Good afternoon. My name is Vincent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 Earnings Call and February Sales. 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. I will now turn the call over to your speaker today Mr. Richard Galanti, CFO. Sir, you may begin.

Thank you, Vincent, and good afternoon to everyone. I’ll start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today’s call, as well as other risks identified from time-to-time in the company’s public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and the company does not undertake to update these statements except as required by law. In today’s press release, we reported operating results for the second quarter of fiscal 2019, the 12 weeks that ended this past February 17th, as well as February retail sales for the four weeks ended this past Sunday, March 3rd. Note that the first two weeks of February fell into the second fiscal quarter with weeks three and four of February are the first two weeks of our fiscal third quarter. The reported net income for the quarter came in at $889 million or $2.01 per share, a 27% increase compared to the $701 million or $1.59 per share last year in the quarter. In terms of sales, net sales for the quarter came in at $34.63 billion, a 7.3% increase over the $32.28 billion reported last year in the second quarter. Comparable sales for the quarter, as shown in the press release for the 12 weeks on a reported basis, US was 7.4%, Canada was minus 0.3%, Other international 0.7%, for the total company a 5.4%, as well e-commerce for the 12 weeks on a reported basis was 20.2%. Excluding gas deflation, the impact of…

[Operator Instructions]. We have your first question, comes from the line of Christopher Horvers from JP Morgan. Your line is now open.

Thanks. Good morning, Richard. So a question on the core margins, the core margins performance this quarter was much better sequentially, I think everyone is sort of taken by surprise by the core margins ex-gas in the last quarter and now they're looking much better. So can you put it into context what sort of drove that change and any commentary about how you're thinking about core margins as you look forward?

Honestly you know we drive our business by driving sales and usually that means lowering prices on things which we continue to do, and we're also buying better all the time. Some of it’s mix, some of it -- the one category that shifted if you look back over the last few quarters of reports where we look at core on core, fresh foods has been a little down and I think the keyword here is little. I appreciate the fact that every basis points for us is $14 million plus pre-tax a year of [nearly 1 billion] [ph] but you are talking about 5 to 10 basis point swings here and there's a lot of things that impact it, whether it's freight, tariffs, some -- negative, in some cases not as bad as we thought. I think we've done a great job and we continue to do a great job particularly in fresh food organics where there's a little -- I believe there's a little less pricing pressure and some competitive pressure, but don't get me wrong, as soon as we have a good quarter next quarter we will change that. Not giving any guidance, we know that we keep it pretty steady and we feel pretty good about it, whether it's up a few basis points or down a few basis points.

Got it, and then just a question about the gas margins industry wide, I understand there are a few ways that gas impacts margin, but if you just focus on the fact that it seems like the core cents per gallon has improved across the industry, the independents may be in the integrated has taken a little bit more and that's given you some room to take a little bit more. So can you talk about what you're making sort of per gallon I guess relative to say last year and maybe a couple years before that? And as you think about the upcoming years, is there anything that you're seeing that would suggest that, that core profitability of every gallon sold is all of a sudden going to revert back to what it was a number of years ago?

I think over the last several years the new normal is better. If you go back to when gas prices sky rocketed several years ago and as they started coming down, what we saw, and what we read frankly from others is that as they came down not all of those savings were passed on to the consumer. They gave us perhaps a little bit bigger window, we're still -- I think if you ask our gas -- the people in charge of gas operations around here, we're saving the customer a little more today and making a little more because there's just a bigger opportunity of [gap][ph] there. It really comes down to that. It is still a volatile, no pun intended profitability item. It can swing back and forth, based on underlying cost of goods sold that change daily. And -- but the new normal is better in all those examples. But I'm sure there will be quarters, this was a -- Q2 was a particularly good quarter. But as I believe Q2 a year ago was a little better than the other three. But that’s not seasonal necessarily, it’s just -- there is a lot of different factors, what's going on in the news internationally, what's going on with inventory levels, world and US inventory levels, what's going on with -- inevitably a refinery shuts down for two weeks for their planned repairs, it takes four weeks. So any of those things switching from winter to summer blend and back. All those things impacted. I think we are fortunate in the fact that we turned a lot of gas. We literally turned inventory about daily and as you know we have locations with up to 24 pumps and they are backed up all the time, it’s great. So I think we’re in a fortunate position that overall retailers whether it’s retailers that have gases in their parking lots, like supermarkets and discount stores and ourselves or full line independent retailers or the ones with the convenience stores, I think everybody seems to have been taking a little more and that's given us an ability to do so over the last couple years. But I guarantee it will evolve and we will always tell you that it was certainly a little more of a benefit this quarter than normal but it was a year ago too.

