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 speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, you may press the pound key. Thank you. Mr. Richard Galanti, you may begin your conference.
Thank you, Luz, 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 first quarter of fiscal 2019, the 12 weeks that ended this past November 25th.
Net income for the quarter came in at $767 million, or $1.73 a share, a 19.3% per share increase compared to $640 million, or $1.45 per share last year in the first quarter. In comparing year-over-year operating results, there were three items noted in the release. One, this year's first quarter benefited from a $59 million, or $0.13 per share income tax benefit related to stock-based compensation. Last year, the benefit was $41 million or $0.09 a share in the first quarter of last year. Number two, the company also recognized an additional tax benefit this year of $27 million or $0.06 a share. This related to the implementation of the 2017 Tax Act.
The third item noted in the release, this year's first quarter results included a charge of $43 million pre-tax, or $31 million 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 $34.31 billion, a 10.3% increase over the $31.12 billion reported last year in the first quarter. In terms of comp sales in the release today, for the 12-week fiscal first quarter, U.S. comp sales on a reported basis were up 11.0%, and ex, not only gas inflation and FX, but revenue recognition, the 11.0% would be 8.3%. Canada reported 2.4%, ex gas, FX, and revenue recognition, it would be +5.5%. Other international reported 4.0%, ex those items, +5.8%.
Total company reported 8.8%, ex gas, FX, and revenue recognition impact, 7.5%+. E-commerce, 12 weeks reported 32.3%. Again, ex those items, 34.0%. I'm sorry, 26.2%. In terms of Q1 sales metrics, first 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 -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%. On the income statement is membership.
Membership, we reported an increase of 9.5% or $66 million, coming in in the quarter at $758 million in the first quarter of this year compared to $692 million last year. FX had a negative effect of approximately $6.4 million. The 9.5% increase would have been about 10.4% ex FX. Reported membership revenue, again, was up 9.5%. About half of that's related to the membership fee increases taken back in June of 2017. 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 renewals in Q1 end came in at 90.5%. That's up from 90.4% just 12 weeks earlier at Q4 end. Worldwide rate improved to 88.0%, also up a tenth of a percent up from 87.9% at 12 weeks ago at Q4 end.
In terms of number of members at first quarter end, Gold Star at Q1 end was 41.3 million. That compares to 12 weeks earlier, 40.7 million. Business Primary, 7.6 million, both at this first quarter end and at year-end. Business Add-Ons stayed at 3.3 million. All told, what we started the fiscal year or we ended last fiscal year with 51.6 million members. We ended Q1 at 52.2 million. Our total cardholders at year-end from last quarter was 94.3 million. Again, at this first quarter end, it was 95.4 million. We opened six new warehouses during the quarter. Also at first quarter end, paid Executive memberships came in a total at 19.7 million, 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. You'll see that fluctuate, but certainly a good showing in the quarter. Related to the annual fee increases, again, I mentioned earlier, we've now passed the halfway point in last year's fourth quarter 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 three quarters, in Q2, three, and four, very little in Q4, actually. Again, that's based on the deferred accounting which we use. Going down to the gross margin line, our reported gross margin in the fourth quarter was lower year-over-year by 50 basis points, coming in at 10.75% as compared to 11.25% a year earlier.
Excluding gas, inflation, and revenue recognition, that -50 would've been a -26. I'll start with my line items, if you will, comparing the -50 to the -26. If you just jot down two columns of numbers and five lines, the first line is core merchandise, the second line, ancillary businesses, the third line, 2% reward on the executive membership, the fourth line, other, and the fifth line, of course, total. On a reported basis, the core merchandise year-over-year in Q1 was -43 basis points. Ex gas inflation and revenue recognition, the -43 would be -22. Ancillary businesses, which was a +5 reported, ex those items, it would've been a +11. 2% reward, 0 and a -2. Other, -12 and -13.
If you add up those two columns, you'd get to the -50 reported, and ex gas inflation rev rec, the -26. Again, going to the core with the -43, ex those items, going to -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 six basis points. Subcategories within core gross margin year-over-year in Q1, both food and sundries and hard lines were up, and soft lines and fresh foods were down. The net of those four categories was a -6. Ancillary and other businesses, as I mentioned, reported +5, +11 ex gas and revenue recognition in the quarter.
