Good morning. My name is Crystal. I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter FY 2013 operating results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you, Mr. Richard Galanti, CFO. You may begin your conference.
Thanks, Crystal. Good morning to everyone. This morning's release, of course, reviews our second quarter and fiscal first half 2013 operating results for the periods that ended on February 17th. As with every call, let me start by stating that the discussions we're having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, that 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, 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. To begin with, our 12-week second quarter, we reported earnings per share of $1.24, up 38% from last year's $0.90 reported number.
As noted in this morning's release, as I had mentioned during our first quarter conference call, earnings call back on December 12th, this quarter's net income was positively impacted by a $62 million or $0.14 per share income tax benefit that was in connection with that portion of the special cash dividend paid by the company in December of 2012 to company 401(k) plan participants. Excluding this one-time benefit, earnings per share for the quarter would've been $1.10, or up 22% year-over-year. In terms of sales for the second quarter, total sales were up 8%, our 12-week reported comparable sales figure was up 5%.
For the quarter, sales were very slightly benefited by gasoline inflation, less than 10 basis points of an impact, were also benefited by strong foreign currencies overall relative to the U.S. dollar year-over-year by net added about 60 basis points. Even so, the 5% U.S. comp sales, excluding the gas inflation, remained at 5%. While the reported 6% international comp figure, assuming flat year-over-year FX rates, would've been 4, total company comps both were reported at 5%, excluding both gas and FX, they still came out to 5% for the company overall. As announced last week, for our 4-week month of February, which of course includes the last 2 weeks of fiscal Q2, the first 2 weeks of our fiscal Q3.
In terms of the four-week month of February, comps came in at 6%, both for the U.S. and the total company. In terms of new openings, after opening 9 new locations in the first quarter, which ended November 25th, we opened 5 new locations in the second quarter, 1 in Washington, D.C., 2 in Canada, 1 in Oshawa, which is in the Toronto market of Ontario, and 1 in Drummondville, which is in the Montreal market in Quebec. We also opened in Leicester, U.K., in Central England, and in Gwangmyeong, which is outside of Seoul, Korea. All told, that puts our 2013 fiscal year openings through the second quarter end at 14 new locations, such that we now operate at 622 locations around the world.
Between now and the end of fiscal 2013, which I think ends on September 1st, we expect to open an additional 14 locations, 5 in the current fiscal quarter, and 9 in the fourth quarter. Of these 14, before fiscal year end that we haven't opened yet, 4 will be in the U.S., 5 will be in Japan, 2 in the U.K., and 1 each in Taiwan, Australia, and Mexico. Such that we will most likely end the fiscal year with 28 new openings this fiscal year and be operating a total of 636 Costcos worldwide at that time. I'll also talk later in the call about e-commerce, membership trends, and discuss, of course, about margin SG&A. On to the quarter itself. Again, sales were up 8%, comps were up 5%, and service reported 5% comp number.
That was the product of an average transaction increase of a little over 2% for the quarter and an average frequency increase of a little over 3%. The frequency trend for the last 3 calendar months that we reported was a 5, a 3, and a 4 for December, January, and February, and year to date we're at a 4. In terms of sales comparisons by geographic region, overall the Southeast, Texas, and Midwest regions were the strongest. Internationally, in local currencies, Korea and Japan were the weakest, again, mostly due to the cannibalization on a relatively small base of existing units. With Canada and Mexico being the strongest internationally in local currency. In terms of merchandise categories for the quarter, for the second quarter, within food and sundries, overall in the mid-single digits, frozen foods, candy, and deli were the relative standouts.
In hard lines, overall in the low single digits, departments with the strongest results were hardware, patio and garden, and tires. Consumer electronics sales were slightly negative, mostly due to the timing of the fiscal calendar, as the typically strong Black Friday sales around Thanksgiving benefited Q2 last year and benefited Q1 this year. You take that out and those numbers would've been a little better. Within the higher single digit soft lines comps, small electrics, domestics, and jewelry were the standouts with media, of course, continuing to be the relatively weak area. In fresh foods, comps in the mid-singles, deli and produce were a little better than the 2 other large categories. Moving on to the other line items. Membership fees, we came in at $528 million or 2.17% of sales. That's up 15% in dollars.
We're up $69 million from the $459 million last year and up 13 basis points. In terms of membership, we continue to enjoy strong renewal rates, and I'll go through a little bit of that in a minute. Continued increasing penetration of the executive membership, which is the roughly $110 a year fee. We're still, of course, benefiting from the $5 and $10 membership fee increases that began a little over a year ago in both the U.S. and Canada. Of the $69 million increase year-over-year membership fees, right at a half of it, or about $35 million, was due to the fee increase.
Membership fee income, as I've talked about in the last few quarters, based on the deferred accounting nature of those increases and recognizing the increases occurred over a 12-month period based on when somebody originally signed up, and then the income comes in over the succeeding 12 months of that first increase. Basically, we'll continue to show year-over-year benefits from that fee increase throughout fiscal 2013 and to a lesser extent, into the first quarter of fiscal 2014 this coming fall. Again, that's due to the deferred accounting treatment for membership fee income. New membership sign-ups in Q2 company-wide were up about 1%. There were more locations open this quarter, five versus last year's two. It's mostly reflective of the very strong sign-ups we had internationally, most particularly in Australia and Asia.
Last year, we opened two units in Japan during the quarter and two right at the end of the quarter, in the first few days of Q3. Of the 14 units opened thus far this fiscal year, only one of them has been in Asia. Again, we have pretty much oversized sign-ups in some of those new units. In terms of number of members at Q2 end, Gold Star 27.8 million, up from 27.3 million at Q1 end. Primary business remained at 6.5 million. Business add-on went from 3.6 down to 3.5. Again, that's somewhat reflective, I believe, of people as they switch into their own membership as an executive member. All told, total members went from 37.4 million at the end of the first quarter to 37.9 million. Including extra cards, spouse cards, 68.2 went to 69.1 million at Q2 end.
At Q2 end, paid executives were a shade over 13 million, an increase of 181,000 over the last 12 weeks, or about 15,000 new executive members. That's both new members and conversions from the base Gold Star membership. Executive members are approximately a third of our membership base and a little over two-thirds of our sales. In terms of renewal rates, they've continued to tweak up in the U.S. and Canada, which is about a little over 80% of our total company, and certainly the oldest and most mature part of our company. Business renewals, which ended the fiscal year at a 93.7% rate, and at the end of the first quarter was 93.8% are now at 93.9%. Gold Star, which was 88.7% and remained there at the end of the Q1, was 88.8%.
