Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter Earnings and February Sales Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Richard Galanti, Chief Financial Officer. Sir, you may begin your conference.

Thank you, Brandy. Good morning to everyone. This morning’s release we’ll review our second quarter and first half fiscal 2015 operating results for the 12 and 24 week periods ended February 15th and our monthly four week sales results for the four week period ending this past Sunday, March 1st. The discussions we well be having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call, as well as other risks identified from time-to-time in the Company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made and we do not undertake to update these statements except as required by law. To begin with, our 12 week second quarter fiscal ’15 operating results, as you saw this morning for the quarter reported earnings per share came in at a $1.35, up 29% from last year’s $1.05. As noted in this morning’s release this year’s net income was positively impacted by a $57 million or $0.13 a share income tax benefit. This was in connection with a portion of the $5 per share special cash dividend paid by the Company last month to Company’s 401(k) plan participants. Partially offsetting this reduction to the income tax line was a $14 million or $0.03 a share income tax charge related to an ongoing overseas income tax letter. And the net impact of these two discrete tax items to our reported second quarter earnings $1.35 earnings per share was $43 million or $0.10 a share to the positive. So excluding these…

[Operator Instructions] Your first question is from Charles Grom with Sterne, Agee.

I guess my first question is when you look at your gas business today clearly it's a bucket for you guys to pull funds and invest back in pricing for you guys to kind of be like Costco if you will. Is there a way to quantify that this quarter I mean clearly the core margins within the [indiscernible] of the business being down 3 basis points, was there some impact for you guys being more aggressive on price or if you can maybe just speak to arithmetically?

I think qualitatively it allowed us to be a little more aggressive we didn’t just say, hey take this extra money and put it all there we didn’t. We certainly benefited from in the quarter. And again it's not like we looked at this as that will be an offset to FX as an example because we know that FX has still got even if FX rates continue to stay where they are right now and don’t get any relatively weaker it's still on a relative basis in Q3 and 4 maybe relatively weaker so yes we've recognized it Q3 and 4 will be a little more challenge in that regard but certainly food margins have been up a few instead of down a few probably but who knows.

And then when you look to March of next year and then change in tenders because my understanding is roughly 750 million U.S. visa card holders today and there's roughly 50 million AMX holders today in the U.S. How bigger opportunity this could be for you guys to expand your membership base when you move into next year?

Well we'll see I mean there's a lot of unknowns, the first order business is for Citi to work with American Express and figure out the account portfolio a lot hinges on that we expect that to happen but there's no guarantees and there'll be -- and again there's a lot I'd like to tell you there's a lot we'll figure it out now. We know the bucket of dollars if you will in our mind of what we can use to drive usage of that kind of card to recognizing there'll be some cannibalization somebody that has a visa mileage card in their wallet. They may want to use that instead. Just like there is cannibalization now there's people who use a non-cobranded AMX card. Similarly there'll be other places where there's outside spend increase because your neighborhood drycleaner one card is accepted and another card is not, so there's lots -- I think there's lots of opportunities we have to get there first and first order business is the transition itself and there'll be a lot more to say once we get there.

And then just last question on e-commerce up 23% in the quarter, can you just remind us number of skews online today relative to a year ago? And where you think that can go? How much is costing through your depots versus not and then just margins on e-commerce relative to the clubs? Thanks.

That is probably approaching 8,000 regular skews and excluding from that that we have a lot of tyre skews based on all the sizes we've got a lot of office product skews through a third-party but core skews on our side is 8,000 probably 1,500 plus more than a year ago and I'm guessing there but that's probably a big number. And then those increases are a lot of sundries items, some apparel items things like that probably gets you to come back on a more frequent basis and smaller ticket items a lot of the items a lot of the items we have added are items like I've mentioned versus $300 to $2,000 televisions and furniture sets.

Any color on profitability?

Excuse me?

Just as margins in the e-commerce business?

Margins overall are probably are a shade lower SG&A is a lot lower so profitability wise e-commerce is a very profitable operation relative to the company as a whole.

Your next question is from John Heinbockel with Guggenheim Securities.

So Richard two part question to get kind of the same thing you've got some very busy clubs and you keep increasing traffic mid single-digit every year and you guys spend a lot of time looking at kind of quality of experience in the club in maybe different parts of the club right like fresh and with that in mind is there an opportunity to open more clubs in the U.S. than you might have thought before maybe cannibalize yourselves gain share improve the experience if some of them are too crowded have you guys done work on that?