Gas was up, e-com was up a little, business vendor was up a little. Pharmacy, a couple of little things were down a little. Net of those all, they were up 11 basis points ex those items. That's the $43 million pre-tax amount that I mentioned earlier related to the Citi Visa co-branded card. We put it here because 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. This impacts the revenue line of our company or the sales line, and therefore, it impacts the gross margin percentage. The $43 million, 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'd 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. These are the reward 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 million adjustment relates to two things. One, to the thing I just explained, I described to the recent increase in these redemptions. 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 the Citi Visa cardholders in February of 2019.
What you see in this line is basically the adjustment to our estimate of breakage on rewards earned on purchases made prior to the beginning of fiscal 2019. Going forward, we're using this lower reward breakage assumption. Moving to SG&A. Our SG&A percentage Q1 over Q1 was lower or better by 23 basis points on a reported basis, and flat or zero without gas inflation and revenue recognition. Again, it came in at 10.13% this year on a reported basis compared to 10.36% last year. Again, I'll ask you to jot down two columns and five 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 four ex those items. Lower or better, I'll use a plus sign.
Central, plus four and plus two. Stock compensation, which is always the biggest impact seems to be in Q1 because that's when we do our annual grants for over 5,000 employees. Stock compensation, -4 and -6 . Other is zero. Your total, again, reported, the sum of those three line items, +23 basis points or lower year-over-year on a reported basis by 23. The second column, basically flat year-over-year on an ex those items basis. The core operations component, again, was lower. This is primarily a result of sales growth, offset in part by the U.S. wage increase to most of our hourly employees that went into effect on June 11th.
The wage increase negatively impacted SG&A by approximately eight basis points in Q1 year-over-year, and this will continue to impact the SG&A year-over-year comparisons over the next two quarters. I believe we did it effective June 11th and 2017, June 11th 2018, so it'll go through the same time period a year later. Central expense was lower, better year-over-year by four on a reported basis, and lower or better by two 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, so you'll see a little bit of a difference there. Next on the income statement is pre-opening expense. It was $5 million higher in this year's first quarter, coming in at $22 million compared to $17 million a year earlier.
We had one more opening this year, there's plenty of other things going on, not just opening new warehouses with everything from chicken plants to expansion of depots and fulfillment. All told, reported operating income in Q1 came in at $949 million, compared to $951 million in Q1 last year. Two of the things I mentioned in this report, of course, is the $43 million related to the Citi Rewards program as well as the hourly wage increases. Those are certainly two things that have impacted the year-over-year comparison. Below the operating income line, reported interest expense was $1 million lower year-over-year, coming in at $36 million compared to $37 million. On the interest income and other, essentially flat year-over-year.
Interest income within the number was actually $8 million better year-over-year, higher interest rates and a little higher invested cash balance, offset by FX items that amounted to about $9 million to the negative. The FX tends to fluctuate both up and down in prior quarters. In total, pre-tax income came in at $935 million, compared to $936 million a year ago. In terms of income tax rates, income taxes, our reported tax rate in the first quarter was 16.9% compared to 30.4% in the first quarter 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 million tax benefit related to stock-based compensation, compared to $41 million a year ago, and a $27 million benefit related to the implementation of the 2017 Tax Act, as I mentioned earlier in the call.
For fiscal 2019, based on our current estimates, and as I mention 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%-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. Lower is good. A few other items of note in terms of warehouse expansion. We've opened eight locations, including two relos, so a net of six in the first quarter. For all of 2019, we expect to open about 23 net new warehouses as well as four relocations. The two we've opened + 2 more planned for the rest of the year.
Within the 23 net new, about three-quarters of them are in the U.S. and about a quarter of them are international. We're also under construction with our first Costco in China, in Shanghai, with the expected opening later in calendar 2019. As of first quarter end, total warehouse square footage stood at 111 million sq uare feet. In terms of stock buybacks, in Q1, we purchased $34.5 million 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 calendar four weeks of November, which would include the first week of Q2. For the quarter, reported e-commerce came in at 32.3% up. Ex FX and rev rec, they were up 26%. As you saw last week, the numbers are even a little higher than that both for the four-week November period.
