Good afternoon. My name is Kimberlynn and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco First Quarter 2017 Earnings 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, CFO, you may begin your conference.

Thank you, Kimberlynn. Good afternoon to everyone. Please note that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today’s call as well as other risks identified from time-to-time in the Company’s public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made and we do not undertake to update these statements except as required by law. For the 12-week fiscal first quarter, that ended two weeks ago Sunday – this past Sunday, earnings came in at $1.24 a share, up 14% or $0.15 a share over last year's reported earrings per share of $1.09. A few items to point out, as was mentioned in today's release, this year's first quarter benefited from a non-recurring $51 million legal settlement. This $51 million pre-tax figure represented a 19 basis point benefit to gross margin and a benefit to first quarter's earnings per share of $0.07 a share. Last year in the first quarter there were two non-recurring items that we mentioned that together negatively impacted last year's earnings results. In that quarter, we recorded a $22 million pre-tax charge, which represented an 8 basis point impact to SG&A to the negative and a reduction in last year's first quarter earnings of $0.04 a share. Stock compensation expense was 13% or $25 million higher year-over-year, so $0.04 a share more. There are about 4,800 people of our employees that receive restricted stock units as a significant part of their annual compensation. These grants are made annually each October in…

[Operator Instructions] And your first question comes from the line of John Heinbockel from Guggenheim Securities.

So, Richard the new Citi agreement, was that a – was a total benefit in the quarter of 38 basis points if I'm hearing you right and I assume that was exactly what you thought it would be?

Probably a little higher than we thought it would be. There's lots of nuances to the program in terms there's bounties that we received for signing up new members and applications that incents the warehouses to do that. There's revenue share on outside spend. I think that's a little more than we had anticipated. We knew and felt that over time it would go up because the exceptions of Visa in terms of the penetration Visa throughout all types of merchants and that happened a little faster than we had anticipated. There's also some other aspects of it, again, there's lots of little pieces, but those are two of the bigger ones. On the merchant side, on the fee side rather I think some of it's related to the fact that we were making estimates of the different reward - bad - buckets if you will, gas at 4, Costco at 2, those velocity categories at 3. Again there's all kinds of equations there that as that changes there's some sharing and so it's all good at this point.

Well, as a sort of the follow-up to that is that recognizing there is some volatility, is roughly that level, is that what you would expect going forward. And right now it's covering right soft sales and some investments in labor would be – is the idea that when that – when the soft sales changes more of that drops to the bottom line or do you think you find other things to invest in?

Well, time will tell, won’t it. I think it's still an early program, we're in the first full fiscal quarter of it. Over the next couple of quarters as I said last quarter this will be the first time we'll try to provide a little bit more insight and I'm sure we'll be able to do a little bit more each time. As you know, we're going to invest in loyalty and growth and – while it's raining on everybody as it relates to higher levels of deflation. We're known for deflating the sell price sooner and faster and certainly one other sound bite example would be meat sales, just in the month of November meat sales were up 6% in dollars and 16% in pounds. That's the kind of stuff that this deflation, it's impacting all retailers of course, and it's probably impacting a lower margin quicker to pass it on up or down and certainly down faster, so all those things go into play. So time will tell.

And then just lastly, have you found or when you think about this conceptually, is it better to make - more impactful to make price investments when we start the reflationary cycle, right. So not raising while others do as opposed to cutting more now, investing more in a deflationary recycle.

Well, we’re always going to do more extreme probably than others. Another example would be as I've said in the past as it relates to some different types of competition out there the competitive pricing moat has gotten wider which is good. We haven't used that to improve our margins consciously in that regard, the wider the better. And so we're constantly figuring out that. We are constantly going back to every supplier with our purchasing power, with our buying power as it relates to – and competition itself with private label to figure out how can we bring the quantity up, the quality up, and the price down. And we know we will sell more and each of us and our suppliers will make a little more times – a little less more times. And so that's what we do, that's what we're always doing. We see that in every monthly budget meetings. And so I think that we'll continue to do what we do. We're certainly not going to benefit from every extra dollar of income. We're going to figure out how to use it to drive that competitive spirit and to drive our sales. And that's been a little tougher in this tough deflationary environment.

Okay. Thank you.

Your next question comes from the line of Simeon Gutman with Morgan Stanley.

