Hi, my name is Luz, and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco Q1 2019 Earnings Call. All lines have been placed in mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you.
Mr. Richard Galanti, you may begin your conference.
Thank you, Louis, and good afternoon to everyone. I'll start by stating that these discussions will include forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call as well as other risks identified from time to time in the company's public statements and reports filed with the SEC. Forward looking statements speak only as of the date they are made, and the company does not undertake to update these statements, except as required by law.
In today's press release, we reported operating results for the Q1 of fiscal 2019, the 12 weeks that ended this past November 25. Net income for the quarter came in at $767,000,000 or $1.73 a share, 19.3 percent per share increase compared to $640,000,000 or $1.45 per share last year in the Q1. In comparing year over year operating results, there were 3 items noted in the release. 1, this year's Q1 benefited from a $59,000,000 or 0.13 dollars per share income tax benefit related to stock based compensation. Last year, the benefit was $41,000,000 or $0.09 a share in the Q1 of last year.
Number 2, the company also recognized an additional tax benefit this year of $27,000,000 or $0.06 a share. This related to the implementation of the 2017 Tax Act. And the 3rd item noted in the release, this year's Q1 results included a charge of $43,000,000 pre tax or $31,000,000 after tax, which is $0.07 a share for an adjustment to our estimate of breakage on rewards for the Citi Visa co branded credit card program. More on this in our discussion of gross margin. In terms of sales, net sales for the quarter came in at $34,310,000,000 a 10.3% increase over the $31,120,000,000 reported last year in the Q1.
In terms of comp sales in the release today, for the 12 week fiscal Q1, U. S. Comp sales on a reported basis were up 11.0 percent and ex not only gas inflation and FX, but revenue recognition, the 11 point 0 would be 8.3. Canada reported 2.4x, ex gas FX and revenue recognition, it would be plus 5.5x. Other international reported 4.0x those items plus 5.8.
So total company reported 8.8x gas FX and revenue recognition impact 7.5 plus. E commerce 12 weeks reported 32.3 percent and again ex those items plus 36.2 In terms of Q1 sales metrics, 1st quarter traffic or shopping frequency increased 4.9% worldwide and within the U. S. 5.2%. Weakening foreign currencies relative to the U.
S. Dollar negatively impacted sales, gas price inflation benefited Q1 comps and revenue recognition benefited as well. Combined those three items added about 130 basis points, essentially the difference you see between the 8.8 reported and the 7.5 that I mentioned above. Cannibalization weighed in on the comp by approximately minus 70 basis points. Our average front end transaction or ticket was up 3.7% during Q1 and excluding the impacts from gas and FX and revenue recognition, the average ticket was up approximately 2.4%.
Next on the income statement is membership. We reported an increase of 9.5 percent or $66,000,000 coming in, in the quarter at $758,000,000 in the first quarter this year compared to $692,000,000 last year. FX had a negative effect of approximately $6,400,000 So the 9.5% increase would have been about 10.4% ex FX. Reported membership revenue, again, was up 9 point 5, about half of that's related to the membership fee increases taken back in June of 2017. And as you all know, it takes about 23 months to get through the book part of the income statement, that benefit.
Our renewal rates also rose in Q1. Our U. S. And Canada membership remains in Q1 end or came in at 90.5%. That's up from 90.4% just 12 weeks earlier at Q4 end and worldwide rate improved to 88 point 0 percent also up a 10% up from 87.9% 12 weeks ago at Q4 end.
In terms of number of members at 1st quarter end, Gold Star at Q1 end was 41,300,000 that compares to 12 weeks earlier $40,700,000 Business primary $7,600,000 both at quarter end this first quarter end and year end. Business add ons stayed at 3.3%. All told, what we started the fiscal year or we ended last fiscal year with 51,600,000 members. We ended Q1 at 52.2. Our total cardholders at year end from last quarter was 94.3 and again at this Q1 end it was $95,400,000 We opened 6 new warehouses during the quarter.
Also at 1st quarter end, paid executive memberships came in totaled at $19,700,000 which is an increase of $442,000 or $37,000 a week since 12 weeks earlier. That's one of the biggest weekly deltas. Part of it depends on when we do different activities to get members to upgrade and as new members sign up as well. So you will see that fluctuate, but certainly a good showing in the quarter. Related to the annual fee increases, again, I mentioned earlier, we have now passed the halfway point in last year's Q4 of the 23 month cycle it takes to recognize the incremental benefit from the fee increase.
The benefit will continue to diminish in each of the remaining 3 quarters in Qs 2, 3 and 4, very little in Q4 actually. And again, that's based on the deferred accounting, which we use. Going down to the gross margin line, our reported gross margin in the 4th quarter was lower year over year by 50 basis points, coming in at 10.75% as compared to 11.25% a year earlier. Now excluding gas inflation and rev rec revenue recognition, that minus 50 would have been a minus 26. And I'll start with my line items, if you will, comparing this minus 50 to the minus 26.
If you just jot down 2 columns of numbers in 5 lines, the first line is core merchandise, the second line ancillary businesses, the 3rd line 2% reward on executive membership, the 4th line other and then the 5th line of course total. On a reported basis, the core merchandise year over year in Q1 was minus 43 basis points. Ex gas inflation and revenue recognition, the minus 43 would be minus 22. Ancillary businesses, which was a +5 reported, ex those items would have been a +11. 2 percent reward, 0 and a minus 2.
