好市多 (COST) 2004 Q1 法說會逐字稿

Good morning.

My name is Shane and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Costco Q1 earnings conference call.

All lines have been place 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 then the number one on your telephone keypad.

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

I would now like to turn the call over to Mr. Richard Galanti, Chief Financial Officer.

Sir, you may begin your conference.

Thank you Shane and good morning to everyone.

This morning I would like to review with you our first quarter fiscal '04 operating results.

To begin with, our 12 week first quarter, briefly we came in at 34 cents a share up 3 cents or 10% over last year's first quarter.

These results were above the 30 to 32 cent EPS guidance I provided you in October which by the way, that guidance had already been built up a little bit due to strong September results, and 3 cents above the First Call of 31 cents.

As I'll review with you later in this discussion, this year's 34 cent figure was negatively impacted by the new accounting rules for vendor allowances to the tune of 4 cents a share.

So in apple to apples basis, more than a 20% earnings increase excluding the effect of EITF-0216.

In terms of sales for the quarter, our 12 week comp sales figures showed an increase of 11%.

You'll note that last week, last Thursday when we reported comps for the 4 week retail month of November, and the 13 week retail period of September, October and November, for the 4 weeks, we came in a 14% of November and for the 13 week period 11%.

Several factors helped these figures and I'll discuss those in a moment.

Other topics of interest today, recent and upcoming opening plans.

We've opened a total of 11 new locations since the September 1st beginning of fiscal year.

Nine of those are consolidated into our figures, 8 in the U.S. and 1 in Canada as well as 2 in Mexico which we account for on an equity net basis, the Mexico operations.

All these openings occurred in the first fiscal quarter which ended on the 23rd of November with one additional unit planned for later this week in Citrus Heights, California, in southern California.

This will be our first location opening in fiscal, in Q2 and the last one prior to calendar year end.

I'll also discuss today our ancillary business results, Costco online results, executive membership, and of course our balance sheet for the first quarter just ended.

And lastly, given the strength in our figures for the first quarter, I'll provide you with some updated direction and guidance for the second quarter and fiscal '04 overall.

As with every conference call, let me start by stating that the discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and that 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 press release as well as other risks identified from time to time in the company's public statements and reports filed with the SEC.

With that said, sales again were up 14.4% to $10.3 billion and on a comp basis for the 12 weeks, up 11%.

For the quarter, our 11% comp sales results were a combination of higher average transaction and higher average frequency.

The average transaction for the fiscal quarter was up about 6.5% with 2.5 to 3% of that being FX because of the weakness of the U.S. dollar relative to the other currencies of countries where we operate.

And the average frequency increase was about 4.5% up for the quarter.

So both good numbers even taking out the FX.

We also had negatively impairing the number in this 11% was slightly increased levels of cannibalization year-over-year as we've geared towards a mix of opening more units in existing markets.

That effect year-over-year was about 90 basis points to the negative.

Geographically, for the first quarter our comps in the Northwest were up 6 and that compared to 4.5 the previous quarter.

California up 9 compared to 5 in fourth quarter.

That of course was helped a little bit by the supermarket strikes in southern California.

The Northeast an 8 versus up 3 in the fourth quarter.

Similarly the Southeast was up 8 compared to 4% in the fourth quarter.

Midwest consistent 12 in the first quarter compared to a 13 in the fourth quarter.

So all told, the U.S. was up 9 compared to 5.5 in the fourth quarter.

In Canada and other international, of course where again, we're getting a benefit from the weak U.S. dollar, in terms of U.S., converted into U.S. dollar sales, Canada in the first quarter was up 24% but only plus 5% on a local currency basis.

So again that helped us in terms of our reported comps for the company.

Other international was 19% up expressed in U.S. dollars parenthically on local currencies these other international were up 13%.

So again, given that about 12, 13% of our sales are in Canada and there's been a fairly strong showing of the Canadian dollar versus the U.S. dollar, that has helped there.

All told again, 11% for the comp for the quarter versus 7% for last year's fourth quarter.

Merchandise category-wise, food and sundries was up 10 in the first quarter compared to up four in the Q4.

Again that was helped by FX.

Each of these categories of course was helped by FX, but also there was a Canadian tobacco price increase during the quarter which helped a little bit.

Hardlines was up 7 compared to up 6 the prior quarter.

Strong departments included automotive, hardware, and sporting goods.

Softlines up 5% in the quarter versus 2% in the prior quarter helped by media, women's apparel, and jewelry.

And fresh foods continued strong at up 18% compared to 15 in the fourth quarter.

And again the up 18 included particular strength in meat and produce.

And of course ancillary businesses are continuing to be the strongest category up 28% excluding gasoline up 16%.

I might add though, that two thirds of the gas comp is gallonage not price inflation.

Gas comps were up over 50% for the quarter with two thirds of that again being gallonage comps.

Moving down the income statement, membership fees came in as you see, $211.7 million or 2.05% as a percent of sales.

That was up 13% or nearly $24 million and down 4 basis points.

That's very good showing, we consider that a very good showing given our very strong comp sales results and actually a shade above our budget.

In terms of membership we continue to benefit from a continued strong renewal rate, increasing penetration of the executive membership, where members generally pay $100 per year versus $45.

That includes, by the way, the recent rollout over the last quarter of the executive membership program into Canada for the first time as well as a few new market openings

In terms of the number of members at fiscal quarter end, Gold Star members, 14.9 million, that compares to fiscal year end at 15.0 Business primary 4.7 up from 4.6 million.

Business add-on 3.6 similar to fiscal year end.

So all told, 23.1 million at quarter end down slightly from 23.2 million at fiscal year end.

Including free spouse cards close to 42 million members throughout the world.

As I mentioned the numbers are about 100,000 down from fiscal year end.

This has completely to do with the fact that last year we had more freebies with some of the new market openings as those tend to fall off at a lower renewal rate if you will, that seems to, that will reduce that number a little bit.

Our new signups, out net new signups in markets continue to be good.

At fiscal quarter end on November 23rd, our paid executive members were just below 2.5 million an increase of 300,000 or 14% in the first fiscal quarter, from fiscal year end.

Again, a little over 100,000, or close to 150,000 of those were Canada.

Even excluding that, we averaged 14,000 a week increase which actually is a step up from the last eight or nine, seven or eight fiscal quarters.

So again, continued signups and continued success in that program.

In terms of membership renewal rates really sound like a broken record, continued strong at 86%, 92% for business members and 84% for Gold Star.

AMEX, continued increased penetration there.

Currently 26% of our sales are paid for with an AMEX card versus 22% a year early, and we have over 2.5 million co-branded accounts so been a very good program for us.

Continuing down the gross margin line, gross margins as reported was down 10 basis points from a 10.67 a year ago to a 10.57 as a percent of sales this year in the first quarter.

As I always do I go through some of the components of that.