Thanks. Hey guys. So my question relates to core profitability and expectations to the extent we can talk about it. So the EBIT growth this quarter was I think about 4% adjusted, the trend line has been a little lower and I'm not taking a lot of currency into this, but if you think about the core profitability going forward Richard, should we expect it to increase granted this quarter had a tough topline compare, we talked about maybe credit card getting better. I'm not thinking about membership price increase, but that's something that could come, but is this – just thinking about the overall business, how it’s performing, do you expect it to do better than where it is or performing about where it should be?

Well, again I'm not allowed to tell you what I think completely. We're encouraged by the last few weeks including the first two weeks of Q2, but yes we got - we feel good about our merchandising offerings, we feel good about some things we're doing operationally, we certainly feel good about the strength of KS, Kirkland Signature, and traffic has improved a little bit. I remember one of the analysts reports a few months ago, was we can exhale. We are hopefully beyond that right now. We feel that again the last - the traffic seems to hit a trough and it’s come back a little, not that we expected to get back before it necessarily, but it certainly it's seems like it's back on the mend a little and we'll see. I feel we're doing a lot of good things; we got a lot of things up our sleeve in terms of merchandising, we’re clearly merchandising and selling from a position of competitive strength. And fresh foods drives the business and the fact that renewal rates ex a little bit of impact from auto bill in the conversion are perfectly fine. So there’s lot of good things out there and I guess I'll stop there. But overall we'll see.

Okay. And then my follow-up, part of it relates to what John asked where you know the credit card benefit that could ramp. There also could be a membership pricing straight down the horizon. Thinking about what you’ll reinvest versus what you drop down, I mean are you – is the investment rate being inhibited right now because you haven't had that membership price increase in a long time so or are you going to let some of these things flow to the bottom line when we get there.

First, let me go back for a minute to the monies that we've benefited from as it relates to the Citi Visa the new agreement. In theory you would say okay if you made a little more [indiscernible] did you put it back in the pricing. We're doing a lot in pricing anyway and also you don't change the reward structure every day it's a new program. I would assume over time and this is - who knows if hypothetical but over the next couple of years if the performance of the program continues to go which we expected to do in the right direction and our piece of that action if you will versus the rewards that our members are getting, you’d expect to see this change that over time. But we're way too early to even think about that. Historically, as it relates to membership increases, we usually invest that back in the business, a lot of that in terms of competitiveness and pricing and it kind of eases in over the next several years and more fully into the bottom line notwithstanding in fact that membership fee increases take about eight fiscal quarters to get into the income statement on the membership line because of deferred accounting. So I don't think first of all we certainly haven't done anything different. As we've seen in some examples where we do comp shops versus certain others, where that moat has gotten bigger if you will, that gap has gotten wider, we haven't said hey let's use this to get a few extra basis points of margin. We've held the course and we continued to go in that direction.

Okay. Thanks.

Your next question comes from the line of Paul Trussell with Deutsche Bank.

Hey, good afternoon Richard. Just want to touch back on margins with - we think about the core GPM, X the benefit from the Visa card. It was still up but maybe a little bit less than the past few quarters. If you can maybe just touch on that and then also on the SG&A, you mentioned the higher payroll and benefits but if I recall I think the second quarter last year is when you raise some wages. Is that correct and should we start to cycle some of that headwind?

On the last point, the wages, I believe the U.S. and Canada which is 80 plus percent or 80% to 83% of our company. We took the bottom of the scale up a $50 basically from 11.50 in 12 up to 13 and 13.50. I believe on an annual basis that's about a $40 million incremental increase in our pre-tax costs or about $3 million little low $3 million per month number. That started in March, so that's kind of halfway through - early the halfway through Q2 of our fiscal year that's when the annual anniversaries and that's kind of a small. I'm sorry, the first part of the question, I didn't write it down.

Just around core merchandise margins.

Yes. Keep in mind, as I try to point out on each of these calls and mentioned what was the core, roughly 80% plus of our business that is food and sundries, hardlines, softlines and fresh foods. What is that margin on its own sales? And again, as I mentioned earlier in the call, that was up 17 basis points. When I look at the weighted average of what impact it had on our Company margin year-over-year. It's a lot less than 17 because there's increased penetration of another category with a lower margin or reduced penetration of another category with a higher margin and so that tends to – that's what we pointed out. We don't see just because that that 80% was 17 basis points up on that that had a much smaller effect on the year-over-year for all company.