So then just a quick one on that. So of the 30 odd basis points in ancillary this quarter, should we assume some portion of that comes out [indiscernible] the second quarter, is there like anything that you would say is one-time that we should put back next year on behalf of it?

I wouldn’t use the word one-time, I’d say unpredictable, and it truly is not predictable. We know that when demand rises at the beginning of summer that impacts -- the gas prices have a little bit more positive pressure on them. And where prices are going up not only for us but when I read the profitability of gas and other big retailers, supermarkets and Walmart alike, it impacts them as well. When prices are going up we are all making the less, when prices are going down we are making a little more. We I think are in the enviable position to being extreme. And as overall, the retail environment has chose to make it a little more -- it gives us an ability to make a little more -- a less than a little more as to make more but even be greater savings to our member. I mean -- and that’s the thing that we are focused on. Are we saving our member more than we used to? And we are.

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

Hey, Richard. A follow up on the gross margin or the core margin. You mentioned mix helped a little to dig in, anything about mix that was either seasonal or something that is changing. You said it was always lower product acquisition cost. Can you remind us when your own [check up plans] [ph] is coming up? And then one more in that mix, can you tell us the channel mix between physical and digital, is that sort of embedded gross margin improving as well?

No, overall our gross margin online is a little lower than our company overall, part of it is the product mix itself and part of it is we are driving that business. The [banana] [ph] hasn’t changed, that’s been that way. We also work on a lower SG&A online as you might expect. In terms of mix there are so many different pieces to it honestly. Part of it is, when you walk into a Costco in the US roughly 90% of the goods are -- come through our cross-stock operations. For us cross-stocks are very profitable. It’s the most cost efficient way to ship stuff. Nobody can do that to the extent that we do it because of how we sell goods in pallet and large case quantities, so I mean there’s lots of little pieces to it. I think private label and continuing penetration of private label, fresh, but all these are anecdotal. There is no one thing that’s driving in a particularly large direction. We think we are pretty good at what we do and we’re constantly buying better even as it related to tariffs, which so far so good in terms of being on hold, but we don't know, what's in the future. I think bigger retailers have the ability to buy better.

And then shifting to SG&A, in the past I think you talked about [indiscernible] your comps hold up in mid-single-digit, you’re leveraging, and that was based on some [indiscernible] of spending, there was IT, there was technology. Has anything on the spending side changed, any curve, that’s increasing, decreasing on that same mantra of about mid-single-digit comps, that [indiscernible] to give you leverage?

Yes, hopefully it won't and while -- the word modernization I think is finally been retired around here. We are still spending a lot and we're going to continue to spend a lot as some of these new things come online like the chicken plant, like the fulfillment automation. These are $50 million to $100 million plus items, chicken plant is more, where a bigger chunk of it is things like equipment and software that is depreciated over a shorter period of time than steel buildings. And that's --all those things [hitting us] [ph] as well. I think the fact is as we've been fortunate with our sales levels. As they go down that will hurt us a little. We are achieving our current SG&A with all the things that we haven't talked about some of these other items that impacted the other way. There are lots of little things and we are not terribly worried though if some of these things -- if sales were to come down a little and some of these things will impact us, so be it, we're going to do what we do and drive the top-line.

The next question comes from the line of Chuck Grom from Gordon Haskett. Your line is now open.

Just on the pricing front, I'm curious how you guys are handling increases in certain categories including any of those that maybe impact by tariffs, just -- are you looking to pass along those increases and do you think that may have helped out the core margins at all here in the second quarter?

I don’t think it would have helped the margins. This question is did it hurt it or not hurt it. And probably it hurt it less than one might think but that again gets back to our ability to buy right and to send those 10% tariff items so as examples versus 25 that's a big difference, in some cases you've got your vendors along with us, ease out a little bit, sometimes not. I think it’s just one piece of what we do. The fact that organic helps us, the fact that KS helps us. The fact that we don’t talk about but we really plan through a lot on the marketing dollars that are out there now, that some of those impact cost of sales.

And I guess just a follow up on Chris’ question here, you've got three consecutive quarters in a row of the core on core, core being negative in this quarter, what’s the positive, is there anything else you could point to?

I would read a lot, look we are happy about it and hopefully you are happy about it. It's not -- it’s how we run our business. We didn't sit there and say hey let's get it up a little higher, it is a few basic, it is I know we were a basis point company and you guys have known us for 30 plus years we talk about basis points. It's some minor switches, it's nothing that we’ve changed dramatically and there's so many different moving parts to it frankly.