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 else 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 one-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. Two-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. We had a few interesting new merchandise items online this quarter. A couple examples, fresh white truffles, golf simulators, all types of high-end cosmetics and creams like La Mer, Pendleton apparel and domestics, George Simonton Couture cashmere coats, Wheels Up memberships for air travel, and even a few Super Bowl packages. Hot off the press, we went live online, I think yesterday or last evening, but this morning we're full online with basically a complete line of Apple Mac products. Both from MacBook Air to MacBook Pro to the iMac and to the MacBook. We're excited about that. 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 inline 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 pick up lockers in about 10 locations for this program. Overall, these efforts continue to reveal as positive impacting our businesses. 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 increase on many items from a 10 %- 25% tariff rate, effective January 1st, has been pushed out, I believe, 60 or 90 days. Not a whole lot new from a quarter earlier. There's some items that when the tariffs have been in the 10 %+ range, have been very little impact on the sales. Some, there's been a little bit more a negative impact. We think we've done a good job, and 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 minimize it. We brought in additional containers of certain seasonal merchandise early before the January 1st deadline. We'll continue to keep you posted.
Lastly, in terms of upcoming press releases, we'll announce our December sales results for the five weeks ending Sunday, January 6th, on January 9th, after the market closes. With that, I will open up to questions, and I'll turn it back to you, Luz.
At this time, I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.
Okay.
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? I have a follow-up.
There are two people in the room here. One's a senior merchant. It's really us. There's not been a lot of change. I was just looking back in the fourth quarter, I believe, year-over-year it was lower by two. I believe in one of the two previous quarters on a year-over-year quarterly basis is in the four to six range. 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 buyer's 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 pointed out in the past quarter or two 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. 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 benefit you got, you have put up some of the best comps we've seen in a long time, and the expense leverage has been modest. When can we start to see that improve? Thank you.
Well, yeah, keep in mind, within these numbers, there's about eight basis points related specifically to that, what I'll call that extra wage 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, 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 rapid rollout a year ago into our business centers of the two-day, 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 get a lot of the small package fulfillment. We're making sure things get there on time, even if it costs us a little more. I mean, I could go through a list. There's lots of little things. 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.
Should we interpret that answer as even if you continue this rate of sales growth, expense leverage should continue to be modest?
We'll see. We never want to predict where it's going to go. 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, what are we doing to control healthcare costs? My first somewhat flip but real answer is expand more overseas. Healthcare costs as a percentage of sales in the U.S. are 20- 60 basis points as a percent of sales higher than all other countries. Our foreign pipeline, international pipeline, it has expanded, and I think you'll see that 70/30 or 75/25 U.S. versus international start to move with a little more international. There's things that we do to ourselves based on when we do it. Again, we've got a lot of things going on with ancillary businesses, with expanding the whole fulfillment and just the depot system.
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 in e-commerce and on the delivery side. We know that we'll see some of those costs associated with that come down as a percentage of those sales. We're not going to tell you when. It'll take some time.
Thank you, Richard, have a good holiday.
Oh, last one, Michael. I mentioned earlier the stock compensation. Stock compensation is not just to a few people at this company. It's over 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%-80% of compensation. Because of our annual grants that invest generally over five years are granted in October, which is Q1, the fact that our stock price has increased as well, and acceleration related to 25, 30, and 35, that was six basis points of it. You're not going to see that kind of thing forever.
Okay. That's helpful.
If you look back at the last couple of years, you'll see that typically in the first quarter, 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? I know you don't like to comment on the reinvestment rate, but did that change this quarter given how good sales were and there's more dollars flowing in?
Well, 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 core, year-over-year was down six 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. 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 on some of that stuff as we roll it out very fast.
Again, in terms of are we investing more because we have it? No. We invest more because whether we have it or not, and we see these things working for us.
Just two quick ones. Can you tell us what the e-com penetration is, either the quarter or just where e-com stands? The other piece is just the cents per gallon or the gas margins. I'm sure you spoke about what they were in and of themselves, but have the margins widened out?
Margins in gas have widened out. Our sense is everybody's 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. I don't know what it was this quarter, but in the last couple of quarters, 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. That's all good in that regard. What was the other piece of the question? I'm sorry. The e-commerce?
The e-com penetration. Yes.
I think it's just under 5%, 4.8%. That's approximately 4.8%. Somewhere between 4.5 % and 5%, I think 4.8%. On that, I think it was about 60 or 80 basis points impact to the comp. Including revenue recognition.
Got it. Okay. Thanks, Richard.
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 50%, ex 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 the 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 the hotels or the cruise or whatever. Historically, that was a brokerage fee, a brokerage commission. I'm making this up completely, but let's say there was a $500 brokerage commission. You had $500 in sales, the brokerage commission, and essentially no cost of sales. Needless to say, that's a very high margin percentage. Now, if that was related to, again, I'm making this up, a $5,000 packed cruise package or $5,500 cruise package, you'd have $5,500 in sales, $5,000 across the sales and very low.