As such, that total U.S. and Canada went from an 89.7 essentially to an 89.8 over the last quarter. Worldwide, recognizing in newer markets, you start off with lower renewal rates anyway. We went from an 86.4 at year-end, remained there at the end of the first quarter, and it tweaked up to an 86.5. Really, over the last year, since the fee increases, we've always been asked a lot about renewal rates. Basically, each quarter have been either the same as the prior quarter or slightly up, and then they continue to tweak up almost a full percentage point in the last year and a quarter. Going down to the gross margin line, reported margins were up six basis points from a 10.53 to a 10.59. Here we get to write down a few numbers.
A little chart with five line items and four columns. Basically, we'll do two columns for each of Q1 and Q2. Of course, those of you who've heard this before, this relates to the fact of how many basis points of margin reduction or improvement come on a year-over-year basis in the comparison. Once we do the chart, I'll give you a couple of comments. In terms of core merchandising, reported in Q1 was -7 basis points year-over-year, and without gas inflation was -1. Going across that line, it was 0 and 0 in Q2 reported and without gas inflation. On ancillary business, the second line item, +14 and +15 in the Q1 columns, +2 and +3 in the Q2 columns.
2% reward, -2 and -3 in the Q1 columns, and -1 and -1 in the Q2 columns. LIFO, +1 and +1 in the Q1 columns, and +5 and +5. Lastly, total. Reported Q1 was a +6, which would be the sum of column one. That's what we reported in Q1 year-over-year margins. Without gas inflation, it adds up to a +12. Then, of course, for Q2 reported, as I just mentioned, we were up 6 basis points, which would be that third column summation. Without gas inflation, +7, recognizing there was very little gas inflation. Basically, again, core margins were basically flat year-over-year. Those are the four core businesses, food and sundries, hard lines, soft lines, and fresh foods, which is a big piece of our business. Basically, not a bad showing.
If you look back, of course, as you know, over the four quarters of fiscal 2012, on average, year-over-year compared to fiscal 2011, those numbers were -13 without gas inflation. The trend in Q1 year-over-year was -1, of course, now it's 0 year-over-year. Secondly, ancillary businesses. You'll note that in Q1 it was +15 year-over-year. A big chunk of that, as I mentioned in the first quarter call, was strong gas margins year-over-year and some inflation. I think I said in the first quarter call, about two-thirds of that +15 related to that. In Q2, gas reversed as gas prices went up, margins go down. As cost of gas goes up, we make less. That +3 reflects strong ancillary business margins offset by probably 5 or 6 basis points of negative related to gas.
2% reward is simply a reflection of a little higher sales penetration to those earning the 2% reward. LIFO was a plus five. Again, that's the LIFO credit I'll mention in a minute, is about $9 million of a credit versus a $2.5 million LIFO charge in the same fiscal quarter a year ago. Mind you, when LIFO is a positive, it means the costs of the merchandise are coming down. As you might expect, we tend to reflect that in our sales price as well, which would be on the merchandise margin line. For the second quarter year-over-year, food and sundries gross margins were flat. Hard lines and soft lines were up, and fresh foods was lower. As I mentioned on ancillary, overall, in the chart you saw it was a plus three without gas inflation.
All the other ones, pharmacy, optical, hearing aids, food courts, were all up during the quarter, more than offset by what I just mentioned about gasoline. The impact of the membership on Executive Member I already mentioned, and LIFO I mentioned as well. Moving to reported SG&A. Our SG&A percentage second quarter year-over-year was slightly higher or worse by two basis points, coming in at 970 versus 968. Again, we'll write down four columns, the same four columns, two for Q1 reported and without gas, then two for Q2. The five line items would be core operations, central, RSUs, which would be stock compensation, quarterly adjustments, and total. Going across in Q1, the two columns were plus 10 basis points and plus five, meaning lower. Plus means good, lower. In Q2, zero and zero.
Central was minus seven and minus eight last year, zero and zero this year. Q1, zero and zero in Q2. Stock compensation was minus four and minus four, in Q2 was minus two and minus two. Quarterly adjustment in Q1 was plus eight and plus eight. That plus eight last year was compared to the prior year, a one-time charge for an initiative in Washington state that we funded for alcohol. Quarterly adjustment is zero and zero in Q2. All told, reported in Q1 was a plus seven, meaning that SG&A was better or lower by seven basis points in Q1 year-over-year. Plus one at total without gas inflation. In Q2, again, it was minus two and minus two. Again, higher by two basis points.
Within core operations, our payroll as a percent of sales improved year-over-year by five basis points. It was lower by five basis points. Total payroll dollars increased about a little over 6% in Q2 compared to the 8% sales increase. A good showing there. This improvement in payroll was offset by higher costs and benefits in healthcare, including healthcare and workers' comp. Pretty much a wash between those things. Some of that was accrual related. These are big expense numbers that we also do actuarial things for. Our central expense, it was flat year-over-year in Q2. Notwithstanding ongoing IT modernization costs, I think in Q1 we talked about that was six or seven basis points year-over-year increase.
On an ongoing IT modernization basis, as we're not halfway through, but into the second year of a three-plus year project, it represented, on an ongoing basis, we estimate it's about a three or four basis point hit over the coming quarters year-over-year. Next on the income statement line is pre-opening. It was $6 million in both Q2 last year and this year. Last year, we only had two openings, this year, five. Really no surprises. A lot of it has to do with timing. Pre-opening starts in some cases many months before the actual opening in terms of the costs associated with it. All told, operating income in Q2 was up $94 million or 15%, as operating income went from $644 million to $738 million year-over-year. Hold on a second.
In terms of below the operating income line, reported interest expense was lower year-over-year with Q2 coming in at $25 million, $2 million lower than the $27 million last year. Basically, we had one big reduction in interest expense in the quarter and then an increase related to the recent debt offering. As you recall, last year on March 15th, we paid off $900 million of what was five-year maturity fixed rate debt. The annual pre-tax interest savings to Costco paying that off, I think I mentioned back then, was about $46 million pre-tax per year or about $10.5 million pre-tax for this quarter. That would have made it lower by $10 million. Offsetting this reduction, of course, was about $8.5 million of additional interest expense related to our recent debt offering.