Got it. And then just when it comes to topline, Richard, obviously November was kind of a tell of two periods with the first half of the month and the second half being much better and from the comments you made around e-commerce, it sounds like there's been some strength maybe that sustained into early part of December. Just kind of what's your view right now kind of the spending levels of your core customer and as we turn the corner into 2017, what's your thoughts around kind of what our core comp expectations should be particularly in the U.S.?

Well, again, we don't know. We’ll have to wait and see ourselves. We are thrilled that the first few weeks have been good. And again, November, the four weeks of November was choppy frankly, particularly the week of the election. I think it was worse than a snowstorm in terms of nobody wanting to go out and buy stuff and that’s what I read about other retailers as well. And again, over the last few months it's been a little choppy a little more in November and a little weaker and so at least, what we can tell you at this point is the first couple of weeks have been okay. And again, traffic has seemed to have stabilized until something changes there, who knows. But again, we feel good about our merchandising what's going on and one of the reasons we continue to provide monthly sales results is for that reason to keep you guys informed and that's pretty much what I can tell you at this point.

Fair enough. Thanks Richard.

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

Good evening. Thanks a lot for taking my question. Richard, you mentioned that you signed up a million new members under the new Visa credit card arrangement. Is that above and beyond what you would normally sign up? Or is that typical with your run rate and how does that compare to your expectations?

First of all, we signed – million of our members signed up for it. Many of them could very well be existing members that historically did not have an AMEX card or historically used not a co-branded AMEX card. And they have now signed up for this because they want to sign up because the rewards, hopefully or they historically again were using debit or non co-branded AMEX card and are now switching to this. So it's not that we did not generate a million new members. Certainly, when a new member being online or walks in and to sign up as a new member, we of course are telling them the virtues of both executive membership and these great new co-brand card.

And how are you seeing the spending patterns of those who signed up for the card or got the card versus how they're spending patterns were under the AMEX card?

It's hard to know this quickly. Generally speaking, irrespective of what credit card it is whether it's a co-branded or rewards card for an airline or hotel. Generally, we find the people on credit card spend more than by cash or check or debit. We also find the people with Executive Member spend more than non-Executive Member. So the trifecta if you will is when they are not only a member, but they're the Executive Member and they use the co-branded card. Lots of incentives for loyalty and for spend and for capacity of the spend. And so that's what we try to do, try to do it in not too hard of a seller as you might expect. And we've got a lot better doing the basics with it. We know existing members, by a lot historically based on their prior 12 months and it’s a no-brainer to be an executive member, we make sure they know and we've done a better job of converting or getting people signed up as an executive member start with. The credit fee, of course is not completely in our hands whether it was the 16-year relationship – 40-year relationship, 40-year or 60-year relationship with American Express or the new relationship here is up to the credit card issuer in this case Citi to accept or rejected application. Now, the ones it converted over they were all in the same deal, but anybody knew they are signing up for new card and there's going to be some people they get and some people don't. But when we do know is a million of the people that did sign up for have gotten it or approved and got it.

My follow-up question is on the prospects for import tariffs, what percentage of your goods do you import from overseas and if you could break that down between the Kirkland’s brand and all other it would be very helpful?

We’re just asking or being asked that question recently and we're putting some members together. Our best guess is somewhere north of 20 and south of 30 and I give you a purposely large number because even you talk to some buyers in different apartments, you find out that it might be imported, but it's all based on this U.S. dollar sale and my guess would be somewhere in the mid-20s.

Mid-20’s as percentage of your total sales?

Yes.

Okay. Thank you so much and have a good night.

In the U.S., now I'm assuming that includes – I'm including in that like electronics. Most electronics are purchased in U.S. dollars by U.S. trading companies that are arms of the overseas manufacture. And so again it's a little tenuous to come up with an exact number particularly since we just started looking at it.

Okay. Thank you very much.

Your next question comes from the line of Kelly Bania with BMO Capital.

Hi, good evening. Thanks for taking my question. Wanted to ask a different question about gross margin, it’s still if you look at the core gross margin I think you set up 17 basis points still very strong, but I think it's been in the 10 basis point to 15 basis point range. I know you’ve talked about online, organics some of the higher margin categories in the mix shift there, is just curious if those are really still some of the same drivers or if there's anything else going on there particularly as online seem to slow a little bit this quarter?

