still manage the basics, managing spoilage and D&D and negotiating with vendors. It's a lot easier to do that. Our buying power and our strength per item is enormous given our $150 million is over 4,000 given items at a given time. Certainly, I get back to some of those other buckets we've had available. We're able to use those and we've also been able to show that we drive even greater value. The vendor sees a big increase in pickup and unit sales. I think that's worked in our benefit.

Okay. Thank you very much.

Your next question comes from the line of Edward Kelly from Wells Fargo. Edward, you are now live.

Yeah. Hi, Richard. I wanted to ask you about margins. Just the performance on the core margin and then the -on-core, which obviously was even better. Any additional color on the puts and takes there and then how we should maybe be thinking about that for the remainder of the year, particularly as tariffs start to accelerate?

Well, I mean, look, we've always been asked when prices are going up, when costs are going up, we want to be the last to raise them. When prices are going down, we want to be the first to lower them. We're not afraid to use some of those monies to, again, drive business. I think a lot of things worked in our favor this quarter. Just when you get comfortable with us, we'll do something else, right? But there's, again, we don't really provide direction or guidance of where it'll go in the future. We feel pretty good right now about our competitive position relative to both in line and online and the value proposition that we bring. In fact, some of the weakness, whether it's tariff related or whatever it's related, in some cases, we feel that it gives us a leg up as it relates to we can go in there and buy large quantities of something at great value. These are all anecdotal comments, though. Overall, we feel, again, good about our competitive position and the things that we have in the pipeline as it relates to having good merchandise and great prices.

Just maybe a follow up on the tariff side. As we think about List 3 and we think about 25%, your philosophy, I guess, generally, I mean, you've always been a bit more of a customer first organization. Is there a margin risk associated with that? As we think about any potential for List 4, how strategically would you think about that?

Well, there's always risk. At some point, you can't, you say no one is so vocal to eat all these tariffs. We work with vendors. There's been some switching, small amounts of switching to other countries of origin where we can, although we're not the only one in town trying to do that. At the end of the day, prices will go up on things. What's interesting is it's hard to predict what the impact is. We've seen strength in patio furniture even with certain tariff price increases, although part of that is because there was a little bit of slowdown in patio furniture because of the bad weather in January and February and we get into seasons early. Again, it's hard to analyze each one. I think what we're most cognizant of is a key price point. If you're at something at $9.99, you hate to go to a new calculation that was at $10.49. But if it's 25% on $9.99, needless to say, you're not worried about $10.49. You've got to figure out where it is above that. Again, I think we've done everything we can and we'll see where it goes from here. The real unknown is how long it's going to last. To the extent it gets into list four, that's a whole new ballgame as well. That's the rest of everything, if you will, including electronics, and apparel, and phones, and televisions. The more discretionary item is we were, again, I think a little positively surprised on the patio side, although we also have to recognize there was some buildup because it took a little while for the weather to turn. But if you start getting 25% tariffs on that list four, but list four is not here yet. We're hopeful that the evident flows of the relations between our countries improves in that regard. Great. Thank you.

Your next question comes from the line of Sion Cotton from Morgan Stanley. Your line is now open.

Hi, this is Josh Campbell, John for Simian. Thank you for taking our question. The expense leverage that you saw in the quarter was encouraging, especially against the wage headwinds that you're facing. Can you maybe go into a little bit more detail about what's driving those specifically and then ignoring the benefit from lapping the wage increase next year? Can you continue to drive expense leverage in the same areas for the foreseeable future to offset tariffs?

