Costco Wholesale Corporation

Ladies and gentlemen, thank you for standing by and welcome to the Q1 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Richard Galante, CFO. Please go ahead, sir.

Thank you, Lori, 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 or 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 first quarter of fiscal 2020. The 12 weeks ended November 24th. Reporting an income for the quarter came in at $844 million or $1.90 per share, compared to $767 million or $1.73 a share last year in the first quarter. This year's first quarter results included a $77 million or $0.17 per share income tax benefit related to stock-based compensation. Last year's first quarter results included a $59 million or $0.13 per share income tax benefit related to stock-based compensation. Net sales for the quarter came in at $36.24 billion, a .6% increase over the $34.31 billion sold during the first quarter of last year. Comparable sales for the first quarter of fiscal 2020 in the U.S. on a reported basis was 4.7%. Ex-gas deflation was 5.0%. Canada reported at 2.9%. Ex-gas deflation and FX plus 5.1%. Other international reported 3.2%. Ex-gas deflation and FX plus 4.5%. So total company was a 4.3 reported and ex-gas deflation and FX a 5.0%. E-commerce on a reported basis was a .5% and a .7% on a reported basis. Total and comparable company sales for the quarter were negatively impacted by approximately .5% due to Thanksgiving occurring a week later this year. E-commerce sales in the quarter were negatively impacted by an estimated 12 percentage points. So again, the 5.5 and the 5.7 were impacted to the negative by 12 percentage points. In terms of Q1 comp sales metrics, first quarter traffic or shopping frequency increased .4% worldwide and .1% in the U.S. This again includes the impact of the Thanksgiving holiday shift. Weakening foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 30 basis points. And gasoline price deflation negatively impacted sales by approximately 40 basis points. Our average transaction or ticket was up 9 tenths of 1% during the quarter, including the negative impacts of gas deflation, FX and the holiday shift. Next on the income statement, membership fee income. Reported membership fee income came in at $804 million, up .1% or $46 million from last year's $758 million. Deflation of foreign FX currencies would have impacted that by a million to the negative, so it would have been about a million higher FX. In terms of renewal rates, at Q1N, our U.S. and Canada renewal rates came in at .9% and worldwide rate was 88.4%. Both of these figures remaining at the same renewal rate levels that were achieved at the 12 weeks ago at the fiscal year end. In terms of number of members at Q1N, member households and total cardholders, at Q4N back in September 1st, we had 53.9 million member households. That at Q1N 12 weeks later was 54.7 million and total cardholders increased from fiscal year end of 98.5 million to 99.9 million at Q1N. During the quarter, we had three new openings all in the U.S., a business center in Dallas, Texas and two additional Costco warehouses in Connecticut and Minnesota. We also relocated one of our units in Canada. At Q1N, paid executive memberships were totaled at 21.4 million, an increase of 579,000 or 48,000 per week since Q4N. This included the recent launch of offering executive memberships to our members for the first time as of the beginning of the fiscal year. Even taking those out, the average weekly increase would have been, the new Japan executive members would have been 41,000 a week. Going down to the gross margin line, our reported gross margin in the fourth quarter was higher year over year by 30 basis points, coming in at .05% as compared to a year ago 10.75%. And again, our reported basis 30x gas deflation would have been plus 26. Doing the little chart that we do each quarter, two columns, reported and x gas deflation. First line item would be core merchandise year over year in Q1 of 20 compared to a year earlier quarter. Minus three basis points on a reported basis and minus six on a x gas deflation basis. Ancillary businesses plus 20 and plus 19. No change to the 2% reward. And other was plus 13 and plus 13. So a total of plus 30 basis points on a reported basis and plus 26x deflation. Now the core merchandise component of gross margin, again, lower by three year over year reported minus six x gas deflation. Looking at the core merchandise categories in relation to their own sales, core on core, if you will, margins year over year were higher by four basis points. Subcategories within the core margins, year over year in Q1 showed increases in hard lines, soft lines and food and sundries, and a decrease in fresh foods. Nearly all of that decrease in fresh foods was the result of the initial operating losses from our new poultry complex. That will be a small headwind throughout the year. Recall that we commenced operations at the Nebraska Chicken Plant on September 10th with a roughly a 45 week plan to get to full production and processing capacity. We're currently on track to do so. Ancillary and other business gross margin, higher by 20, reported in 19x gas deflation. The highlights being year over year being gas, optical, tire shop and hearing aids. The other, the plus 13 compared to a year ago, this relates to what we mentioned last year in the quarter, to adjusting our estimate of breakage on rewards for the City Visa co-branded card program last year. And that was again, so a comparison of the hit last year versus zero this year. Moving to SG&A, our reported SG&A percentage in Q1 over Q1 year over year was higher by 17 basis points, coming in at .30% up from .13% last year. X gas deflation, SG&A was higher or worse by 13 basis points. Again, the little matrix that we do, both reported and without gas deflation. Operations, minus nine basis points, meaning higher by nine basis points versus minus five basis points in Q, X deflation. Central, minus four and minus four. Stock compensation, minus four and minus four. For a total, again, of minus 17 and minus 13. The figure, these figures include, in terms of the core being minus five on a X gas deflation basis, this figure includes the impact from the wage increases that we've talked about in the last couple of quarters. That occurred, this impact relates to the wage increases that occurred in March of 2019, which hit the year over year comparison by three to four basis points in the quarter. As mentioned previously, we would expect a similar impact that will occur in Q2 before we anniversary that wage increase midway through Q3. Central was higher again by four basis points year over year. IT was the biggest driver of the increases. We continued not only to maintain and upgrade, but expand our capabilities and activities. And certainly we have a lot going on there. And stock comp, again, minus four basis points to hit there. That hit usually is in Q1 year over year, based on the fact that we grant our issues in that quarter and how we do things for employees 25, 30 and 35 years out. On the income statement, next on it is the pre-opening expense. It's lower by 8 million. It came in at 14 million dollars this year in the first quarter versus 22. This year in the quarter, we had four total openings, three plus the relocation. Last year, we had eight total openings, six plus two relocations. All totaled operating income in Q1 increased by 11.8 percent, coming in at a billion 61 million this year compared to 949 million last year. Below the operating income line, interest expense was 2 million higher year over year. 38 this year in Q1 compared to 36 million last year. Interest income another for the quarter was higher or better by 13 million. Interest income was actually higher by 11 and other the plus 2 million variance was primarily favorable FX year over year. Overall pre-tax income in the first quarter of 2020 was up 13 percent, coming in at a billion 58 compared to last year's 935. In terms of income taxes, our reported tax rate in Q1 2020 was 19.1 percent compared to 16.9 percent in Q1 of last year. Both of these first quarter tax rates this year and last year benefited from the tax treatment of stock based compensation as mentioned earlier. Last year's rate also benefited from an additional discrete items, which we mentioned in the quarter last year. A few other items of note, in terms of warehouse expansion, we expect to open net new units of somewhere around 20 plus or minus. With a lot of it planned to open new openings, much of it back loaded towards the end of the fiscal year. As of Q1 end, we had total warehouse square footage of 114 million square feet. Regarding capital expenditures, in Q1 our total spend was approximately 700 million dollars. And our estimate of CapEx for all of fiscal 20 remains right around the three billion dollar amount. In terms of e-commerce, our overall e-commerce sales on a reported base in the quarter was a 5.5 as I mentioned earlier. And again, FX a 5.7. Again, those numbers you could add 12 roughly 12 percentage points to each of those to account for our estimate of the impact of the holiday shift. A few of the stronger departments are home furnishings, domestics, tires and pharmacy. Majors electronics were not among those departments as we feel that was the most, we believe was the one most impacted by the holiday shift. Total online grocery continues to grow at a faster rate than the core e-commerce e-commerce comps. Although again, it's still a relatively small piece of the business. New online during the quarter, expanded tickets offerings including airline gift cards, Lyft and Uber cards and Super Bowl packages. We also during the quarter launched as a test in a few locations, same day prescription RX delivery with Instacart. And we launched in the quarter same day alcohol delivery also through Instacart in California such that as of today it's being offered in 12 states. And lastly this week, earlier this week we launched our Japan e-commerce site with our Australia site planned to open in the first half of 2020, calendar 2020. In terms of tariffs, there continues to be a lot of moving parts and changes up to and including an hour ago. Currently there again are, you know, there are three and a half lists if you will, lists one, two, three and four A totaling about $360 billion worth of imports. There were possibilities that there would be four B list would go into place December 15th. Although the current news out today is that China and the US are close to a deal and finalizing a phase one part of the trade deal. And so we'll have to wait and see. In terms of EU, currently again there's seven and a half billion dollars of US imports that are subject to a current 25% tariff. Mostly food items like olive oil, cheese, wine, whiskey, butter, cookies, etc. Again, last week, last Monday the White House announced that it proposed 100% tariff, an increase to 100% tariff on $24 billion in imports which would include those and my other items. We'll just have to wait and see where that is. I believe comments aren't even anticipated to be complete until early to mid January. That's pretty much it on our part. Lastly, in terms of upcoming releases, we will announce our December sales results for the five weeks ending Sunday, January 5th on Wednesday, January 8th after market close. And with that, I'll open it up to Q&A and turn it back to Lori. Thank you.