The core gross margin in the first quarter and I'm going for exclude the EITF-0216 which is the accounting for vendor allowances, I'll leave that as a separate line item.

But core was down 16 basis points excluding EITF with virtually all of that an impact of mix given the particular strength in ancillary businesses and fresh foods, the gross margin dollar contribution from core while on a like department basis was about flat because of the less penetration it was down 16 basis points.

The 2% reward which again has the effect of reducing reported gross margin and increasing membership fees and hopefully what we've seen is increasing sales, 2% reward was a negative impact to margin of 9 basis points.

Now that's up from minus four basis points in Q4.

Again, that has a lot to do with the rollout of the program into Canada.

We'd expect that impact to mitigate over the coming quarters.

Ancillary businesses were up very strong, 42 basis points.

Strong in nearly every business, particularly gas, as well as the mix.

That was an important part of it as well.

International, up 4 basis points.

LIFO zero both this year and last year, we had no charge.

We continue to see slight deflationary trends in our inventories cost.

And the last component that's a new line item here, something to add to the other line here if you will, is EITF-0216.

As I mentioned to you several times in the past, beginning in fiscal '04 in terms of the new accounting rule, this has a negative impact to margin in Q1 offset by positive impacts in Qs 2, 3 and 4 with a very slight impact for the whole year to the negative.

The impact in Q1 was almost $32.5 million or 31 basis points.

So if you add the core of minus 16, the executive membership reward of minus 9, the ancillary of plus 42, international plus 4 and the EITF-0216 of minus 31 you get to your minus 10 basis points.

Overall again starting with the core I think the Q1 trends were good, particularly given the competitive concerns that we ourselves had talked about back in August, and I think that many of you felt even more concerned about.

In terms of other margin things I'll mention, again gas profitability, the sales mix up 28% and up total sales in ancillary business is up 33%.

Now, in terms of the EITF-0216, numbers very similar to what I mentioned to you the last conference call.

Again a $32 plus million, a negative $32 million impact in Q1.

Our current expectations of the offsetting impact to that in Qs 2, 3 and 4 would be plus $9 million in Q2, plus $8 million in Q3 and plus $4 million in, plus $11 million in Q4.

For a total, again as we stated last quarter, a negative impact for the entire fiscal year of this new accounting rule of about 4, $4.5 million or about a half a penny a share.

In terms of our gross margin outlook for the rest of the year, you know, we're hopeful that the trends in Q1 continue, particularly as compared to some of your concerns out there.

We think they will be good.

Notwithstanding the fact that we will stay true to remaining the most competitive warehouse club out there.

We think we have the ability to move margins in the right direction.

And again while EITF will be a positive instead of a big negative, we'd expect ancillary to gross margin contribution to be positive but perhaps not as positive as 42bbasis points up.

All told, we hope it will go in the right direction.

In terms of SG&A, ancillary business accounts we added eight pharmacies, eight food courts, eight mini labs and eight optical during the quarter.

We currently stand at 345 pharmacies, 401 food courts, 397 one-hour photo labs and 385 optical shops.

We continue to have 11 print centers.

We added 4 hearing aid centers to be at 136, and 7 additional gas stations to be at 197 gas stations throughout the company.

These businesses again are all profitable now.

They drive our overall business, they have good comps, better than average comps and again, a good reason to be a Costco member.

As I mentioned ancillary business comp sales were up 28% and total sales in the ancillary businesses were up 33%.

Now moving to SG&A.

As you will recall in the fourth quarter, SG&A came in year-over-year as a percent of sales higher than planned.

In fact in the fourth quarter SG&A was up 31 basis points year-over-year and for all of last year it was up 42 basis points.

In the first quarter of fiscal '04 our SG&A year-over-year was higher by 15 basis points coming in at 10.01 percent of sales this year versus 9.86 percent of sales last year.

Despite the percentage still being a little higher year-over-year, which I'll explain below, we've considered this a pretty good improvement and in the right direction.

Again, going through some of the line item components of SG&A.

Looking at the first quarter, the core warehouse business showed SG&A higher by 5 basis points year-over-year.

That compares to being higher by 12 basis points in the fourth quarter.

And again I'll give you some color on that minus 5 in a moment.

Central we saw leverage of 6 basis points.

In other words, SG&A was lower by 6 basis points due to the central leverage.

Ancillary businesses, again much higher penetration, showed higher by 7 basis points.

International higher SG&A by 1 basis point impact.

And then, of course, as you know at the beginning of fiscal '03, we began expensing stock options.

Given that our big annual grant is done in really right around the time, the beginning of Q3, we're still anniversarying the first year of impact of that.

In the first quarter the charge which goes into SG&A was $5.2 million or minus 5 basis points.

So you add all those things up together you get to 12 basis points higher.

The small other piece which is about $3.5 million or 3 basis points is increasing yet again the workers comp charge.

And again, I'll talk about workers comp in a moment.

Now, going back to the core SG&A which was worse year-over-year by 5 basis points, of that amount, about 3 basis points of that negative impact was new warehouses.

So again we see that continuing to diminish and it should be really not an issue by year-end.

Another 16 basis points was specifically employee healthcare benefits and workers comp costs.

That's on top of the 3 basis points I talked about below in terms of just raising our prior year's reserve for open claims.

So fully, 19 basis points of the reported minus 15 basis points in SG&A was healthcare and workers comp, another 5 was stock options.

That's basically where it is.

Now, in terms of workers comp and healthcare, let me start with healthcare.

As we mentioned in the fiscal '04 year-end conference call back in October, beginning in October we implemented some changes to our healthcare plans which include some changes to the benefits we provide which also includes some changes to what the employees contribute towards their own healthcare.

While it's still the best plan out there, and we estimate that whereas in '03 our employees will pay just under 5% of healthcare costs when many companies out there their employees are paying 20 to 30% of healthcare costs.

We'd expect the changes we're making to change the slightly lower than 5% contribution from employees to about 8 to 9 percentage points over the next four years.

So it's still going to be the best plan out there.

That being said, we indicated that the plan changes we're making this year versus do nothing will have about a $50 million estimated positive impact in our operations this year.

Much of that is back end driven in terms of the fiscal year.

The biggest impact, even though we rolled this out in mid-October, the initial benefit comes from the slightly improved cost structure for new hires that just go into the plan between October 15th and calendar year-end.

The big benefit will start accruing January 1st when all of our employees, the entire employee base go on to the new calendar year for co-pays and deductibles and employee contributions.

That will again start January 1.

So we'd expect some benefit in Q2, but more importantly benefits in Q3 and 4 from that.

As it relates to workers comp, we're accruing more and on top of that we added another $3.5 million to prior year reserves.

As I said again back in October even though we have seen the biggest, any impact to workers comp is going to be California-rated.

As I mentioned at the October conference call they indicated that there have been some legislative changes.

We think it's a step in the right direction and we're hopeful that they'll be able to do more.