Look, the biggest, depending on the level of tariffs, if it's a lot, no. But as we've always said, the biggest thing is driving sales. If we can drive sales, we're not very good at leveraging expenses if sales are weakening relative to others, perhaps, because there are things we're not going to do. We're not going to postpone a wage increase and things like that. We work on meetings, literally. There'll be a little reduced headwind in each of the next few quarters with the big increases we saw in hourly wages both in June of 18 and now in March of 19, as that 10 to 12 negative goes to a 6 or 7, goes to a 4 or 5, or whatever I said earlier. Beyond that, there's basis points here and there that go both ways. A lot of the things we're doing, like the new fulfillment centers and the automation, none of this stuff goes completely smoothly. We don't point out each one of these things, but I'm sure there's some extra hits of half basis points here and half ways there. There's other things that improve. At the end of the day, sales is paramount. The other thing is, I think not over this next year, but over the next several years, to the extent that we have a higher increase of openings outside of the United States, that tends to help the overall percentages on things like healthcare. Healthcare is 30 to 70 basis points higher in every other country than the US, things like that. I'm sorry, lower. Healthcare, the expensive percent of sales is lower in every other country outside the United States. We've been fortunate that our concept works in virtually every other country we've gone to. Sometimes it takes a few years to get there when we first open in a country, but at the end of the day, that'll help. That's not going to help tomorrow. That's over the next five and 10 years.

Thank you. Just as a quick follow up, following up on some of the other questions a little bit more directly, do you think over the next few quarters your merge margin can continue to expand? That's the call and call one. As tariffs have a greater impact on your business?

First of all, we don't guide. That's where I should say stop. Look, tariffs, to the extent that we want to be the last to raise prices, it doesn't mean we're going to wait and not do it at all. We've got to be pragmatic about it. That would be a drag, a little bit of a drag. Now, hopefully, it's a drag from a plus 20 and out of minus five.

Appreciate it. Thank you.

Your next question comes from the line of Scott Ciccarelli from RBC Markets. Scott, you're now live.

Good afternoon, guys. Scott Ciccarelli. I was curious if you guys have considered providing a click and click kind of process for your grocery offering given the success that Walmart's had with their grocery pickup?

Not at this juncture. I mean, the click and click that we're doing is more for small-sized big-ticket items like electronics and jewelry and handbags. We continue to look at it. We continue to scratch our head about it. We recognize that they and some others are putting in a lot of financial commitment to doing this. I think what you're going to find is like everything else in life at Costco, over time, we figure out how to do it our way that makes sense for us, that still works. One of the reasons that, whether it's Instacart or on a smaller scale, Shipt in the Southeast, which is growing its geographic footprint, as well as Google, all those things are ways to do that without us having to get into that business in a big way. And that's on two-day. And the recognizing if somebody wants something in an hour, they're probably not going to get it from us. But what we see is, the other thing is, we still want to drive you into the warehouse. And so far what we see in small bite sizes here, in some of the things we've done, the net of having that one-day grocery with third parties or two-day dry grocery through us, it has been slightly additive. So it's not cannibalized. While it cannibalizes the number of visits to a warehouse a little, the sum of the two still is an increase in sales. These are small data points over a short period of time, so we have to see. But we'll figure out how to keep doing it our way, and hopefully that'll work.

Guys, so certainly nothing in the near future. Okay, thanks guys.

Your next question comes from the line of Chuck Trump from Gordon Haskett. Chuck, you are now live.

Hey, good afternoon. Thanks. Richard just highlighted the trade war rhetoric and market volatility and some of the salt concerns. I'm just wondering if you've seen any change in the consumer behavior, particularly in some of your more important markets such as California. PBH was out saying some things last night. Curious if you're seeing anything on your consumer?

No, we really haven't.

No, okay, great. And just taking a step back to follow up on Ed's question about operating margins, they're much stronger than a decade ago, and frankly not many in retail can say that. I'm just curious when you look ahead and you take a bigger picture about some of the puts and takes, what do you think about operating margin dollar growth in the future?

Well, I guess more, more. You know, the slide that has been shown at our international managers meeting every year for that three or four day event from the beginning of time and through Craig Johnick's tenure over the last eight years, we're a top line company. And as long as we can keep driving sales, all those other things fall into place. The fact that we have been successful longer than I thought of continuing to get more people to convert to executive membership, the benefit that we have with a great value on a credit card, all those things, you know, drive loyalty and will drive sales and everything else to take care of itself. And you know, we feel pretty comfortable right now with the recognizing value is not just price, but value, the price is

the key. Your next question comes from the line is Christopher Mandible from Jaffa. Christopher, you are now live.

