好市多 (COST) 2004 Q4 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the Costco Wholesale Corporation' 2004 fiscal year year end 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. [Caller instructions.] Mr. Galanti, you may begin your conference.

Thank you, Wes, good morning.

As usual I would like to review with you several items To begin with our 16 week fourth quarter of fiscal 2004 operating results.

It was a very good fiscal quarter and fiscal year, for that matter.

For the quarter we came in at 62 cents a share, up 11 cents a share from last year's reported earnings of 51 cents a share.

In terms of dollars, net income increased 57% - - I'm sorry, $57 million, or 24%, from $239 million last year to $296.8 million this year.

These results were well above the 56 to 57 cent EPS guidance I had provided you in May on our third quarter conference call. and 4 cents above current first call consensus estimate of 58 cents.

As I'll discuss pretty much all of the income statement metrics, membership fees, gross margins and SG&A trended in a positive direction in terms of both the quarter over quarter and the year over year comparisons.

For the fiscal year we came in at $1.85 a share, up 32 cents, or 21% versus last year's earnings EPS of $1.53 per share.

And again up 4 cents per share versus first call.

In terms of sales for the quarter as previously reported our 16 week comp sales figures showed an increase of 8%.

That's a 9 if you do it on an apples-to-apples basis with regard to the EITF 3-10 accounting issue this year.

And for the fiscal year a reported increase of 10% or again on an apples to be apples basis, 11 adjusted for the impact of the EITF 3-10.

And regarding our comps for the 5 week reporting month of September, these trended back up from August 4% reported comp figure to a reported 8% increase for September.

And again, excluding the impact of EITF the 8% reported would have been 9.

Other topics of interest I'll review with you this morning, our opening plans.

For the past fiscal year we opened a total of 20 net new locations during the year fiscal '04 which ended this past August 29. 18 new in the U.S. and 2 in Canada.

These 20 of course are consolidated into our operating results as well in Mexico which we account for on an equity basis we opened 3 additional warehouses in this past fiscal year.

Of note the 20 net new warehouses in our consolidated figures; 3 quarters of these 20 opened in existing markets versus new markets.

This a continuing change in mix if you will from '01 and '02 when 3 quarters of those openings, those 61 aggregate openings were in new markets.

I will also discuss our planned higher level of expansion for fiscal 2005 which began August 30 of this year.

Also this morning I'll review with you the 2 EITF pronouncements as it relates to how it impacts our financial statements.

I'll talk about our ancillary business results, Costco online, membership trends, give you - - provide you the balance sheet information for the fiscal year just ended and update some guidance for the upcoming first quarter and fiscal year.

As with every conference call let me start by stating that these discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

And these statements involve risks and uncertainties that may cause actual events results and/or performance to differ materially from those indicated by such statements.

The risks and uncertainties include but are not limited to those outlined in today's call, as well as other risks identified from time to time in the Company's public statements and reports filed with the SEC.

So with that said, again sales for the quarter were $14.8 billion, up 11% in total sales from last year's fourth quarter sales of 13.4.

For the quarter our 8% reported comp sales results were a combination of an average transaction increase of about 6% for the quarter, of which about 1 percentage point of that was FX.

And an average frequency increase of about 2% up from the quarter.

Our average sales per warehouse for all warehouses if you recall in fiscal '03 on our annual report the average Company-wide warehouse generated $105 million in sales.

That was on a 5% comp from the prior year.

And if you look at the U.S. only during '03 it was 112 million.

What we will show you in this year's upcoming annual report that for fiscal '04, Company-wide and again we enjoyed a 10% comp this past year, was $115 million average Company-wide location.

And in the U.S. only $121 million during fiscal '04.

In terms of our sales results for the 5 weeks of September, retail reporting period which we are also reporting today, sales were $4.53 billion, up 11% versus 4.07 billion last year.

And up 8% on a comparable basis.

Regarding September 8% reported comp, it was pretty much evenly split between average frequency which was up a little more than 4% - - I'm sorry, average transaction which was up a little more than 4% and average frequency which was just a shade under 4%.

So each about 4%.

In terms of sales comparisons be geographic region, generally speaking the established longer term U.S. regions like the West Coast and parts of the Atlantic, MidAtlantic and Northeast, were up in the 5% to 7% range, about 6% overall.