I think part of it is as prices have deflated there are instances where we could make a little more, but not a lot more where others have not deflated them as much even though we're going to be the first to take it down and more there's still a little there on the table. Private label helps. I think those are the kinds of things and we've also in terms of driving business, working with our vendors to lower the price and drive more business. And we will participate in it, but we’ll still make a little more. So there's lots of little reasons and again I'd be remiss to say, I mean year-over-year, we had just under a basis point and shrink recovery, in other words better shrink number, inventory shrinkage numbers. We don't talk about it because I mean good news is continues to improve a little for 30 years essentially. We were doing a better job of operating our businesses and controlling our inventories, but it's lots of little things.

That's helpful. And then just another big picture question, lots of questions on the savings and how you would think about possibly maybe reinvesting some of that over the years, but as I hear you online and proving that experience to check out experience to search, do you look at ways to just make things more convenient for your members? Is there anything else you think about on the convenience front versus just the price front?

I got to tell you, a little tongue-in-cheek here, but we arguably were little – have been – many years ago we like it to even do e-commerce, did a little bit begrudgingly, it took a while to do some more things. I think the things that we're doing offensively not defensively, but we're also probably a little stubborn along the way to suggest – there are some extreme examples of when a member orders a big ticket item electronics or light goods or whatever and the delivery window is much larger than anyone else's. They'd like to know it pops up the calendar and here it goes. When they want to return it that process was not very good. And some of these are quick fixes, search was not very good. That's been a quick fix to get a significant improvement and we get some more improvement. So I think that we're doing some things to that we've notwithstanding decent sales. We're investing in better [indiscernible], but by the way that's not at the expense of we want to take our prices down a little and those are truly independent whether it's IT modernization efforts some of which was in necessarily or you know what are we going to do with regard to we need another 10 million or 50 million or whatever to enhance the site, that is truly independent of what we're doing there. We know as Jim said it will set for 25 plus years and [indiscernible] is set for now five plus years. We are clearly a topline Company and we're best when we drive sales. We probably aren't as good at leveraging expenses when sales come down than others because we’re not going to do some things, but we're clearly taking the offense. Again there is some things that perhaps we should've done earlier but we're already seeing some improvement in that we know that will help.

Thank you.

Your next question comes from the line of Karen Short with Barclays.

Hi, Richard, this is Sean Carson for Karen. Thanks for taking our questions. Can you talk about your outlook for deflation and any signs of leveling off or maybe even an upswing?

I'm sorry, I couldn’t hear the question.

Sure. Sorry about that. Can you talk about your outlook for deflation and any signs for potentially leveling off or potentially an upswing?

When we talk with different category buyers probably the ones that have more specific insider on the fresh foods size because they're dealing with commodities and negotiating they're actually looking at the futures contracts and more of the cost is the actual item, the orange or the poultry or the pork or whatever. Whereas sometimes that's not the case, I think usually when we ask there's another three months to six months whatever. And when it gets to the anniversarying of it, there’s been some huge swings, some huge example of swings on some nuts which last year doubled and we’re now down 35%. There's you know eggs of course are down well over 60% year-over-year. So if eggs were down even 50% it doesn't mean that people going to eat twice as many eggs to have flat sales. They're going to eat some more eggs, but not that many. So by the way a few of those things may help in the bakery, the margins of the bakery. We’re going to - also not going to change the package the cost of 16 muffins or 15 muffins. So overall, I think the feeling has given that the last few months have been a little more deflationary. The view is that it's another few months of that, but they all believe that it's going to come back the other way and this is a lot of estimated semi-educated guesses among different departments.

And so I noticed there's also no LIFO reserve, apparently there is no charge or credit in the quarter. Is that right?

Right. That's correct.

Okay. Thanks for that.

By the way as effective the beginning of this fiscal year for 30 years we've been on our retail cost systems, retail inventory system. Most companies historically have been on a cost base system where you can get down more granularly to item level with the modernization that was part of this process too. With a cost system the way you value inventories will not have LIFO charges and credits in the future.

[Inaudible]

At the beginning of the year you'll notice on our year-end balance sheet. We revalued the inventory at cost in a different way and it was about a $60 million plus reduction in inventory. At the beginning of the year but not a P&L impact.

Got it. Okay.

To the extent there's inflation in the future, we will have a LIFO charge. I'm giving myself a thumb up. And once you have some LIFO charges, you can have credits. To the extent that there was LIFO as deflation right out of the box. You won't take that credit because you have no charge against to which you can take it.