As you know, on November 28th, we completed a $3.5 billion debt offering in the form of senior notes, a combination of three, five, and seven-year notes with a weighted average maturity of five years and all in annual rate of interest just under 1.25%, which again, is about $44 million pre-tax per year currently. That's about a $9 million increase in interest expense for the roughly 11.5 of the 12 weeks that it was issued and outstanding during the quarter. Pretty much a wash between those things, and that's why interest expense year-over-year was pretty much in line with last year. Interest income and other was higher year-over-year by $16 million a quarter. Last year it was $10 million. This year it was $26 million. Actual interest income for the quarter came in as $11 million, the same amount year-over-year.
The other component of interest income and other amounted to income of $15 million this year versus $1 million of a negative last year, or a $16 million swing. About $13 million of the $16 million year-over-year change was related to forward foreign exchange contracts we use to manage the cost of U.S. dollar merchandise purchases in our international operations. These contracts are required to be marked to market at each quarter end, and the change year-over-year was attributable to the general strengthening of the U.S. dollar as of the end of Q2 of this year versus a general weakening compared to the U.S. dollar in these various foreign currencies in Q2 of last year. Last year, we again recognized a small loss related to it. This year, we recognized a gain. Mind you, again, this doesn't show as part of our gross margin.
This is where you put these FX contracts, these are generally done by our buyers in foreign countries where they are basically locking in, typically foreign currency or US dollar merchandise purchases in many cases, where they've locked that in. Again, as it relates to the buyers, many of them consider that part of their margin, although we show it here. Our company tax rate this quarter came in at 25.1% versus 34.2% last year in Q2. As discussed earlier in the call, the income tax line benefited primarily from a $62 million tax benefit in connection with that portion of the special cash dividend paid by the company in December of 2012 to employee 401(k) plan participants. At such time, Costco shares held by employees in the plan approximated 22.6 million shares.
These were held through an employee stock option plan, employee ESOP, established several years ago. Dividends paid on these shares were deductible for U.S. income tax purposes, we recognized that one-time tax benefit during the quarter. Excluding the one-time benefit, our tax rate in Q2 came in at 33.5%, slightly lower compared to the last year's 34.2% during that. Basically, a combination of a few positive discrete items that went our way in Q2. Generally, let's see, ongoing, we'd estimate our effective tax rate, barring anything unusual for the balance of 2013 to be in the range up to 35%. Overall net income was up 39% versus last year's second quarter. Excluding the one-time benefit, the 39% increase would've been 23% on a net income basis, and as I mentioned earlier, 22% on an earnings per share basis. A quick rundown of a couple of other topics.
The balance sheet will be included in the info packet that you can get online. Actually, it was in the press release as well. Depreciation amortization for the quarter was $217 million and $430 million year to date. The other component that we're asked about is our inventories to payables ratio, since we're a high turn business and we fund a lot of our inventories with trade payables. It improved year-over-year as of the second quarter end. On a reported basis, it looks really great, 98% at the end of Q2 versus 91% AP as a percent of inventory. Given our ramped up expansion right now, there's a lot of non-merchandise payables in there for construction and related stuff. Really, on a merchandise inventories to merchandise payables, it was 86% a year ago, and it showed a little improvement to 87% this year.
Certainly in the right direction there. Average inventory per warehouse was up $600,000 from $11.6 million per warehouse a year ago to $12.2 million this year. Up about 5% on the 8% sales increase. Just a little under half of that $600,000 per warehouse increase related to higher levels of merchandise in electronics and small electrics, consumer electronics and small electrics, with the balance mostly spread over mostly other non-foods departments. Overall, our inventories are in good shape. No big markdown issues through the recent holidays, as well as our mid-year fiscal inventories, which we take in January and February, halfway through our fiscal year, were our best ever. In terms of capital expenditures, in Q1, we spent $488 million. In Q2, we spent $455 million for a total of $943 million through the first half.
I'd estimate that for the year, it'll be in the $2 billion range compared to last year for the whole year of about $1.5 billion. Again, that certainly reflects our ramp-up in openings. In terms of Costco Online, as you know, we operate both in the U.S., Canada, and the U.K. now. Both sales and profits were up again in Q2 and Q2 year to date. As you know, we re-platformed the site last fall and also have our first apps, and so far, so good. Next on the discussion list, expansion. As again, I mentioned, we have no reloads or closings this year. In terms of units, basically for the four fiscal quarters, nine in Q1, five in Q2, five in Q3, and nine in Q4.
That would put us at 28 for the year up from 16 net new openings in fiscal 2012 and 20 in fiscal 2011. Finally, we got up a little bit there. If you go back to fiscal 2012, the 16 units on the base of 592 was about 3% square footage growth. The 28 this year, assuming we can get them all open, on a base of 608 that we began the year with, which would be a square footage growth in the 4.5%-5% range. New locations by country For the year, of the 28, would be 13 in the U.S. and three in Canada, three in the U.K., a total of seven in Asia, one in Taiwan, one in Korea, and five in Japan, and one each in Australia and Mexico. As of Q2 end, total square footage stood at 88,986,000 square feet.
In terms of stock buybacks, we did not purchase stock in Q2. As you know, we purchased quite a bit less than we had in the last few years, a couple of years in Q1. Certainly, during the first several weeks of Q2, we completed a special dividend and the debt offering and through the holidays. I don't think there's a whole lot to read into that at this point. Sometimes we'll buy a little more, sometimes a little less, and as we've said in the past, we'll let you know each quarter. In terms of dividends, our current quarterly dividend stands at $0.275 per share, per quarter, or $1.10 a year. This currently represents annualized dividend costs for the regular dividend of $480 million.
That's of course, in addition to the $7 special dividend, which totaled a little over $3 billion paid out to shareholders in December of 2012. As I mentioned, the supplemental information pack will be posted to the Costco investor relations site later this morning. Lastly, I'll go ahead and our third quarter scheduled earnings release date will be May 30th. That's a Thursday, I believe. That'll be for the 12-week third quarter, which ends on May 12th. With that, Crystal, I'll turn it back to you for Q&A.