Other, minus 12 and minus 13. And if you add up those two columns, you get to the minus 50 reported and then ex gas inflation revenue recognition to minus 26. Now, again, going to the core with the minus 43, ex those items going to minus 22, that's again based on the sales penetration of that as compared to the total company as well. If you look at just the core merchandise categories in relation to their own sales, what I call core on core, margins year over year were lower by 6 basis points. Subcategories within core gross margin year over year in Q1, both food and sundries and hardlines were up and softlines and fresh foods were down.
The net of those 4 categories was a minus 6. Ancillary and other businesses, as I mentioned, reported plus 5, plus 11 ex gas and revenue recognition in the quarter. Gas was up, ecom was up a little, business end there was up a little, pharmacy, a couple of little things were down a little. But net of those all, they were up 11 basis points ex those items. The other that's the $43,000,000 pre tax amount that I mentioned earlier related to the Citi Visa co branded card and we put it here because it's part of the deal is things like the rewards that are paid out to the cardholders as well as bounties that are earned and revenues that are shared.
So this impacts the revenue of our company or the sales line and therefore it impacts the gross margin percentage. So the $43,000,000 this relates to our Citi Visa co branded credit card program. Over the past few months, we made the decision to expand our efforts to remind our members to redeem their outstanding rewards. By stepping up our reminders, we saw a step up in the redemptions relative to what we've experienced previously. These are the reward certificates that were sent out in February of 2018.
The rewards program on the Citi Visa card is a calendar year program. So these are the rewards certificates that were sent out in February of 2018 for rewards earned on Citi Visa Card transactions over calendar 2017 and that expire at the end of this calendar year. The $43,000,000 adjustment relates to 2 things. 1 to the thing I just explained, I described to the recent increase in these redemptions and second, the additional breakage amounts now estimated on the rewards being earned and accrued on calendar year 2018 card transactions. These rewards will be sent to these Citi Visa cardholders in February of 2019.
So what you see in this line is basically an adjustment to our estimate of breakage on rewards earned on purchases made prior to the beginning of fiscal 2019. Going forward, we are using this lower reward breakage assumption. Moving to SG and A, our SG and A percentage Q1 over Q1 was lower or better by 23 basis points on a reported basis and flat or 0 without gas inflation and revenue recognition. Again, it came in at 10.13% this year on a reported basis compared to 10.36 percent last year. Again, I'll ask you to jot down 2 columns and 5 line items.
The first column, of course, is reported and the second is ex those items. First line is operations, core operations. Q1 2019 reported was lower or better by 23 basis points and lower or better by 4 ex those items. Central, lower or better I'll use a plus sign. Central, plus 4 and plus 2.
Stock compensation, which is always the and then other is 0. So your total again reported the sum of those 3 line items plus 23 basis points or lower year over year on a reported basis by 23. And the second column basically flat year over year on a ex those items basis. The core operations component again was lower. This is primarily a result of sales growth in part offset in part by the U.
S. Wage increase to our hourly employees that went into effect to most of our hourly employees that went into effect on June 11. The wage increase negatively impacted SG and A by approximately 8 basis points in Q1 year over year and this will continue to impact the SG and A year over year comparisons over the next two quarters. I believe we did it effective June 11, 2017, so June 11, 2018, so we'll go through the same time period a year later. Our central expense was lower or better year over year by 4 on a reported basis and lower or better by 2 without those items.
Within that IT spend in the quarter was flat as a percentage of sales. Stock compensation, as I mentioned, the biggest impact typically is in the first quarter, but so you'll see a little bit of a difference there. Next on the income statement is preopening expense. It was $5,000,000 higher in this year's first quarter coming in at $22,000,000 compared to $17,000,000 a year earlier. We had one more opening this year, but there's plenty of other things going on, not just opening new warehouse with everything from chicken plants to expansion of depots and fulfillment.
All told, reported operating income in Q1 came in at 949,000,000 dollars compared to 951,000,000 in Q1 last year. 2 of the things I mentioned in this report, of course, is the $43,000,000 related to the Citi Rewards program as well as the hourly wage increases. Those are two things that have impacted the year over year comparison. Below the operating income line, reported interest expense was $1,000,000 lower year over year, so coming in at 36,000,000 dollars compared to $37,000,000 And on the interest income and other, essentially flat year over year, interest income within the number was actually $8,000,000 better year over year higher interest rates and a little higher invested cash balance offset by FX items that amounted to about $9,000,000 to the negative. The FX tends to fluctuate both up and down in prior quarters.
And total pre tax income was $900 came in at $935,000,000 compared to $936,000,000 a year ago. In terms of income taxes, our reported tax rate in the Q1 was 16.9% compared to 30.4% in the Q1 of last year. This quarter's tax rate benefited from the lower federal rate related to tax law changes as well as some favorable discrete adjustments, notably the $59,000,000 tax benefit related to stock based compensation compared to $41,000,000 a year ago and a $27,000,000 benefit related to the implementation of the 2017 Tax Act as I mentioned earlier in the call. For fiscal 'nineteen, based on our current estimates, and as I mentioned each quarter, these of course are subject to change, we anticipate that our effective total company tax rate for the fiscal 2019 to be in the 26.5% to 27% range. This figure is a little more than a percentage point lower than what we had previously estimated as I mentioned on our last quarterly conference call, but lower is good.
A few other items of note in terms of warehouse expansion, we've opened 8 locations including 2 relos, so a net of 6 in the Q1. For all of 2019, we expect to open about 23 net new warehouses as well as 4 relocations, the 2 we've opened 2 more planned for the rest of the year. Within the 23 net new, about 3 quarters of them are in the U. S. And about a quarter of them are international.