It's a very small piece of our business, for the year, that's $700 million of that revenue recognition line. 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's there and can-
I'm sorry, how much? What's that?
Roughly 10 basis points in the quarter. We thought that's what it would be.
A little less than half.
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 22.
Fair enough. Just again here, just on the model, this 2017 tax impact that you had, was that just a one-time item in the first quarter, or is that going to repeat? It doesn't sound right. It doesn't sound like it will based on your 26%-27% tax rate for the year, just wanted to make sure.
It was a one-time. It relates to the tax act, some of it relates to things that started for us in fiscal 2019.
Okay.
By the way, there's still some moving parts to the Tax Act. 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. 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.
The view is it's incremental. It's hard to say when the in-store frequencies are so strong. I don't think we've done a lot of polling of members to see is this incremental or not. 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 tell me how they love it in terms of they're doing more of some of their incremental food shopping that way or making it more convenient on themselves. We're finding that people that live further away are using it more. These are all anecdotal, nothing science related to my comments there.
Okay. Then just to follow up on Simeon's question about the e-commerce margins. My understanding is historically it's been a margin accretive category for you. 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.
That may be.
No, that's never been a higher margin. It's been a little lower margin. You've got competitive categories like electronics and things, which dominates the penetration. Then there's cost of shipping. It's a little lower margin. It's a little lower margin and a lot lower SG&A, so it's a higher P&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.
Richard, a couple of things. Did you see any COGS pressure from port congestion, either having to pay to prioritize fly product in, and are you seeing any of that today as we go into 2019?
Nothing more than usual at this time of the year. 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 $1,500 for might cost $3,500 for that last truck. Again, these were anecdotal stories I heard. My understanding is there was a little backup in China and Shanghai, but not a heck of a lot there. 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 1st. Can I interest you in some patio furniture?
Broader on supply chain. You think about, I guess, calendar 2019. Is the chicken plant the only lumpy thing? I think that's still slated for calendar 2019. The opening of that, will we actually be able to see that in the P&L? Is there anything else lumpy like that that might impact specifically supply chain in 2019?
Well, first of all, I think the plan is by early summer they'll start processing, but not at 100% capacity, and that'll take six or eight months to get to 100% capacity. It's really into fiscal 2020 or even mid-fiscal 2020, where for God willing, it's running smoothly and at 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, a 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+ years. We opened a second meat plant in Morris, Illinois, that'll handle the Midwest and East Coast. It's by no means at full capacity yet.
There's some lumpiness, and both of those latter two things have been around. The commissary's been around for over one year, maybe closer to two, and the meat plant's been around for a year-ish. Those are some of those when I talked earlier about, I think Michael Lasser was talking about what other things are challenges to SG&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 on those other two-day deliveries. We got a lot of little things going on like that. The big lumpy is gonna be, just by sheer size of it, is the chicken plant. That has more to do with there'll be some more pre-opening, and there'll be perhaps a little more depreciation.
All right. 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.
Okay.
One of the merchants here is shaking their head.
Okay. Thank you.
Next question is from Chris Horvers from JPMorgan. Your line is open.
Thanks. Good evening. First on the rev rec. 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'll be a pressure all year because of the change in the accounting. 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 and January. Over the year is the rev rec impact to the top-line neutral?
That latter question related really to e-com. No, rev rec will be for the year. I think in 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 $1.something billion. Some of the things have more margin percentage impact, but at the end of the day, it has no impact on the bottom line.
Understood. You had a big benefit in this sort of the November month in this quarter because of e-commerce, right? That's rev rec. You had a bigger benefit now, it just mitigates throughout the rest of the year, essentially? Or goes the other way.
Yeah. 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. The gross margin, I know it's up and down to the SG&A line, the gross margin impact persists all year. Or some degree of it.
Yeah, some degree of it, yes.
Of course. We've said it.
Yeah.
It's going to be an eight to 10 basis point headwind, just optically.
Yeah, optically it'll be an eight to 10 basis point headwind.
Understood. 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 buyer's picks.
Higher traffic, higher conversion.
Yeah, 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. The values. I think we've gotten the attention of the suppliers in many cases, and they see how it's improved their business. Particularly in an environment where, in some cases, those products aren't doing as well as our competitor brick-and-mortar operators.