The newer regions which includes parts of the Southeast as well as Texas and the Midwest were up in the mid to high teens and in fact Texas was actually in the low 20s.

And overall that would generate 8% for the U.S.

Canada expressed in U.S. dollars was 6% but as we've seen all year this per year it remained relatively flat.

I think in the fourth quarter was down 1% and September was flat in local currency.

Other international, again given the weak dollar the 8% local increase in comps and local currency rather for other international for the second quarter was a representative of 16% when converted in U.S. dollars.

So all told an 8% reported comp for the Company for the 5 weeks of the queer.

In terms of merchandise categories; food and sundries which as an 8% in the fourth quarter, was a 7% in September.

Hard lines which was a 5 in the fourth quarter, was up to 7% in September.

Soft lines which was flat in the fourth quarter, which was the 16 week fourth quarter, was up 2%.

Fresh foods continues strong, up 11 in the quarter and 13 in September.

And ancillary businesses, which were up 29% in the fourth quarter, although parenthetically 18% up without gasoline given the high inflation year over year in the quarter: in the fourth quarter - - I'm sorry in the 5 weeks of September ancillary was a 15% both with and without gas.

A little color on September 8% comp sales increase, within the food and sundry 7% comp in September, tobacco which is about 7% of total business and close to 15% of just the food and sundry business, was down about a percent, we're up against the price increase a year earlier, we also within food and sundries had strength in sundries.

Within the 7% hard lines comp, what we refer to as majors was the strongest subcategory, with toys and seasonal being slightly negative in terms of comp.

Talking to the buyers a combination of a little bit less commitment this year on our part to the Halloween season as well as some more spreading out of when some of the seasonal Christmas stuff comes in.

Within the 2% soft lines, pretty mixed across the board, housewares, domestics, home furnishings, jewelry were the stronger subcategories, offset by the weaker ones which included media.

In the case of media there haven't been a whole lot of big hits lately, although there's some a few coming up like "Shrek 2" and the like.

Photo camera, flat to down slightly and apparel.

Within fresh foods again these areas continue to be strong for us, a 13% comp and not only strong but a frequency driver and we believe into our locations.

And lastly ancillary businesses as usual strong, again looking at it without the inflation of gas, up 18% in the quarter and up 15% without gas in September.

Moving down to the line items on the income statement, we will start with membership fees.

In the fourth quarter reported membership fees were $306.4 million or 2.07% of sales.

Up 4 basis points and up $33 million from a year ago $272 million.

So again on a top line sales growth of about, top line sales growth of about 11%, a 12% increase in membership fees.

Again a good showing in membership fees particularly given strong comp sales.

In terms of membership we continue to benefit from the same things, strong renewal rates and increasing penetration of our $100 per year Executive Membership which included the roll-out of that program in Canada at the beginning of fiscal '04.

In terms of number of members at fiscal year end we had 15.0 million Gold Star members, 4.8 million primary business members, 3.6 million business add-ons for a total of 23.4 million members.

That compares to a year earlier of 22.6 or up about 5%.

And including the free spouse cards 42 million people at fiscal year end hopefully walking around with a Costco card in his or her wallet.

At the August 29 fiscal year end paid Executive Members totaled just under 3.3 million.

It was an increase of a little over 300,000 members or up 10% since the third quarter end and that represented about 19,000 new signups a week, sign ups or conversion into the Executive Membership during the 16 week fourth quarter.

These figures again reflect the roll-out this per year of the Executive Membership into Canada but also continued what we consider good signups in the U.S. where the program has been rolled out for over 3 years.

I should point out that these Executive Members represent roughly 15% of our membership base but general more than 35% of our sales and are certainly important to our business.

In terms of the membership renewal rates they continue strong.

I think now for well over 4 fiscal quarters in a row our membership renewal rate has remained at our all time high of 86%.

And in fact as compared to a year ago they both round up to 86 but actually a couple tenths of a percentage point better.

Continuing down the income statement to gross margin, our gross margin in the fourth quarter was higher year over year by 16 basis points.

From a 10.65 in the fourth quarter to 10.81 this year.

Again on as I do each time ask you to jot down a couple of numbers.

The I'll ask you to jot down 2 columns, and - - or 3 columns we will add third quarter as well.

And then 5 line items.