We're also under construction with our 1st Costco in China in Shanghai with the expected opening later in calendar 2019. As of Q1 end, total warehouse square footage stood at 111,000,000 square feet. In terms of stock buybacks, in Q1, we repurchased $34,500,000 of stock, 150,000 shares. I'll turn my attention to e commerce. Overall, e commerce sales increase continued at good levels, both for the quarter and just last week, of course, we reported the 4 weeks of the calendar 4 weeks of November, which would include the 1st week of Q2.
For the quarter, reported e commerce came in at 32.3% up, ex FX and rev rec, they were up 26%. And as you saw last week, the numbers are even a little higher than that for the 4 week November period. In fact, the good news is we've established all kinds of records for orders and sales during the Black Friday through Cyber Monday weekend, as I'm sure many of us have as well. The top growth categories in the quarter were grocery, consumer electronics, hardware, health and beauty aids and automotive. One highlight of our website refinement during the quarter was our redesign of the home categories.
We feel that the refresh made departments like furniture, domestics and housewares easier to shop. With that change, we also expanded some of the product selection within those subcategories. We've now passed our 1 year anniversary of the grocery launch last October. Same day grocery delivery is now available to members within a 20 minute drive of 99% of our U. S.
Locations. 2 day grocery, which we do through our business centers, is available throughout the Continental United States. We continue to focus on providing great values on high quality merchandise and we had a few interesting new merchandise items online this quarter. A couple of examples, Fresh White Truffles, Golf Simulators, all types of high end cosmetics and creams like La Mer, Pendleton Apparel and Domestics, George Simonson Couture cashmere coats, Wheels Up memberships for air travel and even a few Super Bowl packages. And hot off the press, we went live online, I think yesterday or last evening, but this morning with a full online with nearly complete with basically a free line of Apple Mac products, both from MacBook Air to MacBook Pro to the Imac and to the MacBook.
And we're excited about that. And stay tuned for similar offerings in store and we're working out the logistics of that. We've also continued to improve our online and in line cross marketing initiatives, continue to do that. In addition to drawing attention to our online offerings via these digital communications, we're leveraging that to highlight and feature warehouse items and hot buys in store and driving traffic. We believe that certainly some of our strength in traffic has to do with that.
In terms of update on buy online and pick up in the store, we've expanded the selection, no new categories, but some additional assortment and testing pickup lockers in about 10 locations for this program. Overall, these efforts continue to reveal as positive impacting our businesses. And again, most importantly, not only online, but in warehouse and helping the sales in both ways. Quickly on tariffs, there's not a whole lot new to tell you there. The big news of course in the last week or so is the fact that the planned increased on many items from a 10% to a 25% tariff rate effective January 1 has been pushed out, I believe 60 or 90 days.
And so not a whole lot due from a quarter earlier. There are some items that when the tariffs have been in the 10 plus percent range have been very low impact on the sales. Some there's been a little bit more negative impact. We think we've done a good job and it's as one of the senior merchants mentioned, this is what we do with regular price increases as well, cost increases. We figure out how to get to minimize it.
And we brought in additional containers of certain seasonal merchandise early before the January 1 deadline, and we'll continue to keep you posted. Lastly, in terms of upcoming press releases, we'll announce our December sales results for the 5 weeks ending Sunday, January 6 on January 9 after the market closes. With that, I will open up to questions and I'll turn it back to you,
Our first question comes from the line of Michael Lasser from UBS. Your line is open.
Good evening, Richard. Thanks a lot for taking my question. Within your core on core gross margin, it's been trending a little bit lower over the last couple of quarters. What's been driving that? Are you starting to feel the impacts of your pretty rapid e commerce sales and the margin dilution from that on your core on core gross margin?
And then I have a follow-up.
There's 2 people in the room here and one is senior merchant. It's really us. There's not been a lot of change. I was just looking back like in the Q4, I believe year over year it was lower by 2. I believe in one of the 2 previous quarters on a year over year quarterly basis is in the 4% to 6% range.
So it's really we don't really view it as much more than the things that we're doing to drive our business. We get pretty excited figuring out how to drive sales and whether it's buyers picks or hot buys or some of the promotional seasonal items, I think that's seen in the strength of our business. The only thing that I've pointed out in the past quarter or 2 is on the fresh side we've seen a little bit more margin pressure as there's been a little bit more retail competitive pressure out there, not only from supermarkets, but Sam's as well. But that's part of the business.
My follow-up question is on the expense side, recognizing that you've been investing in wages and investing some of the tax benefits that you've got, but you have put up some of the best comps we've seen in a long time and the expense leverage has been modest. So when can we start to see that improve? Thank you.
Well, keep in mind, within these numbers, there's about 8 basis points related to specifically to that, what I'll call that extra rate increase that we did in June post the Tax Act changes. On the IT side, we've got a heck of a lot going on. I think it still will bounce around a little bit, but having it been flat on a year over year basis in the quarter, we're starting to see that. Look, it's all sales related. There's really a lot of different things.
We don't go through all the activities we've got going on now whether it's related to bringing into some of our depots the returns activities, the fulfillment side. With the success with the rapid rollout a year ago into our business centers of the 2 day and frankly with the success of e commerce including a lot of small ticket items or smaller ticket items than just the much higher penetration of bigger ticket items that we used to do, You got a lot of small package fulfillment. We're making sure things get there on time even if it costs us a little more. So I mean there's lots I could go through a list, there's lots of little things. But I think we've got a lot of good things going on and as long as we can keep sales going you'll see that.
So should we interpret that answer as even if you continue this rate of sales growth, expense leverage should continue to be modest?