Ladies and gentlemen, as a reminder, to ask a question you will need to press star one on your telephone. To withdraw your question, press the pound key. Your first question comes from the line of Christopher Harbers from JP Morgan. Please ask your question.

Thanks. Good evening. So I just want to step back and get your thoughts in terms of how you plan the holiday season this year given that there are six fewer days. Seems like a lot of retailers are expecting a big surge at the end, bigger than normal into Christmas given the shortened season. Is that something you, I'm not asking about December, just how you planned it. Is it something you saw in 2013? Is it something you're planning for in 2019? And you know, maybe any comment through, you know, what you've reported so far?

No, I think we planned it and with some historical knowledge of what's happened in the past when you've got the shortest period of time between Thanksgiving and Christmas. And we, you know, plan assuming that we're going to continue to have, you know, the types of levels of comps that we have in general, recognizing sometimes there's a switch between months as example of being, you know, the switch in Thanksgiving being in November versus Q1 rather versus Q2 for us in our example. But so yes, we do expect to ramp up on a per day basis. We'll have to wait and see where it goes. But we went into the planning, I think with the confidence that we've had, you know, good shopping frequency increases and good renewal rates and pretty good comps.

Understood. And then, you know, in the pricing environment, it seems like SAMS has been taking some bigger hits to the gross margin line and it seems to be benefiting comps. So are you seeing a step up in terms of in that core club channel? Are you seeing a step up in price investment from your peers?