Understood. I guess the other bright spot here in the quarter was the renewal rates are picking up nicely if you look back at the cadence in '18 they were pretty steady but they're showing a nice uptick both in US and worldwide, just wondering if you could comment on that improvement?

Well, we like it. Look we focus on all the things that we feel we should be focusing on, customer service, great products, great services at the best prices. We've been fortunate notwithstanding the fact that we really don't have a PR department per se, that there's been a lot of good press about us, about purple signature, about our e-commerce site and customer satisfaction. I think that we've been blessed that some of the weaknesses that traditional brick-and-mortars or traditional formats have had in some ways have helped certain other discounters like ourselves and hopefully that'll continue.

Your next question comes from the line of Edward Kelly from Wells Fargo. Your line is now open.

Good afternoon, Richard. I wanted to start with just a follow-up on fuel. If we were thinking about trying to strip out fuel and the impact, do we take the majority of the 33 basis points in order to do that? And then is there any intentional reinvestment to sort of consider as we think about this?

On the latter part of the question, there is no intentional reinvestment. I mean there is a 100 different moving parts to our company all the time and we do what we feel is right. It's kind of like a question that was asked a year ago, we were asked about what the extra earnings from the lower tax rate, will that change, what we're doing with automation online, fulfillment whatever else and the answer was of course no. We've got more cash than we spend and this will add to that and that's all good, but we're constantly figuring out what other things we can do there. What was the first part of your question? I'm sorry.

On fuel, if you’re trying to -- yes.

Well we don't disclose every component, it certainly was the biggest piece of it.

Okay. In the last quarter you mentioned a little bit of competitive pressure specifically talked about Sam’s and fresh. I am just curious if you could give us an update on the competitive backdrop, what you're seeing? And then you know as part of this it seems like we're starting to see maybe a little bit of food price inflation. Just curious on your thoughts on pass-through I guess and expectations for the year?

Well, I think the keyword on price inflation is little, we're not seeing other than the tariff impacts on things. But in terms of food what have you, it's frankly very little and some other time it'll go up. Our comments over the years have continually be -- will be the last to go up and the first to go down and I think that holds true as well. In terms of the comment last time on Sam’s that was an entry comment because I think after the call, the headline in the press was is, that's why things -- margins were down. And the fact of the matter is, we call it out because we're pretty transparent, Sam’s and others but Sam’s has been more competitive as we are -- as are we. And that's the nature of the business and it has been for 30 years. We see that continuing and I think the fact that it's continuing we'll still show improvement on some of these things, is a good sign for us.

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

Sorry to harp on this gas margin question, gas profit question. But is there any way you could just help us get a feel for how much you benefited EPS this quarter because the data we saw in gas margins for the quarter throughout your whole market area was just astronomically high gas margins?

When you say our area, throughout the United States?

Well, we map it by kind of stores by state. But west was particularly strong.

Yes, we don’t disclose that. Again it was a little more than half but not all.

And then I guess just wondering a little bit in terms of the wage increase that you called out for March. Is there anything to think about in terms of the basis point impact as we get into the next quarter?

Yes, I mean that is starting March 4th this past Sunday, I think I indicated. On top of the 7 to 8 that will continue through June 11th if you will. So all through Q3 and the first month of the -- the first four weeks of the 16 weeks fourth quarter effective March 4th we will have that additional on top of that 3 to 4 basis points. And that 3 to 4 basis points will be March 4th to March 3rd of 2020 if you will.

3 to 4 basis point, okay. And then just wondering if you could call anything out in terms of tax refund data, like in terms of your expectations on driving sales and there is a lot of noise on the timeline of that but any color what you are thinking that will do the comp, certain not do I guess?

Well, honestly I never heard anybody here talk about that and I have read some of the same things that you read, it started off in the period was a little lower and now in the period was a little higher, not a lot higher but a little higher. Typically on a macro basis that impacts retail overall and whatever impact it has on that is typically little less to us. That's what we've seen historically, whether it was a change in tax rates or dividend rates or you name it, EBT, food stamps, whenever there's any kind of macro change that impacts retail across the United States, there's a little bit less of an impact to us. But we've not really seen or even know how to answer that.

Okay. And then just last question. I know that you don't want to have people get in the habit of assuming that there will be a special dividend on a regular basis but any thoughts on your philosophy on that as it relates to the timing within this year? Because we're at the two-year mark.

