Motley Fool: Costco Wholesale Corporation (COST) Q1 2019 Earnings Conference Call Transcript


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Costco Wholesale Corporation (NASDAQ:COST)
Q1 2019 Earnings Conference Call
Dec. 13, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hi, my name is Liz, 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 on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session. Thank you. Mr. Richard Galanti, you may begin your conference.




Richard Galanti — Executive Vice President and Chief Financial Officer

Thank you, Liz, 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 in any 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. 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 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 estimated breakage on rewards for the Citi Visa co-branded credit card program. More on this in our discussion of the gross margin. In terms of sales, net sales for the quarter come in at 34.31 billion, 10.3% increase over the $31.2 billion reported last year in the first quarter. In terms of comp sales in the release today, for the 12-week fiscal first quarter US comp sales on a reported basis were up 11% and not only gas inflation in FX but revenue recognition, the 11.0 would be 8.3. Canada reported 2.4, ex-gas FX in revenue recognition, and it’d be plus 5.5. Other international reported 4.0. Ex those items plus 5.8. So total company reported 8.8 ex-gas FX and revenue recognition impact 7.5 plus.

E-commerce, 12 weeks reported 32.3. And again, ex those items plus 26.2. In terms of Q1 sales metrics, first quarter traffic or shopping frequency increased 4.9% worldwide and within the US 5.2%. Weakening foreign currencies relative to the US 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 in revenue recognition, the average ticket was up approximately 2.4%.






Next on the income statement is membership. Membership, we reported an increase of 9.5% or $66 million coming in the quarter at $758 million in the first quarter this year compared to 692 last year. FX had a negative effect of approximately $6.4 million. So the 9.5% increase would’ve 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 the June of 2017. And as you all know, it takes about twice, three months to get through the book part of the income statement at benefit. Our renewal rates rose in Q4. US and Canada membership remains in Q1 end or came in at 90.5%. That’s up from 90.4% just 12 weeks earlier at Q4 end.

And worldwide rate improved to 88.0, also up a tenth of a percent, up from 87.9% 12 weeks ago at Q4 end. In terms of the number of members at first quarter end, Gold star at Q1 end was 41.3 million that compares to 12 weeks earlier at 40.7 million. Business primary, 7.6, both at quarter end and year-end. Business add-ons stayed at 3.3. All told, what we started the fiscal year or we end in last fiscal year with 51.6 million members. We ended Q1 at 52.2. Total cardholders at year-end from last quarter were 94.3 and again, at this first quarter end, it was 95.4. We opened six new warehouses during the quarter.

Also at first quarter end, paid executive memberships totaled 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. So you’ll see that fluctuate but certainly a good showing in the quarter. Related to the annual fee increases, I mentioned earlier we’ve now passed the halfway point at 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 Q’s 2, 3, and 4. Very little in Q4, actually.

And again, that 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. Now excluding gas inflation and revenue recognition, that minus 50 would’ve been a minus 26. I’ll start with my line items if you will in comparing the minus 50 to the minus 26. If you just jot down two columns of numbers in five lines. The first line is the core merchandise. The second line ancillary businesses. The third line, 2% reward on the executive membership. The fourth line, other. And then 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 plus-five reported, ex those items would’ve been a plus 11. 2% reward, zero and a -2. Other, minus 12 and minus 13. And if you add up those two columns, you’d get to the -50 reported and then ex-gas inflation revenue recognition the minus 26. Now again, going to the core, the minus 43 ex those items going to -22. That’s again based on the sales penetration of that 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.

Sub categories within core gross margin year-over-year in Q1 both food in 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 plus five, plus 11 ex-gas and revenue recognition in the quarter. Gas was up, ecomm was up a little, and businesses were up a little. Pharmacy, a couple of other little things were down a little. But 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 cobranded card. And we put it here because it’s part of the deal, things like the rewards that are paid out to the cardholders as well as bounties that are earned and revenues that are shared. So this impacts the revenue line of our company or the sales line, and therefore it impacts the gross margin percentage. So 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 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. So these reward certificates that were sent out in February of ’18, for rewards earned on Citi Visa card transactions over calendar ’17. And that expire at the end of this calendar year. The $43 million adjustment relates to two things: one, to the thing I just described, to the recent increase in these redemptions.