In a word,

no. Got it. Fair enough. And then my last question is, you know, in 2Q, you're going to lap, I think, a pretty big benefit on in the ancillary line last year. I think it was up 33 basis points. Big part of that being gas, you know. So you're going to have, you know, gas prices. Do we have to give that all back? I mean, gas prices look like they will be up, you know, year over year at this point. But, you know, it's still going to be down a bit sequentially. And I know there's an interplay between those two dynamics. So any thoughts? And you could give us around lapping that 33 basis points, given those dynamics would be super helpful.

Well, I think profitability for gas for us, as we've read from other retailers, big retailers that have gas stations as part of their retail concept. It's the new normal over the last few years is it's been a more profitable business. We, I think, benefit from the fact that we've seen our gallon increases on a comp basis in the very high single digits compared. So we know we're taking market share. Despite increased profitability in that business, you know, our savings in our view when we do price shops of competitors gas has never been as strong. So we feel very good about where we are with that. Now, sequentially part of the increase when you look at it on a year over your basis, you know, last year's plus 30 or what I don't have in front of me. But whatever it was had as much to do as what it was the year before. I think when you again, when you read what others have said and what we've said in the last couple of quarters, it's been pretty good for all of us. So it may be you're not going to see that kind of Delta on top of the big Delta last year, but it's still nor nor are you going to see the big negative from that negative from it coming back to two years ago. But we'll have to wait and see. The thing we've learned about gas profitability is it can be very fleeting right now. So it's been good as it was last quarter and as it was over the last couple of years in general, but you never know how to predict it from sometimes week to week.

Awesome guys. Have a great holiday. Thanks so much.

Your next question comes from the line of Michael Lasser from UBS. Your line is now open.

Good evening. Thanks a lot for taking my question. Richard, you touched on this briefly, but how have tariffs impacted Costco's profitability? And if some of the tariffs are rolled back, how is Costco going to handle this? Should we be modeling margin benefit over the next couple of quarters from this dynamic?

Look, I think generally we've said on a qualitative basis that overall, I think companies of scale and certainly we are one of those and the fact that we feel that we've had a relatively good mitigation plan, if you will, easier on a 10% tariff than a 25. I think one thing again on top of our scale in general, our ability to move in and out of items. You know, if all of your items are 25% tariff because you are a furniture retailer or whatever retailer, that's different than a company that has a small percentage of our business in that area. You know, like others, we've moved a few things where we can and sourced it up in other countries. I think our total China imports into the US is about, you know, just a few percentage points lower than a year ago. So nobody can do a lot of that, nor can we. But generally speaking, I don't think it's hard enough for us to budget into our numbers. What we look at is the fact that in some cases where the price has gone up and we've passed on all or some of it, we haven't seen an impact to the unit sales and others we have. And we never know until it happens which ones, you know, are more elastic than others, if you will. But at the end of the day, we think that we've done as good as anybody in terms of being able to mitigate the impact. And so again, I think the fact that our margins are core and core margins, generally speaking, even in the departments like hard lines and soft lines have been slightly up here over here. And certainly we haven't done that without first and foremost being the most competitive out there. That makes us feel that it's... Now, we don't want it to continue and we don't want, you know, list 4b to come on or anything else to go higher. But I think we've done okay by it.

So in cases where you have taken price or re-engineered a product to make it cheaper, how do you handle that?

Well, first of all, I don't think ever we try to re-engineer a product. We're going to try to figure out how to get the price down a little bit with the help of our suppliers, sometimes our own money or whatever else we can do or moving a few items to another country. And sometimes eliminating an item and putting something else in its place here. So I remember, I think one anecdotal story would be in late calendar 08 when the economic downturn hit hard. And what hit hard in our case was a lot of as good as our values were on, you know, $1,000 and $1,500 patio furniture. We had a lot of markdowns to take care to get through that in January, February and March when that stuff hit the floors. I can remember vividly, you know, come June following that when we were still in a bad economic downturn and our head of merchandising and our CEO reminding everybody at the budget meeting. I don't want to see us bring down the quality and stuff to hit a price point. I don't want, you know, we've taken, you know, 20, 30 years to get our members comfortable with the types of values we can bring, particularly on better end goods. And so, you know, might we buy a few less units of something? Yes. Might we augment a little bit with some offerings? Yes, but we try not to.

That's helpful. My follow-up question is, given the well-publicized website allergy over the holiday weekend, should we read that as Costco needs to make a more meaningful investment in its technology infrastructure to keep up with the growing size of that business?

Well, first of all, you know, we live it every day here and certainly, and we are. It was unfortunate, despite all the efforts to have plenty of capacity, processing capacity, if you will, there was something that that that incurred. Well, we looked at the five days between between Thanksgiving and Monday, Cyber Monday, those five days on a year over year basis. I mean, we still were up in the very high teams as a percentage on e-commerce. So consistent what we've showed you what we've currently been running. What tells us we could have done better than that. So we did leave something on the table there. And again, we were able to correct it. It took several hours that day, unfortunately, but rest assured. We're spending a lot of money on things like that.

Understood. Have a great holiday.

Your next question comes from the line of Chuck Grom from Gordon has kit. Please ask your question.

Good afternoon, Richard. First question on MFI, you know, now that we're we're past the fee increase in FX is normalizing. Just wondering if you see any material reason why the 6% growth you reported in the quarter wouldn't be a good proxy in the coming quarters.