The first one, the 3 columns would be Q3, Q4 and fiscal year.

And 5 line items would be merchandising, second one would be 2% reward, third one would be LIFO, the fourth one would be EITF 2-16, the fifth one would be EITF 3-10, and then of course the total would be the sixth line item.

Okay.

Going across merchandising was plus 10 basis points in Q3, plus 21 basis points in Q4 and for the year plus 14.

The 2% reward, minus 13 basis points in Q3 - - these are again the change in basis points year over year in the quarter. 2% reward minus 13 in Q3, minus 15 in Q4, and minus 12 for the year.

LIFO both for Q3 and Q4 minus 11 basis points and for the year, minus 6, again reflecting that in the first half of the year there was no impact year over year in terms of how that impacted gross margin.

EITF 2-16 plus 6 basis points in Q3, plus 7 in Q4, but for the year minus 1.

Again, I will explain that in a second.

EITF 310, plus 13 in Q3, plus 14 basis points in Q4, and plus 8 in the fiscal year.

When you total those columns, Q3 was year over year reported gross margin was up 5 basis points, and Q4 as I mentioned up 16.

And for the year, up 3.

As you can see our overall merchandising gross margin which is everything, it's the warehouses, it's international, it's ancillary businesses.

This was better in Q4 over Q4 by 21 basis points and year over year by 14.

Both the quarterly and the year over year favorable comparisons were helped by strong ancillary business gross margins.

Both in terms of higher sales presentations of these departments and higher departmental gross margins within most of these departments, particularly gas.

With the 4 core departments of our business, food and sundries, hard line, soft lines and fresh foods, showing overall improved gross margins but some what offset by reduced sales penetrations in these departments.

Overall of course the underlying gross margin trends showing nice improvement during the fourth quarter and fiscal year in terms of merchandising.

In terms of our other gross margin components the 2% Executive Member Rewards impacted as I mentioned gross margins by 15 basis points in the quarter; indicating the continued growth and success of this program in our minds and which and this of course included the roll-out in Canada this year.

In terms of LIFE, after a few years of experiencing deflation, as I mentioned on last quarters conference call, we have been seeing the beginnings of inflation, not just in items like gasoline but also in certain food stuffs and in paper goods of late.

In Q3 last year, I'm talking about Q3 for a moment, in Q3 last year, given deflation we had a $5 million LIFO credit in Q3 of fiscal '03.

That compared to a $5.5 million LIFO charge in this year's Q3.

And again that was an overall that $10 million swing represented 11 basis points lower gross margin this year in Q3.

And in Q4, last year we had a $14.6 million LIFO credit and as I mentioned on the fourth quarter conference call in May;

I indicated that I would expect that as compared to last year's Q4 big LIFO credit, that the Q4 LIFO charge could be possibly, the swing could be possibly negative $20 million.

From the 14.6 credit last year to perhaps up to $6 or so million of LIFO charge this year in the fourth quarter.

And that would represent about a 3-cent per share Q4 over Q4 EPS impact.

In fact inflation was slightly less than anticipated in the fourth quarter and our Q4 LIFO charge instead of being what we anticipate at 6 to 8 million was only $590,000.

So about a $6 million pretax better than we had estimated a few months ago.

So all in, our quarter over quarter LIFO swing in the fourth quarter represented a 2-cent a year swing not the 3-cent a share swing that I had anticipated.

A little better than planned.

Now the last component of our year over year gross margin variance, and I spoke to you about these things in past conference calls, this is the new accounting treatment requirements for vendor incentive monies that impacts the timing of certain margin dollars this fiscal year, this past fiscal year.

I've discussed this on each of the last 3 quarterly conference calls stating that the impact was more quarterly timing than fiscal year timing.

In fact the fiscal year '04 total year impact to say us, we estimated that to be about .5 cent per share, maybe up to .75 cent a share, keep in minds when I'm talking cents per share, 1 penny a share is about 8 million pretax.

Well, for the year we came in right at .5 cent a share.

This is known as EITF or Emerging Issues Task Force 02-16, and technically known as Accounting By a Customers For Certain Consideration From Vendors.

Or better known as how do retailers account for rebates, advertising revenues, slotting allowances et cetera.

In our case the timing impact relates mostly to margin dollars we receive from vendors when we publish our monthly Costco Connection magazine, our cookbook and other several items that are direct marketing related to our members.