Yeah. I bought a snowblower, and it was, like, 30% cheaper than what I could find at a big box store. In November, that was my Black Friday gift.
You're welcome.
My last question and they delivered it to my garage. My last question is: What percent of e-commerce are you shipping currently versus direct from vendor? Where do you think this goes over time? What sort of cost savings do you generate over time?
We're shipping about 50% ourselves. 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 third parties.
Is that percentage gonna 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're gonna do it whatever way is most economical. My guess is there are gonna be some things that we're currently doing third-party that we'll bring in-house as we get better and more confident of being able to do it. If you think even of going back to some basic things, like what we're doing with UPS with two-day dry, it's not e-commerce, but it's two-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? 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. Again, part of it is price points. Again, I was talking to a merchant yesterday, and they're giving 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. First of all, if it's in the 10% range, I think we feel we've done a good job of working with the supplier. What is the supplier willing to do to try to minimize that or if there's competing suppliers, getting even more. There's 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's some items, bigger ticket items, where if you're going to go from $500- $625 at 25%, 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. It's all over the board.
Okay.
Overall, as you might expect, Karen, we're going to be the last to increase and the lowest, but it's clearly not subsidizing it with other things.
Okay. I guess just 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? I guess the bigger question I have is, isn't there a possibility that Sam's continues to get more aggressive on other categories? The pressure will likely spread. 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. Within fresh, it's produce and protein. Whatever comes our way, we'll figure it out. 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 for our buck from having Sam's close 63 units than certain incremental competition on certain things. That's what we do. We compete.
Okay. Just last question. You comment on testing pickup lockers in 10 locations. Can you maybe just elaborate, like how big are the pickup lockers? Are you looking to maybe expand that or broaden it? What kind of SKUs would be able to fit in currently?
They won't fit a 60 in television, as an example. They're relatively small and clean looking. They're 10 locations. Keep in mind, the items that we started with and we chose to do, first 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." We think we've picked up a little incremental there. What we're finding is that many of these customers, 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. These items really are limited to jewelry items, some small electronics items, and handbags.
Okay.
Yeah. All buildings, by the way, offer the service and show you that there's more out there. 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 to pick up in store for groceries. A, we don't have the room up front, B, we're probably a little biased, 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. Yeah.
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.
Yeah. 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 retailer, all companies, including us, we want to make money. 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. We do our own price studies. What we're saving our customer relative to competitor stations nearby, whether they're independents or supermarkets or nationals, we're saving more today than we've ever saved them per gallon. 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. Yeah.
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, 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. We're definitely taking market share, and we're able to do that while making a little more, but not a lot more.
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 like EBIT grew somewhere in sort of like the 3.5%-4% range. That was about the same as it was last quarter, but yet your comp is 7%-8%. Fuel's 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%-8% forever. Does kind of flow through improve from here?
Right. Well, first of all, two things. You mentioned the 3%-4%. I think if you add those two items in that impacted the pre-tax, it's 6% or 7%. Even that, and when I say the two items, the Citi Visa breakage as well as our payroll increase that on top of everything we took because of the income tax. We knew some of that income tax was going to impact the pre-tax line in that way. The other thing, and you 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 five 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 we still want to make money, and we still think long term, we're creating a stronger, more loyal company. I think that we're optimistic about what our future holds in that regard. I can't give you guidance of where it'll go.
Okay. Thank you.
Oh, by the way, in addition to just the payroll hitting the tax, in our case, rough numbers, the first full year post the tax reform, on those pre-tax earnings, it was a little over $300 million pre-tax. A little over $300 million tax benefit. That's a little over $400 million pre-tax. 110 or 120 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 and more and more of them to have it top of wallet.
We think, again, all these things are driving. Clearly, in the first year of two-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 two-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. First on the tax rate, a housekeeping question. The tax rate that you gave, the guidance, did that exclude the benefits that you saw in Q1?
Yes, it excludes the benefit, those unusual things.
Okay, great. Then on the capital allocation front, share buybacks, again, 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. As the stock goes down, we buy a little more. It was a small number for the quarter. It was a little higher towards the end of the quarter, the beginning of the quarter. We'll see what next quarter brings. As it relates to special dividends, we have made no decision on a fourth special dividend. We've been asked time and again because each of the three that we've done were spaced about two and a quarter years apart from each other. We've been asked what happens in two and a quarter years from May of 2017, and we've said we don't know. Well, 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. In excess of a roughly $1 billion annual dividend that has grown historically about 13% a year. 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 two more questions?