Well, who knows? Certainly, you know, what are the reasons why it's growing a little faster than the total sales line? A little of its, you know, a couple of recent openings like the China opening. That's a little of it. I think more importantly, it's some of the things that we have done a much better job of getting new members to sign up as an executive member. You saw the terms of the number of new member, which is a combination of new membership signing up as an executive member as well as conversions to the executive member. We're doing a better job of that as well. And of course that aside from improving membership fees, they are more loyal member that shot more frequently and renew more at a slightly higher rate. And so I think a lot of is some of the things that we're doing getting those that use, you know, the the growing number of members in the U. I'm using us example here with the city Visa card, you know, signing up for that and having auto renewal as well as opting into auto renewal on on other Visa. Cards that somebody may choose to use at Costco. And so those are the things that help as well. I'd like to think it's all related to just great value and that's more things that we offer the member, which is certainly part of it too.

Okay, that's great. And just to just switch over to the balance sheet a little bit, you know, inventory levels were a little bit heavier. I presume that's just the timing of Thanksgiving anyway to normalize for that maybe, you know, inventory per club or some other metric just to get a sense for what sort of apples to apples would look like.

Yeah, well, I think it's mostly the the the the shift of holiday. Some of it is a build up with e-commerce and those holidays as well with more in the system, you know, doing more fulfillment on that side. It's you know, again, in a few days since then, it's come down as we've expected. So I don't think there's a whole lot to read into it.

Okay, great. And then just last one on the core of core up for maybe quantify for us the the drag that you're going to continue to see that and then what you saw here in the current quarter from the from the chicken plant just to get a sense for how much that was to the quarter.

Well, if you think about if we open the chicken plant, the first chicken, if you will, went through on January on September 10th, hopefully 45 weeks later, there'll be roughly 2.2 million chickens a week going through there. The first three months, if you will, which is Q1 here, September, October and part of most of November, you were at the lowest end of that. I don't want to straight line it completely, but it's close enough for this discussion going from one chicken to 2.2 million chickens. If you will, there's there's a lot of operating costs and running the plant. And while we don't have both production lines running yet, we now there's just a lot of costs associated with that. So it'll be a diminish. It should be a diminishing drag in Q2 and then Q3 and then Q4 and then not be an issue. Makes sense. Thanks a lot.

And we have a Chris Mandeville from Jeff Rees. Please ask your question. Your line is now open.

Here is a quick question on central SGA so much Michael, just curious with respect to the IT investment. If we should be assuming that that pressure that was realized in the quarter actually progressively gets a little bit more prominent on a go forward basis. I don't know if that's what you were trying to reference or allude to with respect to expanding your capabilities and activities, or if we should be thinking about something similar on a go forward basis.

If I look over the last several years with that word, we've stopped using completely called modernization. And now it's some modernization, but other things as well. We talked about the last I talked about the last several quarters, things like a comp fulfillment, spending a lot of money on that. A lot of that hits SGA in terms of all that technology. The chicken plant to some extent. There's we've also over the last couple years done a reset of certain departments within IT based on salary, comp, wage competition in this part of the woods up here in the Northwest. So, I mean, there's a lot of things that go into it and we've got a lot going on, whether it's Ecom, you know, continued increases in infrastructure and vertical integration as well as our depot operations and modernization. So, I don't know. I think there when we first started talking about modernization years ago, it was just that on as best we could, we estimated, you know, originally over a few years, it would be an incremental 10 basis points to the company. And then quickly we felt it could be 13 and ultimately it was 18 or 19. And then there are a couple of years when on a quarter over quarter basis, some quarters it was six and some quarters it was zero or two or zero. So, I think a couple of quarters ago, maybe three quarters ago, it was flat year over year that had that impact. And I reminded people don't that don't read anything to that like we've hit an inflection point. We have a lot going on both related to modernization stuff as well as expanding as well as vertical integration. So, my guess is it'll still be a negative year over year. Does a negative when when those negatives anniversary of your hands, will we have incremental negative net? I can't say at some point it's supposed to slow down.

Okay. And then just my follow would be with respect to the Instacart pilot and delivering RX to your members. I guess just what exactly you're attempting to accomplish there. Is the structure of delivering pharmacy any different in terms of how you're approaching things from a grocery perspective?

Yeah, well, I mean, look, it's convenient. Like anything in life out there, as you might expect, we're always asked when are you going to start to do online and pick up in store? When are you going to do this? When are you going to have something else? You know, and we kind of do things our own way. We looked at we look at all these things and this is one area that with the Instacart relationship where we have, you know, them already coming into our locations. Let's give this a shot. We already have a good and growing mail order business. We have five hundred and whatever forty ish pharmacies around the country. But this is not another opportunity. Pharmacies are sometimes somebody does want to come out if they're not feeling well. And so it was an opportunity given, you know, and as density increases, that should help. But you've already got these drivers delivering groceries to others. Hopefully we can do this. And and it is something to add to the competitive belt here.

That notable impact, the ones kind of RX margin profile, I guess I'm just curious about that the economics are

now. No, first of all, it's brand new and it's just a few locations who roll out to a few more shortly. So we'll see where it goes. All right.

Thanks.

Your next question is from Simeon Guptman from Morgan Stanley. Please ask your question.

Hi there. This is Michael Kessler on for Simeon. So question on the competitive environment. We've seen Sam's Club undergoing an unexpected round of investments recently. And I guess is there anything notable that you would feel the need to respond to as far as what they're doing or anything that changes on your end from from some of their investments?