Well yes in a lot of different ways but not in terms of let's sit down and do that today at one-time I mean first of all quality of experience as you I think know I'm sure you know our operators and our merchants are in the warehouses a lot create and a random set of merchandising and operating victims just spend two days shopping around part of the country visiting warehouses both us in competition and other things and looking in the sites, so I think certainly the member responses that we get every day the types of throughput for hours and front end registers all those things go into that and I got to tell when a member writes a little complaint then that could be nasty just a complaint it just hurt and recognizing we’re always been have some challenges. So we're constantly looking for that experience and we're constantly looking for that to get you out of there faster and to make it a better experience. I got to tell you we still get probably more positive than negatives in terms of e-mails that are sent in to senior management about positive experience as with a member with a particular employee who they have helped in a warehouse something like that and beyond so we have no illusion that we do everything right but we're pretty steadfast of looking all those things in terms of really deliverable units absolutely I mean if you would have ask me five years ago when we're opening about 20 units a year and probably I don’t have the numbers in front of me we're probably it is 70-30 U.S. and you said Richard five year heads where you are going be and I'd say well we're going to be about…

Do you think you can get to a 1,000 there ultimately or have you gone out that far?

Well we haven’t gone out that far as yet yes if we added 30 year for 10 years around a sense there so yes I think so but certainly not out of the relm.

And then secondly what the though at least it seems like anecdotally maybe in certain items or categories there may be Kirkland introduced maybe the brand or a brand is no longer carried. I don’t think there is a conscious effort to although the quality and value Kirkland certainly outstrips a lot of the brands. A conscious effort to get more Kirkland items in the store more space to them is there a conscious effort or that’s just kind of it happens you put in it is where the demand is and so maybe it squeezes out some brands along the way?

Well I think there is an ongoing conscious effort to there are people that are in charge of coming up with new Kirkland stuff in each merchandize category and their job is to try to find new things just like any buyers job is to find good exciting branded items. And ultimately an item it is our cousin it has got the name on it but it has to live and die like any other item I think if we've added 30 or 40 items in the past 12 or 18 months that should we subtracted 20 or 30 that ultimately did work out when though we bring back some a few years later that worked better I remember years ago we had a organic peanut butter Kirkland team ensured that didn’t set the world on fire. I think we're now testing again and it's a pretty good item. But we'll see how long pretty good means. So it has to -- we recognize the strength of our concept is both KS and brand and I don’t think we if you said Richard you are in the mid 20s now in terms of KS do you ever see going to 50 I’d have to stretch I mean even our own members internally will say how can we get it from 25 to 30 there is no formal game plan how many years is that going to take what items work and certainly there is a not a lot of low hanging fruit there is lots of $20 million and $30 million and $50 million overtime. Not a lot of 300 million and 400 million items like paper goods or water and things like that or K stuffs.

Okay thank you.

And last comment before getting to the next question out there in terms of cannibalization even if that’s ramped up a little bit. I was just looking over the last few years if you go back to fiscal '13 what we called cannibalization that’s just not just here that’s opening three units in Japan and that affects three or five other Japanese units. Total cannibalization in fiscal '13 was 65 basis points and ’14, 58 and for the first half of this year it looks like it's about something in the low 40s so it’s going to fluctuate between 35 and 75 depending on what we do and where we do it, but my guess is something in the 40 to 50 range is kind of -- we’ll have to be able to move that number overall a lot.

Your next question is from Dan Binder with Jefferies.

My first question is related to the gas business, can you just give us an update on where the comp gallons were in the quarter, where gas is as a percentage of total sales? And then you mentioned that the gas margin would start to be little bit less favorable given where price is, what prices is doing. Can you help us just to understand kind of what the excess margin may have been in EPS this quarter?

Yes, look it was just on that line item it was two-thirds of the margin improvement of all ancillary businesses. It could be 200 plus basis points of extra margin, I mean our margin in gas on a daily basis over the years could be anywhere from a zero to a five or six and it's all over the Board might even be a little bit higher sometimes, but it really ranges and frankly when it's a little higher, we’re saving the customer more money. In terms of gallon it comes I remember for a couple of years when the U.S. overall not Costco, but all U.S. vehicle gallons consumption was in the low single-digits and maybe in the -- when the bad economy hit and went to the low negative single-digits and we went from, we remained at four, five, six, seven. Right now we’re in the mid-teens. So, we’re getting a lot of people coming into Costco to buy gas and that certainly drives them into the warehouse as well.

And then on the IT spend, you mentioned I think you said it was $0.02 this quarter as you look at Q3 and Q4, what do you expect that in fact look like?