At this time, I would like to remind everyone, in order to ask a question, please press star one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.
Too soon.
Your first question comes from the line of John Heinbockel with Guggenheim Securities.
Just a couple of things. Drilling into payroll and benefits a little bit, if you looked at total labor cost, payroll is probably, what, 80% and benefits are 20% or something like that?
No. Well, keep in mind, benefits is everything from healthcare to FICA to vacation and sick leave. It's everything. It's not just healthcare. The big one that has the most inflation in it, of course, is healthcare costs, and to a lesser extent, but percentage-wise this quarter, workers' comp. Roughly for every payroll dollar, it's about 50%, another $0.50 in the U.S. and less in other countries.
Well, because I'm wondering.
80/20 is maybe 80/20 if you just did healthcare and benefits, yes. I don't have the exact number off the top of my head.
Well, because you said payroll was up 6%, right?
Yeah.
Dollars. If you look at the other part that would have offset that, the all-in benefits was probably up, what, double-digit or not that high?
I don't think it was up that high, no.
Okay.
I don't have that level of detail in front of me, the big issue is, as I mentioned earlier, keep in mind, given we're talking about $20 billion, $25 billion sales numbers, every basis point is two and a half million $. Just accruals on a billion-dollar annual U.S. healthcare cost and a $100 million, $150 million annual workers' comp cost when you look at different actuarial numbers, you're always going to get plus or minus a few basis points, sometimes plus, sometimes minus. It's like, as I mentioned on some of the discrete income tax items on all those small little things, more went in the positive than the negative. A couple of them went in the negative than the positive here. Is healthcare and workers' comp in the U.S. still inflationary? Yes.
Healthcare, I think is definitely in the low double-digits in terms of percentage dollar growth in Q2.
You still think you need, what, about a 4.5 comp to leverage expenses, or has that changed?
It's somewhere in the 4-5 range. We've given up on trying to figure it out just since there's so many other moving parts now with international and manufacturing businesses and everything else we do in life.
Another thing. On Kirkland, where does that stand roughly when you think about % of units sold and % of dollars, and to what degree has that been growing?
I think units, I don't know the units off the top of my head. I would guess we tend to try to build bigger packs and better quality, and there are examples, as you've known in the past from the tuna fish where we sold our brand, which is a package at a higher spec, higher quality than the leading national brands, at a higher price, but a greater value. Let's assume on average, it's a lower price point by 10% or 20% versus what we would sell the brand for. Private label is in the low 20s and continues to grow. When we talk about aspirational numbers, we'd like to see a 3 in front of it instead of a 2. I don't know how long that takes, but certainly we keep adding new items.
In the last couple of years, we certainly added several items in apparel and canned goods.
Those types of items. I think I mentioned last quarter on the call, like the KS Men's Wool Slack, which is a very high-quality slack at $50 or $65, where we've gone from low six-digit units to closing in on a million units a year. Those are the kind of things that eke out some numbers, too.
Is it growing as a percent of SKUs inside the club? I imagine maybe a little bit.
Absolutely.
That mix that you're getting, because if you're managing or it's coming out to a flat gross, the positive mix you're getting from Kirkland, to some degree, is getting reinvested in price somewhere. I don't know where, but somewhere, right?
Yeah. Again, there's 100 moving parts. At the end of the day, I think that we've seen, as you know, I think you were one of the ones that pointed out earliest back in Q4 of 2011, as we were, quote, investing in price and seeing some of the numbers come down year-over-year in overall gross margins. Certainly, as I mentioned, the core is where a lot of it is. We saw that year-over-year trend flatten out in the last two quarters relative to being down 10 to 15 basis points on a year-over-year basis each quarter last year.
Right. All right, then just one last thing. I don't know if you have anything to say about this, but what are you seeing in Texas with Sam's membership fee increase? Anything different competitively than what you're seeing from them elsewhere since they have that fee to play with?
We really don't see a lot of difference elsewhere. We try to be fiercely competitive everywhere. First of all, I think it'd be too early to tell. I haven't looked that closely, nobody has also mentioned in the last few budget meetings anything regionally big in terms of margin change. I'm not suggesting it's not a little lower. It may very well be. I just don't know off the top of my head.
All right. Thank you.
Your next question comes from the line of Weinswig from Citigroup.
It's Deborah Weinswig. Hi, Richard. Can you talk about your e-commerce strategy as you move outside of Canada, the U.S., and the U.K.? How should we think about it on a market-by-market basis? Then just from a SKU perspective, how should we think about your overlap between online and offline?
Well, just like we've done with our brick-and-mortar warehouses, we go into a new country, we do it slowly, and we see how it goes. Don't expect to see us in five more countries in the next 12 months. We certainly want to expand it, and we'll do so over the next few years in a methodical way. Our strategy is the same, do it as we normally do stuff. In terms of, I think we've expanded some of the product categories to test some apparel items. There's a little overlap there, but it's still small. Historically, over the last few years, the view was this was an extension of our product line, not the same product line that we have in the warehouse. Typically, I used to hear numbers in the 80%-90% range was not overlapping with the warehouse.
Maybe it's a little lower % today, but by no means going dramatically in that other direction. We still don't put our stuff online of what's in every warehouse and what the sales prices are in the warehouse in the brick-and-mortar. One of the challenges in a fast-turning business like ours is we could sell our stuff pretty quickly. We'd hate for a member to look at something and it says we have units in locations they're going to go shop at of something and it not be there.
All right.
At this point, we'll continue to do what we do, and we're pleased with what we've seen so far with the re-platforming and all the little growth pains that you have when you redo stuff. As you might expect, it was more of a hassle for the buyers as they're learning how to use the new system and put stuff on. We're doing fine.
Okay. Then what do you attribute your renewal rates tweaking up to?
I'd like to think it's we're wonderful.
Of course you are.
It's everything we do. The mantra around here, as you've known for a long time, is constantly driving quality up and prices down and never being static and constantly pushing ourselves and improving. I think Executive Member certainly helps. Gas and food, I'm convinced, over the last four and a half years of a bad economy, has certainly driven more frequency. That helps. More food. Anytime we get another reason why you want to come shop at Costco, it's another reason why you're going to renew every year. We try not to disappoint. Then to a lesser extent, on Amex, there's auto renewal, of course. You can opt out of it. A cardholder can opt out of it. Certainly that's, in my view, less of an issue right now because the rate of increase is not as big as it used to be.