Our 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'll be a notable item on a go-forward basis or is it relatively minor and kind of gets lost in the wash?
It's relatively minor. Keep in mind, you're talking about an annual reward that's in the $2 billion range. If you look at it, this really affected. We started doing this a few months ago, these reminders in a bigger way. If you look at it sped up or increased the ones that were going to not be redeemed that related to 2007 calendar purchases on that card. We had to then up the accrual for all purchases in 2018. We had already lowered the accrual prior to this from the previous year. 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. Okay.
I think it was like $6.5 million, $7 million pre-tax.
Understood.
You could annualize that component on an annual basis.
Okay. I wanted to clarify the answer you gave to an earlier question, I think it was from Chuck, regarding the profitability of e-commerce. I was also under the impression that e-commerce was a higher, let's call it, operating profit transaction for you. The way you phrased it sounds like it's a lower gross margin, maybe it's the EBITDA to contribute a positive contributor. Is that the right-
No. It's a more profitable operating margin. It has a little lower gross margin and a lot lower SG&A. Maybe a lot lower SG&A is more appropriately termed lower SG&A because there are a few things that we don't allocate necessarily to it. When you buy something online and return to the warehouse, the warehouse charges for that. 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. At the end of the day, we view it as more profitable than the bottom line of our company as a whole.
Got it. That-
not a lot
Fulfillment.
What?
I'm sorry. That is true whether it's being shipped by you or the third party that you referenced in an earlier question?
It's all blended together.
Got it. Okay, great. Thank you.
Okay. One last question.
For our last question, we have Scott Mushkin of Wolfe. Your line is open.
Hey, guys. Thanks for taking my question. I just wanted to make sure I understood the answer to the last question. Of the $43 million, it sounded like $6 million-$7 million of it is actually not one time. It's going to be kind of ongoing. Did I get that right or am I misunderstanding?
The $43 million 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 January 1st through December 31st, calendar 2017 purchases or 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. Based on what we had previously thought would be redeemed and not expire as of December 31st of this year, we upped the ante on that piece. That's a little over a third of that $42 million. The other piece is all purchases made on this year.
Those card members will receive a reward certificate in February of 2019. Every time a reward is earned, we accrue a little bit of the anticipated breakage or slippage in it. With our reminders, we are going to accrue a little less for that. It's also all the purchases made from January 1st, 2018 through the end of August or September 2nd, whenever the year-end was of fiscal 2018, we upped the accrual on that. In Q1, based on our lower breakage assumption, but therefore higher accrual of breakage. A lower breakage assumption, so that was about just under $7 million pre-tax. That's the piece that will be ongoing.
Okay. I think I got that. My next question.
The total was about 49, almost $50 million. 43 was one-time prior to Q1.
One-time.
Yeah.
Perfect. My second question is more strategic. 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 omnichannel, the flow-through of sales diminishes. The profitability just kind of comes in. How do you think about Costco? Costco has seemed not to have this problem, but maybe we are seeing a little bit of it as we go more omnichannel, just the profitability of the business comes down a little bit. How do you think about that, and how should we be thinking about that?
Well, I think that, 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, and it's all free, that's a necessary part of their business that's not necessarily profitable relative to the old way. In supermarkets, I don't think delivery. To the extent you can incrementally take a customer or grow market share, maybe 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 two-day delivery, we didn't go and spend hundreds if not $1 billion 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.
We're still going to improve the cost of delivery on even that because we want to be in the entire continental U.S., but 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, I think we've also benefited from things like if you look at white goods. Historically, when we had limited white goods in store, I think four fiscal years ago, we did $50 million in the U.S. in white goods. Three years later, in fiscal 2018, we did $500 million, like five or 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. All that White Glove service.
We have been fortunate in that regard. There's 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%+ of our apparel is still in store, not online. We're testing a few things online. It's a $7 billion category that's grown, compounded for four years in the high eights. Furniture, where we'd have it in store, limited 20,000, 30,000 ft of furniture for 8- 12 weeks in the summer after Memorial Day, 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.
Now geographically, the locations where people buy that stuff year-round have the ability to do that. 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, Scot, in the first 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. Those are going to be a few years here, I'm sure, to continue that, but these strong sales have helped that.
All right, perfect. Hey, listen, have a great holiday, thanks for the great explanation.
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.