Hey, good evening. Can I just ask in terms of competition on the consumable side, are you seeing anything notable in terms of change on pricing, whether it be greater aggression or maybe a greater willingness to pass on overall cost inflation? And I guess I'm specifically curious about categories like eggs and pork, where we've seen some significant deviations on pricing.

Yeah, I mean, pork has been all over the board, as I understand. But overall, the answer to your overall question is not really. If anything, I mean, using gasoline is an extreme example. I think the fact that our most gasoline retailers have been willing to make more on gas has enabled us to have a bigger value gap and make a little more. And that's so that suited us well. You know, again, I think we're fortunate that many of the price wars are out there. The traditional retailers in any given category are impacted a lot more than we are on those things. So that's, we've, I think we've been fortunate. And you know, and on basics, you know, what I'll call the supermarket ads of yesteryear. We've been watching those every week since the beginning of time and continue to do so. And where we've helped ourselves is an area as a private label and areas of organic and specialty items. I mean, you go into even something as basic as, you know, the cheeses. We're not just selling the basic cheeses anymore. We're selling premium cheeses. And I think in everything we do and package food items, we've stepped up the quality and whether it's organic or antibiotic free or you name it. And those things, we're able to show great savings and still maintain a decent margin.

Okay. And since you brought up fuel, I guess I'm curious that the comments on being able to capture maybe a little bit more margin all while expanding your gap relative to competition. Is that broad based across the country or is it more so confined to areas like the state of California? And then could you just speak to comp growth on gallons in the quarter?

As I understand it, the only geographic region in the US where that's not the case is parts of the Midwest and it ebbs and flows there. Everywhere else, it's been pretty healthy for us. Where, you know, I think the gaps, the value gaps when you look at some of these third party websites that collect from millions of people across the country pricing, we continue to be shown as the best value out there.

And anything on the comps for gallon growth?

They continue to be in the, I believe they were still in the high single digits in gallons. Yeah. They continue this quarter to be in the high single digits, whereas I think US gallon consumption is in the low single digits. Great. So we're driving people into the parking lot.

Your next question comes from the line of Karen Short from Barclays. Karen, you are now live.

I'm wondering, or core growth margin, was there any benefit to core on core maybe from timing in terms of accelerating delivery of items that may be passing on some price increases? Because I mean, it sounds like it could be a little more structural in nature, although I know you don't really want to commit to that. And then I had another question.

Not really, because in our nobility, we kept the cost down. Even as costs went up, if we had it sooner, we held it off. We held off raising the price until we were into a higher cost unit or product. Okay.

And then I guess then that would lead us to think that there maybe is something more structural in terms of what we just saw on core on core. Or are you reluctant to go down that path?

Look, again, I guess I choose to use the word that we try to be pragmatic about it. We didn't look back two quarters ago and say core on core was down five or six basis points year over year. And then last quarter it was up seven or eight or whatever we reported. Now it's up 20. We didn't strategically plan to do it like that. It's our buying power. I think in some of these weak times in certain categories, apparel is an example. We can go in and buy huge quantities of something where the manufacturer's volumes have been cut by other merchants and really drive great value and keep a little of it and give even greater value to the customer. Yeah, the product mix is a little bit. Certainly, the private label is a little bit.

Okay. And then if we get, if list four does get implemented, what percent is actually imported from China in totality or what would be the increase in what's imported directly from China? Do you just have no way of calculating that really?

It's really not an easy way to calculate it. First of all, list four is somewhat titled everything else, but who knows what everything else is once it goes through that few month process of exceptions and people appealing the process. And look, it's more significant in a sense. It's some categories that are arguably discretionary in nature, apparel to some extent, electronics certainly, and will people put that off? Again, getting back to patio furniture, we didn't see it, although we believe part of that is related to just the season starting a little later this year.

