好市多 (COST) 2003 Q1 法說會逐字稿

Good morning, my name is Marsha, I'll be your conference facilitator today.

At this time, I would like to welcome everyone to the Costco whole Corporation first quarter 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 period.

If you would like to ask a question, during this time, simply press star and the Number 1 on your telephone key pad.

If you would like to withdraw your question, press the pound key.

I will turn the call over to Mr. Richard Galanti, Costco's chief financial officer.

You may begin your conference.

Thank you, and good morning.

This morning, as usual, I'll review several items.

To begin, with the 12-week first quarter of fiscal 2003 operating results.

As you saw this morning, we came in at 31 cents a share, up 3 cents or 12% on a dollar basis, 11% on an EPS basis increase over last-year's Q1.

As you may, we previously lowered the Q1 guidance from 32 to 33, to the 30 to 32-cent range about three, four weeks ago when reporting November's comps.

And show the 31 actual EPS figure is in line with the current 31 cents, and/or R our most recent guidance but below our original budget.

Also, the 12-week comp. sales figure showed an increase of fours%, rounded up to four.

You'll note that last week when we reported comps for the four-week retail month of November, and the 13-week retail period of September/ October/to have, for the 13 week, comps were 3%.

That's because week 13 this year was a six-day week with Thanksgiving versus seven days last year.

That last week, which is -- goes into Q2, but not into -- stayed in the November calendar number, was a minus five.

Other topics of interest, our recent and upcoming opening plans, we've opened 17 net new locations since the beginning of the fiscal year on September 2.

Actually 13 in the first quarter, 14 openings including one relocation, four so far just in the last couple weeks since the end of the first quarter in Q2.

And that four includes new home furnishings concept, called Costco home.

I'll also briefly comment on ancillary business results, Costco online results, executive membership program, our balance sheet, I'll also court reporter on some questions, concerns that Bob and I have gotten here over the last several weeks related to sales outlook and what impact that may have on earnings.

Also questions surrounding the issue of saturation, that seems to be a hot topic of conversation in the warehouse club business.

And lastly, we've gotten some questions about Sam's recent announcement that they're going to enter Ontario Canada, next year.

Lastly, I'll provide you with current guidance, both for near-term sales and estimates for beginning some new guidance or earnings for the second quarter and what that looks like for the year as well.

As with every conference call, let me start by stating the discussions we are having will include forward-looking statements within the meaning of the private suits reform act of 1995 and that these statements involve risks and uncertainties that may cause actual events, results and/or performance to differ from those indicated by such statements.

The risks and uncertainties but are not limited to those outlined in today's press release as well as other things identified from time to time in the company's public statements and reports filed with the SEC.

With that said, let's get started.

Sales for this year, mentioned, came in at 9.0 billion, up 9% from last year's Q1 of 8.3 billion, and again on a 12-week to -week comp. paying, sales up 4% for the quarter.

For the watered, our 4% comp. sales results were a little weak relative to prior estimates, still towards the head of pack.

In terms of breaking that 4%, again, rounded up to four, high three, full, in terms of breaking that into the average ticket and the average frequency, the average transaction was up in the one to 2% range for the quarter, average frequency was up around 2%.

The three months were filled with, as you know, many factors, post9/11 comparisons, deinflation in certain category, increased levels of CANIB a cannibalization in our case.

The timing of Thanksgiving and the most important, the economy overall.

I think that as, you know, I and others have gotten lots of questions, we are in a tough economy.

We're holding our own top-linewise.

That's lower than it had been.

In terms of cannibalization, by the way, incrementally, about 40 basis points greater effect this year than last.

We'd expect to see that continue.

That was, you know, consistent with what we'd expected.

Let me give you quick geographic and merchandising breakdowns for sales.

In terms of sales comparisons by geographic region, the northwest region, which enjoyed a 6% comp. all last year and a 5% comp. in the fourth quarter, THA F that would be the basically the mid May to the end of August 16-week period, end of the first quarter, end of September, October, November, northwest was a 2.

California, which enjoyed a 6 all of last year, and four and a half in Q4 was a 3 in Q1.

Northeast, which was an 8 last year and a 7 in Q4, was a 2 in Q1.

Southeast was a 7, 6 and 4 in Q1, a 4 in Q1.

Midwest, again, benefitting from the fact that it's a relatively new region and just in the last three years, we've opened about 25 or so units there, many of them or one and two years, almost three years old.

The midwest which was a 17 all last year and a 20 in the first quarter was a 12 in Q1.

And which put the entire us at a 7 for all of last year, a 6 for the fourth quarter, and a 3 and a half in Q1.

Canada and us dollars actually has picked up.

Last year, it was a zero for the year, a 4 for the quarter, and actually a slightly better than that, about a four and a half the first quarter both in U.S. dollars and local Canadian dollar occurrence [INAUDIBLE].

Other intersect, a 7 last year, 6 for the fourth quarter, a seven and a half for Q1, a little lower, about a 2 in relative local currencies.

All told, whereas for last year and last year's fourth quarter we reported a company comp. of 6, we were a 4 for the first quarter.

In terms of merchandise categories, again, same trends, both awful last year, the fourth quarter of last year and the third column being the first of this year.

Food and sundries, a 6, 6 and a three and a half.

The three and a half is interesting because this include as lot of basic goods, paper towels and canned goods, light bulbs and what have you.

We had interesting things going on F. you look at some of the recent months in food and sundries, August had been a 6, September of a 4, October of a zero, although it was a 2 normalized with some unusual things going on in tobacco, and bounced back to 4 in November.

We're starting to see that recovery.

October, even under a normalized 2 was a little weak and part September had come down.

We felt a little bit because post9/11 people, we did she see some strength in beam bulking up on staple items, buying extra flashlights and batteries and water and paper goods and things like that.

I'm sure we've cycled through that by now.

Hard lines, all of last year was a 7, pretty strong 7.

A 6 for the fourth quarter, and that's come down in the first quarter to a two and a half.

One area that had hurt that number was what we refer to as majors, which was about a minus 6 for the quarter, that's computers, TVs.

One of the things that's interesting, we are seeing weakness in computers.

I think we're seeing strength in TV sales, but relative to, again, post-nevin, there was a lot of people cancelling vacations, and spectacular numbers in home entertainment stuff last fall and into Christmas.

Some strengthened hard lines included office up 6%, and toys and seasonal during the first quarter up 17%.

We're coming out of Christmas clean as it relates to seasonal stuff.

Soft lines, a 4 awful last year and a 5 in the fourth quarter was a 3 in Q1.

Helped by chem's apparel and jewelry, both of which were 9 during the quarter.

Again, I think 9 in jewelry probably is in part, Nevin, we saw weakness in discretionary big ticket items, original home entertainment.

One area that's been weak, minus 4, has been photo.

While digital camera sales are strong and the little things you put into the camera to take the pictures, I'm having a -- memory cards, thank you.

The, you know, film processing and film sales are starting to show weakness, I think that's consistent with what's going on with the digital camera revolution.

Fresh foods is the tall wart here, all of last year was a 9, fourth quarter was an 8, first quarter was an 8, despite meat and related products deinflation.

We continue to have strong produce comps within that number as well.

Ancillary witness -- businesses, which was a 6 last year, and parenthetically the 6 was a 12 without gasoline all of last year, in the fourth quarter, we had a 1, and without gas, a 9, and ancillary businesses in the first quarter was a 5, again, parenthetically was a 12 without gas.

I guess, as you know, back in June, July, we stopped accepting Mastercard, Visa and Discover which represented about 40% of our gas sales tender format and we knew this -- you know, we would expect, as an example, the 6% -- the minus 6% comp in gasoline sales in Q1 represented a 12% gallonage reduction.

It's starting to be a little less than we had seen before, when we first did it, and a 6% price increase in gas.

The -- all toll then to the Company, a 6 for all of last year comp, a 6 for the quarter, and a 4, as I mentioned, for Q1.

Moving down to the income statement now, let's start with membership fees.

Membership fees were actually quite strong and very encouraging in Q1.

In Q1, we reported membership fees of $188 million or 2.09%.

That's up 11% in dollars, and up 4 basis points versus last year.

More importantly is that on a cash basis, we even saw greater strength.

Remember, because of deferred accounting, when you're having increasing membership fee dollars, you defer, in a sense each month, 11/12 of that into the succeeding 11 months.

So that when we're having increases in that as it relates to people converting to the executive membership, as people in new warehouses that had a free membership last year are now buying their first year in membership.

Those things all help us.