Yes. I mean, our thoughts continue as they have been. The three we did were about two and a quarter years apart but that doesn't mean anything going forward. It's still a topic on the table and we continue to talk about it along with other things. So, really, not a whole lot of news to tell you about.

Your next question comes from the line of John Heinbockel from Guggenheim Securities. Your line is now open.

So, Richard, what are you guys seeing with regard to inbound freight? Is that a slight directional drag? And then, if anything, what are you doing to mitigate that?

I'm shooting from the hip a little on this one but I believe, while it's been up a little bit because of new restrictions on how many hours long-haulers can drive and just truck capacity out there, it's gone up for everybody, I believe we internally look at it in our freight department as a freight factor or premium factor or fuel factor -- whatever we call it. I forget. And it's up a little less than it was a couple of months ago but it's still up. And it's come down a little bit from where it was but it's still up from a year ago is my guess.

Okay. And you've had the adjustment item in gross margin related to some supply chain investments, not there now. Is that now gone for the duration or does that come back with other supply chain investments that you might make, whether it's the chicken plant or other depots?

One of the things was the return centers we talked about for a few quarters. I think there's more things happening that impact us a little bit negatively to start. We opened a new meat plant, major capital expenditure. First, it takes a few things out of our Tracy meat plant that goes to the East Coast. With Tracy, we couldn't accommodate all our needs just from that plant. And then you've got a new plant that's starting with its own -- even though we know how to run one -- it has its innate inefficiencies when you first start and it's not at full capacity. Same thing with the commissary, which was more of a learning experience over the last two years in Canada. I think all these things will impact us. A comment I made earlier is we're not going to point out each one of these but, in the aggregate, my guess is it's still a little bit of a drag which is offset by other things, most particularly sales.

All right. And then, lastly, there was a period there where you'd stepped up the growth of the business centers for a period of time. What's the philosophy now on where they go, US or internationally, as part of your expansion over the next couple of years?

I think, right now, we have one in Canada and what? Sixteen in the U.S.? I would expect one or two a year for the next couple of years, which is not really a change of what we thought. The change was several years ago when we went from zero to eight over a million years, over a long period of time, and then we started opening a couple a year. And so we'll continue to open a few but we're not -- it's part of the plan but our focus is regular warehouses and, quite frankly, a lot of the infrastructure things that we're doing now. We'll continue to do it in a bigger way.

Your next question comes from the line of Scot Ciccarelli from RBC Capital. Your line is now open.

Hi, guys. Scot Ciccarelli. Richard, with your first opening in China coming up, what is the best way to think about U.S. versus international store openings over the next, call it, 2-3 years? And then related to that, any reason why we should see international profitability levels decline as you start to move into some of these new markets, like China?

Well, first of all, if you'd asked us five, six, seven years ago, by now, what percentage of our units would be outside of the U.S. and Canada -- and I include Canada as part of the original, mature, fully grown-out area -- that, by now, we'd probably be 50/50 international, outside of the U.S. and Canada. And we're not. It's 65/35, 70/30 U.S./Canada still. Part of that is the opportunities that we've had in the U.S. and Canada. And part of it is the pipeline is taking a little longer elsewhere. I think you'll continue to see that change and the direction is toward more international. But I can't sit here and tell you that it'll be 50/50 three years from now or five years from now. But, clearly, we've got more things going on. Now, as it relates -- whenever we go into a new country, it's almost, by definition, you're going to lose money for the first few years, even if that first location or two contributes a small amount of profitability, if it does. Because you still have the central expense and the whole full thing, the infrastructure. I look back at Japan. When we first went into Japan, we opened six units in the first five years and the goal was to be at breakeven at the end of Year 5 and I think we beat it by about 10 months. But at the end of the day, fast-forward another 10-12 years past those five years, and we now have in the high-20% and we'll grow from there faster and more profitable than it was in that mid-term when we were opening several units on a small base. But it takes time. And as we go into France, as we went into Spain, by definition, those are going to add more to the bottom line sales in that calculation of return on sales and sometimes even subtract a little at the top. The key is balancing a little of that and I think we're big enough now that, even if we overdo it a little bit on some of that new stuff, it's OK. We'll let you know if it costs us an extra basis point or two.

Got it. Okay. Thanks, guys.

Why don't we have two more questions?

Your next question comes from the line of Mike Baker from Deutsche Bank. Your line is now open.

Thank you. A couple of clarifications. One, to Karen Short's question, you said that gas was about half of it. A little more than half or a little less than half of it. Half of what? Was that the year-over-year increase in earnings or operating profit dollars?