Okay. The last question, if I go back and look over our model for a long period of time, it does seem from an SG&A perspective on the operations line that there is a more consistent pattern in terms of leveraging the operations. Can you just discuss if there is anything that's significantly changed in terms of how you approach the operations or
Any kind of philosophical changes, I guess?
Nothing philosophical. A couple of things I've mentioned on prior calls in the last several fiscal quarters are things like increased penetration in non-U.S. and Canada markets, where certainly in non-U.S. markets that relate to healthcare costs, lower wage relative to price points in those markets. You have a little lower payrolls. You certainly have lower healthcare costs. Those types of things help that increasing penetration. I know I've mentioned over the last few years a couple of times, on a qualitative basis, the word focus, and as wonderful, again, as we think we are in being efficient, when the economy got bad, everybody looks to see what can you do better and what should you stop doing that you used to do, but you don't need to do. It's those little things. I think in the past year, I mentioned the example of overtime hours.
We are probably pretty good at managing and minimizing overtime hours, once we started getting all the 12 or 15 or so senior VPs of operations around the U.S. and the world every month at the budget meeting to report on it, guess what? When total hours were going up 3-plus % year-over-year, or 3.5% or 4%, whatever it was, overtime hours were going down 20-plus %. Again, that's a year or two trend benefit, those are the kinds of things I think that we've gotten better at. I think getting back to John Heinbockel's question earlier about expense, what do you need in comp sales? One of my canned answers in the last few years has been, who knows what exactly the expense leverage is.
I can only tell you that I believe that whatever it used to be, it's a lower number now because we've gotten a little better in the bad economy.
Okay, great. Well, thanks so much, best of luck.
Thanks.
Your next question comes from the line of Karen Short with BMO.
Hi there. Thanks for taking my question. Just on merchandise margins, it sounded like, giving us what your core merchandise margins did in 2011 and 2012, then kind of comparing that to what happened in the first half of this year, it sounds like you're kind of trying to signal that we should not expect this first half of the year to be the trend for the remainder of the year. Did I read that right?
Well, we try not to signal other than to say, I know last year, as each quarter we showed that the core year-over-year versus compared to the prior respective quarters of the prior year, when they were down 10 and 15 basis points year-over-year, that people would say, "Well, once you anniversary that for four quarters, does that mean you're, quote, investing in prices and getting more?" Of course, I would say there's no telling what it'll be. We'll continue to do what we do for a living. Certainly, we are cognizant we want to try to increase earnings and sales, we're going to try to do it by driving sales and lowering expenses first. So far so good. There's two quarters behind us this year that have shown certainly a better relative trend than the four fiscal quarters last year.
Again, I can't really tell you what the next quarter or next year is going to be.
Okay, thanks. One of your competitors had also kind of signaled that they had accelerated their price initiatives. I guess, are you seeing anything on that front, or are you changing anything in terms of your pricing in response?
I don't want to sound arrogant, but we do what we do every day, and we haven't seen any big changes out there in general. We and our competitors, and probably the one you're talking about, are both fiercely competitive. As I've said in the past, direct warehouse club competition, most particularly with Sam's, is going to be the most competitive that we have, and that hasn't changed over the years. As we get questions about what happens when the supermarkets are doing something or other forms of retail food and sundries, as an example, that's less of a direct impact with the exception of a few areas like some of fresh foods areas like fresh meats and everything and some cuts of beef. Other than that, we haven't seen any dramatic deltas.
Okay, that's helpful. Just last question. You've been kind of giving this cannibalization impact on your total comp of about 50 basis points. Is it fair to say that that's kind of steady state for a while? I know you gave the cadence and the locations of new store openings in the back half of the year.
Yeah, I think years ago it used to be bigger because we had a smaller base of units, even in the U.S., and we're opening a half a dozen units in L.A. or something like that. We've always just given it out, and then it got down so it was maybe a quarter of a percent cannibalization, and now it's back up to 50 or 60 in the last year. Yeah, it's not going to change dramatically from that. Certainly as we continue to ramp up expansion, it stays in that range. I don't ever see it going to 1.5% or 2%.
I don't know if it gets up from 50 or 60 to 80, but it probably stays up there as we continue to open, particularly in some of these new international markets where we have very high volume units that we've got to cannibalize them and get more locations open.
Okay, that's helpful. Thanks.
Your next question comes from the line of Colin McGranahan from Bernstein.
Good morning. Morning, Richard.
Hi.
First question on expansion. It looks like you're now targeting 28 units this year. I think last quarter the budget was 30, although you've always said units can slip. Looks like you lost a Korea and a U.S. Anything of note there and anything to read into that?
No. I think the U.S. one is one that's just delayed for six or nine months, and I'm not sure about the other one. No, nothing unusual.
Okay. Just sticking with expansion, there's been a few press reports of some interest in Europe and France, and maybe you can update us on your thinking of continental Europe as a longer-term future opportunity.
Well, I think we've spoken generally, there have been articles in the local and national press in those countries, like France and Spain. I would say over the next couple of years, we hope to be open. It's a long process in some of these countries as it relates to the zoning and the permitting and the approval and the appeals of residential and other businesses can appeal. There's a lot of things going on, we have people landed in a few different countries, including those two, and those are the most likely. Again, once we know more, we'll let you know.
Okay, fair enough. Just on LIFO, obviously had a little bit of a benefit. How are you thinking about that through the year in terms of inflation, deflation? What are the merchants saying about what's coming down the pipe?
The only area I'm hearing a little more inflation still is in protein, beef and poultry and pork. That relates both to international demand for some of those items, as well as the costs associated with the drought last year and grain prices and corn and wheat and things like that. As freight costs have gone up a little, I don't think they went all the way down when freight costs peaked a few years ago, then came back down. I'm not hearing a lot of inflationary talk out there. On balance, there's not a lot going either way with the exception of protein. That's really all I've heard from our buyers.
Okay, that's helpful. Final question, just on MFI. Fees came in a little above our estimate, but it looks like we were fairly good at figuring out the dollar value of the membership fee increase. Two questions there. Was there anything else, or was it just, you had 1% growth in new members and high renewal rates that drove the little bit of upside to MFI? That's the first question. Just out of curiosity, is there any lumpiness through the year in terms of when renewals happen?