So, on a cash basis, whereas again on a reported basis, membership fees in dollars were up 11%, and the basis points up 4 basis points, on a cash basis, in dollars it was up 15% and up 15 basis points.

Again, that will help our membership fees I think continue strong as we go forward.

This is actually better than planned in terms of percent of sales and within a couple million dollars of membership fee estimates for our budget.

So, we felt pretty good about that given the slowdown in sales.

Keep in mind, we continue to benefit from strong renewal rates, increasing penetration, as I mentioned, of the $100 per year executive membership, again, new market openings.

And lastly, I believe that we're benefitting from something I mentioned, two quarterly conference calls ago, the complete rewrite of our membership system which allows a lot more flexibility at the registers for a cashier to prompt the member, hey, you get your renewal date is next week, would you like to go ahead and pay for it now and save you having to write a check?

And so we're not only able to, I think enhance membership fees a little bit, but also get the money more quickly.

A fifth reason actually is also working with HRS Household on our private label credit card and American Express, of course, on our co-branded card to get people to allow us to auto-renew them each year by just putting it on their credit card automatically.

In terms of membership renewal rates, they continue strong, and at a all time high renewal rate percentage.

At year-end it was on the business memberships renewed at 91%, at Q1 end, it was similarly 91%, and Gold Star, both at year-end and the first quarter was 84, so again, it continues at 86.

Actually, we had about a 10th of a percent pickup, so it's a little stronger, 86, than it was a quarter ago, notwithstanding the fact that our membership fees are the highest in our industry.

In terms of number of members at Q1 end, Gold Star members -- primary Gold Star members 14.9 million, up about 300,000 from the end of the year, primary business members flat at 4.5 million, business add-ons up 100,000 at 3.6 million.

So, all tolled, 23 million, or 23 million versus 22.6 million at year end, including [INAUDIBLE] cards, a little over -- a little under 41 million versus 40.5 million at this year end.

Paid executive members continued to increase about almost 11,000 a week during the first quarter, such that we're just under 1.8 million executive members at Q1 end.

In Q1 executive member sales, whereas -- as you can tell they represented about 8% of membership, they represented 22% of our sales, versus 17% of sales in Q1 a year ago.

And again, with this, we see a detriment to margin because of the 2% reward, needless to say, an increase in membership fee income because of the 55 dollar higher membership fee, $100 versus 45, and also we see a higher comp in this group.

This group comped significantly ahead of the rest of the members, recognizing you're starting with the most [INAUDIBLE] members and the highest volume members to begin with.

In terms of AMEX, at Q4 end 2.2 million accounts, added 160,000 during the quarter, continues to be good, just over 22% sales penetration versus 20% a year ago.

American Express continues to do a lot of things for us as we hope we do for them, most importantly, helping us with marketing and membership marketing initiatives in all markets, both existing markets as well as new markets.

Going down to the gross margin line, similar to the third quarter and the fourth quarter of '02, we had strong gross margins in the first quarter of '03.

Margins -- reported margins were higher by 27 basis points, coming in at a 10.67 versus a 10.40 a year ago.

Again, if you would jot down just two quick columns, all of fiscal '02, and the second column Q1 of '03, I'll break the margins down into about five line items.

The core business margin last year was up -- for a total was up 18 basis points of which the core warehouse business represented plus 16 basis points, 2% reward, again, that has a negative effect, was minus 13.

And as we increased sales penetration of executive member sales, theres more 2% rewards, therefore a negative there, although the level of negative is starting to decline.

Ancillary businesses were up 6, International was up 4 basis points, LIFO was a 5 basis point positive for all of last year.

Recall that we had a net LIFO credit last year, versus the '01 year.

So, all tolled if you add the 16 for core, the minus 13 for reward, plus 6, 4 and 5 were Ancillary, International and LIFO, you get the 18 basis point improvement for all of last year.

Now, in the column 2, the first quarter numbers, Core was actually a little better than the plus 16, it was plus 22.

As I mentioned, the 2% Reward negative detriment to margin is starting to lessen, it was minus 9, Ancillary was plus 2, International plus 9, LIFO plus 3, recognizing we had a LIFO charge last year versus no charge this year.

I'll comment on that in a moment.

You add up those numbers, the 22, the minus 9, the plus 2, the plus 9 and the plus 3, you get the 27 basis points.

In terms of the Q1 core improvement, of 22 basis points, fresh foods was particularly strong year-over-year with more modest strength and food and sundries and hard lines, and even a small year-over-year improvement in soft lines as well cause all four departments contributed to the core margin strength.

And again, I'll reiterate, because I'm constantly asked the question, you know, what about everybody out there saying that it's getting more competitive?

All I can tell you is that we figured out how to improve margins while, in many cases, lowering prices and in most cases lowering prices, and every time we do weekly and monthly and quarterly market basket shopping comparisons, we see our level of competitiveness equal to if not greater than it had been before.

We'll continue to monitor that because, as you know, and many of you know Jim Sinegal, our President, we're not going to let anything get into the way of that level of competitiveness.

In terms again, the executive membership to minus 9, I won't go through that detailed chart again that I've done for so many quarters, but basically we see that level of detriment declining and a again you will see a corresponding improvement -- partly corresponding improvement in membership fee income.

With regard to ancillary business margin, again, that was plus 2 basis points.

Basically, it was -- in gasoline there was a slight negative, pharmacy a positive, all others grew pretty much in line with sales growth.

International 9 basis points better, both margin improvement, international gross margins improved by a little over 100 basis points.

That's not that -- again, it's more because we have a lot of -- it's a small number of locations, many of which are brand-new and as you go from a unit in the first year where you're not buying as much [INAUDIBLE], a year later we are buying direct, nothing unusual about that.

That plus 100 is just getting closer in line with the Company overall and a higher sales penetration of these units given the fact that over the last 12 months we've opened three more UK units and one more in Japan.

Regarding LIFO, I mentioned we picked up 3 basis points.

At this juncture, which is still only three months into the fiscal year, we are slightly deflationary.

We felt that it certainly did not make sense, given that it's early in the year, to have any LIFO credit in Q1 but we didn't feel it was necessary to take a charge.

So year-over-year that was a $2.5 million or 3 basis point improvement in the margin.

In terms of the gross margin outlook for the rest of '03, I think it's steady as she goes in terms of the levels of increases we have been able to see.

We think that we'll continue to see good margin improvement, continue to remain competitive and we still believe there's no shortage of margin opportunities out there our way, which means by buying better and passing on the savings, passing on some of the savings and keeping some of the savings.

Before going into SG&A, let me go over ancillary businesses.

Pharmacies, we ended the quarter with 317, food service -- essentially food service, one hour of mini labs, optical, are in virtually all locations.

I think we've got about 20 locations for optical still, 12 print and copy shops, same as year-end, 5 more hearing aid centers, now 116, and since the end of the fiscal year, 7 more gas stations to be at 176.

You know, these are -- again, gasoline is probably the only one that again has -- requires greater stomach lining in terms of the volatility of the bottom line.

For most of the quarter it was slightly unprofitable.

I am happy to say the last couple of weeks it's actually been profitable, and that's what we expect with that business.

It is [INAUDIBLE] business but it's a very good value proposition.

We think that those that are strong like us will continue to be able to wait that out.

Again, in terms of ancillary businesses, comps were 5%, about 12% without gas.

Moving onto SG&A, as with the last couple of fiscal quarters, it's continued to be tough for us.

Recall that in Q4, SG&A came in as a percent of sales higher than planned, up 31 basis points year-over-year.

And that was on a 6% comp increase.

And of course, that was due, of course, to us still digesting some of the older units -- some of the newer units from the new markets, as well as, as we mentioned, probably the biggest other single cost increase has to do with employee related healthcare, workers' comp and everything really related to employee gives rising costs in those areas.

In Q1 of '03, as you will see below in the chart that I'm about to give you, our SG&A year-over-year was higher or worse by 39 basis points, coming in at a 986 versus a 947 in last year's Q1.

Again, just write down a couple of columns here.

We'll do fiscal '02, all of the year, Q4 '02, and then Q1 '03 to give you kind of a trend line.

In terms of the core, all of fiscal '02 was minus 22, that means worse by 22 or higher by 22.

Q4 was minus 26, and Q1 was minus 27.

I guess, relative to a 4% comp versus a 6% comp in Q4, one extra basis point is not the end of the world, given what's going on with healthcare as well.

In central, plus 5 all of last year, meaning it was better or lower, than but 5 by 5, plus 2 in Q4, and minus 1 in central.

Again, I think that's a function of lower comps.