It's hard to guess completely, I know we’ve had a couple of some of the original modules and modules makes it sound like it's a small number, these are big numbers but then you have projects that are $50 million-$60 million projects that the day you are put into service they then over the next in our case 55 four week periods over the next five years generally you take a little under a $1 million a month hit and so some of those are starting to hit so my guess is that much it will is it that much is a little less a little more it is hard to say but still over a several year period incrementally recognizing your denominator sales keep getting bigger too, but with that bigger sales we had indicated something in low to mid-teens of basis points I could be off by a couple of basis points but and they achieve.

And then my last question is related to organics, can you just give us an update on how many that skews are on in the club at this point and what the mix is of sales and how that performed in the quarter, how are you thinking about that business going forward?

Yes, it's still a small percentage of Costco, it's a rising but it's a fast growing area as it is with a lot of other retailers as well. You're are going to see more and more of it a part of that is availability there is -- we could sell -- we and everybody else can sell a lot more if there was more out there. I think we’re doing a pretty good job of winding up our sourcing and I think I mentioned last quarter that for all of ’14 organic was like approaching 3 billion which was more than twice when it was two years earlier or a year and a half earlier. It's growing fast, I don’t know if it is 50% a year, but it is certainly growing at a high and a low mid or mid double-digit number and it's great for us because we show even a better value on that stuff than some of the things that it replaces when we can do organic ground beef I mean for everybody football is regular ground beef and everybody makes lower than average margin this is the item that everybody tries to make more on, and so we can make a little more not a lot more and show a greater value to our member. So it will keep growing, I am sorry I can’t be more specific.

Your next question is from Christopher Horvers with JPMorgan.

Hi, it's Mark Becks on for Chris. Congrats on the fantastic quarter. Just a follow-up on a couple of Chuck's questions, actually, so it doesn't look like you are getting into too much specifics about the change in the credit card to AMEX, et cetera. Just curious what has been the response that you've seen from our friends up north? I knew that changed over in January -- maybe what the reception has been there?

Well it's been good so far, I mean we’re getting a lot of people to switch, recognizing it’s peoples membership card as well and if anything our view of the U.S. should be -- I guess I can’t get into a lot of it right now. We wouldn’t have done this if we thought there was a lot of risk associated with it, we think it's a big positive over a long period of time, but recognize big positive to us means giving most of it back to the customer in this case most of it back to the co-branded user of a credit card and that’s going to happen -- we’re really not going to be able to tell you a lot about it for a number of months.

Okay. I guess I'll switch back to the gas prices then. Historically, the adage has been you guys benefit when prices go up, but it looks like just based on gallonages and miles driven, which has only been up a couple percent, so you guys are actually capturing a lot more share now then in history period. Is that something you would agree with?

Yes there is two places to that just so everybody understands. When prices go up, we make less and save the customer we still save them but save them less. When prices go down, we save them more and we make more. Certainly price is going down, we save the customer more and that's positive and we make a little more or a lot more right that's changed in the last few weeks, but we made a lot more in the last few quarters. If you go -- the other thing the thing I think you're talking about is when it was in the press everyday as prices went from $3 to $4 to $4 plus a gallon it was on the news every night in every city, that helped us I think. The offset to that would be as prices are less important, how can that help you? I don’t know other than it is and it is a lot because our gallon is quite a bit up.

Did you see what the volume and gallonage was/ I think it was, call it, up 11% last quarter?

It was in the mid-teens I think we mentioned.

So pretty big acceleration there and just finally on geography -- go ahead, sorry.

Just getting back to that comment I think people ask us why I think it's because we do a good job of being the most competitively priced and there's that third-party as gasbuddy.com that 40 whatever million people and put their price on what they bought gas for. For three years in a row since they started announcing best overall low price out there by $0.14 a gallon or $0.16 a gallon across the country, now you're going to and that's not every station every day everywhere but on average with all those data points we're it and I think that kind of publicity helps us as well.

And then just the last question on geographical differences, it looks like you called out the Midwest and the South areas as the strongest obviously, a lot of moving pieces there, with the Chinese New Year as a help, but then the port shutdowns, which on our math comes out to 60 basis points roughly. Maybe just what you are seeing, elaborate a little bit geography, and then maybe the Northeast? I know we have seen some pretty severe weather here as of late? Thanks.

Well look I think you summed up or re-summed up on the port strike in the Lunar New Year switch -- I think the big deal is weather has played a role although it did last year as well, but relative to New York, the Northeast as an example the four weeks that complies February the first two weeks were mid positive say normal after weeks were mid negative single-digit that's a huge swing but other areas did just fine and the Texas region got hammered in the last week with weather but overall we're -- it's been, we've done okay.

Your next question is from Simeon Gutman with Morgan Stanley.

A couple quick ones, on the credit card, I know you not going to share a lot of details. Is there -- besides probably some savings just from some slower interchange fees or credit card fees, is there any elevators, such that if there are certain volumes met, you could see further benefits down the road? Or is this the lower fees, you will see a benefit upfront? And then from there, just how much business you do?