As I shared with you previously the timing adjustments by quarter reduced or increased our gross margin dollars by the following amounts in each of the 4 quarters of fiscal '04: About $32 million hit to gross margin last year, a $9 million improvement to gross margin in Q2, the $32 million hit was Q1, I'm sorry.

The Plus $9 million impact in Q2.

Plus $7 million impact in Q3 and about and $11 million plus impact in Q4.

And again that had to do with the Fact that Q4 is a 16 week quarter versus the 12 week quarters in the prior 2.

Again this had little affect overall for the year but did impact the quarterly explanations.

So, again, in Q4, EITF 2-16, actually that $11 million helped our reported gross margin year over year by about 7 basis points and for the year hurt our gross margin by about $4 to $5 million or about 1 basis point.

I'm pleased to report that in terms of EITF 2-16 and my long winded explanations, this is now anniversaried and I won't have to be talking about it a lot in the future.

Now, what I have referred to in the past as the cousin of the EITF 2-16 which I began reviewing with you on the March Q2 conference call is EITF 3-10.

So again let me take a brief moment and discuss with you the EITF accounting, this EITF accounting wrinkle.

Whereas EITF 2-16 tended to defer certain gross margin dollars and earnings into subsequent months, EITF 3-10 deals with certain manufacturers sales - - I'm sorry let me start over again.

Whereas 2-16 tended to defer certain gross margin dollars and earnings into subsequent months, EITF deals with certain manufacturers' sales incentives to retailers that are retailer specific rather than broad-based to many resalers.

This is the 3-10.

The impact of 3-10 is to reduce sales and cost of sales by the same amount of dollars.

Therefore no change to gross margin dollars or to bottom line.

But an increase in the gross margin percentage and other income statement percentages like SG&A because reported sales will be lower.

For Costco the impact of EITF 3-10 which began for us in the beginning of Q3 of fiscal '04 is to reduce current annual sales and cost of sales equally by an estimated $450 plus million over an annual period.

For the 4 fiscal quarters and I'm talking about Q3 and Q4 of the year just ended, as well as upcoming Q1 and Q2 of fiscal '05, our reported sales dollars will be lower by $450 plus perhaps $500 hundred million on an annual basis, or about 1% of sales.

This will reduce cost of sales dollars by a like amount.

Therefore gross margin dollars and SG&A dollars won't change but gross margin percent and SG&A percent will.

In Q3 again looking back at the matrix I had asked to you jot down in Q3 the actual impact of EITF 3-10 to our gross margin percentage was plus 13 basis points and in Q4, plus 14 basis points.

Now, given that EITF 3-10 didn't impact Q1 and 2 for the last fiscal year the basis impact, basis point impact in increasing our gross margin percentage for all of '04 was about 8 basis points.

Again no dollar impact to anything but top line sales.

But for these 4 quarters this is something I will get to explain to you 2 more times over Q1 and Q2 of fiscal '05.

Overall looking at the forest through these trees Q4 gross margins trended in the right direct with merchandising gross margin showing good improvement, helped of course by ancillary business strength.

In terms of our gross margin outlook going into fiscal '05, I feel overall that our fiscal '05 gross margin trends should hopefully be in line with recent trends.

It's still very competitive out there but we believe we can remain very competitive ourselves and still improve our gross margins over time.

Not always in a straight line but we feel pretty confident.

That being said our first quarter year over year gross margin comparison for fiscal '05 may be a little tough.

It sounds like I said this before and that last year's first quarter gross margin was positively impacted by very strong ancillary business gross margins, particularly gasoline.

We so far have not seen that same trend this year.

But as you know gasoline margins tend to vary week to weak, month to month and quarter to quarter.

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

During the fourth quarter we added 8 pharmacies to have a total of 359.

We added 7 food courts to be at 412. 7 1-hour mini labs to be at 408. 8 optical centers to be at 397.

We went from 11 print copy centers down to 10 so we closed 1 during the quarter.

We remain steady at 143 hearing aid centers and we added 6 gas stations to be at 211 gas stations throughout our Company.

These businesses are profitable.

They drive our overall business.

And in fact they have better than Company average comps as a group and yet they are another reason to be a member of Costco.