Ancillary, minus 5, minus 1, and minus 4 during the first quarter, international, minus 2, minus 6 and minus 7.

Again, the minus 6 and 7, early in the Q4 we opened three more units in the UK, so that's more sales penetration in new units than anything else.

So all tolled, all of last year, you recall we were up 24 basis points in Q4, up 31, and in for the Q1, of course, up 39.

Now, getting back to core, of that core, you recall in the last several quarters we've tried to break that out into existing and new markets, recognizing that over the last two years, we've had a lot of new market units and that's certainly been -- added destablization, if you will, to the SG&A number.

That is -- that's showing some improvement.

In terms of that 27, about 13 of it relates to new warehouses over the last 12 months and about 14 to existing warehouses.

And within the 14, frankly, virtually all of it is healthcare and workers' comp related.

There's a couple other things that are slightly negative or slightly positive, but for all intents and purposes, much of that 14 component of the 27 core is healthcare.

We are studying it.

You know us pretty well by now.

We're not going to knee-jerk react to it, but we want to understand how to show some savings there and try to do as little as possible on the backs of all of us.

We have prided ourselves in paying our employees well and providing great healthcare benefits, in an industry that historically hasn't provided great healthcare benefits to both full-time and virtually no benefits to part-time where we do to most of ours.

So, stay tuned there.

In terms of SG&A outlook for the rest of the year, in a nutshell, it will depend on where comps come in each quarter.

Between healthcare costs and lowering comps, that's been a tough one.

Frankly, I think that the 39 [INAUDIBLE] higher, than the 31 the prior quarter given the lower comps and higher healthcare, was about what we expected with those functions.

One final note regarding SG&A in the future.

It is going to come down.

We, too, are anxious and we're trying to make that happen.

We hope we get a little help from sales.

Two things that I mentioned in the first quarter conference call, one is how we account for our phone card business.

Historically, we had actual cards with value on the floor.

Effective about a week or two ago -- or a few weeks ago, we began having no value on the cards on the floor, and now again with the register rewrite, we can initialize those with value at the register.

One, it reduces our carrying cost because we're not buying inventory in advance.

And it's a pretty slick operation and nothing magic, I think we're probably a little later than others in doing some of this stuff.

What that has the effect of doing in terms of gross versus net accounting per sales, it's now no longer a gross sale, it's a net sale, meaning that we are effectively brokering the card.

It doesn't change the bottom line, but it has the effect, when it's fully implemented, to improve margins by about 5 or 6 basis points and hit SG&A by about 5 or 6.

My guess is that 4 or 5 of that will start in Q2 and get up to 5 or 6 the next quarter.

This is something, again, we explained a quarter ago, but I wanted to make sure I have at least one reason that we know about as we go into the next quarter.

The other thing is options expensing.

Again, while we do option grants twice a year, the big -- the majority grants occur in February/March, right around the beginning of Q3.

Those are the annual grants.

And the impact, as we stated when we announced that we're expensing stock options in this first year on a prorated basis over the 5 year life of options, will probably be something about, you know, $13 million I believe, for the -- all of which would be in the second half of this year.

So, you know, rough number you're talking 6 or so million dollars in each of Q3 and 4.

Again, that would be about 5 or 6 basis points, most of which would hit SG&A.

And that -- so we are -- please recognize that that will hit.

I'm sorry in terms -- I'm being corrected by Bob, correctly.

So, in terms of the basis point hit, it will be more like 3 or 4 basis points.

It will be about $3 million in Q3, and about 8 or 9 million in Q4, recognizing Q4 is a 16-week quarter.

Okay.

Next on the income statement is preopening expense.

Preopening was lower by $4 million, 7 basis points lower or better than last year, coming in at 20 basis points.

Low preopening related to fewer new warehouses being opened.

Last year in the first quarter, we had 16 openings, including 3 relocations, this year we had 14 openings including 1 relocation.

So, two extra openings, and not as many right afterwards as well.

No big surprises in that line.

In terms of provision for impaired assets and closing costs, in Q1 '03, these costs totaled 5 million pretax.

In Q1 '02 last year closing costs totaled 8.55 million for the quarter, all of which was the final accruals and costs associated with the Canadian consolidation of our 2 Canadian operations up there in eastern and western Canada.

So essentially, there were net -- no net closing costs last year in Q1.

Keep in mind this year's $5 million figure is simply our ongoing -- it represents costs associated with our ongoing relocation efforts as we relocate -- in many cases, successful older units into better locations.

The cost associated with closing these to be relocated units, are expenses up front once the decision to relocate is made.

So, all tolled with everything up to this point, operating income in Q3 was up $22 million over last year, up 10.4% to 237.8 million.

Below the operating income line, reported interest expense was higher year-over-year by 2.2 million.

Our actual cash interest expense was lower by about a million and a half.

Where we got hit here was the reduction in capitalized interest.

Last year, both interest rates were higher and there was more work in progress or construction in progress, if you will, in the pipeline as we ended the quarter, such that capitalized interest, which is a reduction in interest expense, reduced reported interest last year by more than $3 million.

It was pretty much close to 0 this year.

That's how we get the increase in reported interest expense.

As anticipated, interest [INAUDIBLE] was slightly better and higher year-over-year by 600,000 to come in at 7.6 million this year in the first quarter, versus 7 million a year earlier.

So, overall pretax earnings were up just under 10% versus last year Q1, increasing from 216 million last year to 237 this year.

By the way, in terms of our corporate income tax rate, you may have noticed that our rate in Q1, like it was for all of last-year, remained at 38.5.

On the fourth quarter conference call, I mentioned that historically for the last number of years, we had been at 40%, that because principally in Canada, where the Canadian authorities have greatly reduced their corporate income tax rate in an effort to be a catalyst for business growth, we saw our effective corporate overall interest rate -- income tax rate, go from 40% historically over the last several years to, in fiscal '02 to 38.5.

I mentioned on the fourth quarter conference call a few months ago that we would expect that this year it would probably be about 39, recognizing that there's some state tax changes in New Jersey that would probably cause us about a 40 basis point increase in our overall rate.

That's where we came up with the 39.

Canada -- that being said, in the last three months, Canada continues to show some reductions in its overall rates, such that we came in again at 38.5.

Our expectation, by the way, is that it could get a little lower on the one hand because of Canada, although we're still accruing at this point because we believe that given the state deficits throughout the country, state treasury deficits, many states may have to do something with income taxes.

So we think the 38.5 is the right number for this year.

For a quick rundown on the other usual topics, let me start with the balance sheet.

As of November 24, cash and equivalent, 713 million, again, about half of that is basically float the other way, it's credit and debit card receivables as of Sunday night for the weekend sales.

Inventories, 3 billion, 676 million other current assets 681 million, total current assets 5,000,000,070, fixed net property plant and equipment, 6,000,000,710, other assets, 455, for total assets of 12,235,000,000.

On the right-hand side of the balance sheet, short-term debt, 76 million, accounts payable, 3,241,000,000, other current, 1,575,000,000, total current liabilities, 4,000,000,892, long-term debt of 1,000,000,235, deferred another of 151, total liabilities of 6,000,000,278, minority interests of 121, stockholders' equity of 5,000,000,836 and that side too should add up to the 12,000,000,235.

Point out a couple of things on the balance sheet.

Again, pretty easy one to analyze, it's a very conservative balance sheet, debt to cap rate of 18%.

Plenty of financial strength.

In terms of accounts payable, reported accounts payable this year, Q1 end was an 88 versus 85 a year ago.

If you look at just merchandise accounts payable and take out construction and things like that, it was an 81 and an 81 both years, still vast majority of our inventory is being funded with free trade payables, notwithstanding the fact that we take all terms and discounts and pay as early as possible based on those terms and discounts.

Average inventory per warehouse is actually higher by about 4 percent year-over-year.

This year the average inventory was right at 9.5 million per location, versus a little over 9.2 million a year ago.

Part of that is a function of trying to drive sales during this period of time.

As I mentioned, we feel in talking to the merchants and to Jim yesterday, we feel very good that we're coming out of Christmas pretty clean, that there won't be any great unusual markdowns.

So that's good news.

In terms of Capex, we spent in '02, 1.03 billion.

Our original budget for this year is about 1.1 billion, that's for 30 to 32 planned new openings and 7 planned relocations.

My guess, we're probably close to a billion for '03, as a few things slip a little bit, and I'm sure some things that are next summer will slip into the fall.

Briefly, Costco Online is going great guns.

Last year the sales increase was around 80%.

This year in the first quarter, the sales increase was 102% and was profitable.