Got it. All right. That explains it. Thanks for that. And just my follow-up is just an extra week this year. Can you give us a sense of the impact? I think my math was about $0.10 to $0.11, but curious if you think that’s sort of the right vicinity.

Well, it sounds like that's 2% of X. I don't have a calculator in front of me, [150 third] of a year. For the most part, most expenses even though say on a rental facility, you pay 12 monthly rents; we take it over the 53 weeks. I mean you don’t get a [150 third] credit for that. We amortize it over the course of the 10 years or 20 years. And so there's not a lot of – it generally should be if it's 2% more weeks, it’s 2% more earnings.

Thank you.

Your next question comes from the line of Matt Fassler with Goldman Sachs.

Thanks a lot. Good afternoon, Richard. My first question relates to the Citibank Visa deal. Can you tell what impact the enhanced cashback features have led to? Has it been in your view more sign ups, has Citi seen more traction with some of the categories where you increase the incentives for consumers?

Well, I can't speak for Citi. To you I can't speak to them. But we certainly have discussion with them, but they’ve made their own comments that I think we are generally positive about how the program is working so far for them. What I can tell you from our perspective is some of things I already mentioned in terms of – look it's a significant improvement in the value proposition of the reward to the members assuming they spend like they did. Hopefully, they'll spend more because of the 2% at Costco instead of 1% on top of executive rewards, the 4% on gas instead of 3% and 3% on velocity categories instead of 2%, so all that stuff is good. There's more utilization, there’s more places to use the card. Typically these are smaller merchants that only perhaps accept certain brands over others, they pay higher fees, but we’ll have to see.

Are there any surveys you’ve conducted that would suggest customers have really digested that extra penny they're going to get back at the end of the year?

No.

Okay.

What I can tell you from talking to our Head of Membership marketing is it stands out in good print on everybody's monthly statement, they see it and it’s pretty big pretty, pretty fast. And so I think those are the types of things that people look at. We know if any programs work. And again, based on Citi’s comments, publicly it seems like it’s working in the right direction for everyone which means more spend on it.

Great. And then my follow-up is on deflation and gross margin, we've looked through your transcripts going back quite a while and this is a period I think a remarkable deflation particularly in the context of a decent U.S. economy. In your experience, how those gross margin progress through a deflationary cycle? You talked about your expectations for when if and when deflation turns and number of months going forward et cetera. But in the past as you've seen food prices in particular recover, how do your gross margins tend to behave?

Really is all over the board. I mean with inflation the dollars go up, the percent probably changes a little downwards, so that would imply perhaps a little bit of improvement in dollars, but it could be all over the board. Gas is an extreme example; it is a low margin competitive business. As prices tumbled dramatically across general competition, prices were lower, but not nearly proportional to the amount of savings to that retailer. We were able to improve our margins little and widen the gap that's a win-win. Another silly example is organics. Organics because there's perhaps a little bit of less price sensitive – elasticity to organic prices. We are able to make a little more margin not a lot and have a wider value proposition versus others, so those are good things for us. Generally speaking, when there was cost inflation on milk and cheese and things like that, we would point out as you know historically some of those quarters were we kept the chicken at 499 and margins went down essentially from something to nothing to the tune of $40 million a year on one item that was four, five years ago – four years ago. Conversely, when cheese prices fell, food court margins went up nicely because we've always – we never really change the price of a slice of pizza. So there's lots of little things that don't fit in a square box or – a square box or round hole here. I would say generally a little inflation is good, it help sales and we could be more competitive both up and down. And when price is going up, probably is a little bit more margin beneficial.

Thank you so much. I appreciate it. Thanks Richard.

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

Hi, Richard. Thanks. What are your thoughts regarding bricks plus clicks and whether that would be by online pick up in store, reserve in store, car pick up from store because we're just seeing a lot of innovation as retailers in pure plays go into physical retail that are previously digital, so I want to know what’s you think about that and if it's meaningful for you and if we should be concerned about your long-term store traffic trends with the rise in Amazon. And then mobile is about two-thirds of online traffic from many retailers, what should we expect for your mobile app in the five-year plan for what you want to do there to make it really exciting and fun and great?