As you're asking I'm looking at my wall behind me and there's a handwritten note from many years ago when our securities counsel is sitting here and quickly somebody's asking a question he wrote we have no comment beyond the release and then the reality is that there's lots of buttons that you push on these agreements there's all aspects of it at the end of the day whatever our current arrangement as we look at it whatever our current arrangement is with our current provider both what we pay what we receive to offset some of that what our member using that co-brand cardholder is rewarded with a premise of how much is that to start with where we think it can go to at the end of the day we can whatever that bucket of money is it can go towards lowering merchant fees raising rewards or using some other place in our company and we'll figure it out there's we think that's it's an exciting bucket and we'll do a lot with it but just like I've told people in the past if we can save the dollar on buying a product better whether it's detergent or coffee or anything or due to packaging or raw materials cost or energy cost we're going to give $0.80-$0.90 back to the customer and rest assured there'll be whenever benefit x is a little bit of will accrue to our P&L and a lot of it will accrue to the member in some way shape or form but none of that can really be -- we can’t really tell you until next year.

On membership, I know you don't say a lot on international versus U.S., but can you just speak directionally to whatever growth rate you are seeing in membership, whatever trend line has been occurring, how has that -- has it changed much? Is it the same in the U.S. versus international?

It's higher international because we're newer we didn’t save -- and I think I've shared in the past I mean if you take the total number of members divided by our total number of warehouses you've got roughly 59,000 to 60,000 member households per warehouse in Japan you've got a number that has it's a three digit number it's in the low hundreds you also have a lower renewal rate in those first few years so it tends to bounce out overtime but we operate overall in other countries on a membership fee as a higher percent of sales particularly in Asia.

But whatever prevailing growth rate there has been in membership in the U.S., up until second quarter or up until the first -- meaning, has that run rate stayed the same in the U.S.?

Yes and a lot of it is dictated by new openings and again it's going to be dictated more by what I said in new member signups in the quarter were up 9%. There have been times when it’s been almost flat but prior are down a little bit because a year earlier in that quarter you opened three units in Asia where you might have and again I talked about an average of roughly 60,000 member households per location. We had locations that will have new member signups as of opening day and that as of day mean during the 8 or 10 or 12 weeks prior to opening when their parking lot is kind of set and we have the flags and the tabling activities out front side you could have anywhere from 25,000 to 40,000 members signed up now 40% of them renew a year later but in terms of new members coming in and buying a membership and that really distorts that number. So I don’t know how much meaning is that plus 9 is a function that as well but we always point that out.

And then just very quickly, can you just remind us of the e-commerce business, is there other member-only items or is there items someone can just -- who is not a member can just come on the website and purchase as well?

In this crazy world there are some items that we have online where we've agreed not to show the price unless you are a member.

Not to show the price but the only person who is buying on your Web site is a member?

Yes.

And your next question is from Paul Trussell with Deutsche Bank.

I wanted to just touch on membership as well. Certainly, with consistent and strong traffic and you certainly are saving people money at the pump, how are you thinking about the value proposition of your membership currently in the U.S. and international? What may be the timeline in terms of you kind of reassessing what you think the value of the membership should be?

I think round about what you're asking about when do we see this I think the possibility of our fee change historically that’s really we think about last. We drive prices and value everyday in everything we do and I mean it you go to our budget meetings every four weeks you got a day and a half of that time or a third of time is merchants and we’re figuring out how to improve the value and lower the price and raise the quality. And historically using U.S. and Canada as 80% of our business first of all and probably 80ish and a little different than that number pretty close in terms of percent of members you have -- we have done a fee increase about every five or six years the last time we did was very late '11 very early '12. So most of the calendar year of '12 those renewals been a first time in five or six years saw the increase from 50 to 55 and from 100 to 110 on the executive in the U.S. and Canada if history repeats itself five to six years from January of '12 will be January of '17 into January of '18. So that again based on history it doesn’t mean we are going to do it or not going to do it. We've chosen generally the whole membership fees at whatever their prices are mostly of the countries impart because it's so darn strong to start with and why not continue to drive the business. And so again I think it's generally the last thing we look at but something we've looked at regularly over 30 years and I'm sure we'll look at it again at and when time tends right.

And then just circling back to gas profitability and I know you have addressed this a few times on the call, but given the spread between the Street's forecast and the actual for 2Q, I just wanted to touch back on your comments around the third quarter. You mentioned that gas prices have started to trickle back up, but frankly, can you help us just kind of think about our expectations for the back half of the year? Should it be closer to a more normalized cadence around gasoline profitability or do you continue to see a little bit of tailwind, given the favorable mix?