Nothing more can be said on that one.

In terms of Costco Home, last Thursday, we opened up a new test concept here in the Seattle market in the city of Kirkland called Costco Home.

We took over an old 105,000 square foot home base location, about three-quarters of which, 75,000 feet, is devoted to retail selling space, and it includes everything from furniture to home furnishings, accessories, lighting, carpeting, wall coverings, window coverings, a limited amount of bedding and things like that.

It's way too early to tell -- you know, we've blown away our estimates for the first weekend, but it's the first weekend.

As you might expect, we got a lot of good press up here.

But we have well-known names like Lexington and Thomasville and Lane, and [INAUDIBLE] and basically it's gotten good press and good sales so far.

But a lot of these are not impulse purchases, they're 4 and 4 and $5,000 purchases.

So we'll see.

It's a test.

If nothing else, we're creating relationships with manufacturers that we can expand to other locations as well.

In terms of expansion, as I mentioned earlier from the beginning of the fiscal year in early September to the end of Christmas now, end of December, we opened 17 new warehouses, including the Costco home location.

We relocated 1 so for a total of 18 openings, 17 net opens.

For the remainder of year, through August 31, between January 1st and August 31st, probably we will be somewhere in the 13 to 15 range, and again there could be a few fallouts, not consciously, but just in terms of timing.

And relocations, probably instead of 5 to 6 more, probably 3 to 4 more.

Again, there's been timing delays on those, not any major change in interest there.

Let me comment before I turn it back to the moderator on three of the topics that I mentioned earlier, as well as a little guidance and then I'll turn it back.

In terms of the sales outlook for December and the rest of '03, as I've talked to many of you and I know Bob has talked to many of you and I think Jeff Elliot as well, we have -- it's a little weaker than it's been.

There's nothing new that's gone on in December.

We've -- it's in the very low single digits.

You know, one week it might be slightly negative less than a point, one week it might be plus 2 or 3.

But the fact of the matter is that it's a little weak.

I think we'll get some benefit in the last two weeks of the month based on having an extra pre-New Year's and pre-Christmas selling day in those two weeks.

And this week has been slightly better than it had been despite the mid Atlantic ice storms.

But, you know, we're not banking on anything big.

I would guess that in terms of looking at a December number, and trust me, it is somewhat of a guess at this point, we'll probably have something in the, you know, 2 to 3 range and we'll go from there.

The outlook for the rest of the year, again, a little bit like reading tea leaves.

We actually are getting new vendors.

We're doing a little better than others and it's been very consistent.

And we're hopeful that that number can go back to the 3 to 5 range after that.

But we're going to have to wait to see.

And perhaps even a little more.

We are encouraged by the types of things we're getting.

We're encouraged by, again, the vendors and we're encouraged by the fact that we haven't had a -- we haven't seen big trade-downs in merchandise overall.

The second point is saturation.

You know, again, I think a couple of the sell-side analysts have focused on that, which is their prerogative, and as well, our largest competitor, Sam's, of course when they announced management changes and changing the philosophy of what they're going to do in the warehouse clubs and their next new way to drive that business, one of the reasons is that they believe that the industry, they and the industry are saturated.

Well, we vehemently disagree.

We continue to see opportunities.

We continue to infill and even if you deduct the level of cannibalization, the net new units are opening strong and profitable overall.

We, I think part of the saturation that our competitors have felt over the last several years is, frankly, that we've opened a heck of a lot of units in their markets.

And that, both having to protect their markets, as well as lose some sales to us, not a lot, has caused some of that.

We think there's plenty of market share, when we look at markets, not just Seattle and Portland and the Bay area in L.A., but we compare some of those -- those sales levels, penetration levels, are significantly greater than some other parts of the country.

And even in those markets, like L.A., we see there's plenty of opportunities.

We believe even in Puget Sound, where we're probably the most saturated, we see several more units over the next 5 or so years, which is again a far cry of what we said a few years ago where we felt we were saturated.

So we keep coming up with new stuff.

I don't think anybody has lost confidence in us as it relates to our ability to innovate, to drive prices down and to be a great merchant here.

Last comment, many of you may have seen that Sam's announced a few weeks ago their announced entry into Ontario, Canada.

My understanding is, and I believe this is from their press release or from a newspaper article up there, that it's going to be run by their Canadian operators, which are frankly the Wal-Mart operators up there that have been very successful.

Toronto, Ontario, is probably, while we think most of Canada is relatively saturated, we still see a few units opening over the next several years.

Probably Toronto is one of the least of those, but still, you know, in terms of saturation.

Needless to say, we're going to make it as uncomfortable as possible for our new competitor, but we also have a lot competition up there, Loblaws and some of the other retailers up there are strong competitors.

We're going to do what we have to do, in terms of protecting our market and protecting our membership base and making sure we're on top of our game.

So I don't see anything other than the fact that I recognize that's what the competition is all about.

We've done it in a lot of markets to our competitors and we look forward to competing with them.

Finally, before I turn it back to Marsha, I will give you some direction for Q2 and and '03 overall.

You have got to recognize, I know this is not a surprise to you guys, a lot of it is based on the level of sales.

As we began -- a month ago when we brought down Q1 estimates, it was entirely a function of our original sales budget versus what we felt we were going to come in in sales.

As you know in Q1 we were 4, I keep saying a weak 4, it was somewhere between a 3.5 and 4, relative to our number and just simply taking those incremental sales times a pretax profitability factor, was the entire difference of about, 1.5 to 2 cents in Q1.

We would expect in Q2, I believe first call is at 46 cents, although I know in talking to many of you over the last several weeks, since we brought down Q1, and haven't expressed any great comfort that sales are screaming, that people, I think, have brought down the numbers.

They brought them down in their own mind, they haven't necessarily published yet, they were waiting for our earnings announcement to come out.

Basically, the 46, our guidance is going to be in the 42 to 44 range.

We're being probably a little conservative on our numbers but we want to be.

We're hopeful that, you know, I was asked earlier today by some of my colleagues here before the conference call, you know, what happens if sales are even lower?

There are no guarantees.

I think that's a good range right now, if sales remain even weaker -- and we don't think they will, but they could -- that could be a little lower.

If sales surprisingly got a little hotter, it could be a little better.

But a lot of this is sales-related, which of course affects expense leverage, margins are strong, membership is strong.

Q3 and 4 first call estimates are 33 and 58.

That would give the current first call estimate for the year at a buck 67.

We're going to go out a little bit on a limb for the year and to be probably a range that averages around $1.60 with a range of $1.57 to $1.63, which would be 6 to 10% increase over last year.

We'll have to see.

We, again, I think if sales get better, we can do at the high end of this range, if not, a little better.

But we'll have to wait and see where sales come out, recognizing that it's been a tough economy out there.

With that, I will turn it over to Marsha for Q&A.

Thank you everyone.

Thank you, Mr. Galanti.

At this time, I would like to remind everyone in order to ask a question, please press star and the number 1 on your telephone key pad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from George Straken of Goldman Sachs.

I hardly endorse you taking the range down.

That's very realistic and it's what the numbers seem to show and hopefully there will be some upside.

I was wondering if you could comment on the comps that you're getting out of the units that have opened up over the last couple years.

Are you getting the kind of kick that you should as those newer units start to mature?

In terms of comps, over the last couple of years, one of the things that we've seen is that the level of comps has -- used to be that you open a unit anywhere in year two, which would be the first year of comp, it would be up 25 or 30% and so on.

Over the last few years, as we have done the free check mailer to get more warm bodies in the door to start with, that has tended to allow us to start stronger and then to come down a little bit.

Then not come down a little bit, but to not have that 25 to 30.

I'm looking in the - our 2002 annual report that has just been printed, and is being mailed this week - or later this week, and so you should get that, we had all those wonderful charts up front.

What that shows is that, as an example, if I go back a few years ago, bear with me here, if you go back to, like, 2000, and 2001, in the first partial year, all units did 55 and 57 million annualized.

In '02 that was 58.

If I look back 2 years ago, the 55 that the 21 units in 2000 did, did 64 in their first full year, which would be their second year of operation.

So that basically they were up 16% comp.

And then the second full year, or the third year of operation, they were up another 19%.

Similarly, the 32 units we opened in '01, they did 57 in the first year, and 63 in the second year, they were up about 10.5%.

Again, if you go back a number of years ago, those numbers will probably end up in the high teens to mid-20s.

So the productivity levels were good and comparable with prior years.

Is that what you're saying?

Yes.

You have segment them into newmarket units versus existing, but we haven't seen what I'll call the slowdown in rate of increase in that second full year of operations, but first full year of comps, it's simply the base started off higher.