And second, the additional breakage amounts now estimated on the rewards being earned and accrued on the calendar year 2018 card transactions. These rewards will be sent to the Citi Visa cardholders in February of 2019. So what you see in this line is basically an adjustment to our estimate of breakage on rewards earned on purchases made prior to the beginning of fiscal ’19. Going forward, we’re using this lower reward breakage assumption. Moving to SGNA, our SGNA percentage Q1 over Q1 was lower or better by 23 basis points on a reported basis. And flat or zero without gas inflation in revenue recognition. Again, came in 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.

The first line is operations, core operations. Q1 ’19 reported was lower or better by 23 basis points. And lower or better by four ex those items. Central, 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 minus four and minus six. And then other is zero. So your total again reported the sum of those three line items plus 23 basis points or lower year-over-year on a reported basis by 23. And the second column, basically flat year-over-year on 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 US wage increase to our hourly employees that went into effect on June 11th.




The wage increase negatively impacted SGNA by approximately eight basis points in Q1 year-over-year. And this will continue to impact the SGNA year-over-year comparisons over the next two quarters. I believe we did it effective June 11th in ’17. And June 11th ’18 so it’ll go through the same time period a year later. The central expense was lower or better year-over-year by four on a reported basis and a 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 a pre-opening expense. It was 5 million higher in this year’s quarter coming in at 22 million compared to 17 a year earlier.




We had one more opening this year but 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 that 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. So coming in at 36 million compared to 37. And 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 have 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 was 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 ’19, 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 fiscal ’19 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 had mentioned on our last quarterly conference call. But lower is good. A few other items of note in terms of warehouse expansion. We’ve opened eight locations including two relocations so a net of six in the first quarter. For all of ’19, we expect to open about 23 net new warehouses as well as four relocations; the two we’ve opened plus two more planned for the rest of the year. Within the 23 net new about three-quarters of them are in the US 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 square feet. In terms of stock buybacks, in Q1 we repurchased $34.5 million of stock, 150,000 shares. I’ll turn my attention to e-commerce. Overall, e-commerce sales continued at good levels, both for the quarter and just last week, of course, we reported the 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 valor up 26%. As you saw last week, the numbers are even a little higher than that 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 are 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 US 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 and we had a few interesting new merchandise items online this quarter.

A couple of examples: fresh white truffles, golf simulators, all types of high-end cosmetics and creams, like La Mer, Pendleton apparel and domestics, George Simonson couture cashmere coats, Wheels Up memberships for air travel, and even a few Super Bowl packages. And hot off the press, we went live online I think yesterday or last evening, but this morning with a full online with basically a clean line of Apple Mac products. Both from MacBook Air to MacBook Pro to the iMac into 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.




We continue to do that. In addition to drawing attention to our online offerings, these digital communications, we’re leveraging that to highlight the feature warehouse items and hot buys in-store in driving traffic. We believe that certainly some of our strength in traffic has to do with that. In terms of an update on buy online and pick up in the store, we’ve expanded this selection. No new categories, but some additional assortment. Testing pick-up lockers in about ten locations for this program. Overall, these efforts continue to — we view as positively impacting our businesses. And again, most importantly, not only online but in warehouse and probably in 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. And so not a whole lot new from a quarter earlier. There are 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 of 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. And we brought in additional containers of certain seasonal merchandise early before the January 1st deadline. And we’ll continue to keep you posted. Lastly, in terms of upcoming press releases, we’ll announce our December sales results for the five weeks ending Sunday, January 6th on January 9th after the market closes. With that, I’ll open up to questions and I’ll turn it back to you, Liz.

Questions and Answers:

Operator

At this time, I would like to remind everyone; in order to ask a question, please press * then the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.

Our first questions come from the line of Michael Lasser from UBS. Your line is open.

Michael Lasser — UBS — Analyst

Good evening, Richard, thanks a lot for taking my question. Within your core on core gross margin, it’s been trending a little bit lower over the last couple of quarters. What’s been driving that? Are you starting to feel the impacts of your pretty rapid e-commerce sales and the margin dilution from that on your core on core gross margin? And then I have a follow-up.