On the first question, your thoughts are generally correct. On the second question, I probably need to go look at it again, historically, since we generally try to get openings done, ideally, if we could, I'm thinking of the U.S. holiday and seasonal calendar here, you could take it to each country and do that as well. Generally speaking, we'd love to get every location opened, A, as soon as possible, and every location open the week before back to school and Labor Day, and to enjoy, again, Labor Day, back to school, Halloween, Thanksgiving, Christmas, seasonal, you name it, New Year's. That's why there's typically more done. Of course, if you're trying to push those units to get open, you probably slow down a little bit in January and February.
If I think you look back at the calendar, probably there is a little lumpiness of openings, probably not as much as there used to be. Because of deferred accounting, and such a big piece as the total now, it tempers some of that lumpiness even more.
Okay, that's helpful. I said that was my last question, let me slip one more in. The U.S. comps have been really consistent. It looks like your business has been incredibly resilient and impervious to some of the pressures out there, like the payroll tax hike, the delay in tax rebates that other retailers have pointed out. Have you guys done any work on how that might be impacting your business and any offsets to that?
No. We haven't. We kind of joke about that we don't spend a lot of time trying to analyze, other than driving the quality and lowering the prices and everything else take care of itself. I know back when the payroll tax holiday occurred, and some of those same companies were talking about how it did help them a little bit. When asked, we basically indicated and looked at it and indicated that we didn't really see much benefit from it. I think the same thing's happening on the tail end the other way. It can't help, but it doesn't seem to really be impacting our members.
Great. Thank you very much, Richard.
Your next question comes from the line of Chris Horvers from JPMorgan.
Thanks, good morning. Executive membership, 15,000 per week. It slowed down here in the second quarter. Does that have to do with the timing of the opens in Japan? Do you generally over-index to executive in those countries versus domestic? Do you sit there and say, "Hey, we need to step up executive membership to a higher percentage of sales" as you think about what traffic could be in the future? Is it something that you're watching and maybe saying, "You know what? If executive membership grows at a slower rate, maybe our traffic could fall below that recent, very consistent trend"?
Look, every day, our people in our membership marketing department are coming up with ways to drive both new members and converting members to the executive member, signing them up, a higher percentage of new members signing up as executive members. I think we've done a good job over the last few years of doing that. I remember a few years back, for every 100 members that signed up in the U.S., 20 or 21 were executive, or 10 or 12 were executive members, a few years later, it was in the low to mid-20s. Why? Because we started focusing on it a little bit in the warehouse. Not doing a whole lot of fancy stuff, but just doing the 80/20 rule that we're pretty good at. What are the simple things we can do to drive this?
Certainly, trying to get people to also do the triple value play, what we jokingly call it, is to also sign up for the Amex co-brand card. All those things drive frequency, drive loyalty, drive sales. We're constantly looking at ways to do that. Ultimately, it's got to slow down a little bit. We've now had it in the U.S. for 13 or 14 years, in Canada for seven or nine years, I think, and a few other countries for less time than that. Those other countries, though, were a much smaller piece of the total company pie. I would expect it to continue to come down a little bit. I actually think 15 a year is still pretty good. 15 a week.
Yeah, absolutely. You said one-third of your members are executive and two-thirds of the sales. Can you talk about the deviation around that? Is there a wide deviation around that among your stores and maybe where some of your better and best stores are as an indicator of where potentially that could go?
Well, I think it has less to do, if I think about it. I'll take the U.S. I think it has less to do with the typical geographic areas other than the operators in those areas that push it a little harder. We try to learn from them. One of the benefits, I think, of our 13 every four weeks, so 13 times a year, our 13 fiscal period meetings out here for two days, day and a half, is each of those 15 or so Senior VPs of operations, in this example, in the U.S., the eight Senior VPs of operations gets up, and one of the things they talked about is what's going on in these areas and what are the new things they've done to drive whatever. I think some do focus more than others. We try to learn from that.
I guess you have some stores where it's 40%-50% of your membership base?
Absolutely. Yeah. Okay, I see what you're saying. Yeah, I don't have that number in front of me, but if it's roughly a third or a little over a third overall, it's probably in the U.S. in the mid to high 30s. Let's just make up a number here, 36. If it's 36, I would bet you across the 430 plus locations, it would range anywhere from the high 20s to the low 50s.
Okay.
I'm shooting from the hip that answer.
Sure. Very helpful. Just from an accounting perspective, can you talk about how the calendar shift might impact total sales versus comp in the next two quarters?
I don't think it's a big deal in the next two quarters. There's no Easter shift. It's in the same month.
It's the same one.
It's in the same month.
Yeah
Quarter. I don't think there's a whole big deal there. Of course, in Q4 last year, it was a 17-week quarter, and I haven't looked that far out in terms of when Labor Day falls and all that stuff. What? I think Labor Day, well, if Sunday the first. We end on Sunday. Sunday September 1st is fiscal year-end. I guess Labor Day is second. That might affect it a little bit too, but I haven't thought through that yet.
Okay. Last question. Online, you accept credit card purchases, so how does that change the profitability of an online versus an in-store transaction? Thanks.
Well, one of the cost components, of course, online and in store as well, is what we call bank charges, which is credit, debit, and other fees related to vault and cash and currency and check cashing. Online, we, of course, have the ability to, since you can't pay by cash or check online, we also accept other national forms of credit cards. Of course, in-store, it's exclusively American Express in terms of branded national cards. It's a higher merchant fee elsewhere. We have a higher bank charge line, although we have, overall, a much, much, much lower SG&A number online because 75% plus of the goods are shipped factory direct. There's a lot less handling, and as a % of sales, online is a more profitable business than brick and mortar, but we do both.
Thank you.
Your next question comes from the line of Mark Miller with William Blair.
Hi, good morning. It's encouraging to see the step-up in club openings, particularly more coming in the first half of the year. I wanted, Richard, to get your view on, I know there's an objective to possibly accelerate the club growth further, I think had been potentially as high as 6%, you'd hope, over the long run. Is that upper end of the objective becoming more credible in your view? Maybe you can just talk about that pipeline of club openings you look at, I think, that pool going out, say, three years. Is that group of opportunity stores growing at that type of rate?