Great.

Thank you very much.

Your next question comes from Emmy Kozloff of Sanford Bernstein.

Just to go back to the point on sales productivity, I'm trying to get a idea of when you think the sales activity will be able to hit the revenue run rate that you're targeting.

I see what you're saying about the comp, but I just, it's still unclear to me how far out we're looking.

I mean, we are talking first or second quarter of '04 where we start to hit some SG&A leverage.

Thanks.

Emmy, I'm a little bat shy in too trying to estimate that.

You know, the old saying it's always something.

Right now, it's healthcare costs.

I don't believe -- I think we'll be able to get those in control.

We'll do what we can to get them in control but they're rising.

So, that's going to be a negative detriment.

A couple other things that were a little unusual.

My guess, it very well could be in the first half of '04.

I hate to predict right now, because there are dual factors.

One is sales leverage, you know, are comps going to be at 2 percent or 4 or 5%?

And two, is some things like healthcare, which ultimately will cycle as we started this conversation on healthcare and related costs, in the latter part of Q3, and certainly all of Q4 -- and all of Q4 -- all of Q1.

So sometime, you know, this summer hopefully we'll be able to say that's now anniversaried.

As we go through this year, one of the things I mentioned earlier, in terms of the impact of SG&A related to the last 12 months of openings, as the respective last 12 months of openings continues to be -- continues to grow more towards existing market units, that will help.

But we're still in that, you know, still digesting the majority of newmarket units from last year.

So I don't have a good answer.

I've learned that, you know, I try to be realistic and cautiously optimistic, but a lot of it depends on sales.

I think the fact that the component of SG&A related to the last 12 months of openings is coming down in terms of that detriment level, the fact that -- that should help us, but it could very well be early in the following year.

What would be the difference in the comp required to leverage SG&A on the new units in new markets versus those in existing markets?

Well, I'm sorry, say that again?

What would be the comp. you'd need to leverage the SG&A of the new units, you know, I would assume there would be potentially a higher comp. required for new markets you've entered, versus existing markets you've entered because you could leverage -- you know, do some of the advertising or what have you, in those existing markets.

On the new units, it's less than a comp. issue, it's more of, of the last 12 months of new units, how many of them are LAs that are doing 100 million or [INAUDIBLE] that will do 80 or 90 or 100 million versus Kansas City or a Cincinnati unit that will do 45 to 55 million.

As we -- I'm sure that -- Jeff, do you have the -- what this number will be for '03?

In the budget?

If you look again at that chart in terms of partial year new units, which had been 55, 57 and 58 million over the last three respective years including '02, my guess is it's going to be quite a bit higher because the mix will go from 65/35 in '02 new market units, to 40/60 new market units.

And that will do more than anything comp related.

Again, that's more the tail wagging the dog or that's the tail of the dog.

The dog is still the 92% of the units that are existing market units where healthcare costs are going up in.

Okay, great.

Thanks.

OPERATOR: Your next question comes from Robert Durbull of Lehman Brothers.

Good morning.

A couple of questions, Richard.

First, on the hard lines, you're talking about the deinflationry pressures, do you think it's a traffic issue as much as just the items or -- Can you flush that out a little bit more for us?

No, I don't think it's that.

I think in terms of inflation, you look at something like DVD players, I think sales in DVD players were last month were down, I forget how much, were down 20% or 28%, high teens percent.

The average price point for DVD players were probably down 1.5 times that amount.

Again, I don't have the exact number in front of me.

There are some issues like that.

Even though we're -- we have a sales increase in electronic games and Game Boys and X-box and Playstation, the average price points will come down but there is still a lot of units sales.

Computers, I think, are one area where -- again for us it's been all over the board.

We -- I think in the month of November, computer sales were down compwise, but there's an area where people are saying, I don't need the latest and greatest, I've got plenty of megahertz, all my programs work, it's not like we're going a few years ago from 166 to 256, to 512, to whatever else.

Everything now is in gigahertz's, most people use it for e-mail and Word.

So, that's where you're seeing some of it.

I might add by the way though, we just instituted a test program where we are in-store, in I think 10 locations, a Dell computer program where we are the, I believe, one of the few, if not only, retailers that basically you can build to order a Dell computer at great prices.

But computer business overall has been weak.

On the existing stores versus new stores, can you give us a better idea in terms of what's happening on the cannibalization as you do open more of the new stores around?

I'm sorry, the increased level of cannibalization?

Yeah, or what you're seeing on it.

As an example, when we reported November comps, when we looked at, comps were X, what portion of that, if look back over the prior 12 months, represents -- what was the impact within that comp. number for the company of cannibalized sales.

A year ago in November, it was 40 basis points.

It might have even been 39 or 41.

Call it 40 basis points.

This year in November, it was 79 or 80.

So essentially, the increment was 40 more.

My guess is that increment can be maybe another 20 more on top of that.

It's never going to be 3 or 4 percentage points, but it will swing from being 30 or 40, as it was over a couple years when we're doing a lot of newmarket units, to 80 to 100 let's say, over the next few months, then it will subside into that level and then anniversary is not an issue anymore.

Okay.

Thank you.

Your next question comes from to Todd Slater with Lizard.

Thanks, good morning.

Good afternoon.

As you look at the membership fee income, you're getting some nice growth to partly the executive membership rampup and the first year renewals on the new clubs, I noticed a slight deceleration in executive membership this quarter, at 11,000 a week versus 12,000 I think last quarter.

It's not dramatic, but I think it's the first slowdown we've seen.

I'm wondering if the incremental growth, you see that as kind of peaking now, if you see or maybe if you expect to see any trend where people might do the calculation, say hey, you know, I need a $2,750 a year spend to justify the $50, $55 upgrade.

Maybe some people will come back down to the $45 membership pricing.

Are you seeing anything like that?

And my next question is is there any evolution in your thoughts about the timing of a potential price increase in the core membership fee?

In relation to the first question, we're actually, Todd, all of last year and into this quarter, we're ahead of our budgets.

Clearly, we're not the biggest experts on pushy marketing.

We don't -- we're not too pushy, although we've got a little pushier on this over the last year.

When we introduced the 2% reward, we went from essentially over 3 years of effort prior to that to get to get to about 100,000 paid members, to we did I think in 1 year we went from 100,000 to a million.

The next year, our budget was to go from a million to a million five, and I think at the end of the year, this past year, we were a million six or seven.

Natural attrition in that number is expected.

Frankly, I'm as surprised it's holding up as much as it is, because like you say, it's a no brainer for anybody spending more than $27.50.

All those people have already signed up.

It's the ones on the cusp that are still coming in, which, frankly, are a little more profitable because we're not starting off in negatively with a reward and we're still getting increase in comps because there is the game of -- the reward game and the incentive to do that by the member buying more.

So I don't really see any issue there.

Our comps of those members as a whole are doing well and the second question was?

Was just a follow-up on that.

On the price increase question, we have not actually discussed it in any formal way.

We discussed it informally a little bit.

The fact of the matter is when I've asked the question, my gut check reaction is that historically we've shown that we have done a $5 increase about every 3 or 4 years, I think 4 times in the last 11 or 12 years, that it's conceivable that, you know, 3 years would be September of '03, 4 years would be September of '04, what I've told everybody whose asked me that question in the last several months, is don't plan on it in '03, for no reason other than we haven't really talked about it in detail yet and so let's not get ahead of ourselves here.

As I've indicated from the renewal rates, they've actually climbed a little and so there's certainly no question or concern there that we would run into a problem.

At least we don't think we would.

But we really haven't had a discussion.

Now, keep in mind, this is not like, you know, developing -- designing a new jet.

It doesn't take 5 years to figure out.

Once we start talking about it, it will take, you know, a couple of weeks to talk about it again and make a decision.

But we haven't talked about it yet.

Can you keep growing the double-digit growth in membership fee dollars that you've grown?

I mean, you've said you're very, you know, the numbers are very strong, you see them coming in, continuing to come in strong for the rest of the year, at this double digit rate, assuming renewal rates remain flat and there's this deceleration in membership fee income, and there's no growth for at least a couple more years on the core membership fee?

I think it will go in a cycle.

At some point, let's assume for the point of the conversation it's only a hypothetical, that it was, you know, two years hence in September of '04 when we raised the fee.

What does that mean for the rest of '03 and '04?

Well, first of all the rest of '03, again, you get the deferred benefit as evidenced by the difference between the cash and book recorded amount of membership fees.

So even if things start to slow down tomorrow a little bit, we've got some lessening of that blow, if you will.