Richard Galanti — Executive Vice President and Chief Financial Officer

There are two people in the room here, one Senior Merchant — it’s really us. There’s not been a lot of change. I was just looking back at 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. It’s really — we don’t really view it as much more than the things that we’re doing to drive our business.

We get pretty excited to figure out how to drive sales. Whether it’s buyers’ picks or hot buys or some of the promotional seasonal items, I think that’s seen in the strength of our business. The only thing that I 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 up there. Not only from supermarkets but Sam’s as well. But that’s part of the business.

Michael Lasser — UBS — Analyst

My follow-up question is on the expense side recognizing that you’ve been investing in wages and investing some of the tax benefits that you’ve got. But you have put up some of the best comps we’ve seen in a long time even though expense leverage has been modest. When can we start to see that improve? Thank you.

Richard Galanti — Executive Vice President and Chief Financial Officer

Keep in mind, within these numbers there are about eight basis points related to specifically 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 but had it been flat on the year-over-year basis in the quarter, we’re starting to see that. It’s all sales related. There are really a lot of different things. We don’t go through all the activities we’ve got going on now, whether it’s related to bringing into some of our depots, the returns activities, the fulfillment side.

With the success — with a rapid rollout a year ago into our business centers of the two-day and frankly, with the success of e-commerce, including a lot of smaller ticket items than just the much higher penetration of bigger ticket items that we used to do. You have a lot of small package fulfillment. We’re making sure things get there on time even though it costs us a little more. I could go through a list. There are lots of little things. I think we’ve got a lot of good things going on. As long as we can keep sales going, you’ll see that.

Michael Lasser — UBS — Analyst

Should we interpret that answer as, even if you continue this rate of sales growth, expense leverage should continue to be modest?

Richard Galanti — Executive Vice President and Chief Financial Officer

We’ll see. We never want to predict where it’s gonna go. Our first — we are clearly a topline company. We clearly aren’t’ going to do things to wages or to healthcare costs. Over time, people have always asked us, what are we doing to control healthcare costs? My first somewhat flip but the real answer is, expand more overseas. Healthcare costs as a percentage of sales in the US are 20-60 basis points as a percent of sales higher than all other countries. Our foreign international pipeline has expanded and I think you’ll see that 70-30 or 75-25 US versus international start to move with a little more in international.

There are things that we do to ourselves based on where we do it. We’ve got a lot of things going on with ancillary businesses, with expanding the whole fulfillment and 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 either more growth in e-commerce and on the delivery side. And we know that we’ll see some of those costs associated with that come down as a percentage of those sales. But we’re not gonna tell you when. It takes some time. Last one, Michael. I mentioned earlier the stock compensation. Stock compensation is not just through a few people of this company, and still, we’re 5,000 employees.

And in many cases, from warehouse manager above and buying managers and above and certainly the senior people, it’s 60-80% of the compensation. Because of our annual grants that invest generally over five years, are granted in October, which is Q1. The fact that our stock prices increased as well, any acceleration related to 25, 30, and 35. That was six basis points of it. You’re not gonna see that kind of thing forever. 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.

Operator

The next question is from the line of Simeon Gutman from Morgan Stanley. You may ask your question.

Simeon Gutman — Morgan Stanley — Analyst

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 an investment as an external factor? 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 are more dollars flowing in?

Richard Galanti — Executive Vice President and Chief Financial Officer

In terms of — we’re not that scientific and smart about how we do it. We’re merchants at heart and where we see things work we go for it. As it relates to the core to 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, are competitors, and we’re feeling a little larger there and we’re not gonna let anybody take it away from us.

But that’s a small piece of that delta. There are a lot of other moving pieces to it. Part of it is related to the fulfillment side of it. We’re encountering slightly smaller margins in some of that stuff as we roll it out very fast. Again, we don’t really see — in terms of, are we investing more because we have it? No. We invest more because whether we had it or not, we see these things working for us.

Simeon Gutman — Morgan Stanley — Analyst

Okay. And then, just two quick ones. Can you tell us what the ecomm penetration is, either the quarter or just where ecomm stands? And then, the other pieces. Just the cents per gallon or the gas margins? I’m sure you spoke about what they were in and of itself but have the margins widened out?

Richard Galanti — Executive Vice President and Chief Financial Officer

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. In the last — I don’t know what it was this quarter but in the last couple of quarters, whereas overall US 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?