But whatever legislative changes occurred we would not, and we said this back in October anticipate any changes in our accruals or any reduction or benefits from our higher accrual levels until 6 to 9 months out.

That's when we would start to expect to see anything at all.

And so again, these numbers are consistent with that so in my view the good news is, is that healthcare is still a little bit of second but more importantly third and fourth quarter benefit and workers comp hopefully by third quarter and into fourth quarter we'll start to see some retraction there but we'll have to wait and see.

So again, I think you take some of those things out, we showed good leverage and in terms of the SG&A outlook for the rest of the year, again it will depend on where comps come in each quarter and we can't expect that the strong comps we had in Q1 will continue forever but so far so good.

We'd hope to be close, in Q2 we hoped to be close to flat year-over-year in SG&A probably a shade higher, but close to flat.

Remember in Q2 a not complete impact of the healthcare really not very little and then also the impact of options year-over-year will still impact Q2 by about 5 basis points.

Next on the income statement is pre-opening expenses.

Pre-opening expenses were lower by $8 million coming in at $10 million versus $18 million.

Quite a bit lower year-over-year no big surprises here.

Last year in Q1 we had 14 openings, this year 9 openings.

And again a little of that is timing.

In terms of the provision for impaired assets and closing costs.

For Q1, '04 these costs total $4 million pre-tax.

A year ago the closing costs in the quarter were $5 million pre-tax so a million better.

The $4 million again is simply ongoing relocation efforts whereby the costs associated with closing the to-be relocated units are expensed up front once the decision to relocate is made.

Taking all that into account operating income in Q1 was up $17 million over last year's first quarter figure or up 7% to $254.8 million.

Again, excluding the EITF impact of vendor incentives of $32.5 million, operating income on an apples to apples basis would have been up $54 million or 21%.

And that would imply of course on an apples to apples basis that our operating margin improvement in the first quarter instead of being down a reported 17 basis points heading back to 31 basis points from EITF would have shown up 14 basis points.

Again that's not excluding, that's including the impacts of workers comp and healthcare.

We think overall certainly the strong sales helped us but overall a good improvement in our part.

Below the operating income line reported interest expense was essentially the same year-over-year with both fiscal first quarters coming in at $8.5 million.

Interest income and other was slightly better year-over-year $7.9 million this year up $300,000 from last year.

That's up $300,000 from $7.6 million last year.

Overall pre-tax earnings were up 7% from $237 million last year to $254.2 million this year and again excluding the impact of EITF-0216 pre-tax earnings on an apples to apples basis would have been up year-over-year 21%.

Last before I get to some other items let me comment on our effective tax rate which continues to go down a little bit.

For our fiscal '02 you recall our effective tax rate was 38.5% and in fiscal '03 it dropped to 37.75.

Back on the October call on October 8th, we stated that we would expect that our accrual rate this year would actually be done a little further to 37.25%.

You'll note that in Q1 we actually booked 37 a quarter of a percent lower than our prior estimate.

For estimating purposes and budgeting purposes I would assume the flat 37% rate for the remainder of the fiscal year.

Again that compares to 37.75 for all of last year and actually a little higher each of Qs 1 and 3 last year.

So that will be a little bit of a help to us.

With the lower tax rate reported net income was up 10% and again excluding EITF would have shown up 24%.

In terms of the balance sheet for November 23rd first quarter end, cash and equivilants $1.802 billion again about $400 million of that is, that's cash and equivalents and short-term investments.

That would include about $400 million of credit card and debit card receivables from over the weekend.

Inventories $4.080 billion.

Other current assets $736 million for total current assets of $6.618 million.

Net PP&E of $7.159 billion.

Other assets of 549 for total assets of 14,326.

On the right side short-term debt of $17 million.

Accounts payable of $3.886 billion.

Other current liabilities of $2.047 billion for total current liabilities of $5.950 billion.

Long-term debt $1.303 billion.

Deferred and other 208, for total liabilities of 7461.

Minority interest stood right at $60 million.

Stockholders equity $6.805 billion.

Again for total liabilities in shareholders equity of $14.326 billion.

In terms of balance sheet debt to cap ratio of 16%.

One of the numbers we look at internally in terms of controlling our inventories average inventory per warehouse was up about a half million or 5%.

This year at Q end it was $10.049 million in warehouse versus last year first quarter end at $9.499 million.

This is generally the time where we peak our inventories anyway because this is the month before Christmas.

But in terms of the increase of $500,000 year-over-year about $200,000 per warehouse higher is the FX impact.

So again on a light basis you take that out.

In addition a year ago if you recall on the West Coast we had the dock strikes.

That lowered inventory by a little bit last year.

And as well we built up inventories in Southern California due to the supermarket strikes a little bit.

So again, we look at inventories.

Talking to the merchants our inventories are clean.

We don't anticipate any post-Christmas markdowns of anything other than normal.

In terms of accounts payable as a percent of inventories, again another metric that we look at internally.

At this year at Q1 end reported was 95% compared to a year ago reported at 88%.

In accounts payable includes, you know, accounts payable related to expense accounts payable as well as merchandising.

If we just look at merchandising accounts payable to inventories at quarter end this year it was 86% versus a year ago 81%.

So five percentage points improvement there.

Recognizing every percentage point on $3 billion inventory.

I'm sorry, $4 billion in inventory is $40 million.

In terms of Cap Ex, as you recall last year at '03 we spent a little over $800 million.

Our plan for this year remains at 1 to $1.1 billion for the 25 or so planned units this year and the three or four planned relocations.

In terms of Costco online, last year we had sales of $226.2 million up 64% year-over-year.

In the first quarter sales stood right at $60 million up another 58% so that business continues to grow for us.

We continue to procure and secure new branded vendors and it's a business that's a nice little business for us.

It's nice and it's profitable.

In terms of expansion, for first quarter as I mentioned the beginning of the call, we opened nine new units this year.

Now I'm just talking about the consolidated units.

In the second quarter we -- well, later this week we are going to open one more.

That will be it for Q2.

We tend to open a lot right before Christmas of course and then there's a little bit of lull.

In Q3, three to four units and in Q4 which is the 16 week quarter 11 to 12 units.

All told that would be about 25 units for the year.

Relocations again another two to three, perhaps four, but looks like two to three.

So all told 27 to 28 units for the year.

Looking at the net new units of 25 on a starting base of 397, that would imply 6% unit growth and 7% square footage growth in line with what we said a quarter ago.

Finally before I turn it back to Shane for Q&A, let me just update our direction for Q2 and fiscal 2004 overall.

In the second quarter I think First Call as of yesterday as of December 5th stood at 44 cents.

That was actually in line with our guidance we gave you in October.

Given the strength in Q1, but not expecting the types of comps that we've had hopefully we'll do fine but there's no way to predict that.

Would we feel comfortable raising that 44 to a range of 44 to 46 in Q3.