And they're not slowing down tomorrow, at least so far, we think.

My guess is, under that scenario, as it were to slow down a little bit over the next year, as the level of executive members, while increasing, are increasing at a lower rate, all those things like you say will play, this double digit growth become high single digit, does that become mid single digit, low single digit?

It used to be, I remember years ago when we had a flat number there on higher comps, the same member was buying more each year and paying the same the same fee for 3 or 4 years.

We've actually seen that come down.

In terms of my budgeting and extrapolating over the next 3 to 5 years, you know, the feeling was that -- is and was that margin improvement could continue, that membership improvement has been strong, will still -- should still be a little strong, but start to flatten out until that next time, if you will, and that SG&A, while going the wrong way, at some point will start to go the right way.

As that starts going the right way, you know, then there's less pressure on membership and margin improvement.

But I think, again, we'll get a little of all of that and we'll see how it goes.

Thanks for tackling that, Richard.

Your next question comes from Debra Weinswig with Salomon Smith Barney.

Good afternoon.

Richard, a quick question on gross margin improvement in the core.

Can you break out for us or help us get a better sense in terms of what piece was the mixed shift, which you talked about, some of fresh foods and soft lines, versus buying a better versus private label?

I don't have that breakout in front of me.

Basically, fresh foods is clearly, their margins have improved.

We made a conscious effort over the last couple of quarters to drive margins in that area.

Part of that is availability.

You know, if you do a little bit better in volume, you do a lot better in margin because cost of sales includes not only the product but direct labor and supplies.

You have much greater marginal leverage in those areas.

So, as comps have been stronger, that helps you.

Every day and every week and every month there's another deal that the buyers coming through that is better than the deal we used to have.

In an off way, the weak economy helps us not only with getting vendors it didn't sell us, but helps us in renegotiating as one or two-year deal previous deal comes up for renewal.

Okay.

And then on the, I think it was the fourth quarter call, you had talked about in terms of really kind of honning in on your SG&A that you had reviewed and there were 40 clubs that you had sited that were I think it was 50 basis points above cost, what have you looked about as you drill down into those clubs?

It's about 40.

All the operators are doing it.

As you might expect, right now there's a lot -- trying to drive business right now.

So my guess is over the last quarter, there's been more focus on trying to drive our business and trying to look at healthcare costs and I don't think we've gotten as much there -- we haven't gotten a lot of bang there yet.

And lastly, there was an article I read, I think it was actually an academic work and it talked about how on the saturation side, in the Puget Sound area, the current estimate was about 200,000 people per club, and that people were impressed that Costco had been able to get to that level.

In terms of, and I don't want to necessarily pinpoint you to a number, is the number more properly like 175,000 to 200,000 people per club, versus a higher number that's been previously thought?

I think the number keeps coming down.

When we started this business, we thought we needed at least a half a million or more.

We have very successful units in trade areas of 100, 125,000, and the trade area geographically is 50 miles wide.

You know, part of it is we keep adding stuff.

And you know, we keep getting the new products.

And food drives the business in a big way.

You know, as you all know, many of you know, if you live near a Costco, every time I go to shop for anything, it boggles the mind when you see a husband or a wife or both with a cart full of groceries and you know, this is part of their regular trip and while they're there, they're going to pick up a few other things.

I think it's the art of what we do that will continue and allow us to drive that number down.

I don't know where -- I'm not saying it's going to go from 2 or 250 down to 75, but I think it will keep coming down a little bit.

Great.

Thank you so much.

Your next question comes from Linda Christensen with UBS Warburg.

Good morning Richard.

Two questions, one, I'm trying to get a sense of the American Express, the marketing program that you're doing with them.

How significant they are in driving your business.

Has it become more significant?

And secondly, also a question on the furniture store.

Well, with regard to American Express, first of all, getting back to the original environment when we agreed to partnership with American Express two and a half years ago.

At that time, we were in 28 states, not 36.

Of course, it's extended to all the states that we're in.

But at that time, I think the numbers were like each of us, they had about 11 or 12 million card members in those 28 states and we had about 10 or 11 million Costco members in those 28 states.

About a little over a third, I think it was 35 or 38% of those, 35 or 37% of those people overlapped, meaning that 7 million of those 10 million, if you will, or 7.5 million of those 11 or 12 million Costco members didn't have an AMEX card and similiarly 7 or 8 million of the AMEX cardholders didn't have a Costco membership card.

So it was a great opportunity for them to promote the Costco membership to those people that weren't Costco members and similarly for us to do that.

Also, in new markets, we do a lot of things with them where we -- they -- and frankly, not only do we do a lot of things with their help, they do a lot of things for us.

They already have a -- an envelope coming out to each American Express cardholder.

As you know, filled with stuff.

Some of that stuff could be incentives to come shop at Costco or be a member of Costco.

They've done a lot of good things for us.

Even on things like the wallet of savings which we do coming up in January, February and the passport to savings which we do during the summer, June through August, and again, these are rough numbers.

But let's say we mail it out to about 20 million people, I believe 1 to 1 and a half million of those people are nonCostco members, they've never been a Costco member, but they're AMEX card holders at certain income levels in the markets where we operate.

So there's lots of things we're able to do together.

I think if you ask Jim or Mr. Shenault at American Express, or Jim here, we're 3 years into a 10-year relationship -- initial partnership and we feel good about it.

We collectively feel good about it.

Richard, also on the furniture store, I guess I'm hearing that you're not buying directly, at least from some of the vendors and where are you sourcing some of the furniture from and can you elaborate on the brands?

You've mentioned a few brands, I was wondering if you can elaborate at all on that?

Before the call started, I talked to Doug Shut who is in charge of it, and I said do you mind if I talk about some brand names?

He says I'd rather not.

We have a variety of brand names in there, including well known high-end names, some of which we're getting direct, some of which we're getting indirectly direct.

In other words, don't tell where it's coming from, because it's coming from some distributor that's not the manufacturer.

And some that is coming diverted.

You know, it's not unlike anything else that we sell that's hard to get, whether it's clubs and golf balls or certain professional tools, electronics, you know, Sony TVs.

We're out there -- we're out there kicking and scratching and trying to find stuff through other retailers through other wholesalers, through distributors, exporters.

There's stuff available.

As you might expect in this economy, it's tough.

Certainly, there's some very respected high-end manufacturers that refuse to sell us.

We're hopeful that if we're successful here and again, we are so far, but it's all of, you know, 6 days, 7 days, that over time, that will change.

But, you know, we'll have to wait and see.

Thanks a lot.

Your next question comes from Sherry Eberts with JP Morgan.

Good morning, Richard.

Just a couple of questions.

First, on the EPS guidance, just to clarify what comp you're including in there?

Bob and I had a bet who was going to ask that question.

Did I win?

Well, you would have been on the list.

You were at the top.

You know, I hate to throw out a comp number because I'm wrong sometimes, because other things are affected.

My guess is that a comp number assumption in that range is something that probably is a weak 2, to a weak 5.

Those are guesses on -- I'm looking at some small amount of sensitivity stuff that we've done, not a lot.

Okay.

So a weak 2, to a weak 5.

And that -- so the midpoint of that range would be sort of like a 3-ish.

Yeah, that's fair.

Okay.

And then secondly, I've noticed that your wholesale membership in actual numbers of membership has been flattening out, it's not a new thing, but I'm wondering if you can talk about the sales momentum that you're seeing there, is that part of the slow down in the sales momentum?

I'm sorry, I didn't get that question.

On your business membership side, the actual number of memberships has sort of flattened out over the past several quarters.

Can you talk about what you've seen on sales from your business side, is that part of why the comps have slowed down?

No.

When we look at the percentage of sales to business members versus Gold Star members, it hasn't changed that much.

One of the things that's happened, with the executive member program, we probably haven't been as kosher if you will, when somebody changes from a regular business or Gold Star member to a executive member, sometimes, and I think early on, sometimes they are -- they become an executive member, but are then classified as a Gold Star member.

Okay.

The other thing is that all the new markets where we've done the check mailer, a lot of people come in and sign up as an individual, even though ultimately they are a business member.

It used to be a business member paid 5 or 10 dollars less.

Now it's the same fee so they don't raise a fuss at the window when they sign up.

There's a little of that going on there.

It's a little bit of a fuzzy number in terms of what is a real business sale.

We've always said when the numbers are roughly 60% business sales to business members and 40% or 62, I'm sorry, 52 to 48 other whatever it is, or 58/42, that, you know, the 60/40 is probably 40/60 because business members buy for personal use.