Well first, we're fixing some of the basics and improving some of the basics and I'm pretty excited about some of those things. You mentioned a number of mobile versus non-mobile e-commerce sales. Our numbers are lower than that mobile, but they're improving quickly. Again, we’ve recognized those things that we can and can't do. We think that we could and should do a lot more online, but we also as you pointed out want to get people into the warehouses. We think that some of the things that we do in store will keep them coming. So far it's not been an issue and even – while we try to point out these things each quarter in terms of traffic, in terms of even when traffic was impact a little bit, we’re asked that $64,000 question is it all these other things. We see some of the categories that one would think would have been impacted negatively by it aren't being impacted negatively. In terms of click and pick up, we've looked at it and we are not prepared to do that at this point. When we see it in other places not just the other warehouse club, you need space for it or you need a lot less volume in the location for it neither of which we have and we're not getting a lot of demands for it. We do that at business centers. You can log on and get it delivered and so that's more for the business member not the individual. And we recognize that we're not the retailer, they're going to sell you a smaller pack size or something and even a little bit higher margin. That's not what we do. Now time will tell over time, there's a lot of things that are…

You’re live Mr. Galanti.

Thank you. Hi, Oliver, yes.

Thanks for answering that. I just wanted to briefly ask you, does scan and go make sense for you or is that something that's not conducive to your experience. And then as you do your own research on Amazon which categories or what would you say like try out your best competitive advantages and what are your opportunities just to make sure you remain very competitive against Amazon and how are you feeling about millennials and generation Z. It sounded like you still had a lot of good momentum with younger demographics?

Well, look in terms of scan and go honestly we did a version of scan go literally 20 years ago a customer I remember walk in get an RF gun, radio frequency device walk around scan their own items come up to the front hand that thing to the cashier and the scanner and they print out a receipt. Needless to say, there's a lot more efficient things today. We continue to look at scan and go type things, we are not testing it currently but we are looking at it. And I’m not suggesting we are going to do it. We have done self checkout for a while. We've chosen to not do self checkout and higher volume units because we get people through without it. And as it relates – in terms of millennials and generation Z all those numbers are doing better for us and part of it is things like not that we set down and strategic - how do we get them. We have a great value proposition certainly some of the things that we sell like organics in my view is a big impact to that. Certainly some of the things we do you know we've done a couple of tests with LivingSocial over the last couple of years. All those things, we think help. As it relates you asked question about Amazon and Amazon is also the word for everything out there that's delivered or dot com and everything else it's certainly they’re doing a lot of things. We want to make sure we understand what all of these people are doing. We do not just from a competitive price shop and whether it's them or someone else. We recognize convenience is a value but there’s also some things that we can and…

Thanks. Happy holidays. Best Regards.

Thank you.

And your next question comes from Dan Binder with Jefferies.

Yes, hi. Good afternoon. My question was around some of the things you’ve already covered including pricing and the moat that you said is opened up. And in light of that there's been a lot of debate around the traffic just north of 2% or just under 3% depending on the months and lot of questions around convenience. And I just wonder as you review this online strategy, do you think there needs to be a major shift towards a broader SKU assortment, obviously Amazon's got marketplace, Wal-Mart is building marketplace, targets chosen not to. Do you think as part of that convenience factor Costco just needs to materially up their SKU count online?

Well, keep in mind we have materially upped it over the last couple of years. Recognizing it's still a fraction of anything else out there. If we were again at 3,700 active items in a physical location and roughly that many online excluding like office products which is through a third-party and there's several thousand of those items, but in terms of what we do ourselves and we now taken it up to 8-ish, 8,000 maybe a little more. Is it likely to go to 40,000 or 50,000? Absolutely not. Unless it does one-day, but I don't think so. And is it like you go up a little bit more? Sure. And is it likely for us to do a few more things that provide convenience? Yes, but we still want you in the door. And again to Amazon and others credit, they’re trying a lot of things. Some will work and some won't and we're pretty good at understanding what works and figure out how to augment and to do what we know how to do and what we want to do. And we recognized that we can't be – sell you a smaller size or something and our margins nor we prepared to double or triple the margin to do so.

Got it. My other question was around the membership fee or potential membership fee increase, next year that's been talked about quite a bit. I'm just curious if there's a sensitivity and what that threshold is, at which point you would not do it. In other words, if the comp store sales were to continue being at the level that they were at in the first quarter, would you be less likely to put it increase through and maybe an easier way to talk about it is what kind of comp level would you like to be at when you do it?