I think the previous guidance was around 36 with First Call currently at 35.

That's fine.

Maybe 35, 36.

And Q4, you know we'll see.

That's still a couple of quarters out so I probably to be conservative put a range of 34 to 36 on that but again we're hopeful that what's happening in Q1 will continue.

No reason to believe it won't.

In Q4, the estimate First Call was 57 and again that's still two quarters out, so I'd probably stay there at 57, maybe put a penny on each side of it recognizing that in the fourth quarter last year we had the benefit of a big improvement in tax rate to the tune of 2 cents a share.

So again, we'll stick with what we have for Q4 not because we're fearful that things coming down but because it's 9 months away.

If we do what these guidelines show, that would imply a range which First Call is currently at $1.67 was as of December 5th which gives you a range of $1.68 to $1.74 or up 10 to 14%.

That's it in terms of our conference call.

We'll be happy to turn back to Shane for some questions and answers.

Shane?

At this time I would like to remind everyone in order to ask a question press star then the number one on your telephone keypad.

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

Your first question comes from Emme Kozloff of Sanford Bernstein.

Hi, Richard.

I've got two questions.

First was there any increase in membership signups in those clubs that benefited from the Southern California grocery strikes or was the uptick in comps just a function of your existing members spending more during their visits?

And the second question is, can you tell us how the clubs that you open in new as opposed to existing markets in 2001 are doing?

How far off are they from the average club volume?

I'm just trying to gauge the ramp-up of new store productivity at this juncture.

Thanks.

In terms of signups in California, I don't have any exact numbers.

I mean, we've looked at like, what's the improvement in sales, we estimate in the first quarter that we had about, you know, I've heard from the different operators down there something to the tune of an expected increase in sales related to the strike of 60 to $80 million.

You could put even a more aggressive range of 60 to $100 million.

Even at $100 million and assuming gratuitously 5% pre-tax incremental dollars it's less than a penny a share.

That's how we looked at it.

Did we get more sign-ups?

Absolutely.

You know it's gotten a lot of press down there, there were actually some units recognizing that some of our locations in California are union, but not on strike or anything, of course.

At some of the locations, and this is anecdotal, that some of the picketers early on in the process were recommending that people go to Costco.

So it was on the news and we of course were interviewed by the L.A.

Times a number of times.

So clearly we had some increased signups to it.

In terms of how the units in 91 are doing, I'm sorry, the units opened in '01, I'm looking at a preview of our annual report which will currently be printed this week and be sent out next week.

If you looked at the 32 units we opened in '01, in '01 they had an average annualized volume of $57 million that's right over our annual report the little matrix in our annual report.

In '02 those '01 units had an annualized volume of $63 million.

In '03 those 32 units had an annualized volume of $72 million.

So actually a nice pick-up from 63 on average to 72.

That includes, again the '01 units are very [inaudible] were about 80% new market and 20% existing market.

So a lot of that increase there is needless to say is new market related.

Similarly, the units, the 29 units we opened in '02 which had an average annualized volume for the partial year they were open in '02 of $58 million, was $62 million in '03.

And the 24 units that we opened in '03 had an average annualized volume for their partial year of 67.

And that 67 in that first partial year compared to 58 and 57 in the class of 2001 and class of 2002 is certainly a function of fact that we changed our mix from roughly 75%, you know 72% new market units in the aggregate over the prior two years to in '03 being about, you know, 35 or 40% market units.

Great.

Thanks.

Your next question comes from Daniel Barry of Merrill Lynch.

Good morning, Richard.

Could you discuss how your sales are doing in your units that compete directly with Sam's?

I'm not talking about just this quarter but last several quarters, given that they've been lowering prices.

How has it affected your sales?

I think we've both shown good comps.

Ours actually a little better.

Without looking at the detail right in front of me, I would say that it's been fine.

We've generally, as we've gone into new markets the last few years, we did one year free membership.

We've gotten away from that now because many of the "new markets" are now not completely new but kind of new.

So as we've opened now, I think 9 or 10 units in Chicago as an example over the last three years, the last few units we've cut way back on any kind of promotional stuff.

I think that we've done quite well versus them.

Again, one good thing for all of us in our industry is that we've seen this is a positive sum game.

Whatever activities they've done and of course their comps have improved, ours certainly we've shown a good improvement, so I think that things have gone pretty well there.

And then also, how are you doing in the upper end categories?

I know your sales were quite good during the tech bubble.

Are you seeing any pick up in your high end luxury goods type items?

Yes, for two reasons.

One, I mean, that's the customer we cater after.

Two, some of those what I'll call diverted branded goods are more plentiful in a weaker economy and a lot of little things help.

As some of you I'm sure saw or heard about, we had the pleasure of having about a 15-minute presentation on a recent Oprah show where she went into Costco and Target, actually and each of those were about 15-minute presentations on her show.

And as they were simply panning the collectibles case with some high-end women's purses and watches, we literally had several thousand calls as that show aired starting on the East Coast trending towards the West Coast over those few hours.

So all that type of publicity helps us.

There's an author that came out with a new book talking about trading up.

We've gotten lots of both business and regular periodical press on that and I think all those things tend to help those sales.

As well as the strength overall in consumer electronics.

Given that price points have come down dramatically, you know what was a $5,000 plasma T.V. just a couple years ago is now, there's some of them that are price points below $2,500 for the first time and more importantly they're more plentiful and available.

Digital cameras are strong.

Printers and PCs, all those things have helped what I'll call the bigger ticket items as well.

Great.

Thanks, Richard.

Your next question comes from David Schick of Legg Mason.

Hi, good morning.

Two questions, if I could.

First, could you break down that 42 basis points of growth from ancillary, just sort of giving more detail on fresh versus the year-over-year margins in gas.

And then secondly just sort of a what if scenario.

How would you foresee if gas prices were to fall flat year-over-year or go to flat year-over-year or even fall year-over-year not really the topline impact but the total P&L impact or would it be sort of nothing for the full year basis?

Thanks.

Sure.

First of all fresh foods is not part of ancillary that's part of the rest of it.

Fresh foods is about 10, 11% of sales, ancillary is another 11 or 12 or 13% of sales.

But when we talk about ancillary, that does not include fresh foods.

Well, first of all, in terms of breaking out the 42, for competitive reasons we generally haven't done that.

I can certainly tell you that gas both because of improving gross margin and because of significantly increased penetration, was the biggest piece of it.

But, you know pharmacy contributed nicely to it as well and some other ones were net positive.

Certainly gas was the big one, though.

In terms of what is the impact of gas, you know, it's all over the board.

You know it used to be when prices were going up we'd see sometimes unprofitability in gas and when prices were going down we'd see very strong profitability.

That paradigm is not always happening as well.

I can tell you both for the quarter and for the month we're profitable in gas and we hope that continues.