Well, we'll see. I mean, we never want to predict where it's going to go. Our first we are clearly a top line company. We clearly aren't going to do things to wages or to healthcare costs. Over the time, people have always asked us, how do we what are we doing to control healthcare costs?
It's my first somewhat flip but real answer is expand more overseas. Healthcare costs as a percentage of sales in the U. S. Are 20 to 60 basis points as a percent of sales higher than all other countries. Our foreign pipeline, international pipeline has expanded and I think you'll see that seventy-thirty or seventy five-twenty five U.
S. Versus international start to move with a little more international. So there are things that we do to ourselves based on where we do it. We've got a lot again, we've got a lot of things going on with ancillary businesses, with expanding the whole fulfillment and just the depro system. I think I'm beating around the bush because, A, we can't really tell you where and when.
We feel good about we're building to accommodate even more growth on in e commerce and on the delivery side. And we know that we'll see some of those costs associated with that come down as a percentage of those sales. But we're not going to tell you when. It will take some time.
Okay. Thank you Richard and have a good holiday.
Last one Michael. I mentioned earlier the stock compensation. Stock compensation is not just to a few people at this company, so we're 5,000 employees and it's in many cases from warehouse manager above and buying managers and above and certainly the senior people, it's 60% to 80% of compensation. Because of our annual grants that invest generally over 5 years are granted in October, which is Q1, the fact that our stock prices increased as well, an acceleration related to 25, 30, 35 that was 6 basis points of it. Are not going to see that sort of thing forever.
If you look back at the last couple of years, you will see that typically in the Q1 and that will ease off in the next three quarters.
Thanks again.
The next question is from the line of Simeon Gutman from Morgan Stanley. You may ask your question.
Hey, good afternoon. Thanks. Richard, I missed some of the prepared remarks, so I didn't hear what the core on core merch margin was. But my question is, if margins, let's say, came in a little lighter than what the Street was looking for, curious if you can talk about, is the cost of business going up? Is it reinvestment?
Is it investment? Is it external factors? And then I know you don't like comment on the reinvestment rate, but did that change this quarter given how much of how good sales were and there's more dollars flowing in?
Well, in terms of we're not that scientific and smart about how we do it. We're merchants at heart and when we see things work we go for it. As it relates to the core on car year over year is down 6 basis points. As I mentioned in the last couple of quarters, we've seen a little bit more competition on the fresh side, which is fine. We've got good fresh sales numbers.
But we like others, our competitors are working a little lower margin there and we're not going to let anybody take it away from us. But that's a small piece of that delta. There's a lot of other moving pieces to it. Part of it is related to the fulfillment side of it. We are encountering slightly smaller margins in some of that stuff as we roll it up very fast.
But again, we don't really see in terms of are we investing more because we have it, no. We invest more because whether we had it or not and we see these things working for us.
Okay. And then just two quick ones. Can you tell us what the e comm penetration is, either the quarter or just where e comm stands? And then the other piece is just the cents per gallon or the gas margins. I don't know if you I'm sure you spoke about what they were in and of themselves, but have the margins widened out?
Margins and gas have widened out. I mean everybody our sense is everybody is making more money out there. As they make more money, we make a little more money, but we sell a heck of a lot of gas. In the last I don't know what it was this quarter, but in the last couple of quarters, U. S.
Whereas overall U. S. Gallon consumption is in the very low single digits. We've been in the high single digits of gallon consumption, physical people coming in and filling up their tanks. And so that's all good in that regard.
What was the other piece of the question, I'm sorry, the e commerce?
The e comm penetrate, yes.
I think it's just under 5% 4.8%. That's approximately 4.8%. So somewhere between 4.5%, I think 4.8%. But on that, I think it was about 60 or 80 basis points impact to the comp.
Higher than that. Higher than that. Higher than
that. Okay. Including revenue recognition.
We have the line of Chuck Grom from Gordon Haskett. Your line is open.
Hey, thanks. Good afternoon, Richard. Just on the grosses again, I think you said overall down 50x rev rec and gas down 26. Can you quantify what the actual rev rec impact was for 2Q and how we should think about that over the upcoming quarters?
Hold on, what was that? I can't give it to you. I don't have it exactly. Revenue overall is down about a half. I'll give you an extreme example though.
Historically what they call a curated travel package where we put it together, we have a commitment to the different components of that travel package be it hotels or the cruise or whatever. Historically that was a brokerage fee, a brokerage commission And I'm making this up completely, but let's say there was a $500 brokerage commission, you had no sales, I'm sorry, you had $500 in sales, the brokerage commission, essentially no cost of sales. And so needless to say that's a very high margin percentage. Now if that was related to, and again, making this up, a $5,000 cruise package or $5,500 cruise package, you'd have $5,500 in sales, $5,000 across the sales in Mary Voat. Now it's a very small piece of our business, but that's over the year that's $700,000,000 of that revenue recognition line.
So there's lots of moving parts within this thing.
Okay. We thought it maybe could be about 10, 12 basis points. I don't know if Bob is there and can I'm
sorry, how much?
What's that? Roughly 10 basis points in the quarter, but we thought that's what it would be.
Yes, qualitatively I'm hearing in this room a little less than half of it, so 10 sounds like it's a little less than half of 'twenty two.
Okay, okay. Fair enough. And then just again here just on the model, this 2017 tax impact that you had, was that just a one time item in the Q1 or is that going to repeat? It doesn't sound right. It doesn't sound like it will based on your 26% to 20% 26% to 27% tax rate for the year, but just wanted to make sure.
It was a one time. It relates to the tax act, but some of it relates to things that started for us in fiscal 2019.
Okay.