Simeon Gutman — Morgan Stanley — Analyst

The ecomm penetration.

Richard Galanti — Executive Vice President and Chief Financial Officer

I think it’s just under 5%, approximately 4.8. So somewhere between 4.5 and 4.8. On that, I think it was about 60 or 80 basis points impact to the comp. Including revenue recognition.

Operator

We have the line of Chuck Grom from Gordon Haskett. Your line is open.

Chuck Grom — Gordon Haskett — Analyst

Thanks. Good afternoon, Richard. Just on the grosses again. I think you said overall down 50, ex rev rec from gas is down 26. Can you quantify what the actual rev rec impact was for Q2 and how we should think about the upcoming quarters?

Richard Galanti — Executive Vice President and Chief Financial Officer

I can’t give it to you. I don’t have it exactly. Revenue overall is down about — I’ll give you an extreme example. 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. And I’m making this up completely, but let’s say there was a $500 brokers commission.

You had 500 in sales, the brokerage commission, and essentially no cost of sales. So needless to say, that’s a very high margin percentage. Now, if that was related to — and again, I’m making this up — a $5,000 cruise package, or $5,500 cruise package, you’d have $5,500 in sales, $5,000 across the sales. To a very small piece of our business, but over the year that’s some $100 million of that revenue recognition line. So there’s lots of moving parts within this thing.

Chuck Grom — Gordon Haskett — Analyst

Okay. We thought that maybe it could be about 10-12 basis points. I don’t know if Bob’s there.

Richard Galanti — Executive Vice President and Chief Financial Officer

I’m sorry, how much?

Chuck Grom — Gordon Haskett — Analyst

Roughly 10 basis points on the quarter. We thought that’s what it would be.

Richard Galanti — Executive Vice President and Chief Financial Officer

Qualitatively, I’m hearing from this room a little less than half of it so 10 sounds like it’s a little less than half of 22.

Chuck Grom — Gordon Haskett — Analyst

Okay. 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 gonna repeat? It doesn’t sound right. It doesn’t sound like it will be based on your 26-27% tax rate for they are but just wanted to make sure.

Richard Galanti — Executive Vice President and Chief Financial Officer

It was one-time in relation to tax act but some of it relates to things that started for us in fiscal ’19. And by the way, there are still some moving parts to the tax act. It’s hundreds of pages. Some of the things don’t work completely outlined. There may be little plusses and minuses. This was a little bit bigger than a little plus, which was good.

Chuck Grom — Gordon Haskett — Analyst

Okay. And then just with the –, I think a year from now under the boat with the cost to 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.

Richard Galanti — Executive Vice President and Chief Financial Officer

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 pulling of members to see, is this incremental or not? But we feel that we’re seeing less than we originally thought, which wasn’t a lot, to begin with in terms of, does it take away from the frequency in-store? You 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 some more of their incremental food shopping that way or making it more convenient of themselves. And we’re finding the people that live further away are using it more. These are all anecdotal. Nothing science related to my comments there.

Chuck Grom — Gordon Haskett — Analyst

Okay. And just to pop on Simeon’s question about the e-commerce margins. Am I understanding it’s been a margin accretive category for you? in other words, it garners a higher margin than the store margins. I just want to make sure that that’s still in fact correct.

Richard Galanti — Executive Vice President and Chief Financial Officer

That’s never been a higher margin, it’s been a little lower margin. You’ve got competitive categories like electronics, which nominates the penetration. And then there’s the cost to shipping. It’s a little lower margin. It’s a little lower margin and a lot lower SGNA so it’s a higher P&L if you will, in terms of earnings. Recognizing that not every expense is allocated back to it.

Operator

The next question is from John Heinbockel from Guggenheim Securities. Your line is open.

John Heinbockel — Guggenheim Securities — Analyst

So Richard, a couple of things. Did you see any cogs pressure from port congestion? Either in having to pay to prioritize fly product in, and are you seeing any of that today as we go into ’19?

Richard Galanti — Executive Vice President and Chief Financial Officer

Nothing more than usual at this time of 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 — I’m just talking about truck containers. Something you paid $1,500 might cost $3,500 for that last truck. Again, these were anecdotal stories I heard. My understanding is there is a little back up in China in Shanghai. But not a heck of a lot there. And part of that is every extra container goes 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?