But we haven't seen a big change there.

Okay.

In terms of the new units that you said you see slipping into next year, because that usually happens, are most of those going to be in new markets or existing markets, do you think?

Or you don't know because it's random?

First of all if we're talking slipping, we're talking 2 or 3 or 4 units, not a whole lot.

If I looked at what we have planned for the end of the year -- if I looked at the last 8 units on our original budget, let me look here, most of them look like -- if I look at the last 6 units, 2 are new-market units, 4 are existing market units.

Okay.

Last question, Wal-Mart's been talking about taking some of the ancillary businesses at Sam's actually out of the club and not building them into some of the new clubs that they're building, and they've mentioned pharmacy, a number of times.

I was just wondering your thoughts on that, and what impact you think that might have on your business?

Well, I think that helps us.

You know, keep in mind, we believe that Wal-Mart doesn't like competing with itself, as you might expect.

And you know, in our view, when they've had a Wal-Mart next to a Sam's and both of them had pharmacies, the pharmacy should be in the Wal-Mart.

But ultimately if there's a Sam's customer there on a macro basis, there's is some small [INAUDIBLE] Sam's members that let's say went to Sam's because of the pharmacy, similar to Costco.

We have some members that went there primarily for that.

They may not want to go to Wal-Mart.

We'll be another alternative.

So hopefully, because they want to be in a club, but if they don't have a pharmacy, maybe they'll switch over to us, we're not talking big numbers here but on a macro basis, it's like chicken soup, it can't hurt.

I think in many instances, Wal-Mart doesn't want to compete with Sam's on the retail consumer side.

What I read, and again this is my hypothesis, is that, you know, one of the reasons Wal-Mart has talked about with regard to Sam's focusing more on the business member, is because that way doesn't compete as much with the Supercenter and the Wal-Mart store.

Keep in mind also with ancillary businesses, they are much more operating leverage sensitive because of the higher -- because of some portion of the membership -- of cost of sales that is not just a cost of the merchandise, as in the case of produce and bakery.

I'm sorry, in the case of bakery and meat departments, those are manufacturing businesses where including cost of sales is direct labor and supplies.

When you have warehouses that are on average are doing 103 million, actually about 114 million in the U.S. for us, versus warehouses that on average are doing somewhere in the 60s, that's a big difference in profitability levels at the same pricing.

So I think those two things, that they don't like competing themselves and that at lower volume units some of these things don't make sense I think are net positive for us and give us an advantage in that area.

But, Wal-Mart's a great company and irrespective on how they've on anything in the past, not just warehouse clubs, they seem to figure out things and they're very strong and very capable.

But we think short-term certainly that's a probably a slight net positive.

Okay, thanks, Richard.

Your next question comes from Cecil Godman with Highland Capital.

Yes, Richard I just wanted to get a little bit of clarity.

I think somebody already asked the question regards to the comps going forward because you had your competition in the 2nd quarter your toughest comps and then you get a little bit easier out there.

Are you just assuming no rebound in the 2nd half of the year on comps?

No, frankly we're assuming and hopeful that it will be a little rebound but that's I feel a little bit like Mr. Jackson saying, [INAUDIBLE].

I mean we are getting good deals with vendors, merchandising-wise we're strong, our inventories are clean.

Our level of competitiveness is strong as it's ever been in terms of pricing.

We think there's a lot of things that will help us.

Honestly, people always say, well what do you think it's going to be?

Our best level of knowing what it's going to be is what we did yesterday.

I understand.

That's the challenge.

I think, and Jim I know -- talking to Jim, Jim feels it will pick up a little, not because of the easier comparisons, just because for a lot of reasons, it's been a tough Christmas comparison.

We're looking at probably some positive stimulation come in next year on the fiscal side.

Hopefully.

Okay.

Those things happen, we're talking, you're talking about a much easier range to achieve, obviously?

Or exceed?

In fairness, Cecil, we are not planning for them to go up, that's why we've tried to give you a fairly wide range.

That's very fair and I commend you for that.

Very good for that.

One last question, on the gross margin range.

Would first quarter be a-type or typical of what you think the ability to expand gross margin for the year would be?

We beat our budget in Q1 percentagewise.

Over the last few quarters, we've beaten our budget.

Again, I think it's the strength of our competitiveness and our ability to drive buying power and our ability to do private label and all the stuff we've talked about in the past.

My guess is, I'll stand by the company -- I'll tow the company line, and say that yes we think it can go up, not as much as it has this quarter or last quarter, but we seem to be doing pretty well.

I'm not going to budget 20 to 27 or 30, but I'd probably say it will be 10, would be a good number.

But I said that last -- I said that before this quarter began.

All right.

Thank you.

Your next question comes from Bob Toomey with RBC Dain Rauscher.

Good morning.

Richard, I wonder if you could comment, you know it seems like when you look at the slowdown in your comps sales here in the last few months, would you say most of it is due to the economy and the consumer or, you know, you talk about the saturation issue.

What would you say is the most significant impact on comps in the last few months here?

In the slowdown.

I don't think it has anything to do with saturation, I mean, I think it's the economy.

It's funny, I was talking to somebody the other day and we were talking about the fact, you know, whether is Abby Cohen or some other economist or Mr. Greenspan, or whoever is it out there talking about things seem to be getting a little better, 100 people in the room from a truck driver to a financial analyst to a doctor to a business person, I think they would all look at each other and say, what are you talking about, things are bad out there.

It is tough out there.

You hear about people getting laid off and I think just this morning on the radio they talked about, well retail sales I guess were a little better than planned for the country, that the level of unemployment was the highest in 4 or 5 months.

So I don't think anybody is terribly excited about it getting better fast.

One advantage, structurally, we have from an inventory caring standpoint, we can afford, in my view, to be more aggressive on our inventories because, one, we're selling at the 80/20 rule, we are generally selling the 20% of the items that are the 80% of the sales.

When we have a slowdown in sales or a slowdown in items, all we do is not order it again for an extra couple of weeks.

We don't have to worry about taking an entire season of a category and marking it way down.

It gives us the ability to be more aggressive in a weak economy, frankly.

So I think it is the economy.

You know, I can look at every department, why is jewelry up 9% this quarter?

Partly because it was down last year, because it was post-9/11, the last thing somebody wanted to do was feel good about themselves by buying discretionary jewelry.

That's my view.

Photo processing is down, that makes sense because of digital cameras.

All the digital camera sales are way up.

I go through almost every category and explain a lot of it, but when it comes down to it, my guess is the economy is the one with the capital letter.

Okay.

My second question had to do with getting back to this question on SG&A, you talked about healthcare costs and some of the other employee benefit costs.

Did you say that that that should anniversary by third quarter?

I just wanted to make sure that I understood that you said that you think in the second half you could see some better leveraging there?

Well, you know, what I'm saying is that we have done a pretty good job of -- I think I made the comment in Q4 when we really talked in earnest about rising healthcare costs, last year for the company in the U.S., workers' comp incident experience or claims experience, we actually improved by about 4 to 5%, in other words, number of claims per hours of labor or whatever, we actually had an improvement of 4 or 5%.

The dollars were up 15%, implying the average cost per claim was up close to 20%.

You would think that that can't last forever.

That big delta, that big change in what's been going on out there, seemed to have started for us in Q3, in middle to late Q3, which would be spring, early summer.

So it would be spring, early summer this year when that would anniversary.

Maybe there's a couple years of it, I don't know.

There are also some things we could do, but we are stepping lightly there because we, feel pretty strongly about what we provide our employees.

Okay.

And then the last question I have, is anything new on the merchandising -- outside of obviously the home initiative, anything else going on in merchandising that you think is notable that could help your traffic or your sales?

Well, I think the two notable things that are, again, small by notable, you know, in a bad economy, you get vendors to sell you for the first time that didn't before.

For years we've had Hinkle, Corian, Cuisinart, Mixmasters, but they were always diverted.

Now they're direct.

There's some watches that we used to get diverted, now they're back.

That ongoing ability to buy direct enhances your sales in those areas.

And extreme example is Levi's over the last year.

And the other thing would be the special work kiosk program, we're constantly trying and testing things there.

You know, the Fresh area, we keep trying and expanding -- I think, you know, one of the things that we're going to test next year, but keep in mind, it's nearly a full year away from opening, and I'm sure whatever we think it's going to look like today will change three times before then, is what we're going to call Costco Fresh.

You know, whether it works or not, we are not sure, and whether it works or not, we don't care as much as what we learn from it.

And now, I use the example of rotisserie chickens.