In total for Q4 ancillary business sales comps were up 29%, up 18 without gasoline, the inflation of gasoline.

And up 15% in September both with and without gas.

Moving to SG&A, I am pleased again to report that as I mentioned before after 16 fiscal quarters of increasing SG&A percentages the positive trends that began in Q2 and which were a little better in Q3 were better again in Q4.

In the fourth quarter of fiscal '04 as you will see, our SG&A year over year was lower or better by 19 basis points coming in at 9.64% of sales this year's quarter versus 9.83 last year.

Again I will ask you to jot down a few numbers here so we can make the explanation a little more easy to understand.

I will ask you to have 4 columns;

Q2 '04, Q3 '04, Q4 '04, and the total fiscal year '04.

And the line items would be operations, second line item would be central and administration, third line item would be stock options, fourth line item would be EITF 3-10, remember that's the one that impacts the percentages, not the dollars, the fifth line item would be quarterly adjustments, which is principally Workers' Comp related.

And the last line item would be total.

Now on this chart again this is a year over year variation and the difference in basis points, SG&A as a percent of sales.

And in this case a minus means higher or higher SG&A, or bad, a plus means lower SG&A, or good.

Again, going across line items here, operations in the Q2 was minus 5 or higher year over year by 5 basis points, Q3 was plus 12, or lower year over year by 12 basis points, Q4 plus 23 basis points, and for the year, plus 6, or lower by 6 basis points.

Central, plus 5, plus 8, plus 7 and plus 7.

Stock options, again we - - this is fiscal '05 will be the third year that we have been expensing stock options.

So we see that quarterly impact each year quarter over quarter as relates to the fact that our options that we have granted vest over 5 years.

Stock options starting in Q2 were represented minus 5 basis points or higher year over year by 5 basis points, then minus four, minus 4 and for the year, minus 4.

EITF 3-10 was 0 in Q2, of course it didn't start until Q3.

Minus 12 in Q3, again represents higher margins and higher SG&A, so that's a minus 12, minus 13 in Q4, and again since there was no impact in the first half of the year even though it was minus 12 be 13 in Q3 and 4, it was minus 7 for the year.

Quarterly adjustments in Q2 '04 it was plus 23, or an improvement year over year and that simply relates to the fact that a year earlier in Q2 of '03 we had a $26 million Workers' Comp charge to increase our reserves for Workers' Comp.

I'm sure many of you remember that.

In Q3, 0, in Q4, plus 6, in other words lower year over year by 6 basis points and I will explain that in a minute, and for the year plus 6.

You add the columns: in Q2 '04 we had 18 basis points lower SG&A, but again 23 of that - - 23 of that 18 improvement was the fact that we had a big charge the prior year.

In Q3, plus 4, or lower by 4 basis points.

In Q4, plus 19.

And for the year, plus 8 or lower by 8 basis points.

In terms of a little editorial on these SG&A figures let me point out the following.

Again, the Q2 '04 quarterly judgments for adjustments for Workers' Comp up plus 23 basis points again was due to the fact that in Q2 of '03 we took a substantial additional charge of $26 million to true up our Workers' Comp. accruals as we reviewed those at mid year at that time.

With the impact of EITF 3-10 beginning in Q3 of '04 the impact to our SG&A percentage was to increase SG&A by 12 and 13 basis points respectively in Q3 and Q4 and by 7 overall.

Now the 6 basis points of improvement in SG&A in Q4, this is a combination of 2 things.

One, it related to a 13 basis point improvement year over year in Workers' Comp.

Again I refer to fiscal '02 - - I'm sorry, fiscal '03, while we had the big charge in Q2 '04 we had a, about $11 or $12 million charge, additional charge in Q4 of '04 and I had mentioned that to you back on that conference call a year ago.

This year we actually had a little pick up in Workers' Comp.

So that swing year over year was a 13 basis point improvement.

The - - however that was offset, somewhat offset by a $10.6 million charge we are taking in the fourth quarter.

And this is due to reserving for certain losses that we had previously expected to be covered by third party, a third party insurer that we now expect will not be covered by that insurer.

Or by certain states' guarantee funds.

This insurer went into run off mode in '03 and ceased writing new business.

Some of this $10.6 million amount that we are reserving now relates to open claims and incidents that occurred as long ago as 1990 or as recent as a year, year and a half ago.