John Heinbockel — Guggenheim Securities — Analyst

And then broader on the supply chain, right? So you think about I guess calendar ’19, is the trick in plan the only lumpy things — I think that’s still slated for calendar ’19. 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 ’19?

Richard Galanti — Executive Vice President and Chief Financial Officer

First of all, I think the plan is by early summer they’ll start processing but not in 100% capacity, and that’ll take six or eight months to get to 100% capacity. So it’s really into fiscal ’20 or even mid-fiscal ’20 where God willing it’s running smoothly and full or close to full capacity. There are a few other things that aren’t as big and slightly less lumpy. Last year, we opened a commissary bakery in Canada, it’s by no means at full capacity yet. We’re adding items that we sell but doing some things we didn’t start off doing that. The 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. So there’s some lumpiness.

And both of those latter two things have been around — the commissary’s been around for over a 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 — Michael Lasser was talking about — what other things are challenges to SGNA? There are lots of little things like that. Notably, some additional — the ramp up getting up and running fulfillment both for e-commerce and all those other two day deliveries. So we got a lot of little things going on like that. The big lumpy is gonna be — just by the pure size of it — is the chicken plant. That has more to do — there’ll be some more pre-opening and there’ll be some, perhaps a little more depreciation.

John Heinbockel — Guggenheim Securities — Analyst

Lastly, are you seeing any early signs of a pick up in fresh inflation? Meat, produce — looks like it might be percolating a little bit. But have you seen that yet?

Richard Galanti — Executive Vice President and Chief Financial Officer

We haven’t. One of the merchants here is shaking their head.

Operator

Next question is from Chris Horvers from JP Morgan. Your line is open.

Christopher Horvers — JP Morgan — Analyst

Thanks, good evening. First on the rev rec. As we think about that gross margin pressure that you experience in this quarter, is that something to 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? And then also on the top line front, I know you mentioned there was a benefit to this month on the top line in November but that has pressure in December and January. So over the year is the rev rec impact to the topline neutral?

Richard Galanti — Executive Vice President and Chief Financial Officer

That latter question related to ecomm, the revenue rec will be for the year. In our September sales release we talked about the fact that for all of the ’19 we estimate that this new standard will benefit sales by about 1%, so one point something billion dollars. Some of the things have more margin percentage in the back but at the end of the day, it has no impact on the bottom-line.

Christopher Horvers — JP Morgan — Analyst

Understood. So you had a big benefit in this sort of November month in this quarter because of e-commerce, right? And that’s rev rec. So you had a bigger benefit now. So it just mitigates throughout the rest of the year, essentially? Or goes the other way?

Richard Galanti — Executive Vice President and Chief Financial Officer

Relatively speaking, there’s a bigger benefit at the end of Q1 and into December because of the holidays and the strength in e-commerce.

Christopher Horvers — JP Morgan — Analyst

Okay. And then the gross margin, I know it’s up and down to the SGNA line but the gross margin impact persists all year?

Richard Galanti — Executive Vice President and Chief Financial Officer

To some degree of it, yes. Optically, it’ll be an 8-10 basis point headwind.

Christopher Horvers — JP Morgan — Analyst

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 the new normalized rate of 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?

Richard Galanti — Executive Vice President and Chief Financial Officer

There was 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 are better values. I think a year ago we talked about not only online but in-store, better values, hot buys, and buyers’ picks. Higher traffic, higher conversion as well. Some of that stuff is improving your site 101; recognizing that some of these things we hadn’t done as well in years prior. And the values. I 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 wherein some cases, those products aren’t doing as well as our competitor brick and mortar operators.

Christopher Horvers — JP Morgan — Analyst

I bought a snow blower and it was like 30% cheaper than what I could find at a big box store, so in November that was my Black Friday gift. And they delivered to my garage. My last question is, what percentage of e-commerce are you shipping currently versus direct from vendor? And where do you think this goes over time? What sort of cost savings do you generate over time?

Richard Galanti — Executive Vice President and Chief Financial Officer

We’re shipping about 50% ourselves and that tended to be the smaller sized items and what have you. all the big stuff and all the white club stuff like white goods, big electronics, furniture, patio furniture. Those typically are done by third parties.