Okay. And then just last question for me. I think you're testing self-checkout in some stores maybe. Can you just give an update on how many stores that's in and then any color and what you're seeing with respect to traffic in the stores that's been rolled out? I think I

approved 250. Of the

540-ish locations in the US, it's in about 100 and a quarter. And we're going to move to 250 in rapid order over the next several months. It works, by the way, for us, it works best in high volume locations where it's gotten a lot easier, particularly if you have a credit card now where you can just contact us. And it's very fast. And customers are using it. Our members are using it. And so it's saving some labor at the front end. As important on the highest volume units, it's getting people through the front end faster, which we recognize when you get... If our average unit is in the 180, 190 range, you got a lot of units in the 250 to 350 range, that helps.

Great. Thanks very much.

Your next question comes from the line of Gregory Melich from Evercore ISI. Gregory, you are now live.

Hi, thanks. Richard, could you give us a little more on the e-commerce front? Specifically, is it still more profitable from a margin standpoint than retail globally? Could that change as you now roll out into Japan and Australia? How should we think about that?

Well, keep in mind, the US dwarfs everybody else. Canada dwarfs everybody else to some extent, proportionate to the size of our company. Overall, it's more profitable, recognizing we don't charge back every item. There's a charge that the warehouse gets for accepting merchandise and things like that. But at the end of the day, we think it is slightly more profitable at a lower gross margin. And there are certain categories. The most notable one is white goods. Four years ago, in the US, we did maybe $50 million in limited amount of white goods sales, meaning refrigerators, washers and dryers and the like. Now, we display a few items in store, go out three fiscal years, which was last year's fiscal 18, we did $500 something, $500 plus a little over $500 million. And that should be, we should be able to double that, go over $700 this year and double that in a few years. So that's a category that by necessity, nobody was going to go pick it up, buy it and pick it up in the warehouse anymore. This has enabled us to have, so there's those kinds of things that have helped as well, where we would have lost some of that business, I think, over time in the warehouse anyway. Patio furniture, or patio furniture during the 12 to 16 weeks in the January through April period, predominantly, and regular furniture during the, kind of after Memorial Day and before back to school during the 10 or so weeks in the middle of the summer. That's when we sold that stuff. Now, we sell some of that stuff year round online, most notably patio furniture that we sell year round in a decent amount in geographies where the sun actually shines more often.

Got it. And so is it fair to say that still that e-commerce business is very general merchandise heavy? And can you update us on what vendor direct is as a percentage of that business, or just, and just how big it is as a percentage of sales?

Well, vendor direct, yeah. When we first started years ago, it was mostly all vendor direct because it was big ticket. It was solely big ticket items being shipped, drop shipped. That's a lot smaller percentage to date than it's ever been. First of all, in addition, over the last few years where we have gone is to, one, improve the site greatly itself, whether it's search, returns, and you name it. But we've added categories to create more velocity and more reasons for you, somebody to think about going to Costco.com, whether it's health and beauty aids or food and sundries and things like that. And so, and I think you'll see that continue. One of the reasons that we're doing some of these automation fulfillment for small packages, if you will. And that's the natural progression of how we do things. And I was reading an article just this morning about the writer was suggesting a small percentage of our members shop online at Costco. That is, it is small relative to others, but it's increased each year and is increasing at a greater level now. And we're getting better at it. But again, we still want to use the internet to get you into the store as well. And we think we've done a pretty good job of both of those.

Great. And then just a clarification on the tariffs. It sounds like if just pick a number, let's say 15% of your COGS came from China, list three would be less than half of that. And list four, theoretically, would be bigger if it went on everything.

List four would be, yes,

absolutely. Yeah. Okay. Great. Thanks, Scott. Good luck.

Yep. Your next question comes from the line of John Hayne Bockel from Guggenheim Securities. John, you are now live.