Okay. And by the way, there's still some moving parts to the tax act. I mean, it's hundreds of pages. Some of the things still weren't completely outlined. There may be little pluses and minuses.
This was a little bit bigger than a little plus, which was good.
Okay. And then just with I think a year now under the belt with Costco Grocery and Instacart, I'm just wondering, it doesn't seem like it based on how strong November was. Just wondering if you think you're losing any in store traffic from somebody just replacing that trip with buying online either through CG or Instacart?
I mean the view is it's incremental. It's hard to say when the in store penetration frequencies are so strong. And I don't think we've done a lot of polling of members to see is this incremental or not. But we feel that we're seeing less than we originally thought which wasn't a lot to begin with in terms of does it take away from the frequency in store. It can't add to it, but it has opened some new markets for us or some expanded markets.
Anecdotally, I have plenty of friends that come up to me and they have told me how they love it in terms of doing more some of their incremental food shopping that way or making it more convenient on themselves. And we're finding that people that live further away are using it more. But these are all anecdotal, nothing science related to those my comments there.
Okay. And just to follow-up on Simeon's question about the e commerce margins, my understanding is historically it's been a margin accretive category view. In other words, it garners a higher margin than the store margin. I just want to make sure that that's still in fact correct.
No, no. No, that's never been a higher margin. It's been a little lower margin. You've got competitive categories like electronics, I think, which dominates the penetration. And then there's cost of shipping.
And so it's a little lower margin. It's a little lower margin and a lot lower SG and A. So it's a higher P and L, if you will, in terms of the earnings, recognizing that not every expense is allocated back to it.
Okay. I understand. Thanks very much.
The next question is from John Heinbockel from Guggenheim Securities. Your line is open.
So Richard, couple of things. Did you see any COGS pressure from port congestion, right, either having to pay to prioritize fly product in? And are you seeing any of that today as we go into 'nineteen?
Nothing more than usual at this time of year. Again anecdotally I know that when we had very strong produce sales on a few items like watermelons around Labor Day, when you had to get an extra container somewhere fast, not shipping across, I'm just talking about truck containers on this side trailers, something you paid $1500 for might cost $3,500 for that last truck. But again, these were anecdotal stories I heard. My understanding is there is a little backup in China and Shanghai, but not a heck of a lot there. And part of that is every extra container that was out there, merchants like Costco were filling them to bring in things in anticipation of certain tariffs going to 25% on January 1.
Can I interest you in some patio furniture?
Then broader on supply chain, right? So you think about, I guess, calendar 2019. Is the chicken plant the only lumpy thing? So I think that's still slated for calendar 2019. The opening of that, can that will that actually will we actually be able to see that in the P and L?
And is there anything else lumpy like that that might impact specifically supply chain in 2019?
Well, first of all, think the plan is by early summer, they'll start processing, but not in 100% capacity and that will take 6 or 8 months to get to 100% capacity. So it's really into fiscal 2020 or even mid fiscal 2020 where God willing it's running smoothly and full or close to full capacity. There's a few other things that aren't as big and slightly less lumpy. Last year we opened a commissary, bakery commissary in Canada. It's by no means at full capacity yet.
We're adding items that we sell, but doing some things that we didn't start off doing there. Same thing, we've had a meat plant in Tracy, California for 20 plus years. We opened a second meat plant in Morris, Illinois that will handle the Midwest and East Coast. It's by no means at full capacity yet. And so there's some lumpiness and that's both of those latter two things have been around, the concentrate has been around for over a year, maybe closer to 2 and the meat plant has been around for a year ish.
And so those are some of those when I talked earlier about, I think Michael Lasser was talking about what other things are challenges to SG and A. There's lots of little things like that. Notably, some additional the ramp up in getting up and running fulfillment both for e commerce and all those other 2 day deliveries. So we got a lot of little things going on like that. The big lumpy is going to be I mean just by sheer size of it is the chicken plant, but that has more to do with there's there'll be some more preopening and there'll be some perhaps a little more depreciation.
All right. And then just lastly, are you seeing any early signs of a pickup in fresh inflation meat produce? Looks like it might be percolating a little bit, but have you seen that yet?
We haven't.
One of
the merchants here is shaking their head.
Okay. Thank you.
Next question is from Chris Horvers from JPMorgan. Your line is open.
So first on the rev rec. So as we think about that gross margin pressure that you experienced in this quarter, is that something you expect for the rest of the year? Essentially, there's no recapture, it will be a pressure all year because of the change in the accounting? And then also on the top line front, I know you mentioned that there was a benefit to this month on the top line in November, but that has pressure in December January. So over the year is the rev rec impact of the top line neutral?
That latter question related really to e comm. The rev rec will be for the year. I think our September sales release we talked about the fact that for all of 2019 we estimate that this new standard will benefit sales by about 1%. So, dollars 1,000,000,000 Some of the things have more margin percentage impact. But at the end of the day, it has no impact on the bottom line.
But understood. So you had a big benefit in this sort of the November months and this quarter because of e commerce, right? And that's rev rec. So you had a bigger benefit now. So it just mitigates throughout the rest of the year essentially or
goes the other way?
There's probably relatively speaking, there's a bigger benefit in the end of Q1 and into December because of the holidays and the strength in e commerce.
Okay. And then the gross margin, I know it's up and down to the SG and A line, but the gross margin impact persists all year? As
it relates yes, some degree of it, yes. Of course. Yes, optically, it will be an 8 to 10 basis point headwind. Understood.
And then in terms of the e commerce strength in the month of November, you've added a lot of stuff to the website, you're advertising it more. Were you more, I guess, aggressive with advertising or promotions because it was Black Friday? Or is this just a new normalized rate of like, hey, this is what we're offering and sort of there's some sustainability to that growth that you saw in the month of November?