Well if you look at history when we each quarter for the last several years we’ll share with people that gas helped us a little hurt us a little helped us a lot hurt us a lot. It's virtually all -- it's pretty much in proportion with the trend of gas prices per gallon. And so as you know in the constant to drive down has stopped and went up a little bit. So a lot of that party is now behind us for right now and but I can't really tell you what is going to be other than historically that’s what it's been.

Your next question is line Matthew Fassler with Goldman Sachs.

First question relates to the special dividend. I guess this is our first conference call since you announced the last one. What the prior special dividend that was around the time of tax policy change and many companies pursued that tack. As you take a bigger picture look now at capital allocation, understanding that you did accelerate the stock buyback a bit, how are you thinking about special dividends, perhaps as a recurring element of capital allocation? And any other light you want to shed on your decision to issue that one last week?

Well, I mean we now have two data points instead of one we did it and you're right the motivation or one of the motivations could be really the one we did it was reading about in the Wall Street Journal everyday and just before people expected a dividend tax rates is automatically, so it make sense to be not only shareholder friendly but shareholder friendly a way that might help people as well if tax rates were going to change and we feel active about that. I think we appreciated the fact that it was perceived as being shareholder friendly, as you might expect both management and the Board wanted to be in that regard and it's not like we sat down and did this giant study exactly when how much and what should we do, I think we liked it the first time and it seems like our shareholders liked it the second time. And that’s how we clearly worry about it and there a little on dependent of each other. I think that when we did the first one which was a little over $3 billion worth it was quite sizeable it was a time when I guess in retrospect we could have bought some more stock back it have been a smart thing to do given where it's at now. We want to -- we tend to do both and we tend to look at all things, first and foremost CapEx, how through we ramp-up CapEx and we’ve done that. Second would be our regular dividend, what are we going to do with that every year again there is no guarantees, but in each of the last spring periods over the last nine years I think we’ve raised it on average around 13.5%. We looked as you know premiere models and our models we are generating more cash than we can use in CapEx and so we’ll continue to look at ways to the shareholders run rate. But there is no reason of thinking that will be two year sense we’ll do another one, there is always a thing we will mostly.

It's interesting even though you're running with several billion dollars of cash on the balance sheet, you haven't gotten to the debt markets, which I understand is opportunistic. Should we think about the cash balance that you have today as something that you feel you need to be comfortable with or is that a number that you could whittle down over time?

I think it is a number that you wrote down mind you, I am looking at quarter end and this number might be a shade different than the balance sheet number, but I think we had cash and short-term investments was across this number there, hold on a second, cash in short-term investments at the end of the quarter of 7.4 billion roughly and add a number that wasn’t completely consolidated of like 7.2, but if you look at that roughly 7.4 number about 2.5 is really cash in the U.S. another 2.5-3 is real cash outside the U.S. where we’re spending it frankly. In addition we announced last year that we brought back some of the cash in Canada. So, I think we can withheld the number down but some of its cash equivalent, if you think about from the time base close on Friday night, so the time they open on Monday morning all those debit and credit card receivables which could be upwards of a $1 billion, $1.5 billion, 1 billion plus that is cash equivalent, but is not cash.

And then just a very quick follow-up, we are seeing the LIFO creep up. I know it's only a couple basis points, but it's a nice change from year ago, when, I guess, you peaked out at around 8 basis points hit. Could you just talk about what the moving pieces are in driving that? And I know you feel like you are fully marked at the end of any given quarter, but if you had to place bets on which direction it would go for the rest of the year, it would be very helpful?

I don’t know, gas has come up a little bit, although it's still below where it was at the beginning of the year, so that is still probably LIFO as of today it is LIFO creditable, I don’t think it's going to be a big giant number either way, but it's a little bit of attraction at this point. Yes, you were right about it Matt, a point of that is some proteins are inflationary right now for not always is related and some other things we’re just starting to see what beginnings of some deflationary pressure on items manufactured in the oil, plastic bags and alike, so some of that is starting to finally flow through so there will be some things that are inflationary and some that are deflationary.

Your next question is line Kelly Bania with BMO Capital Market.

I am not sure if it's too early to ask this, but just curious about the members that you brought in via the Living Social promotion several months ago just curious if you are tracking them? Are they following that typical spending pattern of a new member in terms of spending and frequency?

I'm going to plead because I don’t know the answer to that, but we hold that question for next quarter I promise we'll have some numbers. I know that we're tracking it and I just don’t have the detail on it. I know that on average, they're a little younger. I don’t know spend habits.