Not really. I mean, look, our warehouse managers are in their locations every week. We hear about it and I hear about it here every month by location or by region rather. And and look, they're they're a good operator and a good competitor. And we feel that we do a lot of things very well, too. And and but there's nothing that I can point out. You know, a year or so ago, you know, we had pointed out that they had gotten a little more aggressive on fresh. And, you know, some of these things ebb and flow. But at the end of the day, we feel very good about our competitive position.

Got it. OK, great. And just one follow up on China, the news story that you open there, you're a little further away from the opening. Is there anything notable that you've learned over the last couple of months and any changes to your plans as far as the the rollout, which I know is a little more on the slower side. But any updates on that on that front?

Well, first of all, on the rollout side, we have one one other one plan which was planned previously. Probably about a year and a quarter year and a half away. And and, you know, we'll continue to look to see what we want to do next. But not a lot of change there. There's overall it's the location has exceeded our expectations. You know, we brought in additional help from from neighboring places to help. But, you know, the sales continue to grow. The signups continue to do very well there. And we'll see. So we've got a great reception. We feel good about, you know, from a merchandising standpoint and maintaining a supply chain. Very good. And we're getting, I think, good reviews over there. We've also identified a few items, one in particular that is again just anecdotal. We've done a very good job over there with sea cucumbers, which I still have never tried. But we have found is is particularly on the West Coast in several cities where you've got customers that value that as a great item. We have done very well. So just like anything in life, we have found items that make sense in other parts of our operation throughout the world. It's fun to see out there and it's a high value, a high price item and a great value across.

All right. Thank you.

And we have a question from the line of Greg that is Kenyan from city. Your line is now open.

Hi, this is actually Spencer Hanneson for Greg. You guys called out some sales headwinds related to the Web site issue. Do you think those sales have been lost or do you think they were just pushed out?

I think some was pushed out. Some went to the warehouse and some was lost. You know, in the scope of things, given our whole company, recognizing that e-commerce, while growing faster than the rest of the of inline, is still five, a little over five percent of our company. So it's not, you know, I don't want to be cavalier about it. We didn't excite the members that were delayed. And but we feel we got some we extended the the values that hit the 30 plus million emails that we sent out it in the early hours of Thursday. We extended those deals for an extra two days. And so we think we got some of it back. And again, for that five day period, we did just fine. Frankly, we feel we did lose something that we could have done better than we had anticipated.

And then any comment on big ticket sales trends that you're seeing? And then how does the consumer feel heading into the holiday season this year?

Yes, big ticket items are strong, particularly, you know, electronics items. The fact that back in March or April this past year, we were able now to offer a full line of Apple products, including the Macs and the watches and the like. And we've done very well with those. And online, we've done even better with those. And it's not just the Apple products. It's other big ticket, you know, high end game computers and game consoles. Big screen TVs are huge, recognizing the price and value of those things for consumers keep coming down, which is great. Those are the things that have done very well for us. Thank you.

Your next question comes from the line of Karen Short from Barclays. Please ask your question. Hey, thanks very much.

Just a couple of questions, I guess, starting with the core on core. So you've obviously had pretty meaningful stability, I guess, in the core on core. And you alluded to this a couple of quarters ago in terms of your scale and your buying power. But I'm wondering if you could just frame a little bit on how we should think about core on core going forward, because it does seem like we're kind of in a new norm of that being stable to up generally.

Well, I think the fact is that you're right. All the things that we do to drive value or to get better pricing or based on our volume or curve from signature or whatever, you know, just when you think it's safe to go out, we're going to use it to drive business, which we've done. We talked in the past about, you know, the monies from increasing the membership fee, the monies from changing credit cards, the income tax reform, recognizing about a little over a third of the income tax reform went to improve hourly wages. But at the end of the day, those have given us additional monies to continue to drive value. And there are times when we see something, a particular department or something where the margin might be might be very strong year over year. That's the first thing we look at. Even if we're if we're giving a greater savings to the customer, you know, is it too much? And so again, we are a for profit business. We want to grow our top line first, and that'll help the other things. But we don't manage it completely to the basis point. That we'd like to see it year over year even or go up a little bit, but we have avenues to do that.

Okay. And then on tariffs, just specifically to the tariffs for this Sunday, if they were or were not to go into effect. Sorry, I'm just can you just clarify? I mean, you know, the rest of the list, like one through 4A, I guess, obviously is kind of already embedded. But is there anything to think about in terms of 4B does not go into effect with respect to your positioning or, you know, the model or anything?

Well, wait, we don't know. I mean, to the extent that we bought in advance certain merchandise to the extent we could, anticipating that that was going to go into place and so let's get it in before the tariff we did. But what's that? It wouldn't change. Right. So it's here saying it wouldn't change things immediately there. So if any, I mean, if anything, we've had a little extra inventory in advance of it.

Okay. And then last two for me is just housekeeping on inflation and food and also in non-food and then thoughts on cash on the balance sheet as it continues to build.

Thanks. Inflation is almost a non-issue. It's not either inflation or deflation, generally speaking. I mean, yes, we mentioned there's slightly deflationary year over year. Tariffs is slightly inflationary, of course, on those limited items. Yeah, proteins are up a little. My understanding that has to do partly with China and with swine flu as well as more demand for beef. Other than that, not a lot to talk about there. What was the other part of the question?

Oh, it's cash on the balance sheet building. Yes.