Christopher Horvers — JP Morgan — Analyst

Is that percentage gonna go up for a time or just because the mix of small items goes up, that’s what drives it up?

Richard Galanti — Executive Vice President and Chief Financial Officer

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 will bring in houses we get better and more confident at being able to do it. If you’re thinking of going back to basic things like what we’re doing with UPS with two days dry — it’s not e-commerce but it’s two days 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.

Christopher Horvers — JP Morgan — Analyst

Got it. Thank you.

Operator

The next question comes from the line of Karen Short from Barclays. Your line is open.

Karen Short — Barclays — Analyst

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 increases if you need to on a skew-by-skew basis? Or are you looking at the whole box more broadly and trying to figure out how you can offset with a lower price increase across the box?

Richard Galanti — Executive Vice President and Chief Financial Officer

It’s a skew-by-skew basis, recognizing it’s a heck of a lot easier to do when you’re only selling 3,800 skews in its entirety to start with. And again, part of it is price points. I was talking to a merchant yesterday, and they were giving examples of where on a $40 or $50 item that’s up 20% or 10-25%, they’ve seen no change in the unit volumes. First of all, if it’s in the 10% range, I think we’ve done a good job of working with the supplier, what is the supplier willing to do? And to try to minimize that. Or if there are competing suppliers, getting it more.

So there are some items that even with a 10% increase we haven’t had to change the price. Now maybe we aid inner margin a little. Sometimes not at all. There’s some items, bigger ticket items, where if you’re gonna go from 500 to 625 at 25%, that may impact the unit volume of that stuff. In some cases, in anticipation of 25% coming, we cut back quantity a little bit on some items. So it’s all over the board. But overall, as you might expect, Karen, we’re gonna be the last increase and the lowest but it’s clearly not subsidizing it with other things.

Karen Short — Barclays — Analyst

Okay. And then 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? And then 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. So I guess, are you seeing any of that today? Or is it just limited to fresh?

Richard Galanti — Executive Vice President and Chief Financial Officer

Look, we’re respectful competitors. We’ve been doing this for 35 years. We’re not moving away and we feel we’re in a pretty strong area. I mean, within fresh it’s produce and protein. 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 from our buck from having Sam’s close 63 units than certain incremental competition on certain things. That’s what we do. We compete.

Karen Short — Barclays — Analyst

Okay. And then just last question, your east comment on testing pick up lockers in ten locations, can you maybe just elaborate how big are the pickup lockers? Are you kind of looking to maybe expand that or broaden it? And then what kind of skews would be able to fit?

Richard Galanti — Executive Vice President and Chief Financial Officer

They won’t fit a 60-inch television, as an example. They’re relatively small and clean looking. They’re in ten 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’ve 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. So we think we’ve picked up a little incremental there. But we’re finding is 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 than you can order online and pick up in store. And these items are really limited to jewelry items, some small electronics items, and handbags. All buildings, by the way, offer this service and show you that there’s more out there. But look, it’s a test. We’ll figure it out. What we’re not looking to do any time soon is full order online and pick up in store or for groceries. A., we don’t have the room up front, and B., we’re probably a little biased but we see that not every customer shows up when they order online and you have to separate it between dry and refrigerated or frozen. It’s very costly. And we do have the alternative now with the Instacart agent.

Operator

We have the line of Edward Kelly from Wells Fargo. You may ask your question.

Edward Kelly — Wells Fargo — Analyst

Hi, guys, good afternoon. Richard, you mentioned the gas business in March is rising everywhere. We are seeing that at our other companies. Thoughts on the reason for that and the sustainability of that?

Richard Galanti — Executive Vice President and Chief Financial Officer

I think the reason is traditional retail — 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 could just look every week at gasbuddy.com but 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 on pre-gallon.

And we’re making more than we’ve ever made, partly because everybody else is making more and we’re able to make a little more. How long does it last? I don’t know. It does seem that there’s not a heck of a lot of traction on gas prices going up. I mentioned earlier, you 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 US population where it’s just above flat, 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.

Edward Kelly — Wells Fargo — Analyst

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, the just 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? Can the factor improve from here?