And so we are taking that charge in Q4.

And, of course, notwithstanding that charge we had a pretty good quarter in SG&A.

Lastly the 23 basis points improvement year over year in Q4 in terms of lower what I refer to as operations gross margin, several expense line items within SG&A helped us.

With the biggest Q4 over Q4 improvement coming from our changes to our healthcare plans.

Such changes made earlier in the fiscal year but really starting to be felt in Q3 and beyond.

I'm also pleased to report that our payroll as a percent of sales also showed improvement both in the quarter and for the fiscal year, in the mid single digits.

And lastly with regards to SG&A, in terms of Workers' Comp, I stated back last December that despite some legislative changes in California's Workers' Comp that were effective January 1, '04 and more importantly a new round of legislative changes subsequently signed into law but some of which don't become effective until January 1, '05; from an actuarial standpoint, I have stated over the last couple of quarters we would not expect to see or to make changes to our accrual assumptions for a couple, 3 more quarters.

While the trends helped us a little in Q4 I'll continue to be cautious with regard to Workers' Comp expectations until we see the fourth quarter - - to see that fourth quarter trend hopefully repeat itself in the current first quarter of fiscal '05.

But we are pleased to see what we that was Q4.

So our SG&A trends continue to show improvement, a little in Q2, a little more in Q3 and even better in Q4.

Helped of course by good comps but also due to changes in thing like healthcare plans and some other old fashioned efficiencies in the warehouses in terms of some rapid receiving, some efficiencies, the anniversarying of thing at the front end where we added labor a year ago and the like.

In terms of SG&A outlook for the rest of '05 it will depend of course on where comps come in each quarter.

There are certainly several factors that will help our year over year comparisons.

In terms of SG&A.

Again the healthcare changes that are now into effect.

We would expect to see that continue:, particularly in the first half of the year as we anniversary the biggest impact, positive impact of these changes.

The annivarsarying of increases in front end labor costs.

If you recall last August we announced were committing significant additional labor to the front ends of our warehouse because that was the one place that we felt we had vulnerability given how busy our warehouses are.

That's now anniversaried.

Good comps hopefully.

And hopefully also, that we will see some positive impact from changes in the California Workers' Comp legislation.

Stay tuned.

Next on the income statement is preopening expense, $5.6 million last year in Q4. $11.6 million this year in Q4, or $6 million or 4 basis points higher year over year.

This related to more warehouses being opened.

Last year in the fourth quarter we had four openings.

This year in the fourth quarter we had 4 openings as well as higher international preopening related to the last Saturday's fifth Japan opening in the Tokyo suburb of Hisayama Seaside.

And that's our fifth opening in Japan.

No real surprises with those numbers.

In terms of provision for impaired assets and closing cost line, for Q4 '04 we had a $2.5 million charge and in Q4 a year earlier closing costs totaled $4 million for the quarter.

So all told, operating income in the fourth quarter was up $91.3 million over last year's fourth quarter figure.

Or up 24.4% from - - to 465 million this year from 374 million last year.

Below the operating income line, reported interest expense was slightly lower year over year.

With Q4 '04 coming in at $10.9 million versus 11.7 million last year in the quarter.

Actual interest expense was slightly higher year over year but capitalized interest this year in Q4 represented a bigger offset to that expense as CapEx projects underway now were greater than in Q4 last year.

And like in both Q2 and Q3 interest income and other was quite a bit better, higher year over year by $4 million in the quarter and fourth quarter this year 16.5 million versus 12.7 million last year in the fourth quarter.

The $4 million higher income figure was primarily due to higher investment income earned on our higher cash balances and at some small amount of higher interest rates as well.

And some improvement - - some dollar improvement also from the elimination of the UK 20% minority interest as you probably are aware the U.K. is a profitable operation and last year we acquired the final remaining 20% of that interest.

So that 20% that would be offset and recorded on this line item is now gone.

Overall pretax income was up 26% versus last year's fourth quarter, up from $375 million last year to 471 million this year.

In terms of our effective tax rate, our fourth quarter tax rate this year came in at 37.0% as it was for all of the year.

Our fourth quarter last year was also a little lower than that, it was 36.2 because we were adjusting downward the entire year of '03 to 37.75.