There were the same number of ads or marketing pieces. We have more emails that we're sending to. We've done a better job over the year of collecting emails. There's better values. I think a year ago, we talked about not only online, but in store, better values, hot buys and buyers picks, higher traffic, higher conversion as well.
Those are all things some of that stuff is improving your Site 101, recognizing that some of these things we hadn't done as well in years prior and the values. I mean, I think we've gotten the attention of the suppliers in many cases and they see how it's improved their business. And particularly in an environment where in some cases those products aren't doing as well as our competitor brick and mortar operators.
Yes. I bought a snowblower and it was 30% cheaper than what I could find at a big box store. So in November, that was my Black Friday gift. My last question and they delivered to my garage. My last question is, what percentage of e commerce are you shipping currently versus direct from vendor?
And where do you think this goes over time? And like what sort of cost savings do you generate over time?
We're should be about 50% ourselves and that tends to be the smaller size items and small pack sizes and what have you. All the big stuff and all the white glove stuff like white goods, big electronics, furniture, patio furniture, those typically are done by 3rd parties.
Is that percentage going to go up over time or just because the mix of small items goes up, that's what drives it up?
We'll have to see. We'll do it whatever way is most economical. My guess is there are going to be some things that we're currently doing 3rd party that we'll bring in house as we get better and more confident of being able to do it. If you think even going back to some basic things like what we're doing with UPS with 2 Day Dry, not e commerce but it's 2 Day Dry. What other things can we do in that box size?
We're working with vendors as others are I'm sure as well, to figure out how to get certain products, how to minimize the freight cost by getting, given our volumes and our predictability of certain items, how we can get closer in a more efficient freight way to the ultimate delivery to the customer.
Got it. Thank
you.
The next question comes from the line of Karen Short from Barclays. Your line is open.
Hi. A couple of questions. Just on tariffs, can you maybe just elaborate a little on what your pricing philosophy will be with respect to tariffs? Meaning, will you address price, I guess, increases if you need to on a SKU by SKU basis? Or are you looking at the whole box more broadly and trying to figure out how you can offset with a lower price increase across the box?
It's a SKU by SKU basis recognizing it's a heck of a lot easier to do when you're only selling 3,800 SKUs in its entirety to start with. And again, part of it is price points. Again, I was talking to a merchant yesterday and they gave me examples of where on a $40 or $50 item that's up 20% or 10% to 25%, they've seen no change in the unit volumes. And 1st of all, if it's in the 10% range, I think we've done we feel we've done a good job of working with the supplier. What is the supplier willing to do?
And to try to minimize that or if there's competing suppliers getting even more. So there are some items that even with a 10% increase, we haven't had to change the price. Now maybe we ate into our margin a little, sometimes not at all. There are some items, bigger ticket items where you if you're going to go from 500 to 6.25percent or that may impact the unit volume of that stuff. In some cases, in anticipation of a 25% coming, we cut back quantity a little bit on some items.
So it's all over the board. But overall, as you might expect, Karen, we're going to be the last increase and the lowest, but it's clearly not subsidizing it with other things.
Okay. And then I guess just a color a little more color on your comment on Fresh getting more competitive with both conventional and Sam's. Can you just give a little more color on what you're seeing exactly? And then I guess the question bigger question I have is, I mean, isn't there a possibility that Sam's continues to get more aggressive on other categories? I mean, the pressure will likely spread.
So I guess, are you seeing any of that today or is it just limited to fresh?
Look, we're respectful competitors. We've been doing this for 35 years. We're not moving away and we feel we're in a pretty strong area. I mean within fresh, it's produce and protein And whatever comes our way, we'll figure it out. And I'm only point part of the challenge here in trying to be helpful to all of you guys is give you some examples.
It so happens that fresh right now year over year is down a little bit. There are times when it's been up. Right now, it's notable. We still feel that we're getting more bang from our buck from having Sam's close 63 units than certain incremental competition on certain things. And that's what we do, we compete.
Okay. And then just last question, you used to comment on testing pickup lockers in 10 locations. Can you maybe just elaborate like how big are the pickup lockers? Is there are you kind of looking to maybe expand that or broaden it? And then what kind of SKUs would be able to fit currently?
Well, they're not I don't think they don't they won't fit a 60 inches television as an example. They're relatively small and clean looking. I think in there are 10 locations. Keep in mind the items that we started with and we chose to do, 1st of all, were items where we had heard time and again, I would have bought that from you Costco, but I can't have it shipped to my office and I don't want it to be left on my doorstep until I get home from work. And so we think we've picked up a little incremental there, but what we're finding is that many of these customers, they shifted, they bought it that way.
First of all, we have more availability of items because we offer a much broader selection that you can order online and pick up in store. And these items really are limited to jewelry items, some small electronics items and handbags. All buildings by the way offer the service and show you that there's more out there. But look, it's a test. We'll figure it out.
Okay.
Thanks. What we're not looking to do anytime soon is full order online and pick up in store and we're paying groceries and A, we don't have the room upfront and B, we see we're probably a little biased, but we see that when not every customer shows up when they order online and you have to separate it between dry and refrigerated and frozen. It's very costly. Right. And we do have the alternative now with the Instacart engine.
Right. Okay. Thank you. We have the line of Edward Kelly from Wells Fargo. You may ask your question.
Yes. Hi, guys. Good afternoon. Richard, you mentioned the gas business and margins rising everywhere. We are seeing that at our other companies.
Thoughts on the reason for that and the sustainability of that?