Richard Galanti — Executive Vice President and Chief Financial Officer

First of all, there are two things. You mentioned the 3-4%. I think if you’d add those two items that impacted the pre-tax, it’s 6-7%. But 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 gonna impact the pre-tax line in that way. The other thing — and you mentioned a couple of the other questions on — there’s lot’s of stuff going on here guys. And I think we’re less worried about, was gross margin 5 or 10 basis points different than it could’ve been?

It could’ve 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. We still want to make money, we still think long-term we’re creating a stronger, more loyal company. We’re optimistic about what our future holds in that regard. I can’t give you guidance of where it’ll go. 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, it was a little over 300 million tax benefit. So it’s a little over 400 million pre-tax. 110-120 of it went toward those wages. We view these monies as partly our members. We’re doing what do to drive our business.

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 that have it more of them to have it top of wallet. So we think again, all of these things are driving. Clearly, in the first year of two-day delivery and a big ramp up in small package. The money 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 where we first started than today, which is still more expensive than it will be tomorrow.

Operator

We have Rupesh Parikh from Oppenheimer. Your line is open.

Rupesh Parikh — Oppenheimer — Analyst

Good afternoon, thanks for taking my questions. So 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?

Richard Galanti — Executive Vice President and Chief Financial Officer

Yes, it excludes the benefit as our usual fees.

Rupesh Parikh — Oppenheimer — Analyst

On the capital allocation front of share buybacks, again, you guys are not buying that many shares back. Just curious, on a special dividend, how you’re thinking about capital allocation going forward?

Richard Galanti — Executive Vice President and Chief Financial Officer

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 it a little less. Each day that the stock goes down by a little more. Even if it was a small number for the quarter, it was a little higher toward the end of the quarter than the beginning of the quarter. We’ll see what next quarter brings. As it relates to special dividends, we have made no decision on that fourth special dividend.

We’ve been asked time and again because each of the three that we’ve done was spaced about two and a quarter years apart from each other. So we’ve been asked, what happens in two and a quarter years from May of ’17, and we’ve said, we don’t know. Stay tuned and see. When we’ve done them, they’ve worked well. We still continue to generate a lot of cash in excess of our capex and in excess of a roughly $1 billion annual dividend that has grown historically about 13% a year. It’s certainly on the table but there are no promises of if and when and how much. Why don’t we take two more questions?

Operator

Our next question is from Scot Ciccarelli of RBC Capital Markets. Your line is open.

Scot Ciccarelli — RBC Capital Markets — Analyst

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?

Richard Galanti — Executive Vice President and Chief Financial Officer

Well, 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. And if you look at it, it’s sped up or increased the ones that were not gonna be redeemed that related to 2017 calendar purchases on that card. And then we had then upped the accrual for all purchases in ’18. We 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 a penny a share. I think it was like $6.5-7 billion pre-tax. You could annualize that component on an annual basis.

Scot Ciccarelli — RBC Capital Markets — Analyst

Okay. And then, I wanted to clarify an answer you gave to an earlier question. I think it was from Chuck regarding the profitability of e-commerce. Can you help us? I was also under the impression that e-commerce was a higher upgrading process transaction for you. But the way you kind of phrased it, it sounds like it’s a lower gross margin but maybe its EBIT that’s a positive contributor.

Richard Galanti — Executive Vice President and Chief Financial Officer

It’s a more profitable operating margin. It has a little lower gross margin. And a lot lower SGNA. Maybe a lot lower SGNA is more appropriately termed lower SGNA because there are a few things that we don’t allocate necessarily to it. But like, when you buy something online and return to our warehouse, the warehouse gets charges for that. What we try to do — and not a complete full — it’s charged for its IT expenses and things like that. Certainly, all of the direct buying and what have you. but at the end of the day, we view it as more profitable than the bottom-line of our company as a whole. But not a lot.

Scot Ciccarelli — RBC Capital Markets — Analyst

And that is true whether it’s being shipped by you or is there a third party that you referred to in an earlier question?

Richard Galanti — Executive Vice President and Chief Financial Officer

It’s all blended together. Okay. One last question.

Operator

And for our last question, we have Scott Mishkin of Wolfe.

Scott Mishkin — Wolfe Research — Analyst

Hey, guys, thanks for taking my question. so I just wanted to make sure I understood the answer to the last question of the 43 million. it sounded like 6-7 million of it is actually not one time, it’s gonna be kind of an ongoing. Did I get that right or am I misunderstanding?