Then just another one, you mentioned the Bay Area as I think a strong region either in the quarter or for the month. I know that's an area where you have more robust offering in organics and I was just curious if that's part of it? And maybe how plans are to kind of bring that more robust organic offering to some more clubs in the rest of the country?

Well and that's probably a little piece of it. I think weather overall has helped. The West Coast is as bad as it's been in Texas and the Midwest and the East Coast it's been offsettingly good over on our side of the country. And I'm sure that's helped some. Clearly I think some of the merchandising efforts we've done on organic have helped. Part of that, we are doing it more in other parts of the country. Part of it is supply issues and it will still take time for that to grow.

Your next question is from Scott Mushkin with Wolfe Research.

I want to get back to e-commerce and maybe the ancillary services ex-gas and just explore I know I think you said that the margins are great. Did you give us a number on how big e-commerce is?

No, it's -- do you mean total size of e-commerce?

Yes.

It's about 3% of our total.

3% of your total sales?

Yes on an annualized basis, I think last year was like 2.9 or something, 3 billion and growing at 20%.

3 billion growing 20%-25%. And then from a gross margin perspective, I mean that how do we think about SG&A associated with that business? Is there much of it? I mean is it like fractional a couple percent? I mean how do we think of SG&A when you look -- I know a lot of the stuff just goes directly to the consumer about 60% of it. Is there really a lot of SG&A associated?

No there's -- margins are let me just look here, margins are a shade lower not a lot and SG&A is a lot lower.

And then from a philosophical perspective -- everyone has always ragged on or not ragged on that's a bad way to say it, everyone's always -- some people have criticized Costco because they don't let enough flow through to shareholders. How do we think about that? I think the gross margins are what you are saying are a little bit lower. SG&A is a lot lower, so net-net we got much better operating profit in the e-commerce business. Is that okay with the Company or is that something that you would try to make look like the rest of the business?

No I mean we're a retailer, there's different part of it. No, we're happy to make a little more there. We're still making first and foremost are we as competitive as we can be relative to others and we feel that we are very competitive. We are also recognizing that e-commerce is supported by the buying sites of the warehouses as we brought in line electronics and furniture and some of those bigger ticket categories that buying strength, how do you compensate -- how does e-commerce if you will compensate to that so it's all part of the same thing. The fact it's margins overall are a little lower than the warehouses I think it's indicative -- it's a function of that and we'll continue to do that. We work on strong profits in some of the other ancillary businesses but they also have different either cost associated with it or purchasing powers. Pharmacies of course you got pharmacist and pharmacy techs that make more than average hourly employees, so you got a higher cost structure there as well as all the regulatory and billing stuff going on in that business so we work on a higher margin to offset some of that and but we also work on a profitability number that's good so it's all part of the equation if you will.

So then just one last one. So I think you said you are up to 8,000 SKUs. One of the things we think benefits Costco hugely on the e-commerce is that you are basically letting me use your people to do the shopping for me. In other words like the fact that there isn't 2 million skews like there is on Walmart's site I think is a great attribute. So what's your thought about where the SKU count goes, kind of balancing Costco being a personal shopper versus wanting more maybe more SKUs? Where do you think it goes?

I think it probably goes up a little bit but not a lot, the fact that it went from 4,000 to 8,000 or something in the last few years is a lot, but part of that was just trying to drive business adding some categories to get people -- for people to think of it as top of mind or near top of mind instead of not at all. If I have to think about and comment from very loyal shareholder and somebody who loves Costco with three kids at home three teenagers and said look I love Costco and I know when I go into a warehouse I know I'm going to get the 10 items I planned to get in the food and sundries area and the other 10 that I didn’t plan to get but I know I'm going to come out with 20 I'm going to be sated I know I'm going to have great food samples I know we have three other things in nonfood area that I have no plan to get and I'm excited about that but I knew going in I was going to get three items or four items that I didn’t plan on getting. So I don’t know why when do I go to costco.com so part of our challenge in the last year on costco.com is not only driving sales of those bigger physical ticket bigger dollar ticket and physical ticket items that not everybody wants to shop home like furniture and big screen TVs and had a great price and in many cases write about service delivery and we're driving that business. But also how we just did it more regularly and whether it's take ups in other items for your office or home or some apparel items. As you know the 5.5 million KS restaurants that we sell every year which is a great value if you always joked if you really tall with short runs we can assort you because we don’t sell all the sizes and collar combinations online we do. So trying to get different reasons to get you under the state more often is part of the equation here and nothing we're doing pretty job of doing that. I don’t see and you said Richard you're taking again 15,000 one day I don’t see it in my near future.

Your next question comes from the line of Oliver Chen with Cowen and Company.