Directionally, I responded in the past by saying if comps were a little weaker, it would be more likely to want to do it or no impact on that decision. It's all in our view about what additional values that we brought to the table. Whatever amount of an increase might be contemplated, have we improved the value proposition significantly greater in that amount which is in my view is always been a no-brainer for us. Our renewal rate is okay and if sales are a little weak, it would be the time to do it – not do it. I'm not trying to suggest that it’s tomorrow afternoon, I'm just saying that generally speaking a little bit weaker we're going to use that to drive business.

Okay. I guess my question, my response to that is, if you had this widening mode in place and you are priced right. This idea that you would reinvest membership fee dollars into price, do you think that would drive an incremental gain to get comps at a higher level?

On some items, yes, on some of things that we do. If you keep in mind, 30 years ago, the original business for 33 years ago, the original business plan and talked about it. It doesn't matter where you locate. You could be on the other side of the railroad tracks and in downtrodden area people come to you, it’s a destination. And that was fine until you add into that sentence until somebody is between you and your customer. And over time while we’re certainly not at the mall, we recognized that we have to do something. So what we're doing online right now with some of the member experience and distributions, timing and costs and capabilities. Those are the types of things that we are investing in. Vertical integration and some aspects whether it's the chicken plant or bakery commissary in Canada. There's a lot of things that we're doing to drive value not just lower the price, but I don't – yes, I don't see it that being a reason to do it or not to do it. We look at it as a – it's a value proposition. We may become a little – price is primary and I think it will continue to be primary if we look at a few other things as well.

Great. Thank you.

And your next question comes from Robby Ohmes with Bank of America.

Thanks. Hey, Richard. Hey, you mentioned going into Iceland and France and I know you guys are doing Kirkland on Tmall in China. Can you just maybe sketch us up on when you might ponder opening brick and mortar up in the Mainland China? Thanks.

Sure. Well, on Tmall I think it’s about 300 items about a little over half of which are Kirkland Signature, so it’s certainly the cast name is getting known and that's a positive. We've continued to look at it for a number of years. Is it in the next couple of three years? It's probably more likely to say yes to that than two years ago or five years ago, but there's nothing definite at this point.

Okay. And just a quick follow-up on the credit card. Is there any – the new sign ups for the card, anything on the demographic side of who is signing up that's different than what you were seeing with AMEX card?

No. Not at all. I mean, they are called millennials instead of something else now, but that’s no.

Got it. All right. Thanks very much.

Your next question comes from Peter Benedict with Baird.

Thanks. Couple of quick ones. First, just on the Google Express, can you just talk about are there any plans to expand that. I know you mentioned the Bay area, but we’re hoping that being done or any thoughts to moving that out?

Start of the Bay area, but then with LA area and in the last couple years is expanded to as well Chicago, Boston, New York and D.C. I believe they're expanding and we're expanding is a few other markets as well. I believe I don't have that list in front of me, but I know it includes a few more. So let's say it's going from 6-ish to 12-ish plus and now recognizing we're working with them in different markets, testing different things. I think we've done a couple of small tests with some fresh foods, but it's a limited selection of items and each of these are little different.

Sure. I understood. On tobacco is that – is the weakness in tobacco - does that have any kind of a material effect on a core gross margin, I understand that’s a very low margin for that product?

Well, it's a low margin business so it would help improve the margin a little bit.

I mean is that a material benefit to your core margins right now or is it…

No. Gas would be an offset to that in a bigger way in my view.

Okay. And then last just on capital allocation. Remind us kind of what your thoughts there in terms of priorities in a way that you on leverage – some of your leverage ratios to get down for the next year so what your thought there? Thank you.