I'm sure we'll, as sure as I'm talking here there will be months when it's not profitable, but right now, things are fine there.

Thanks.

Your next question comes from David Beerman of Berman Capital.

Hello, David, are you there?

Okay, sir, at this time there's no response from Mr. Beerman.

Hold just a moment.

Your next question comes from Todd Slater of Lazard Capital.

Thanks.

Richard, given what you've seen in the recent margin trends, do you think that the concerns that you talked about back in August about Sam's and competitive landscape, do you think they were a little overblown or unwarranted, or how do you look at it now?

I certainly think they were overblown and we're certainly partly at fault for that.

It took several weeks I think after that call including several conversations one-on-one with many of you guys and including some conversations with Jim to one, talk about the fact that this was not a price war, it was increased price competition.

That we're going to remain aggressive, but as Jim said on even on that August 6th conference call that we think we're smart enough to figure it out how to do both, how to be competitive and to improve margins.

We think that first quarter trends are consistent with that and we'll hopefully continue to do that.

We take nothing away from our competition in terms of the fact that there is increased competition, but not crazy.

And we are showing that so far, at least, that we're smart enough to figure out how to do both.

So yeah, I think in retrospect, I think where we were pulling also was catching people off guard which is never a good thing in our business, and hopefully we've conveyed that we can do a little better than that.

Have you seen any changes incrementally at all in the market basket that you guys do with compared to Sam's in the last, I don't know, you know, four weeks or six weeks or eight weeks?

You know, when we look at market baskets compared to our direct competitors, we still see that we're the price leader and of course we're doing the study.

But I mean, it is a very broad range of goods.

Several hundred items in the market.

A hundred to 250 items in the market basket which tend to be focused more on commodity items which arguably are the most competitive.

We've seen some studies from some of you guys that show in some markets where we were flat or even up a little bit relative to our competition.

When we go through those from our point of view, in some instances they're different sizes or qualities.

Quality is a big difference.

We're not going to drive ourselves crazy if we have a superior quality on an item or quantity or size.

Now, if I had to look.

This is a general statement, but if I had to look across all of our regions and a cross of all the weekly and monthly market basket pricing studies I see, if I look back a year ago to five years ago, typically when we looked at 100 like items against let's say a Sam's, we might see that we'd be the same on 40 or 50, higher on 40 or 50, I'm sorry, same on 40 or 50, lower on 40 or 45 and higher on 5 or 10.

Today I would say that looking at that same market basket and I'm generalizing here across the last several months of budget meetings, that instead of being the same on 40 or 50 we might be the same on 60 or 70, lower on 20 or 30 and higher on 10 or 15.

So again that trend has been there is a little bit more pricing competition out there, but I'll also say that when we see studies that show us higher, I'm happy to talk to any one of you individually and point out very specific examples of where it's a quality, size, different threads per inch, more bone in a piece of meat, you name it, where I can show you that in our view of our customers view, that there's a difference that we understand why our price on an item that may seem similar may be a little higher.

So we feel very strong about our level of competitiveness.

As Jim will tell any one of you and will tell many of you on Thursday, that you know, we will remain the price and value leader out there but we're not going to play games with the products.

And we, by the way have been consistent on that forever, and have remained consistent on that even since August 6th, even though we have seen improving trends in our margins.

Okay, great.

Could you just update us on private label penetration trends?

I actually don't have that in front of me but as a matter of course not over the last quarter, but over the last year it's up probably half a point to three quarters of a point in penetration.

Okay.

And just remind us again sort of the gross margin differential there between private label and the rest of the stores?

If I had to again generalize, on private label the margin probably averages somewhere between 12 and 14.

By comparison, some of the products they're replacing, again sometimes you get a commodity item that might have been as low as 4 or 5%.

So my guess is on average the margin it's replacing is seven or eight.

But again the price point's lower.

And again the penetration will change depending on what season it is.

This year as an example and if you haven't gotten them yet you're out of luck I think because we've sold most of them, but we've probably sold 30 to, I don't have the exact number in front of me, 30 to $50 million of the cashmere sweaters.

Thirty to $40 million of the cashmere sweaters.

That's something we didn't have last year.

So certainly penetration and private label under the current Signature name has gone up over the last four or five weeks.

Next month it may be down a little bit from that number.

But overall on an annual basis we see that trend continuing to increase a little.

Again I don't want to overstate the private label.

We think private label is great, it's a quality difference, it's a distinction between us and our competition.

Great items.

But we still, if you say where, you know private label today has 13%, where is it going to be five years from now, ten years from now, we'd still say it's going to trend towards 20 but not anymore than that because we still want to be considered a branded supplier of goods.

Okay, great.

Thanks.

Your next question comes from Gary Balter of UBS Investment Bank.

Hi, Richard.

First of all, I have a Kirkland Signature sweater from last year that's cashmere so I'd like to know how I got it if it just started this year but we'll skip over it.

On the expenses, could you talk, I'm just trying to understand or put it in context essentially what you're saying is Q2 we won't see as much on the healthcare but then as we get into Q3 and Q4 that's where we'll start to see the leverage.

Is that the way we should understand it?

As it relates to healthcare, yes.

Again, the quote $50 million savings relative to what would have occurred this year had we done no changes, you know big chunks of that relate to deductibles, co-pays, employee contributions, some of it relates to new hires.

Well, new hires needless to say is pretty small.

It takes three to six months to become benefits eligible.

So if this went into effect early to mid-October it was for people that started over the prior six months, three to six months that are just starting to get benefits for the first time.

That's a small piece.

Come January 1st when all of us go on a new plan, again I'll give you my example.

I'm a family of five that benefit from Costco's employee healthcare, medical dental and vision.

Last year my employee contribution through payroll deduction was less than $1,000 for all five of us.

On average at the executive level, that will more than double, slightly more than double this year.

For the rest of the employees it will be a little less than that increase.

But still that's even slightly more than doubling is a fraction of what others pay.

The good news is, it's $50 million this year versus do nothing.

The reality is come January 1st.

Now Q2 is about six weeks pre-January 1 and six weeks post-January 1 so you get some of that benefit starting in Q1 and bigger chunks of that in Q3, Q2 rather.

And of course the biggest chunk in Q4 because Q4 is a 16-week quarter.

Getting back to the Kirkland Signature sweater, I'm going to ask the buyer because I didn't see them out here last year.

Maybe it was only in the Northeast.

I'm talking about the crew neck ones but we'll find out.

Just finishing up on the expense side.

So with core being essentially something that you explained well and the stocks options being more first quarter, comps could be a lot lower and you could get leverage in Q3 and Q4 is that a fair statement?

First of all in terms of stock options, again that's going to be about 5 basis points year-over-year in Q2 as well.

And in Q3 and 4 because the way the stock option accounting works, you incur an expense as they vest and our options vest essentially, ratably over five years.

Okay.