I think that was something that was actually tested originally in Montreal at Costco in our eastern Canadian operations, one of the merchants saw it somewhere else and said, you know, we can do this, we can sell a bigger chicken at a lower price.

It became a cost [INAUDIBLE] where we're now selling close to 20 million chickens.

Having a food operation will allow us to learn some things that we can continue to be in notice of in our warehouses. 15 years ago if we were getting you in every four or six weeks, now we're getting you in every two or so weeks, every day we can shave a day off that, that does great things.

And clearly, the greatest things were when we first implemented fresh foods or first did a pharmacy or first did a gas station.

I'm always asked what's the next big thing?

I don't think there are a lot of big things left but we'll keep frying a bunch of small things.

Great.

Thanks very much.

Your next question comes from Chris Blackman, with Imperial Capital.

Thank you, I missed part of the call, if it's repetitive, I apologize.

But you had one of your grand openings or a grand opening for Costco home in Kirkland, Washington, I think last week.

Did you comment on how that went or would you please comment on how that went?

Sure, my simple comment was, we did -- we've done great sales in the first seven days.

We're not saying what they are, but they far exceeded our expectations.

But keep in mind, we had a lot of free press here, you know, 65 or so of the passage jot sound household are members, we were quite surprised because some of the tickets were not just 50 and $100 item, but larger.

People were demanding they take a floor sample in the case where we had to ship to it them two weeks later.

They said we'll rent a truck and get it tomorrow.

So six or 17 days doesn't mean anything.

Right.

How much inventory do you carry in those stores, dollarwise?

I think about 6 million.

About 6 million.

And have you given an opening schedule or what your plans are, how aggressive?

I know you've got one coming in Portland, I think in a week or to?

No, we don't, that's incorrect.

This is the only one we have that we've announced and planned and we have nothing on the drawing board until this one's open for six or so months.

Six or so months.

Thank you very much.

Your next question comes from Sandra Backer with Montauk.

Most of my questions have been answered, I was just curious, in going back to the underperforming units for an SG&A standpoint that you talked about, on the last conference call, other than, I assume, maybe a lot those are new units is there anything else in common, that's a common characteristic of those units that, you know, is a particular thing to work on, or what would you say are the other things that make those underperformers?

Well, first of all, in terms of underperforming, they're mostly existing units.

Okay.

You might have, I think I used an example like Bakersfield and Lancaster, California, where you have two units open the same month or quarter, 15 years ago or 12 years ago, that are about the same size, that about to five or 10 million volume, 100 plus million range, one as 20 or 30 basis points SG&A, sometimes it's the manager or it's sometimes where it's located and traffic congestion or maybe two units are similar in Volume, but 1 has, because of ingress and egress and the configuration of the site itself on the property, has, you know, two less receiving doors.

Some of those things we have identified that don't where are you can't change, like if you have fewer receiving doors, or you have less receiving room, that may cause some inefficiencies, but then ultimately, some of it is your manager.

So it's trying to identify where there are -- everything's similar but this cost component is different and how you attack it.

But it's more of over units than existing, than new units.

Thanks.

Your next question comes from Marie Driscoll with Argus Research.

Hi, Richard?

I was wondering have you looked looked, have you said at all about instituting a active dividend policy given the talk that's going on in Washington.

And secondly, I was wondering if you could just tell me what you hope to learn on the at this that you're doing with Costco home.

Dividend policy we haven't haven't -- hello?

Hello?

Can you hear me?

Can you hear me?

Yeah.

Okay.

Can you hear me now?

Yes, I can.

Okay, good.

On dividend, I don't have anything to say, we haven't talked about it.

Historically we haven't, the answer is no at this point.

Okay.

And how about what -- you know, I'm wondering what your hopes are in your Home, in the Home test.

Well, the Costco Home, it's Friday straightforward.

Whether or not it's successful is as a stand-alone operation, we don't know.

That would be in our view a console litigation prize or an -- a consolation prize.

That or an additional prize where we could role those out.

What we hope to learn is what can we learn to this that we can put into 400 Costco's or 300 or whatever it is.

You know, maybe it's an item, maybe it's a category, maybe it's an extended products within the category.

You know, years ago, 12 or 15 15 years we tested in a half doesn't locations, we added 900 extra things of home improvement.

What we found was we couldn't overwhelm anybody because the serious DYI or the small contractor didn't care if they could safe a little bit on the two most popular nails out of the six he needs for a [INAUDIBLE] he wants all six right is there and wants it delivered and wants to be build.

We don't offer those services and we could not offer the lower volume selling items.

But from that experience, we don't really have it anymore except or one or two units, we have expanded a little bit.

But what we learned from it, is we develop relationships with tool manufacturers that wouldn't sells before now do, and we learn some things where where he R -- we brought in additional items.

That's the kind of this things -- thing we expect.

We'll take two more questions, given this has gone for a while, okay.

The next question comes from William knobber with Atlanta phones.

It's hello?

Hello.

It's I was also going to ask the question of the dividend and also the potential for the company to initiate a stock buy back program, and I am thinking from the perspective that with your stock back to five years ago level, even though you're obviously a tremendous effective retailer and I'm a member of Costco and buyer at Costco, the growth has slowed down, the company has a strong balance sheet, and particularly if you look at the earnings growth sales over the last -- since fiscal 2000, you know, if you earn $1.60, that's an 18% increase over three years.

So why wouldn't the company, for example, have a dividend in the context of some institutions not even being able to buy your shares because of that?

Well, you know, I'm sure that we'll talk about both of those question in the future at board meetings.

As you know, we do have a board authorization to do stock buybacks up to, I think, $500 million.

We've only done one in the past, that was about two and a half years ago when we bought a little over 3 million shares when the stock was around 32.

The -- you know, our view is there's been no great sense of urgency to start.

We never have done it for short-term effect just saying hey this will indicate that management feels strongly bit.

Right now, we've been focussed on running our business.

I'm sure that as the stock has gotten weaker, we'll continue to look at it, but I can't make promises there.

We do have a strong balance sheet.

Our view is that even at least when the multiples were in the low 20, it was terribly accretive.

Over long-term it could be slightly accretive, but there was no sense of great rush to do I. We will get to it.

As it relates to dividend policy, again, if going back years ago, I remember responding when somebody asked, will we ever pay a dividend, the answer was sure, one day we will.

But at this point, we're about net-free cash flow neutral, maybe slightly positive this year, probably slightly positive, but we have a strong balance sheet.

We just haven't made that decision yet.

With Mr. Bush's comments to an extent that they do eliminate double taxation, I know that's probably -- that would certainly be a positive factor.

I can't say that that would be the one that would turn the corner, but I'm sure we'll be discussing it in the future, but I don't know where to start in terms of making promises or thoughts because currently the stated company line is we button pay dividend and we don't plan to.

Thanks.

Your final question comes from Theresa Donahue with Newburger Burman.

Hi, continue on to the last two questions, Richard, as you pointed out, you'll probably be neutral to mostly positive-free cash, even on the lower guidances here and the balance sheet so strong, and if you assume roughly this level of capex the next few years, you should become pretty significant-free cash flow generated, what do do with it, if not one of the alternatives that was discussed before?

Well, I think ultimately, Terry, that's what you do with it, one of those -- one or both of -- both of those things one day.

I remember three or four years ago when we were sitting around, Jim and Bob and I and talking about the fact that you know we're generating two or three -- 200 plus million a year cash flow.

We have very little debt, other than subordinated zero at the time, there's no way we're going to go from six or 700 million capex to a billion or so.

And sure enough, two years later, we were at a billion 41 year, and a billion year a couple years or a billion one this year.

I continue today saying there's no way we can go from a billion to a billion five, and I'm not suggesting we are, because we aren't right now, but the collective you on the board, and this goes back a year ago, was -- collective view of the board and this goes back a year ago, was we'll do it at some point, but right now, since it's gnat terribly accretive, there's no sense or great rush to do it.

I think if we have a couple years here, if we step into a big time, if the economy continues to go down, the stock went down God forbid a lot more, all things change each dollar it goes down.

I can't say where that point is.

State police thing with dividends.

As we continue to get stronger billion sheet and continue to be more confident that positive cash flow is the norm, for the next foreseeable future, we'll probably change that tune as well.

So we'll just have to wait and see.

I guess we've been -- arguably, we're a little bit of a for test, not the heir on that one.

Okay.

Thank you.

Okay.

Well thank you very much, and we'll be available for additional questions and comments.

Have a good day.

This concludes today's Costco Wholesale Corporation first quarter earnings conference call.

You may now disconnect.