Well, first and far most CapEx is expansion and expansion is not – first and far most new units or the improvements in existing units a little bit, but probably an equal priority is all the things associated with it ancillary businesses, whether it's gas stations or as well as some of the manufacturing things we're doing. We're opening up a second – we’ve had it for a number of years a B plan in Tracy, California. That does I think around 200 million pounds a year 4 plus million pounds a week of four or five items that are us. It's our items. We're opening B plan on the east coast shortly. In Canada, we're building. I think we've broken ground on a commissary for bakery. We are investing 250 million plus and closer to 300 million on a big chicken plant, processing plant in Nebraska. That is not broken ground yet, but it’s in the process of getting permits and stuff. And so there's things like that as well. We're still spending money in IT, but priority-wise none of this stuff impacts what we're doing for expansion. We're expanding as much as we want you know we try to be - we look at our dividend every year you know historically it's been about 13% plus increase year-over-year for the last nine years or 10 years since its inception in 2005. We buyback a little stock, in terms of leverage you know arguably some would say that we are - I would say we're well capitalized, I would say we're under levered. We've got $1.1 billion 10-year fixed rate debt instrument that comes due in March 2017. The good news is that, it’s got that low, low fixed rate of about I don't have it in front of me - about 5.5%. What we do in terms of whether writing a check for it or refinancing part of it, we’ll see. So no big changes of what we do. We’ve done a couple of special dividends, one in late 2012 and one in early 2015 and I'm not indicating if we are – we are into the future that was something that we chose to do it at that time.

Okay. Fair enough. Thank you.

Your next question comes from Greg Melich with Evercore ISI.

Three quick ones. Of the 15% of people that haven't activated the card, what are those people using? Are they using other Visa in their wallet? What can you tell us about their behavior? Are they coming less frequently or using cash or what are they doing?

Well a bunch of them it's between 11% and 15%. But a bunch of them is, are people that it was not active as a co-brand AMEX card. We had about 15% that had not – upon conversion about 15% of the 11% or whatever million people in the 7.5 million or so accounts about - just under 15% of them had not been using the prior two months I believe, the prior 60 days. And not to suggest that may be some of them just hadn’t used it and they will use it or they’ve been out of town or whatever else. It's every answer on this - and I think the vast majority of would be that, though, they were using something else in their wallet. And to the extent that the membership card was on the back, they still have it in their wallet and they still have to do it in their wallet and hopefully they see those giant signs and they reminded the cash register by the cashier and have you heard about the 4321 or the new exciting warranty program on electronic, on TVs where you get a four-year free warranty if you use it at Costco.

All right. Any other ads you want to put out there, or we will leave it at that?

I thought I would do that just I didn't have it in my script.

That’s great. So then the second question is on international, so that's an area that as traffic has been running below the U.S. now for a while which has been kind of unusual to look over the last few years. Could you give us some insight as to why that is and how that's behaving maybe in the markets where you raised the fee, is it linked to that? Or renewal rates doing okay in those markets where the fee went up?

It's mostly cannibalization. We've got a $200 million, $300 million business. You open up a second one in that Citi. The new one does 100 to 100 in a quarter or 100 to 150 and 75 of its bled. Let’s say your traffic number is the old unit that's being cannibalized, so on the basis of 10 or 12 units that’s the biggest single reason.

And on the markets where the fee went up.

There is probably a little bit of softness in Japan beyond that. And I can't say you why and other than – the economy has been tough there, but it rains on everybody.

And in terms of the markets where the fee went up, what have renewal rates done in those markets?

I am sorry.

What have renewal rates done in the markets where the fee was increased?

Well, it just happened three months ago. We don't have any numbers yet, but it's de minimis of anything. And that's why I actually asked our marketing people earlier today [indiscernible]. Bob has made a good point. It takes about six months to know because you've got people not every member comes in every two weeks. So trend wise we don't see any big issue there at all.

Fair enough. Good luck.

Thank you, Grey. Why don’t we take two more questions?

Your next question comes from Chuck Cerankosky with Northcoast Research.

Hello Richard. Just a quick question about what you're seeing in Visa usage from people who are using – who never were AMEX card, Costco AMEX cardholders and how they're spending behavior is changed or somehow affected by Costco accepting Visa's payment now?

It's up. Particularly somebody – to the extent somebody is choosing to use another Visa card in his or her wallet. Maybe it’s airline program or hotel program. They may not be spending more because nothing is changed in their wallet. To the extent that they are using cash or debit that's you see an increase and we have seen that as we would have expected.

Are you seeing any related impact on membership? Are you able to see if new members are being generated by the Visa acceptance?

Well, we know that's the case to a small extent though, Citi for example is done marketing activities in their branches, but it's more existing members that it converted and you'll get a few – few could be in the tens of thousands, but out of a million couple or 20,000, 30,000, 40,000 is not a big piece of that.

All right. Thank you. End of Q&A

And we have no further questions.

Okay. Well, thank you everyone. Have a good afternoon.

This concludes today’s conference call. You may now disconnect.