No. First of all, I said it was more than half. I didn't say it was a little over half. It's substantial. But we try not to be that specific. Clearly, there's a lot of things that helped our earnings this quarter year-over-year, as evidenced by improvement in core-on-core. And the fact there's evidence of things that hurt you a little bit. We don't pick out each one. Gas certainly helped but, again, I think Karen had mentioned she's done some studies, in terms of profitability, and it's a good piece of it but it's not entirely. There's other things --

That's what I'm trying to clarify.

There's other things that benefited it and other things that hurt it a little too.

It being the growth in earnings?

Well, gross margin and earnings, ultimately.

Okay. Thank you. Understood. One other question. I thought that you said that the ancillary margins were helped mostly by gas. We get that. But you also said helped by e-commerce. So, are your e-commerce margins getting better year-over-year? And, if so, why is that?

I believe the e-commerce bottom-line margin improved a little but also the sales were stronger than the rest of the company. So, it's penetration as well.

Okay. Understood. Last, real quick, SNAP. Any benefit from the pull-forward in SNAP? I don't know how much of it is your customer but it's helped others.

No, we really don't see any of that. Very little of it. Those kind of things don't really impact us.

Your last question comes from the line of Scott Mushkin from Wolfe Research. Your line is now open.

Hey, Richard, thanks for taking my questions. So, I just want to go back to e-commerce. I know you touched on it, in the quarter, that it was a little helpful to margins. But you're putting a lot of money into it, it sounds like, with two-day and one-day grocery. I was wondering if you could walk us forward on e-commerce and what you think it's going to do to margins as you go forward.

Well, every company allocates things or puts things in different silos. In our e-commerce, the one-day grocery is not part of e-commerce. Even though you go online to order, it's really the Instacart engine and it's in warehouse. They come into our warehouses, they shop, they deliver the same day. And so that's part of the e-commerce numbers. That and a couple of other things would actually increase the percentage increases a little bit but it's still so small, it wouldn't have that much of an impact.

And then the rest of the e-commerce business? I think you said you were building out some fulfillment for e-commerce. I think it's for more consumables. How are you guys thinking about margins on that business as we move forward because the mix is going to shift, I think?

Well, it has shifted. As you know, a few years ago, the average ticket was $400 or something because we sold big ticket items. We didn't have lots of little things or things that got you back to the site more frequently and more regularly. Some of that's just starting. As I talked about, the first of three planned fulfillment -- what we are calling fulfillment automation centers, we have our first one in southern California. It's literally open less than eight weeks, I believe. It's over a $100 million investment. The first one is the most expensive because you developed all the systems and everything as well. We have two other planned for depots in other parts of the country. I would hope that that's something that's going to hit our number a little bit because it means we're doing well in it as we're growing it. We're going to see the cost of picking an item dramatically reduce because we've done it not quite manually but less automated than we'll do over time. But that's going to be an ebb and flow over time. We'll just see how it goes. I think, in the scheme of things, recognizing that e-commerce, in its entirety is still, what, 5% to 6% of our business? 5% plus of our business? Even as we hope and assume that it's going to grow at a higher rate than the rest of the company, it's still going to be in the single digits for a while. So, those impacts -- and even with the first one, you're talking about the inefficiencies of getting something open up and running and building it up over the first 6-12 months and then the associated depreciation and the like. Those things, in the scheme of things, are not huge. As we do three and four and five of them, it's a little bigger. So is one chicken plant, so is one new concept bakery commissary a few years ago. So, all these things will be -- I would think these are things, we'll hope to balance some of them, but net-net, if they're a little drag, that's a positive.

All right. And then last one. I guess this is the last question. But February sales and traffic, anything to read there? It seems like it was a little slower than we've been seeing. Any thoughts there? Any read?

No, look, I think we, more than anybody, hate to use the word "weather" as a reason. And you see it every day. Clearly, whether it was rain, snow, cold, you name it, that impacts things like patio furniture, spring wear. But I think if you ex out the things we try to, as I pointed out on the call, if you ex out the weather, which we assume -- I think I said it was 1% in the month for the full company. A little more, therefore, in the US and Canada. We try to err to the conservative assumption on that. I mean, it's not a lot more than that but we feel comfortable in talking to the operators of the impact. And if you add that back in and you add the holiday shift in Asia, you take those things out, we're a little lower, not a lot lower, than we've been enjoying for the last several months. I guess we'll have to wait and see how March is.

See how March is. Exactly. All right. Well, thank you so much and take care.

Thank you. Thank you, Vincent, and we'll be around to answer questions. Thank you.

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