Yeah. Well, we have two debt payments coming due this week or next Monday, next week and in mid-February totaling a billion seven from prior debt offerings. Beyond that, of course, cash at the end of Q1 generally is the highest level because you've started to sell more, but you haven't paid for everything yet relative to seasonal stuff for Thanksgiving and Christmas. So our AP ratio is always the strongest then on a quarterly basis. Beyond that, stay tuned.

Okay. Great. Thanks. Have a great holiday.

Thank you.

And we have a question from John Heinbockel from Guggenheim Securities. Your line is now open.

So Richard, where do you stand now with self-checkout? I know you've been expanding that. How many clubs is that in? What are your learnings in terms of member satisfaction, speed of checkout? And then what do you think the rate of expansion of that is going to be?

Well, we currently have it in the U.S. and Canada at 135 locations. It's going well. We have another 92 planned for rollout in early calendar 2020, so up above in the low 200s. And the senior operators continue to discuss additional rollouts with Craig based on the performance, but overall it's a positive. And so we'll continue to do it as my expectation.

I mean, roughly speaking, when you think about savings, right, I don't know how material that is, but is there an idea that you reinvest that – can it be enough to reinvest back into the business in something like expanded BOPUS? Or I know you've been sort of reticent about BOPUS because of the cost. Is that something you can now begin to get your arms around or no?

Well, first of all, I think thoughts on either of those are mutually exclusive to one another. When I look at the millions or billions of front-end seconds we save in labor, we know full well that some of it is – you don't get it all back. But even if you take a conservative amount, there is money to be saved there. More importantly, the members like it. The only thing the member doesn't like is when there's a member in front of them that it's going through with a full basket and it's taking longer. But generally speaking, even the few high-volume units that I've actually gone to of late, like the ones in Seattle, and I use them when I'm in and out of there fast, they work well and fast. So there is a savings, but I think as well it improves that customer experience. As it relates to buy online and pick up in store, we continue to look at what others do and continue to scratch our head. Recognizing the average cost go, even compared to our two direct competitors, is two and almost three times the volume per location. Almost two and almost three times the volume per location. So we'll have to wait and see. We're still not at a point – we look at it, but we're not at a point that we're planning to do anything with that. Okay. Thank you.

Your next question is from Kate McShane from Goldman Sachs. Hi.

Good afternoon. Thanks for taking my question. We wanted to ask about apparel. I know that this is a category where you've been a little bit more focused. I wondered if you could give some color about the performance of apparel during the quarter, what you see the opportunity to be, and how Costco can kind of position itself to capture some share going into the next year.

Yeah, I think it's part of the same story that we talked about, fortunately, for the last few years. Apparel is a combination of both expanded Kirkland Signature as well as a few additional brands willing to sell us or expanding what they're selling us as well, and great value. And it's a category in the several billions of dollars that continues to grow in the roughly high single digits compared to retail apparel overall that's a lot less than that. So, and I think I'm always amazed at our monthly budget meetings when, in this case, buyers are bringing in and showing what's coming in for the new season, whether it's Adaware, you know, a few months ago Adaware for the fall, or both men's, women's, and children's stuff.

Thank you. Your next question is from Scott Ciaccarelli from RBC Capital Markets. Your line is now open.

Good evening, guys. Richard, I had a follow-up question on the Shanghai location. Can you just provide any context on the sign-up activity of that location relative to a more traditional facility?

It's what? No, I know. It's beyond good. I'm sitting here with my colleagues, what I'm allowed to say. You know, the average Costco in the world has somewhere in the -to-high 60,000s of member households. We've had locations in other countries in Asia where we might be at 100, 120,000 after a few years, maybe even after one or two years. This one is more than twice that. So I guess... I recognize that there's a lot of press in a city that is populated with 25-plus million people.

Yep, I understand. So just given the fact that in the past you kind of talked about how long it takes locations to hit a break-even point, I guess given the early sales and membership trajectory of that location, does that change how you're kind of thinking about the break-even point for that warehouse and hence the China opportunity? Or do you need more distribution scale to really get the profitability to where you want it?

Well, you know, getting to seven or eight or ten locations in a country where a bunch of stuff is American-supplied or barge-shipped, not air-flown, you know, you become more efficient as you go from one to three. You're maybe using some third-party consolidation or storage to do high-volume bulk items because you don't want to run out of water or toilet paper, as you may, the no-brainer items. And over time, by the time we get up to eight or ten, we want to have a bigger cross-stack that then can... with enough land to continue to expand it over time. You know, cross-stacks in the U.S. and Canada serve 40 to 60 locations each and 40 to 60 relatively high-volume locations. So we have one in Australia that services 11 locations. That will continue to be a little bit of economic improvement to that country as it serves 15 and 20 locations. We've opened two in Japan, essentially south and north, for all of 26 or 27 locations. We plan to have a lot more there over time. So certainly, in addition, we have a lot of extra help there. We're doing big volume. And, you know, we brought over additional people from Taiwan that, you know, speak the local language and that understand our concept. And it's been great. We've been fortunate to have that additional history and expertise when we've gone there. But also, it's cost some more. So I think you've got to... you know, what is the normal once it's doing whatever volume it's doing and, you know, it's efficiently run at the warehouse? Maybe you don't have all the efficiencies from cross-stock. That will take several years. But the most efficiencies are what's in the building and how many people do you need to help that process and you become more efficient. So I think it takes a couple of years to do that. And that's one of the reasons why we generally go slow in new countries because we want to get it right from a customer experience and an operational side. Got it. Very helpful.

Thank you.