For estimating purposes for '05, we are assuming a slightly higher tax rate than the 37.0% rate that occurred in fiscal '04.

We are currently estimating for the year that it will be about 37.5%.

This is a combination of increased focus by states on tax rates as well as a couple of small one time tax benefits internationally that we have benefited from over the last year or so.

That we don't expect this coming year.

Now for a quick rundown of the other usual topics I will start with our balance sheet.

As of the fiscal year ended August 29, cash and equivalent, $3.129 billion, inventory, 3.644 billion, other current assess 496, total current assess, 7.269 billion, net PP&E 7.264 billion, other assets, 560 million, for total assets of 15.093 billion.

On the right hand side, short term debt, 22, accounts payable, exactly 3.6 billion, 3.600 billion, other current liabilities 2.549 billion, total current liabilities 6.171 billion, long-term debt, 9.94, deferred and other, 2.44, total liabilities, 7.408 billion, minority interest, 59, stockholders equity, 7.625 billion, again for a total on the right-hand side of 15.093 billion.

The only thing I'll point out that is different is that we have a 10 year $300 million straight debt instrument that is due in June of '05 and so now that it's less than a year in duration of total maturity we switched from long-term liabilities, took roughly $300 million out of long-term highlights, or our of long-term debt into other current liabilities.

And that's why you saw the long-term debt number come down from prior quarters and the other current liabilities number come up.

We would expect to simply right a check for that come June.

I will point out a couple things on the balance sheet.

Our debt to cap ratio still is at 15%, plenty of financial strength.

Our accounts payable as a percent of inventory, a measure of our turns and our ability to negotiate with our vendors, reported was 99% in Q4 - - at the end of Q4 up from a year ago at 94%.

Now some of that delta is, all of that delta is due more to noninventory payables like the increased construction activity that we've got going on right now versus a year ago.

If you look at just merchandise accounts payable and merchandise inventories, you would see roughly the same number.

A year ago it was 83% and 82% currently.

Average inventory per warehouse while higher year over year a little bit it has gone in the right direction in terms of reducing that delta.

Last year in fourth quarter end on average per warehouse cost basis inventories represented $8.412 million per warehouse.

This year, 8.738 million.

So about $300,000 plus dollars or 3.9% increase in inventories year over year per warehouse.

I might add though that that 300,000 higher number - - $326,000 higher number at the end of third quarter was 537 higher and at the end of the second quarter per warehouse it was 718,000 higher.

Now about 100,000 of that is due to weak dollar versus FX and again FX while the U.S. dollar while weak relative to some foreign currencies currently is not as week as it has been.

Also higher consumer electronics inventories consciously on our part and has a lot to do with the success of that department and the brand availability and sales strength in those areas as relates to things like plasma the first question TVs and digital cameras and media and the likes of computers.

Also, slightly higher year over year pharmacies inventories.

Again a very strong area for us, that's mostly over the counter increases there.

And lower and offset a little bit by lower year over year tobacco inventories which represented about 100,000 per building.

In terms of CapEx; in fiscal '04 we spent 702 million on CapEx.

I would estimate for '05 that this number will be closer or at or slightly above $1 billion.

And again reflecting the fact that we plan to open more units which I will talk about in a minute.

I also want to mention our recent - - initiation of a dividend.

On May 28 of this past year we paid out our first quarterly dividend, 10 cents a share to record shoulders as of May 10.

We've done that once since then.

This 40 cents per share annualized dividend represents the cost to the Company of just under $200 million based on our current total shares outstanding of 460 million shares.

In terms of Costco online, it's continuing to do very well, 64% sales increase both for the quarter and the fiscal year.

So sales for the year came in at 388 million.

It's profitable and we would expect that sales of Costco online this year will be well over $500 million.

In terms of expansion, again we opened 20 net new units in fiscal '04.

And actually had no re-los.

So 20 units.

In the first quarter of '05 we anticipate 6 new openings, including 2 re-los so a net increase of 4.

The remaining 3 quarters of the year, and these are middle point estimates, 28 new warehouses of which 5 of those would be re-los.

So a net increase of 23.

And total 34 openings including 7 re-los for a net increase of 27.

Now we have in our budget to open about 30 or 31 but as you have seen in the past typically that includes a half a dozen in the last month or 6 weeks of the fiscal year and inevitably delays a couple or three of those.