So Richard, let me start with the sequential improvement in core on core. I'll beat that horse again. Is that fairly broad based, right? The eight to the 21. And then secondly, I don't think you guys don't spend a lot of time thinking about item by item elasticity or do you? And have a real good sense where some of that can be given back productively.

Right. It is broad based and we certainly do not think a lot about price elasticity. Well, we think about price elasticity in one direction. If we lower the price, will we sell more? And if you think back, John, two or three years ago when we kind of restructured the MVM, which had worked well and grew sequentially over 15 plus years, and it was a little stale. And so we changed it out, fewer items at greater values each. And what we found is on some cases it worked and on some cases it didn't. But I don't think we ever think about what if we raise the price and sell 2% less units.

Yeah, I'm thinking more of it on the if we cut the price, if we reinvest some of our core on core benefit, can we get more share or are we just pushing on a string?

We do that. I think we try the most extreme example of seeing can we drive more value or more volume. And if we can't, we don't stubbornly push on the string in every case.

All right. And then secondly, where do you think we stand gross and net openings for next year? Right. So I know you probably have wanted to get up both of those, right? Gross openings, probably in the high 20s and maybe a bit higher than it's been. And obviously, you'll open Shanghai, but what's going on with China? Does that give you any pause for additional openings beyond Shanghai or no, you're still looking for real estate?

Well, at this juncture, Mike, we have two locations. One we're opening this late summer and one we would all things go well about a year, almost two years from now. So let's say a year and a half plus after the first one opens. That's not that different than what we've done in other countries. I think in Australia, we opened three over the first four years. I think in Japan, we opened five. We opened actually, we went fast. We opened six over five years. In Spain, we opened two over four years. So that's not inconsistent. When they're there, Craig and the real estate guys and Jim Murphy, the head of international and the local country managers, they're looking at other sites. But right now, we want to get the... Look, China is a little unique in many ways. Aside from any issues right now with tariffs, that's not hopefully a long-term issue. Each item has to be registered separately. We're fortunate in the sense that we have a successful operation in Taiwan, which we were able to bring some key people. But we want to hire from within and like we do in other countries, start with a very small core group of people that are expats, but really grow it internally. And if it's also... What we've said is if a new country is very successful, we're perfectly happy to have a couple of units over the first two or three years and four or five total units four or five years after we opened our first. We'll go from there. And your thoughts on openings this coming year?

Excuse me? This coming year, 2019, August of 20, early thought on gross and net, where that goes to? I

think that this year will look about the same as

this year. All right. So like mid-20s gross and low-20s net? Yes. Okay. All right. Thank you.

Your next question, Kim from Dwyane. Scott Mushkin from Wolf Research. Scott, you are now live.

Hey, guys. Thanks for taking my questions. Richard, you talked about driving top line sales, and that's the key to the company. Everything else takes care of itself. And if you kind of look back over the last five years, you did a huge expansion, even blew out a number of centers to add to the fresh. So I think that helped a lot. The credit card helped a lot. When you look out over the next year or two or three, what do you see as already substantial? What do you see as similar type of sales drivers? Potential?

Well, I think we continue to see... First of all, fresh foods continues to evolve and grow. Specialty items within both food and non-food, organic, both fresh and shelf stable. One of the things that's... Again, the good news in my view is there's lots of little things, not one giant thing. We continue to add gas stations in other countries besides the US and Canada. It works. E-commerce, as I mentioned, we'll add it to two more countries this year. All those things add on each other. One of the things that we historically had not done a lot, and again, this is not a game changer overnight in terms of our performance, is we've been very good at taking items in the US and bringing them elsewhere. And maybe to a small extent, some Canadian items because of the size that we're up there. We've been bringing and continue to test items that we find in other countries that are high-end, specialty, unique items, and we're getting some success with that. It's a small thing right now, but we're very good at figuring out how to do that and taking it to the next step. So I think you're going to continue to... We're merchants and we're the best price. And I think that's more than anything what you'll see with us. I think we're doing a better job on the membership side in terms of converting people to executive. We're still seeing good sign-ups with the credit card. And as those rewards get bigger, we believe that that member becomes even more loyal. So I think we've continued to see... The good news is some of the concerns that many of you have had over the years that we haven't moved fast enough in certain areas, whether it's the internet or e-commerce, there's a lot of low hanging fruit out there and we're benefiting from some of that. So I got to tell you, I go to every budget meeting and you hear the merchants or the merchants from some of the other countries talk about some things that we're doing. And I think that's exciting. We're now at the size from a value proposition. There's certain bulk, high-volume Kirkland items and paper goods and the like, water, where we're now at a size where we can produce them in another country at the same quality level and dramatically lower the freight cost. Now, this is not across the board on everything, but there's lots of those types of opportunities that we continue to do. There's not a shortage of things to stay busy trying to drive our business around here that we feel pretty good about.