I just had a bigger picture question about holiday. Did you have -- would you prioritize any major learnings from holiday in terms of where you might look to do things differently next year? And then on the core merchandising margins number, what should we look at as helpful drivers for that positively going forward? Or what kind of run rate might we expect there? Thank you.

What's the second part of that question?

The core merchandise margins. What are some of the positive drivers we should look for in terms of optimism on the core merchandise margins, whether it be inventory control. Or is the run rate at a slight negative kind of realistic for us to model?

We didn’t say we don’t provide on the latter part we don’t provide specific direction on that area. I remember several years ago when our margins were just down year-over-year every quarter for a couple of years and every quarter we'd say margins are fine. We can tweak them a little bit if we want and where we want to I think that sentence and that response is still there I think we continue to get excited by strong sales and strong loyalty and strong conversion to executive member. And all those things will continue to take front seat to a little margin improvement. But if we want to get a little bit we think we can while still being very competitive. In terms of what do we learn or not learn during the holiday. I think when we look back I think we did a pretty good job of planning for the port slowdowns and arguably it's probably easier to do a better job when you're managing fewer items. And so while we felt that we got hurt by a little bit I think we probably mitigated that hurt. Beyond that again I think we are comfortable when raw materials, prices, and bakery and food court and the alike go up that we're not going to change our prices and if it hurt our margin a little bit it hurts it we can get elsewhere. So I don’t think this was given our strength we didn’t they weren’t a lot of things to necessary learn as it relates to did sales soften and we drive more sales by more mark down just something I think we thought we had came out of this season pretty good. And if anything continues to be aggressive in terms of price of the products the price points of products that our member wants great value or great items and we'll continue to drive the value proposition in upscale items.

And inventories were nicely growing versus the sales, like underpinning sales. Is that a trend we should also model going forward in terms of the spread being neutral?

Probably a little bit again I wouldn’t read too much into one quarter. For a number of years here we've generally again taking FX gas out of it the four walls of warehouse inventories that on a non-FX diluted or increased basis. Generally speaking we've had sales greater than inventory per warehouse increases if sales were up 8 or 9 inventories were up five or six. I think my guess is Q2 was a little better than we thought but it not's going to drive a little bit but still trending in a positive ratio there.

In our last question, you gave a lot of great details on the e-commerce and the evolution there. What about flexible store fulfillment and reserve and pick up and ship from store. Is that on the horizon? Is it something your customer appreciates and will that be a material driver of traffic? At some competitors, e-com contributes 100 basis points or more to comp.

Well 23% of growth on 3 billion is like 60 or whatever 500 million. So that’s like little under half a percent of comp to the company. First of all we don’t do it right now with the exception of the 8 or 9 Costco business centers that we have that we both to delivered and order for pick up several things we’re testing like Google and the cart are something enhancement, it's not like you can’t call Costco, or online Costco and say I want to order this stuff and I’ll come and pick it up. So, I don’t know if our member appreciates it, I know there is a lot of effort out they are doing it, our first order business is get -- we just are installing the membership module which includes a lot of hooks to things, but I don’t see us doing that certainly in the next year.

Your next question comes from the line of Michael Lasser with UBS.

One, have you seen any evidence that gas prices correlate either to customers' willingness to spend more on food, sundries, and hardlines in your stores or your ability to sign up more members at your Clubs when gas prices are either moving up or moving down?

Well, it used to be when prices were moving up and it was the topic du jour every night on the -- from the consumer product and the consumer activist on the local news station, when were prices were skyrocketing is when we saw some real signups related to in that market. Conversely you see less of that right now, certainly we’re seeing and the answer is I don’t know completely, but certainly we’re seeing more traffic to the gas stations, more and continued strong shopping frequency in the four walls of the warehouse and some of that’s got to be related that but I couldn’t tell you how much.

And my second question is on the credit card. Can you give us a sense of what the private-label credit card penetration is in your Clubs?

I don’t think we disclosed that, total credit card, in U.S. total credit card is about 40, debit is about 40, cash, check and other is about 20.

But presumably a big portion is private label?

Probably and certainly more than half but there are people that choose even using our credit thing, there are people that choose to get star reward points or drop the points on a different AMEX card than the Costco one. Our goal though is to certainly drive more of it and we have successfully historically and hope we can do that in the future to drive more of it to this top of the wallet card.

Your next question comes from the line of Meredith Adler with Barclays. There is no response form that line, we’ll move to the next question. Your next question comes from the line of Bob Drbul with Nomura.