So come the second year of the option grant if you will, we have another one-fifth layer on top of the last year's fifth.

So that will be continued into the SG&A.

Okay.

As it relates to the workers comp and healthcare, particularly healthcare, I mean that's the one that's more quantifiable from my perspective.

Yes that should start helping you in Qs 3 and 4.

So what type of, what comp number should we be thinking of in Q3 and Q4 to get expense leverage?

I'd try to stay away from that number because I've been wrong in the past.

Given, as well when we've been given the question about what comp level do you expect even for, forget what it's going to do to expenses, what comp level do you expect in Q3 and Q4, I'd still stand by something in the five to seven range just hopefully it will be better, but we don't know yet.

Again, there are a lot of moving parts.

When I look at First Call, and I provided some additional guidance that have upped those numbers a little bit, when we look at our internal budgets, our internal budgets are generally correct in the right direction.

Whether I'm off a little bit on SG&A or off a little on margin, offset by SG&A or SG&A offset by margin, we generally seem to get there.

So I can't really give you a number other than I would say that our comp estimates would still be in the mid to low middle high single digits and I'm assuming that the benefit of access is starting to be curtailed as we get into the second half of the year and not a 300 basis point improvement.

Thank you.

Your next question comes from Teresa Donahue of Neuberger Berman.

Good morning, Richard.

If you step back a minute and look at the 14% comp and I know you gave the various components, how much of that would you say is an improving economy and how much may be that the prior use classes of stores that seemed at least in the '01 comp accelerated?

And I'm wondering what's going on, you know, with the new stores and whether they are becoming a bigger factor?

Well, actually, you know of course we had increased levels of cannibalization as a negative to comps.

It's increased incrementally by 20 or 30 basis points year-over-year.

Right.

So that's actually going the other direction.

That's net after adjusting, that's net of the new store contribution on their own?

Okay.

Never mind I gotcha.

Okay.

Now beyond that, I mean, how much of the economy, I hate to sound a little bit of a naysayer and again, we don't have an economist around here, it's what we read and hear in the paper and of course we experienced a little bit of, you know, there's been a lot of employee lay-offs locally because of Boeing.

I've got to believe the economy isn't getting any worse, maybe it's getting a little better.

I think part of it is, is some categories like consumer electronics where price points have come down dramatically and quality of items like the flat screen T.V.s, the plasma T.V.s and the digital cameras, all that stuff helps and PCs you can get a good laptop now for $1,000.

All that stuff helps.

Some of it I think is also just pent-up demand.

When we were strong in computers back in August back-to-school, part of that was because we were weak in computers back-to-school a year earlier in August.

I don't mean to suggest that I have any clue what's going on with the economy more than you do.

Our numbers thank goodness are good.

In a bad economy, the availability of branded goods whether it's on a diverted basis or on branded manufacturers willing to sell us for the first time, those are all positive as well.

The press we're getting, the Oprah show, the Sharon Osborne show, all those things help.

I guess I'm wondering why you wouldn't be looking at a higher sustainable comp rate than 5 to 7%.

I mean not that that's so horrible, but given the recent trends been so far above your expectations and I know California helped, but you indicated yourself that it might not have been much.

It's a half a point to a point.

California at some point even though there's no indication it's going to end tomorrow.

If you polled everybody that have been reading the newspapers it's probably not going to last more than a month or two more.

I think we're being conservative.

You know, why be more aggressive until we get there because I don't want to get burned the other way.

Thanks.

Your next question comes from Sherry Ebert of JP Morgan.

Hello, Sherry?

Can you hear me?

Yes.

Sorry about that.

Richard, I just wanted to follow-up on the SG&A.

For Q2 in terms of the guidance, are you assuming sort of flattish including the $26 million workers comp charge from last year?

Um -- well --

I would think at a minimum you would get some leveraging against that.

Hold on a second, Sherry.

Okay.

In looking at the quarter, let me get to the quarter page here.

In looking at the quarter last year we reported 39 cents, which included, that 39 included 3 cents, so it would have been 42 and First Call was at 44.

We've kind of upped that from a 44 single point to 44 to 46.

And we would hope, you know we'll get there if not a little better but we have to see where we go.

Okay.

I guess I was just trying to understand when you said the SG&A margin would be sort of flattish year-over-year should we be comparing that with the SG&A that includes the $26 million workers comp charge, or should we be excluding that?

No.

That would be excluding that.

Okay.

Thank you.

And then just in terms of thinking about your cost structure, have you ever provided any information in terms of how much of your SG&A is a fixed cost versus a variable?

Because obviously the leverage, you know, has been an ongoing issue.

Is it just that is your cost structure is more variable than fixed and we're just focusing on the wrong thing here?

Can you talk about that a little bit?

Unfortunately, we're a business that's labor driven and workers comp and healthcare driven.

I look at just Q1 here, you know, fully 19 basis points of that core component was healthcare and workers comp both of which should show some breathing room as we get into the latter part of this fiscal year, one by definition because of changes we've made, the other by hope because of legislative changes in California.

So, you know, I think, you know there's some other things we're doing in the warehouse, well, we increased, as you know, labor at the front end a little bit but we've reduced it at the back end so we're looking at everything.

I think I don't have a specific fixed and variable in front of me.

I think we're still very much a variable cost business, but on top of that you've had some big out of control expenses, healthcare and workers comp.

Okay.

And then last question just on Canada, I didn't know if you had any comment in terms of your plans there as Sam's continues to roll out and what we might expect to see in terms of new club openings in Canada?

I'm sorry.

In Canada.

Well, you know, as you would expect from us, we're on the offensive not the defensive.

You know starting a year ago when even probably a little more than a year ago, before they announced, but once, because of permitting and real estate people up there knew that they were coming up there, we did what we're supposed to be doing.

We remodeled and added a couple of locations in that greater Toronto market.

We rolled out the Canadian executive membership program.

We've done some other marketing and canvassing for business members and Gold Star members.

We made sure we're sharp on prices even though we're sharp to begin with.

Certainly our impact on pricing up there relative to what we had been is not as big as what it would have been if it was the other way around in our view because we're already sharp.

And we're making sure that we're doing everything right.

We're going to make it as inhospitable as possible for our competition.

We would expect that we'll open more units not only in Toronto but other parts of the country up there over the next several years.

We've got several things on the planning board.

I don't want to suggest that it's not going to be easy, but I also want to, you know, many of you don't have as good a feel for Canada, needless to say the Canadian retail market as here.

We have some very strong competition up there even though there hasn't been a warehouse club.

Loblaws is a very successful and strong retailer.

There's real Canadian super store, and there's several what I'll call chain discount cash and carry operations.

So it has always been a very competitive market notwithstanding there hasn't been another warehouse club.

We have respect for Wal-Mart in Canada.

Certainly the Wal-Mart Canadian Wal-Mart team up there has done a very good job with the Woolco or the Woolworth stores that they bought several years ago and expanded and they're certainly a major player up there.