Your next question is from Oliver Chen from Cowan & Company. Your line is now open.

Hi. Thank you, Richard. On your digital innovation roadmap, what are your thoughts about fulfillment from in-store and micro-fulfillment centers and also thinking about the robotic capabilities across inventory management or supply chain from in-store? We'd love your thoughts.

Well, we have, you know, just because of what we did currently a couple of years ago, we have our business centers that act as a focal point, as you know, for today. We have our depot operations. We've moved some of that fulfillment to annexes off some of our depots as well. We put in to our biggest depot some automation fulfillment, which I talked about over the last few quarters, last six months, and we continue to roll some of that out. You know, one of the things we've done is particularly things like how do we improve the time, particularly if items that might even be presented in store but are only sold online like white goods or what I'll call big and bulky. And those that require not only installation but sometimes take away the old one. While many third parties do that, we do a little of it, we've also figured out what are some of these items based on our volumes that can be staged efficiently in, you know, a dozen, I'm making the number up, but a dozen geographic locations across the continent of the United States to take the shipping times down dramatically. And we've done some of that stuff, and that's evolved over the last couple of years, and we'll do more. You know, you've got a business just white goods, and that's certainly not the only big and bulky. There's furniture, there's patio stuff, there's exercise equipment, but just on white goods, you know, we've gone from essentially sub-50 million a year four years ago to over 650 and growing. And that's part of that is not just selling this stuff at great prices, it's getting it delivered to you in fewer days.

Okay, and Richard, on the vertical integration opportunities ahead, what are you thinking could or should be possible, and what's your framework for evaluating what makes sense for you in terms of owning, you know, more parts of the supply chain across different categories?

Well, you know, what started 25 years ago was a ground beef plant to save four sixths of a pound, we thought, on ground beef is now, are now two major meat plants, one in Tracy, California, where we started, and one in Illinois, which is still growing into itself over the last year and a half, two years since it opened. I think the one in California does well over four million pounds a week of just a handful of items that we, that's out there in ours. That gave us comments to the hot dog plant. We did almost partly by necessity a bakery commissary in Canada, which we're finding can serve not only Canada but the US on making more consistent and more efficiently crusted items like cookie dough and croissants. So we learn each time we do something. I think there's been some press out there about testing a greenhouses for produce. We've got one up and running just the last few months in California that I think some of the product is just starting to hit our shelves. But we think there's some great opportunities on the produce side for hot houses and greenhouses, if you will, particularly where transportation costs and time is a necessity on stuff that spoils quickly and easily. Right now, much of the produce that we ship to our Hawaii locations is air shipped. If you can do some more of that over there, that's a no-brainer. And given our volume and limited SKUs, we think that it's an efficient model to help. But that's not just us. Others are trying that. Again, we think that the structure of our business allows us to take more advantage of that, but it's new. I don't know if there's anything big. There's nothing as big as the chicken complex on the drawing boards. But I think we'll continue to do things. But we're catching our breath a little bit right now. We've made some major investments in a second leaf plant, in the bakery commissary, just recently in the chicken complex, and even more recently, the first of a few green hot houses. So we've got a lot going on. And the answer is it works. So far, so good.

And our last question, Richard, Kirkland is a nice competitive advantage. What are your thoughts on how that percentage of mix may increase and categories that it may be suitable for that you're not in yet? And also, you cited new services that you've added to your product assortment. How will services evolve as a percentage of total? I just would love the magnitude of what may happen there over time.

Well, on the Kirkland Senior side, there aren't a lot of half a billion and billion dollar items like water and various paper goods and things like that. And there are many, but not a lot of many new few hundred million dollar items. But at the end of the day, there's lots of 20 and 50 million dollar items that can go to 50 and 100. And certainly, I think on high end packaged food items, on everything from not only organic, but antibiotic free. And I don't have all the adjectives in front of me, but there's lots of things that we can do that are high end and that our members want. And frankly, has added benefits of seemingly gets in the millennials on some of this stuff. But I think we've expanded it to some sporting goods. So there's lots of little things that will add to it. But if the number, and I don't have it exactly in front of me, but ex gas, if the number is 24 or 5%, does it go to 30 over the next 10 or 15 years? Maybe. We think it's going to go up. Yes, likely a little bit because we found ourselves and our ability and our suppliers. Some of our private label suppliers are very good at what they do. But we also are still a branded retailer. We have very good savings, as you know, on branded items. On the service side, we don't talk about a lot because they're small relative to the size of our company. But it's other things that make the membership sticky and are very profitable, whether it's the Costco auto program or our travel business, which continues to grow. So we now a year or so ago, we added the hotel only bookie engine and more recently the airline reservation only, not just packaged items, you know, packaged trips and everything. And so I think we'll keep adding things. I can't tell you what yet, but we keep looking at things.

Great. Happy holidays. Thank you.

Your next question is from Greg Melick from Evercore ISI. Your line is now open.

Hi, thanks, Richard. I wanted to get an update on how the private label card, now that you've had a few years for it to properly season and scale, anything you could say on the penetration or how the sales are doing outside the club and maybe link that to what the auto renewal rates are now as part of the renewal rates?