Well, I think the reason is traditional retail all companies including us we want to make money. And what we have found is that as prices have come down, our view is our moat, if you will, our competitive pricing has gotten bigger. What we're saving, you can just look every week at gasbuddy.com, but we do our own price studies. We're saving relative to competitor stations nearby, whether they're independents or supermarkets or nationals, we're saving them more today than we've ever saved them per gallon and we're making more than we've ever made partly because everybody else is making more and we're able to make a little more. How long does it last?
I don't know. It does seem that there's not a heck of a lot of traction on gas prices going up. Yes, I mentioned earlier, you've heard this from me before, we want to make a little a lot of times. As it relates to gas, I mean we've been enjoying for the last several quarters on a year over year basis close to high single digit gallon comps in a U. S.
Population where it's just above flat in the low single digits. So we're definitely taking market share and we're enjoying able to do that while making a little more, but not a lot more.
And I just want to take
a step back and ask you a question about EBIT growth. If we look at EBIT growth this quarter and adjust for one time items like the charge on the breakage, adjust for the wage investment, remove the MFI benefit. If you do all that, it looks EBIT grew somewhere in sort of like the 3.5% to 4% range. That was about the same as it was last quarter, but yet your comp is 7% to 8%, fuel is contributing. I'm just kind of curious, if we take a step back here, help us understand how we read that, I guess, why that number is not better?
And then how do we think about going forward because you might not be comping 7% to 8% forever. Does kind of flow through improve from here?
Right. Well, first of all, two things. You mentioned the 3% to 4%. I think as you add those 2 items in, that impacted the pretax. It's 6% or 7%.
But even that, and when I say the 2 items, the city Visa breakage as well as our payroll increase that on top of everything we took because of the income tax, We knew we were going to some of that income tax was going to impact the pre tax line in that way. The other thing and get back to a couple of the other questions on there's lots of stuff going on here guys, and I think we're less worried about was gross margin 5 or 10 basis points different than it could have been. It could have been a lot better than what we did. We don't look at it that way. We look at what we can do to drive our business and still want to make money.
We still think long term we're creating a stronger, more loyal company. So I think that we're optimistic about what our future holds in that regard. I can't tell you I can't give you guidance of where it will go.
Okay. Thank you.
By the way, in addition to just the payroll hitting the tax, in our case, rough numbers, the 1st full year post the tax reform, it's about on those pretax earnings, it was a little over $300,000,000 pretax. So it's a little over $400,000,000 sorry, a little over $300,000,000 tax benefit. That's a little over $400,000,000 pretax, dollars 110,000,000 or $120,000,000 of it went towards those wages. We view these monies as partly our members and we're doing what we do to drive our business. I mean certainly what we did to remind our members of those that have the Citi Visa card to drive that business, which is long term positive through the revenue share when it's used outside as we get more and more people to have it, more and more of them to have it top of wallet.
So we think again all these things are driving. Clearly, we in the 1st year of 2 day delivery and fresh I'm sorry, 2 day delivery and a big ramp up in small package with the monies we're investing in fulfillment and the monies we're clearly delivering a package to our member even on the 2 day delivery side at a more expensive price when we first started than today, which is still more expensive than it will be
tomorrow.
Hello? We have Rupesh Parikh from Oppenheimer. Your line is open.
Good afternoon. Thanks for taking my questions. So first on the tax rate, a housekeeping question. The tax rate you gave, the guidance, did that exclude the benefits that you saw in Q1?
There's a tax yes, it excludes the benefit of those unusual things. Yes.
Okay, great. And then on the capital allocation front, the share buybacks again, you guys are not you're not buying that many shares back. Just curious on the special dividend and just how you're thinking about capital allocation going forward?
Well, first of all, in terms of buying back stock, we do buy it regularly. We have a matrix that we look at and we adjust periodically as the stock goes up, we buy a little less each day and as stock goes down, we buy a little more. We tend to even it was a small number for the quarter, it was a little higher towards the end of the quarter than beginning of quarter. But that doesn't we'll see what next quarter brings. As it relates to special dividends, we have made no decision on that 4th special dividend.
We've been asked time and again because each of the 3 that we've done were spaced about 2.5 years, 2.25 years apart from each other. So we've been asked what happens in 2.25 years from May of 2017. And we said, we don't know. We'll stay tuned and see. When we've done them, they've worked well.
We still continue to generate a lot of cash in excess of our CapEx and in excess of a roughly $1,000,000,000 annual dividend that has grown historically about 13% a year. So it's certainly on the table, but there's no promises of if and when and how much.
Okay, great. Thank you.
Why don't we take 2 more questions?
And next question is from Scot Ciccarelli of RBC Capital Markets. Your line is open.
Hey, guys. Scot Ciccarelli. Richard, as you guys change your accrual for the rewards breakage, is that something that will be a notable item on a go forward basis or is it relatively minor and kind of gets lost in the wash?
Well, it's relatively minor. Keep in mind, you're talking about an annual reward that's in the $2,000,000,000 range. And if you look at it, this really affected we started doing this a few months ago, these reminders in a bigger way. And if you look at it, it sped up or increased the ones that were going to not be redeemed through that related to 2,007 calendar purchases on that card. And then we had to add up the accrual for all purchases in 2018.
We had already lowered the accrual from prior to this from the previous year, but that's what we do. On an ongoing basis, I think the impact to the quarter relative to our old one was about $0.01 a share.
Okay, got it.
I think it was a little bit, it was like $6,500,000 $7,000,000 pretax. So you could annualize that component on an annual basis.