Probably six is a little high. Given that we were at three and now we're getting towards five, that's a good sign. I think there's certainly a lot more in the pipeline now to give I think me a little more credibility with you in terms of what we talked about at the beginning of the year. There's always going to be a couple that fall out because we try to be optimistic that everything we've got going on is going to work and get done on time, and maybe push the envelope at the end of any fiscal year to get them still open. I'm feeling better now that two years ago, I was feeling that, let's try to get into the low 20s at least, and we did 20 in 2016.
We began this fiscal year talking about 30, I think we have a good chance of actually hitting the 28. I think that going forward, I think Craig would like to see it have a 3 in front of it, probably a very low 3 in front of it. If I was a betting person over the next three years, fiscal 2014, 2015, and 2016, 27 to 33 or 34, which would give you a 30 estimate, I could be off a few. I think we've got enough in the pipeline to be able to do that, we'll go from there.
Great, thanks. Then on pre-opening, you indicated that it was nothing particularly unusual there. The pre-opening costs first half are up about a third, the number of openings was more than double first half. Is that because you've got the openings coming late in the year with the nine club openings in fourth quarter, or is the pre-opening cost coming down a little bit for you?
I would be willing to bet it's the former reason, not the latter. A lot of it just has to do with timing. Keep in mind pre-opening, let's say that we're doing a lease, not an own. You get the property four or five months in advance of opening. We might have a few hundred thousand dollar charge per period for rent expense, which is pre-opening, prior to the opening day. That alone might be $1 million or a little over $1 million on a location. That's the exception, not the rule, since we own a lot of the units. Certainly, when we're building a multi-story unit with parking and two stories of retail on a two-acre site in Japan or Korea, it takes a lot longer to do, so you might have even more pre-opening. Some of those are leased.
Those are the kinds of things that'll bump that number up the other way. Overall, again, like everything around here, each location has pre-approved by Jeff and Greg and the respective operations heads in those areas of what pre-opening is going to be. We hit it and miss it. Overall, we have a pretty good handle on what it is. The thing we don't have a good handle on, sometimes when there's a delay, again, a two or three-month delay because of soils issues or rain or freezing ground, you couldn't get the foundation laid before the ground froze. They could be $200,000-$800,000 on a location of pre-opening during those several months.
All right, fair enough. Thanks.
Your next question comes from the line of Greg Melich from ISI Group.
Hi, thanks, and good morning, Richard. I want to follow up on the LIFO gain. Which area was actually deflating or which categories, and did any of that actually flow through to retail deflation?
On the deflation, if I look in the big pools, what we call foods and sundries, foods was down a little, about a half a percent. Sundries was up less than 20 basis points. Apparel's down a little bit. Electronics and appliances are down a little bit more than that, but still less than 2 percentage points. Pool 5, which is a mixture of things, including gas and sporting goods and office and auto, is down a shade. Then alcohol and tobacco, beer, and wine is up a shade. Overall, again, it's down a little over half a percent from the beginning of the year.
Got it.
Again, certainly, the bigger deflationary items are still electronics. Sometimes there's deflationary items like, I'm just looking at the top 20 deflationary components. Aside from gas and a small amount from gas, the biggest chunk is electronics, pecans, they're down 20%. Well, that's because they were probably double last year, or whatever it was. Sometimes you have these giant commodity price increases a year ago, particularly in the nuts category or some of the grains, and then it comes down the other way.
Got it. On the 600,000 increase in inventory per warehouse, could you help us sort of break that down and figure out where it's going into, that investment?
I think right at 200 of it was electronics, and another 75-plus of it was small electric. We definitely expanded apparel. I gave the example of the wool pants. We've got a much better, I think, commitment to apparel. Then there's a lot of little stuff everywhere else. The single biggest component is consumer electronics. You go into the warehouse, you see a lot of 60 and 80-inch TVs now.
Just to maybe understand a little bit better, as you grow the online business, how should we think about the inventory per warehouse vis-a-vis the online growth? Is it the same SKU assortment? Is it an extended assortment?
Well, right now it's an expanded assortment. It's not the same. Certainly, you're going to see some overlap on electronics or a few apparel items, but you're going to see more SKU selection online and perhaps in and so whatever changes you're going to see there are going to be very slow in terms of percentages because the brick and mortar is so big.
Right. Great. Lastly, you mentioned on the accruals, and we know that just the $2 million or $2.5 million is one bip. The ones that you cited in this quarter, was that sort of a one-off catch-up accruals or do you think now there's a different sort of accrual run rate for those things you cited?
No. I think as it relates, I don't have the exact basis points in front of me, but like on workers' comp, I think there was a couple of basis points there. My guess is there's a little catch-up in that number. Again, I get back to the income tax. We benefited by several million dollars. I'm not talking about the big $62 million number, but there are discrete items. Usually when you've got discrete anything, there's two or three pluses and two or three minuses and it balances out to be very little, a basis point or two. My guess is there are three or four here, so it's not a whole lot. I wouldn't read a lot into that.
Okay, great. Lastly, on the club openings, as we do more outside of North America, how should we think about CapEx in terms of how many of those might actually be leased? I know you're well over your 90% plus here, but as we go international, are most of those units in Asia and elsewhere going to be leased?
Probably a little more of them are leased or at least ground leased with long-term ground leases. We still try to buy where we can, and I think we're getting a little more aggressive on that, but it's hard to predict. I think overall we're in the low eighties in terms of how many we own. I know even in the U.S., when interest rates plummeted four years ago, all of a sudden, a lot of times when you have an individual landowner, they don't want the cash. So we've done a few more leases in the U.S. as well in the last several years. Certainly there's probably a higher proportion of those done in areas like Asia. I think we own more in Japan than we do in other like Korea, I think we lease more. Every country is a little different.
If I took the three Asia countries as an overall, there's more leases there, of course, than in the U.S.
Maybe asked a different way. If there's 27 or 28 openings, is it fair to say that maybe this year, given where they are, that half are leased and half are owned, or would that be too extreme?
No, we'll still own more.
Still own more. Okay, great.
Yeah.
Thanks a lot.
Okay.
Your next question comes from the line of Dan Binder from Jefferies.