So we don't take them lightly, but we're pretty good at what we do and we're going to make it tough.

So we feel, you know, not unlike many of the markets where we compete with them here.

We have our act together and we're adding to that.

Great.

Thank you.

We seem arrogant, but we're going to do what we have to do.

Your next question comes from Cecil Godman of Highland Capital Management.

Richard I asked the question because I think you answered it but I may have been just didn't understand it.

When we look at the SG&A line, I know you broke out the 3 basis point hit to workers comp that are basically below the line as you look at this.

And if I look at this going forward, is it going to be in central where I see the benefit you talked about from particularly healthcare and then hopefully by fourth quarter workers comp as we see some diminution of those numbers?

Sure.

First of all the 3 basis points in workers comp I simply separated that out because it related to prior years claims.

Right.

That was incremental reserves.

On our balance sheet at fiscal year end, I don't have the number in front of me but it was $160 million roughly of open claims for workers comp from the last five to eight years.

In looking at that, both what's closed and what's been added to that reserve, we felt that it was appropriate based on actuarial, actual paids and actuarial studies that we now review on a quarterly basis that we should add $3.5 million to that.

Normally I wouldn't have even talked about the 3.5 other than the fact that it is, I would have included it in normal when I talk about workers comp and healthcare in general.

But given that is has been a topic of discussion over the last year, I wanted to separate that out.

The other 16 basis points of quote healthcare and workers comp and I add that's where I get the 19.

The 16 that's in the core and the 3 that's down below that's the 19.

Central, there's a small amount of healthcare workers comp in there related to the 2,500 or 3,000 employees at central, but it's the other hundred thousand employees that's in the core.

So that's all the help you'll see in -- the hopeful help you'll see from healthcare and hopefully a little later in the year workers comp will come in core not in central.

Core.

Thank you I appreciate it very much.

Your next question comes from Lloyd Zigman of Bernstein Investment.

My question has been answered.

Thank you.

Thank you, sir.

Your next question comes from Robert Toomey of RBC Dain Rauscher.

Good morning.

Richard, can you follow-up on -- I have a question on free cash flow.

Can you comment on what your depreciation amortization was in the quarter and did you generate free cash in the first quarter?

Yes.

Hold on a second.

Depreciation in Q1, depreciation and amortization was 97, actually about $101.5 million.

I'm sorry $97.3 million.

That's up about $12 million from the prior year first quarter.

And operating cash flow, you know cash flow provided by operating activities was $703 million.

That's the way they show it in the GAAP statement.

I still like to look at net income versus depreciation that would have been about $255 million.

From that our additions to PP&E were $222 million.

So a slight net increase there.

Now in terms of the formal cash flow statement on a GAAP basis, increasing cash and cash equivalents in Q1 was plus $256 million with a big chunk of that being working capital improvements and about 30, $40 million of it being net income plus depreciation minus Cap Ex.

How much is that last figure, Richard?

Net income plus depreciation would be about 257.

Okay.

Cap Ex is 222 so that's about $35 million plus.

The increase in our cash and cash equivalents during the quarter was 256.

So the other $220 million is everything else, principally improvement in accounts payable ratio and that's a big chunk, and also changes in other working capital items.

Great.

Thanks.

And then with respect to the workers comp I'm trying to get a better understanding of why you see that improving.

Is it the legislation in California that was passed, or what exactly is happening there that helps those relative comparisons improve later in the year for workers comp?

Yeah.

In terms of workers comp, one is right before the recent California governor election, Mr. Davis signed into law some legislative changes to the workers comp.

The State of California of course is 36% of our U.S. employees but over 70% of our workers comp charges because it's a system that has run amuck over the last few years and it's become an entitlement program for people.

It's subject to great abuse for a lot of reasons which I won't go into here.

There have been some improvements in that.

As an example I'll give you one example.

Up until now there has been no limit to how many times somebody who, let's say has a back strain, goes in for physical therapy.

Now there's a limit of I think 30 or 34 visits.

You know, most states have a 10 to 15 visit limit.

But in California at least they've capped it at something.

We think that under Governor Schwarzenegger and the new team that they are looking with a lot of input from not only big business but small business that is getting hammered even more than we are percentage-wise to see some more change, but we can't predict that yet.

We think that as that occurs, keep in mind what we're paying now is still based on current claims that were already in the loop.

Our incident levels and severity and frequency of new incidents is still below our sales and personnel increases, so we're still managing it well.

The biggest impact is going to be from change down there.

The insurance commissioner in California very much understands the issues, is an advocate of change and improvement to get rid of some of this abuse.

I was reading just a few months ago where Safeway indicated and they too are in many states that their average employee back strain in all states other than California required ten visits to the chiropractor or physical therapist.

In California for like frequency and like severity of back injuries, back strains it required 40 visits.

Something's wrong.

That's changing.

We believe it will change more.

And we think whatever the change is we'll see some impact as we get later in this year.

Later, later in this year, not like tomorrow but towards the end of Q3 and into Q4.

Great.

Thanks.

One last question if I might.

Is there anything significant on the merchandising front, Richard, that you think is important, you know I see the Dell kiosk in the store.

Is there anything else going on that you think is really significant in terms of new merchandising for Costco that could result in significant differentiation?

Thanks.

If you add up all the little things I think there's something significant.

But it's the kiosk, it's the improvement in the special order, it's ability to get more brand names, and get brand names in great quantities.

It's continually upgrading.

I don't know if some of you have shopped, you may have seen we have a -- it's got to be about an eight or ten-foot artificial tree that's $2200 with 1500 lights and other things on it.

I mean we constantly are going to improve the value and upgrade the items.

We are, now we've rolled out to about 25 locations I believe, an interactive terminal in warehouses which is an expansion of what you referred to as the Dell kiosk which is the Costco.com kiosk which allows our members to also buy Dell products directly from us through Costco.com.

And so all those things add up, you know and are what we do well.

That's a vague answer, but I personally think and based on the last several budget meetings when the merchants get up there to speak we're very much at the top of our game in going out there and getting new stuff, getting new vendors.

Certainly the weak economy over the last year or two has helped us in that regard.

Great.

Thanks very much.

Your next question comes from Ross Margolis of Solomon Brothers.

Richard, could you elaborate on the way the mechanism that the workers comp benefits kicks in later?

Does it have to do with some reinsurance premium that you pay or is it related to actuarial or is it some other issue?

It's mostly actuarial.

We're essentially funded, almost fully funded, or self funded on that.

The only, I think there's one state, I think it's Hawaii that requires you to be in the insurance program.

But we're essentially self funded.

We do have, I think, a $2 million retention or deductible on claims above $2 million where we do carry insurance but that cost of that insurance component is small relative to the entire program.

When do you reset your actuarial assumptions then?

Well, we look at it every three months.