Yeah, I don't know if I'm ahead with the auto renewal rates. They're increasing. You know, the big issue is when we converted, you know, prior to conversion when it was the other provider, there was both the co-branded card plus other branded cards of that provider like Delta SkyMiles or something. And all those -co-brand ones, all those auto renewals went away, went to zero. So that had to be picked up over time and we saw that impact our overall renewal rate a little bit. The other thing is, is we continue to add new, increasing number of members that have this deco-brand card. And, you know, the value keeps getting better and bigger. And so we think that will continue to be additive. That's helped. I think overall we've also done a better job even when somebody walks in to sign up, not only to upgrade, but when they like to auto renew. And so all those things help. Certainly the Citi Visa is probably one of the biggest movers of that because of just the sheer size of it and the fact that we're still adding new cardholders to that.

Is Citi Visa doing, you know, multiples of sales outside of the club that it's doing in the club at this point?

There's certainly more sales being done outside. As there were over the 16 years of the previous relationship, that evolved over time. As we would have expected, this would be even greater than that outside versus inside spend. And that's where we have revenue share, which is good for us and them presumably. From the standpoint that the Visa card is offered at more smaller businesses, which tend to have higher merchant fees in general anyway. So it's a whole new additional market potential of revenue share to those people using that card. If my card is top of wallet, there were certain places previously that I couldn't use it, like the local dry cleaner or restaurant. Now I can.

Got it. And then you mentioned Japan and I think it was Australia coming for e-commerce, if you look around the world. Any early learnings out of the launch in Japan?

Other than it went well, it's been two days. So I'm happy to report I know nothing.

That's good to hear. Have a great holiday, Richard.

Thank you. Well, we have two more questions.

Your next question is from Scott Mushkin from R5 Capital. Your line is now open.

Hey, Richard. Thanks for taking my question. So I wanted to talk a little bit about, you know, maybe growth that's being left. I mean, obviously left on the table. Obviously your performance is incredible, but the number of club openings come down a little bit. You might think through Omni Channel. So it's just as you take a step back, we look at our research, we look like you're kind of almost underserving certain markets in the U.S. How do you think about growth? Is it time to speed things up a little bit, get back up to the 30 clubs, maybe put a little bit more money behind Omni Channel? You know, kind of what's the company's thought process here?

I think I don't disagree with you. We want to open more than 20-ish units a year. Part of that was I think some delays in how long it took overseas. We've got the pipeline filled a little bit better. And, you know, five years ago I always said our hope and plan is to do more than we were doing. Today I would say the same thing. We do have, I think we'll increase it a little bit, but I can't exactly say by how many and when. We are a very hands-on company and we have a lot of other things going on. And, you know, certainly there's a lot of emphasis on the e-commerce side, not only getting into the few remaining countries, but building it. Not because we're supposed to, but it's working. And we think in some cases it's either sales that we would have lost anyway, like big white goods, you just don't sell those in store anymore. But we're getting people in the building still and using these things. So I think don't expect some giant change from 20 to 30 in a couple of years, but our goal is to work harder to open a few more of those while we're doing all these other things as well.

All right. Thanks very much.

And your question is from Kelly Bainier from BMO Capital. Your line is now open.

Hi, Richard. Thanks for fitting me in here. Just wanted to ask about executive penetration. I'm curious, and you called out Japan and the impact there a little bit, but just curious how much in the U.S. you're seeing executive penetration move higher. I know we've asked this over the years, but just where do you think that could kind of level out at some point?

Hold on a second. I had some numbers here. Hold on. When I look at my country, in the U.S. and Canada where it's been the longest and we've got the most units and the most services as part of the executive membership offering, it's in the mid-70s. In other countries where it's been, like Mexico, it's in the 50s and growing. But I think it starts off lower. I don't know if the marketing department has a plan for where it could go. It's more of what can we do to get people to convert and sign up originally. And so I think there's, you know, if I was shooting from the hip totally, you know, at some point there's going to be some members that don't want an executive membership, period. And even if it's provided them some savings. And there's some people that want it that sometimes it's not as much savings as they thought, but at the end they convert back. But at the end of the day, you know, I'd be thrilled to think that that could go to 80 one day, but I have no idea where and how long it'll take to get there. We know that executive members are more loyal in terms of their renewal rates. They shop more frequently and they spend more each year.

Got it. And maybe just one more on gross margin. Obviously, mix impacts some other retailers more than it really impacts you. But I guess over the years we've talked about things like private label organics or international or even e-commerce in terms of mix shift. And just curious as you kind of look at that core on core up for which clearly very stable. Just what what kind of mix shift is kind of underlying that?

Well, I think it's more than mixture. I mean, certainly gas has the biggest impact. Yes, is more than 10 percent of our business. It can be a gross margin line. First of all, as you enter deflation. So you could have the gross margin contribution plus or minus by a number of basis points. You have all these services while they're small work on higher gross margins than normal because they cover the pharmacy, the pharmacists and pharmacy techs and optically optometrists, things like that. And those are all growing businesses, generally growing a little faster. Some of them that the company travel as an example would be travel. Some of the things are gross sales and some of our brokerage fees. So a very high margin. There's there's there's really no very low cost of sales commission. But getting back to the core merchandise, private label generally is a slight positive. Although, again, the the percentage of stuff that's private label versus branded while growing is growing at a slower rate than it has in the past. So and then there's that magic word competition. Our view is, is we look, how do we drive the top line? How do we how can we be the most competitive? And we're fortunate that we have different buckets to do that with. So it's hard enough for us to know where the margins are going each month and each quarter, other than we wanted to be flatter up a little bit. And we want to go to the top line, which will which will solve a lot of things.

Understood. Thank you.

OK, well, thank you, everyone. Thank you,

Laurie. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.