Just have two questions for you. The first one is when you look at the impact of FX this quarter throughout the P&L, can you just help us understand a little better, like what we should expect both on MFI and on SG&A over the coming quarters as we look at the foreign exchange where we are today? And the second question is, with gas prices rising a bit over the past few weeks, are you adjusting the merchandise pricing that quickly to reflect the movement in gas, as you were opportunistic this quarter. With gas prices going up, will you change things as we go into the next few weeks, given the rising prices?

The answer to last one is no and again I am not -- I can’t tell you how exactly what, when, where and how, but did it give us a little bit of cover to be aggressive? Yes. Did it give us a lot? No, it gave us a lot of cover, but we choose not use it. So, I mean it's not like we’re going to say, hey, let's take all this and go use it. So yes, as gas profits come down that was probably our improvement, it so happen in this quarter where is that pointed out all those other things, some of which we will continue doing it, you guys can figure out FX based on where the currencies of each country are. If it weakens a little bit relative to dollar from a year ago, it is a little more impactful, if it weakens little less, it's a less gradual but still with a negative front of it. Yes, interest income and others that little bit of a crapshoot. It goes both ways. Gas now is going to be less outsize profitable in the coming quarters and there is another reason hopefully that sales will continue to drive in the right direction. I think overall, I look at Q2 and taking all the good of gas out and the negatives and sort of other things some of that will go away in Q3, but if we can drive sales frequently we’ll be fine. I am going to take two more calls.

Your next question comes from the line of Gregory Melich with Evercore ISI.

Two questions, one is -- and I realize there's a lot of moving pieces, but if you were to look at gas and how much that helps EPS this quarter, could you give a range or if it was $0.10. And then sort of think about it going forward, if gas was steady, is that something you have to cycle, it comes back, or is it something that is a new plan? And then my other question was on gross margin. I think I heard you say that in ancillary, there was pharmacy and maybe something else where there was some margin expansion. Could you help explain that, if I heard that right? Thanks.

Sure we're not going give specifics on gas it was very profitable a little bit of it could be an offset to other margins a lot of it is just outsized but then we also had a few other things that went the other way and so that outsize this was a little less outside. In terms of gross margin optical and hearing aids again just looking just like I say in the core gas was the big one but several other key businesses, ancillary businesses also had slightly improving margins year-over-year pharmacy optical and hearing aid.

And what drove that? Was there a mix issue or --?

I think some of it is driving sales a big chunk of it driving sales I think on hearing aids and I'm guess here because I don’t know our success of purple signature which is a incredible value and quality I am told that the penetration that’s huge generally we make more margin and save the customer more money on our private label. But I'm guessing it that way.

And I guess just because it is linked a little bit, where are we now with inflation for the whole store? If you were to roll it together? Does it meet enough in electronics now and all that kind of stuff?

Year-to-date we're about a 0.5% deflationary and that’s a LIFO index for U.S. inventory, so what we're all like items cost update one of the fiscal year and one of these same items cost us on day 180 or so whatever this year and if day one it was 100.00 at the end of 24 weeks it was 0.995 so literally 0.5% you had a little bit of inflation in for sundries and apparel and domestics. You had deflation as you expect in majors you had deflation in gas and you had deflation in foods a little bit sundries are up a little food was down a little.

That’s tough.

Not a lot of deflation.

And your final question comes from line of Joe Feldman with Telsey Advisory.

Wanted to just ask about international for a moment, I think you have been in Spain now for about a year. Just was curious for a little update there, update on what you are thinking about new countries. I believe France was going to be next. And also just more generally, just store productivity. When you are opening internationally, are you still kind of achieving and exceeding the targets that you have set out?

In Asia and Australia historically achieved and exceeded recognizing whenever you are in a new country. And as go back I use to depend as an example 15, 18 years ago 15 years. Our original plan there was over a unit a year for five years and just achieved breakeven at the end of your five I think we ended up opening six in five years and we achieved breakeven at the end of year four roughly. And a lot of that has do with you have got a 5 plus million plus a year net on central expense, buyers, and carry department. Small IT department you name it and then of course all the efficiencies are starting up memberships wide were doing great in Spain. We have one unit mind you sales wise we're under our plan but it's starting to finally grow nicely. I think now that we're here to say we've got two openings planned for the rent remaining part of this calendar year both of them are in the mid grid area and one in September and one is later that year. I think that both in the fall and again what we find even if it's a different city once we're there you start getting more local vendors willing to sell you because we're going be around and you get a little more play in the press. Yes we'll see but we feel good about going so far, France we’re still at least a year away for opening I think when we first set down four or so years ago the view was is that Spain would take three to five years and France would take three to eight years and it is. So it is a long run out process of permitting and the whole appeals process over there by third-parties.

Well thank you and I thank you for listening for an hour and a half. And have a good day.