Good morning. It's Dan Binder. Couple questions. First on IT modernization costs. I didn't hear you call it out this quarter. I know it's been adding some pressure. Are we now kind of through the worst of that?
No, I think on an ongoing basis, looking over the next few quarters, and this is a guess, somewhere in the three to four basis point year-over-year. I think it was higher in Q1. It was closer to flat in Q2. Some of that is just, again, timing of things. You also capitalize some of those costs. Again, overall it's going to, my guess, over a two or three-year period, it's going to add sometimes three, sometimes five.
Right. Okay. Yeah, I remember last year you guys were very focused on some of the operational opportunities to improve your cost structure. You called out some of that today. Overtime reduction was one of them, which you mentioned earlier. I'm just curious, as you look at the organization today, are there any big buckets where you can still pull costs out?
I don't think there have been any big buckets. Even, by the way, like I did mention the overtime, 20%+ reduction in overtime hours. That was several million dollars a year, maybe a basis point or two over a couple of years, but nothing so dramatic that's going to change. Nothing like everybody thought that RFID would free up the front end and reduce our biggest labor cost area. That ain't happening. We have done a better job at front-end labor, picking and tackling little things. There's still the focus out there, other than driving sales, again, I'm shooting from little things here, we've streamlined and tested and now rolling out how we return merchandise. In some cases, not doing it at the warehouse, bringing it into some of the depots.
If that can continue to work, do we save a few million here and $5 million there? Yes. There's no giant thing out there.
I'm sorry if I missed it, did you comment on the dotcom sales growth and the contribution to comps this quarter?
No. I think it was in the low teens in terms of sales growth.
Okay. What does that look like in terms of the contribution to comp?
I don't know. We're going to do in the high 2s for the year on 100 whatever your budget is for total sales for the company. It's 2.5% of sales and Up in the low teens.
Okay, great. On consumer electronic sales, I know you called out the calendar issue that affected the quarterly number. Generally, your monthly sales updates have been showing some pretty good strength in that category. I just wonder if you could speak to some of the bigger trends that you're seeing take place in the club there.
Well, I think electronics, the biggest takeaway is our TV sales in general. TV sales are the biggest piece of electronics. While that was down slightly in February, over the last several months, it's been up in the mid-very high single digits. A lot of that, I've been told in the budget meetings, as it relates to the fact that we've done very well with 60- to 80-inch TVs. We've done relatively well. We've now cycled by not selling, as you know, we stopped selling some of the Apple products, the ones that we were allowed to sell, well over a year, maybe 2 years ago. On that low base, we are starting to sell some of the other tablets and the like. The cell phone business is pretty good. Again, it's all dwarfed by TVs.
Great. Okay. Thanks.
Your next question comes on the line of Sandra Barker.
More questions.
With Montag. I'm sorry, with Montag.
Caldwell.
Caldwell.
Richard, I just had a clarification on the website. What impact have you seen from making it searchable and adding the mobile apps? Has it been anything notable now that you're sort of more visible?
I think sales are up a little better than they had been. The first thing is, I know for the months leading up to it, everybody's warning us, from our own dot-com people to the IT people, that the day you flip the switch is not the day you start to see immediate benefit because it takes time to build the clicks and all that stuff. Again, like the other things we do, we're methodical and slow about it, and it's showing some improvement. Off the top of my head, I can't give you any specifics.
Great. I can't remember, is Jim still in the building a little longer, or what's he focused on?
Jim is on vacation this week, but yes, he's still here a lot. Somebody asked me the other day, you go to Craig to ask questions and get permission to do stuff. Jim's still traveling, and he's still on the board, of course. I see him quite a bit. To his credit, and I think to the company's success, it's been a very good little over three-year transition with he and Craig, and he's still traveling a lot to openings and with the merchants and with Craig, and spends a lot of time with Craig and Jeff still. He's doing a good job of staying away a little more. If you asked me six months ago, I would've said he's in the office 80% of the time. Now it's still well above 50%, but we'll see. He's still doing well.
Thanks.
Your final question comes from the line of Robert Drbul from Barclays.
Hi, Richard.
Hi.
I just have two questions for you. The first one is, can you talk a little bit on the numbers around, I think you said new member sign-ups and the metrics in the international markets versus the U.S. and Canadian markets, the numbers higher abroad. Can you tell us how much higher it is? The second question is, you talked about the buyback a little bit, but on the buyback going forward, is there any reason why you wouldn't be active at these levels where the stock is?
Well, I'll take the last question first. No, we look at it, and we'll keep looking at it. I think generally speaking, as I mentioned in the past, we issue our issues that add three and a half million shares a year. It'd be nice to cover that. We don't feel pressure on a given day or week to do something. Generally speaking, we still feel good about the company long term. Again, I think at this point, we'll wait for 12 weeks and see what we're doing. On the other question, what was it?
How much higher are sort of the new member signups in international markets versus U.S., Canadian?
I'll give you some general numbers. Keep in mind, when we talk about opening day signups, it's for the generally eight to 12 weeks leading up to the opening day, where the parking lot's partly done, and you can get in and out of the parking lot, and people come in and sign up in advance of opening. There's the little flags outside and the whole bit, and the table activities. In the U.S., where we've opened a new unit, even in a very strong existing market, you might have a few thousand signups because you've already got a lot of people in that market, and it's not like this giant thing for a new market.
I know I was at an opening back in the Carolinas four or five months ago, it's a relatively medium-sized town, less than 1 million people, in a brand-new market. Through opening day, so opening day signups for those several weeks, and they're all booked, if you will, starting on opening day, was in the 6 or 7,000, which was better than we were thought. We have some openings that we've done over in Asia and Australia, whereas through opening day, we've had anywhere from 20,000 to 60,000 members signed up. Now, mind you're going to have a much lower renewal rate on those a year later. We have units, our membership numbers, and we've been in Japan for a while now, but we also have some new units there.
The number of members per unit over there is a little over double what the company is running. It's a little different metric in some of those markets, quite a bit. When you open four or five of those, that's going to jump your membership increase, the number of members, recognizing we don't use deferred accounting for counting members, but for their dollars, we do.
Great. Thanks very much.
Okay. Well, is that it, Crystal?
There are no further questions at this time.
Okay. Well, thank you. Bob and Jeff and I are around. Appreciate your time today.
Thank you. This concludes today's conference call. You may now disconnect.