Perfect. Then my follow-up question really goes to the competitive climate and we're seeing that maybe one of your competitors, biggest competitors is kind of tacked a little bit differently. Maybe they were investing a lot in price a year ago and not so much now. Is that part of what's going on with the core and core gross margins is that the competitive climate is just a little bit easier?

It's really across the board with traditional retail as well. One of the things that I've mentioned on the last few quarters calls on the SAM side is on the fresh side, they've become and continue to be more competitive than they had been historically. That's the nature of the beast. Again, we're not competing with just one direct competitor. We're competing with traditional merchandise retailers and supermarkets. On an overall basis, we haven't seen any dramatic change.

So you'd say the competitive climate is stable, not worsening, not getting better?

I think that's fair.

All right, guys, thanks for taking my questions. Appreciate it.

Why don't we take two last questions?

Here next question comes from the line of Rupesh Haig from Openheimer. Rupesh, you are now live.

Good afternoon. This is actually Erica Ilon for Rupesh. Thanks for taking our question. I was actually hoping to dive a little bit deeper into your online grocery efforts. Can you maybe talk a little bit more about how the Instacart and dry grocery ramps are going so far and what you're seeing with these offerings? Then any metrics you can provide such as type of basket you're seeing and how you're viewing the incrementality of the purchase, etc. would be far.

First of all, with two-day dry, which we do with UPS, it's now the entire continental United States. Much of it arrives in one day, but we guarantee two days. It's expanding and we're actually getting a small number of sign-ups where that member is signing up just to receive online because they're too far away from driving. On Instacart, they too, as you I'm sure know, have dramatically increased their geographic footprint over the last two or three years. I think the thing that's most notable is that the value proposition to someone buying either directly from Instacart going to their site or going to our same-day grocery site, one day, one day, sorry, one day grocery site, which is the Instacart engine for fresh, we've dramatically improved the value proposition over the last two years. I think that's reflective of the fact that they've grown and have their own structure in place. If we believe we can be that anchor type customer, anchor type tenant in terms of driving value. We have sequentially, I think now four times, brought down pricing over the last two years of what the ultimate markup on goods is above what you can walk into a Costco and buy it for. We're doing more business. It's growing at big numbers, high double digit numbers, but it's on a small base.

Okay, great. Thank you.

Thank you. Your last question comes from the line of Simon Seigel from Nomura. Simon, your line's now live.

Hey guys, it's Steve McManus on for Semi and thanks for taking our questions. So apparel's obviously been a huge call out for you guys, but it looks like the soft line comps have been trending a little bit lower over the last couple of months, kind of towards the mid single digit range. Can you just give us some color on what you're seeing within the category? Notable call outs there?

Hold on. Within soft lines is jewelry. That's been a little soft.

Household furniture,

although some of that had to do with, I don't know, it's been a little

soft. All right, if I could squeeze one more in. On the MFI growth, did you guys call out what exactly was the fee-high contribution for the quarter?

10

million. 10 million?

Yes. All right, great. Thanks guys. Thank you very much. Have a good afternoon everyone.

Thank you. And that includes Costco's third quarter earnings conference call. Thank you for joining. Hear me now,