Richard Galanti — Executive Vice President and Chief Financial Officer

The 43 million relates to activities prior to the beginning of fiscal 2019. That’s one time in the sense that it goes back to anticipated redemptions, higher than what had been previously reserved for, both for January 1st through December 31st. Calendar ’17 purchases, transactions, both in and outside of Costco on the Citi Visa card. From February of ’18 when they were mailed out to everybody, they’ve been redeemed. In the last few months, we upped the number 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.

The other piece is all purchases made on this year, those card members will receive a reward certificate in February of ’19 but every time a transaction is — a reward is earned — we accrue a little bit of the anticipated breakage or slippage in it. With our reminders, we’re gonna accrue a little less for that. So it’s also all the purchases made from January 1st, ’18 through the end of August or September 2nd, wherever the year-end was of fiscal ’18. We upped the accrual in that. In Q1, based on our lower breakage assumption, therefore higher accrual breakage. A lower breakage — that was about just under 7 million pre-tax. That’s the piece that’ll be ongoing.

Scott Mishkin — Wolfe Research — Analyst

So I think I got that.

Richard Galanti — Executive Vice President and Chief Financial Officer

The accrual was about 49 and almost 50 million. 43 was one time prior to Q1.

Scott Mishkin — Wolfe Research — Analyst

Perfect. Then my second question is, it’s more strategic. We’re seeing a lot of companies — and I think a couple questions got to this. 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 is seen not to have this problem but maybe we are seeing a little bit of it as we go more Omni channel just the profitability of the business gets a little bit — it comes down a little bit. How do you think about that and how should we be thinking about that?

Richard Galanti — Executive Vice President and Chief Financial Officer

I think that we’re fortunate that we’re not impacted. If you look at traditional department stores, which deliver stuff to your home and then you send 70% of it back, it’s all free. That’s a necessary part of their business that’s not necessarily profitable relative to the old way. And supermarkets I don’t think delivery — to the extent, you can incrementally take a customer or grow market share. Maybe that’s negative is offset by the positive of the 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 a billion dollars on our own delivery. We’re doing it with a partner of UPS limiting the things that we do. And it seems to be working.

Now, we’re still going to improve the cost of delivering on even that because there are some parts we want to be the entire continental United States. There are some places that are a little further away, so we pay a little more on that. I think when we look at — to the extent it’s incremental. We’ve also benefited from things like just 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 US in white goods. Three years later, in fiscal ’18, we did 500 million. none of it in store. We had displays in locations and display high-end LG, Samsung, Whirlpool, and the like. And most people want it delivered and be able to take it away. So all that white glove service. We have been fortunate in that regard.

There is an example of because of what’s happened in the world. You’ve heard me mention apparel where brick and mortar apparel is generally down over the last few years. That’s given us an opening to buy certain things that historically we couldn’t in the quantities. 99%+ 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 — 20-30,000 feet of furniture for 8-12 weeks in the summer in the slow part, after Memorial Day, before Labor Day.

We’d still do some of that in store but now it’s year-round online. Same with patio furniture, which is in there for 12 or so weeks January through maybe early April. And now geographically, the locations that where people buy that stuff year round have the ability to do that. I think we’ve been fortunate. There are some things that given our item nature of our business has helped us in that regard, and perhaps offset of the net. Clearly, Scott, in the first couple of years, some certain of these things cost us more. Building up some fulfillment centers. Part of that success online is getting people to open to email, to click on something and to buy something. And there’s gonna be a few years here I’m sure will continue that. These strong sales have helped that.

Operator

And this concludes today’s conference call. Thank you, everyone, for participating. You may now disconnect.

Duration: 65 minutes

Call participants:

Richard Galanti — Executive Vice President and Chief Financial Officer

Michael Lasser — UBS — Analyst

Simeon Gutman — Morgan Stanley — Analyst

Chuck Grom — Gordon Haskett — Analyst

John Heinbockel — Guggenheim Securities — Analyst

Edward Kelly — Wells Fargo — Analyst

Rupesh Parikh — Oppenheimer — Analyst

Scot Ciccarelli — RBC Capital Markets — Analyst

Scott Mishkin — Wolfe Research — Analyst

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