But again, what we're talking about legislative changes, some of those legislative changes, and I don't have the detail right in front of me, but I recall don't even go into effect until the beginning of calendar '04.

So it's then three or six months after that that you start to see, hopefully, some benefit from it.

Now, I would, as you might expect since I'm the guy trying to share with you how we're improving our numbers here, I'm sitting down with our HR people and our actuarial people.

If we think it's going to get better can't we start to look at some of the assumptions and improve them?

And the view is, is you got to get there first.

And so we're going to wait until we get there first.

Thanks.

Your next question comes from Deborah Weinswig of Smith Barney.

I guess it's good afternoon now.

Can you discuss the investment Richard in labor at the front of the store?

How do you measure the return on that and the increase in customer satisfaction?

And last quarter you'd actually given us the basis points impact on SG&A.

Can you give that to us again as well?

Sure.

I think back in August when we talked about that, first of all, I'll start by saying is, is not that it doesn't matter what it costs but certainly the primary reason was that we felt we were vulnerable at front end.

Vulnerable because time and again we hear from members, particularly in the higher volume warehouses that they're tired of shlumping out to Costco, fighting the battle of shopping at Costco, finally turning the corner to get to the front end, the registers and seeing long lines while some of the registers may not even be open.

We're spending a lot of money on the front end, not just the extra labor.

Combine that with the fact over the last six or eight months our competitors have been a little more aggressive on going out and canvassing small businesses as have we.

And I think we're both probably seeing good signups in new small businesses.

That being said, we recognize that for our own reasons as well as competitive reasons we felt we were vulnerable of not satisfying the member at the front end.

Now, that being said there is a cost to it.

Our view is that the up front initial cost is somewhere in the 10 to 12 basis point range, that probably the current incremental cost is more like 7 or 8 basis points.

In some regions, in some locations we're seeing a little less than that and some we're seeing better than that.

That has to do with who's running those buildings and how they're doing it.

There's a big focus on driving that down and making sure we're doing it in all locations.

In terms of how we measure it, we measure it by talking to the operators, by member compliments.

We are definitely hearing from members.

In fact many of you on the phone I'm sure I've heard from a dozen of you over the last couple months.

And if I heard it from a dozen of you, 11 of you said yes you've seen the improvement and one of you said you really didn't see the improvement.

So, that's how we measure it.

We think it was the right thing to do.

We think we're getting and we will continue to see that number down.

Our best guess in August and I would stand by that today is that what is the net impact of it ultimately going to be?

Probably a one-time incremental charge ultimately after we get through a year of doing it of perhaps 5, 6 basis points.

And then do we pick up a little, maybe 7, who knows.

But then do we pick up a couple basis points in shrink to offset it a little further?

So call it 5 to be reasonable.

Okay.

And then, there's a lot of discussion in terms of the gross margins.

On the core side, could you give any more details in terms of the mix and, you know, the question was asked earlier on the private label side, how do we think about that in terms of the deterioration we saw in the core?

Okay.

Say that last again, I was --

So earlier there'd been a question that was asked about increasing private label penetration and I would assume a lot of that's in the core side.

So we did see a deterioration in core so if you could be more specific on the categories, and then how do we also think about private label as it impacted the core?

As I look at the four major categories in core, food and sundries which is about half our sales, hardlines which is about 25% of sales, softlines which is about 15% of sales and fresh foods which is 12 or 13% of sales, I'm off by a couple of percentage points on some of those but basically that's the right direction of those.

If I look at those four categories taking out EITF, I would say that all categories other than fresh foods were about flat.

Fresh foods was down a little.

And then how did all of those impact -- are impacted?

I would guess, I don't have the detail on that.

There's probably a slight improvement related to -- slight improvement, I bet you by not more than a basis point or two related to private label.

Okay.

But the decrease in the core was related to fresh foods.

Is that correct in terms of the mix shift?

Yes if I look at each stand alone department core was down a little bit.

But again, by the way, I didn't mention before.

When I looked, if you go back to your, I'm sure many of you keep spreadsheets on all this stuff.

If you look back last year to Q1 our core margin was higher by 22 basis points.

I don't recall why but I'm willing to bet we had, so really the roughly flat core margin excluding mix is pretty good given that it was 22 basis points up last year.

Okay.

Great.

And then, obviously there's been a lot of concern over the, maybe too much concern over the impact of the snow storm in the Northeast over the weekend.

Can you talk about what you saw in your clubs?

We estimate it was about $13 million that was the number I heard from Jim yesterday after talking to the operators.

Okay.

Great.

Thanks so much.

Your next question comes from Bob Drbul of Lehman Brothers.

Thanks, Richard.

Just a quick question.

Can you give us an update on home and the trends that you're seeing there and your expectations for the business?

Well, Costco Home, we still have one, we've stated that we'll probably look to open another one or so.

We've not made any announcements where.

My guess it's west of the Mississippi in a strong market.

You know, the numbers are good.

We're profitable which, you know in fiscal '03 we beat both sales and bottom lines.

And it continues to grow.

This is not the do all or end all it's still a very small piece of our business.

But we are seeing vendors willing to talk to us, not everybody.

Again, most importantly, we're identifying items and categories that make sense for us to add to all 400 locations on a seasonal or road show basis and in a few instances on a permanent basis.

Okay.

Thank you.

Your next question comes from Van Guyman of McAdams, Wright and Reagan.

Good morning.

Can you update us on our thinking as to what you might do put your cash to work going forward either as share repurchase, a dividend, possibly some other vehicle?

Also might you do something this fiscal year or is this more likely a longer term type of thing?

I think it's, you know, mid-term type of thing.

We have not made any decision.

We do talk about it, both internally at the executive level as well as at the board level.

We have not made a decision on what we're going to do, but we recognize that if we continue to show these types of positive cash flows, we need to put some of that to work.

We're not just going to go out and try to find 20 more locations to open, we're opening as many as we can get done recognizing it's harder to get them done today than it was.

We're putting more effort into getting as many open as we can.

We'll continue to look at, you know, the other two likely scenarios of dividends and stock repurchase, although there's been no decisions made on either.

Also what are your thoughts at this point on the membership fee increase and I ask that partly vis-a-vis the competitive environment?

We have not made any decisions on that as well.

History has shown we've done it every three to four years.

Four years would be next fall.

What we said a few months ago was we good not have a plan to do it right now.

None of those reasons are because of competitive issues.

Even though our membership fee is $10 and $15 higher than our competitors' we still think it's the best value out there.

We think many of you shop with us so you believe it as well.

We have no concerns about, at some point, as long as the value increase is exceeding the price increase that we might do something in the future.

We've not made any announcements as to when, though.

Great.

Thanks very much.

At this time there are no further questions.

Mr. Galanti, do you have any closing remarks?

Just thank you and we'll see some of you on Thursday.

Thank you.

This concludes today's conference call.

You may now disconnect.