Okay. And then I want to clarify and answer you gave to an earlier question. I think it was from Chuck regarding the profitability of e commerce. Can you help us I was also under the impression that e commerce was a higher, I would call it, operating profit transaction for you. But the way you kind of phrased it, it sounds like it's lower gross margin, but maybe it's EBITDA to contribute a positive contributor?
No, no, it's a higher it's a more profitable operating margin. It has a little lower gross margin and a lot lower SG and A. Maybe a lot lower SG and A is more appropriately termed lower SG and A because there are a few things that we don't allocate necessarily to it. But like when you buy something online and return it to warehouse, the warehouse gets charges for that. So we try to do not a complete full, but it's charged for its IT expenses and things like that, certainly all the direct buying and what have you.
But at the end of the day, we view it as more profitable than the bottom line of our company as whole. Got it. And that's why I thought
the fulfillment.
What?
I'm sorry. And that is true whether it's being shipped by you or the 3rd party that you referenced to an earlier question?
It's all blended together. Got
it. Okay. Great. Thank you.
Okay. One last question.
And for our last question, we have Scott Mushkin of Wolfe. Your line is
open. Hey, guys. Thanks for taking my question. So I just wanted to make sure I understood the answer to the last question of the $43,000,000 It sounded like $6,000,000 to $7,000,000 of it is actually not one time. It's going be kind of an ongoing.
Did I get that right or am I misunderstanding?
Well, the $43,000,000 relates to activities prior to the beginning of fiscal 2019. That's one time in the sense that goes back to anticipated redemptions higher than what had been previously reserved for both for calendar January 1 through December 31, calendar 2017 purchases transactions both in and outside of Costco on the Citi Visa card. From February of 2018 when they were mailed out to everybody, they've been redeemed. In the last few months, we upped the amount of times we remind our members to redeem them. That increased the redemption.
So based on what we had previously thought would be redeemed and not expire as of December 31 this year, we upped the ante on that piece. That's a little over a third of that 42. The other piece is all purchases made on this year, those card members will receive a reward certificate in February of 'nineteen. But every time a transaction is a reward is earned, we accrue a little bit of the anticipated breakage or slippage in it. Well, with our reminders, we are going to accrue a little less for that.
So it's also all the purchases made from January 1, 2018 through the end of August or September 2, whatever the year end was of fiscal 2018, we upped the accrual of that. In Q1, based on our lower breakage assumption and therefore higher accrual breakage, lower breakage assumption, so it will that was about just under $7,000,000 pre tax. That's the piece that will be ongoing.
Okay. So I think I got that. So then my question is
The question was about $49,000,000 almost $50,000,000 $43,000,000 was one time prior to Q1. Yes.
Perfect. Then my second question is, it's more strategic. I mean, we're seeing a lot of companies and I think a couple of questions got to this is that, as we go more and more omni channel, the flow through of sales diminishes. The profitability just kind of comes in. How do you think about Costco?
I mean, Costco seemed not to have this problem, but maybe we are seeing a little bit of it as we go more omni channel, just the profitability of the business gets a little bit it comes down a little bit. How do you think about that and how should we be thinking about that?
Well, I think that we are in my view, we're fortunate that we're not impacted. If you look at traditional department stores, which deliver stuff to your home and then you send 70% of it back, it's all free. That's a necessary part of their business that's not necessarily profitable relative to the old way. Supermarkets, I don't think delivery to the extent you can incrementally take a customer or grow market share, that will be incremental maybe that's the negative is offset by the positive of incremental sales. I think we've been fortunate.
The way we've done it as it relates to e commerce in general or even 2 day delivery, we didn't go and spend 100, if not $1,000,000,000 on our own delivery. We're doing it with, in that case, a partner of UPS, limiting the things that we do, and it seems to be working. Now we're still going to improve the cost of delivery on even that because there's some parts we want to be the entire continental United States and there's some places that are a little further away, so we pay a little more on that. I think when we look at to the extent it's incremental, we have found I think we've also benefited from things like you look at white goods. Historically, when we had limited white goods in store, I think 4 fiscal years ago, we did $50,000,000 in the U.
S. In white goods. 3 years later, in fiscal 'eighteen, we did 5 $100,000,000 like $50 something in white goods, none of it in store. We have displays in locations and display high end LG, Samsung, Whirlpool and the like. And most people want it delivered and actually the old one taken away, so all that white glove service.
We have been fortunate in that regard. There is an example of because of what's happened in the world. You've heard me mention apparel where brick and mortar apparel is generally down over the last few years. That's given us an opening to buy certain things that historically we couldn't in the quantities. 99 plus percent of our apparel is still in store, not online.
We're testing a few things online. It's a $7,000,000,000 category that's grown compounded for 4 years in the high eights. Furniture, where we have it in store limited, 20,000, 30,000 feet of furniture for 8, 12 weeks in the summer in a slow after Memorial Day and before Labor Day, we still do some of that in store, but now it's year round online. Same with patio furniture, which is in there for 12 or so weeks, January through maybe early April. And now geographically, the locations where people buy that stuff year round have the ability to do that.
So I think we've been fortunate there's some things that, given our item nature of our business has helped us in that regard and perhaps offset of that. Clearly, Scott, in the 1st couple of years, certainly these things cost us more, building out some fulfillment centers. Part of that success online is getting people to open the email to click on something and to buy something. And those who will be a few years here, I'm sure, have continued that. But these strong sales have helped that.
All right, perfect. Hey, listen, have a great holiday and thanks for the great explanation.
Well, we try. Thank you. You guys have a good holiday as well. Thank you very much.
This concludes today's conference call. Thank you everyone for participating. You may now disconnect.