But clearly a conscious effort on our part to ramp up our expansion from I think what at mid-year we had indicated that for '04 we were closing in on 17 or 18 but we ended up at 20.

And again we would expect to try to get closer to 30 this year.

But assuming that kind of midpoint range of 27 expected net new units in '05 on a starting base of 417 consolidated locations and the 417 of course excludes Mexico.

That would be about 6.5% unit growth and close to 7.5% square footage growth, up from 5% unit growth the prior year.

And finally before I turn it back over to Wes for Q&A, some direction for Q1 in the fiscal year in terms of earnings guidance.

We of course with a very good Q4 it's going to be hard to hold you guys down.

I think the first call, current first call prior to today's announcement consensus out there for Q1 was 39 cents compared to 34 cents reported last year.

We would look at that and say that's fine, maybe a little better.

Remember we had very strong comps a year ago.

We are still having strong comps but a year ago they were stronger and as I mentioned strong gas profits.

We are also anniversarying next week the LA supermarket strike, while we've kept a good chunk of that but we didn't keep it all.

And also in Q1 we would expect to have some impact related to charges that we will take related to the several hurricanes that we've encountered in the Southeast U.S.

While we are covered we certainly have insurance we've chosen to self insure to a certain extent and we would expect that probably something below 10 million pretax, somewhere between 5 and 10 million pretax would be reserve that we would take for damages incurred net of insurance proceeds in the first quarter.

So taking into account if you will that roughly penny a share related to that as well as the anniversarying of the LA strikes in supermarkets, we feel very good about our numbers.

For the year, again the $1.85 that we reported this per year compares to the first call consensus of $1.81 because we beat Q4 by 4 cents, consensus.

The current consensus for '05 was - - is $2.03 and needless to say that's going to go up.

Again, we are going to continue to be a little cautious or I would like to say cautiously optimistic but I frankly like to do that given, we will see how we're doing.

We've done well by being cautiously optimistic the last few quarters.

I think it's fair to say that you guys will come out with numbers in the probably low or even closer to mid-teens and that's probably what we will look at as well.

But we will have to see.

Lastly, if you look at our website we actually have the most recent cash flows, balance sheets, EPS calculations putting on there rather than sending out directly to everyone.

With that I will turn it over to Wes and I will be happy to answer any questions.

Thank you, Mr. Galanti. [Caller instructions.] Your first question comes from Daniel Barry of Merrill Lynch.

Good morning Richard.

And congratulations on a great quarter and a great expense ratio.

Most of us listening to this call I think or some of us certainly, have come back from the Wal-Mart meeting and we heard Sams talk about how they've been aggressively going after the business customer which they've been doing now for 2 years.

And yet I notice your gross margin improved in the fourth quarter.

So can you give us a little flavor on what's happening in the competitive front with Sams?

And has it eased any has that had anything to do with your better gross in the quarter?

No, I think we just had our 2 day budget meeting each month that we had the last 2 days and hearing from the merchants, it remains very competitive out there both in general and more specifically with regard to Sams.

But as I think Jim mentioned a year ago when we surprised everyone when we said that fourth quarter in '03 was going to be a bit of a negative surprise partly because of increased competition I think he said at that point that we think we are smart enough to figure out how to do both, be very competitive and drive a little margin.

I think we've done that.

Part of that is that we are very aggressive in terms of pricing to start with.

Part of that is fresh foods.

Part of it is private label.

Part of it is the upscale nature of our products versus our competitors.

So all those thing but we've seen a continued strong competitive front out there.

I think the good news for both of us is that our comps were very good.

I have not heard what theirs are yet.

But they historically over the last several months theirs and BJ's have been good.

So we are as an industry at least taking and growing our business not necessarily from one another but from other forms of retail and wholesale.

As relates to their focus on the business, well, so do we.

We focus on both.

We very much strongly believe that we are both a retailer and a wholesaler.

And we are very proud of our numbers and our average sales per warehouse.

And we think that the Executive Membership has gone a long way to improving even to a greater extent that business customer.

And to some extent the individual customer but certainly the initial growth in that area had to more with business members.

Same store comps were up 5% but would you say that you are still price leader, maintaining your price leadership in this area?

Well, as you well know and as many on the phone call well know is that, both of us claim to be the price leader.

I think a lot of that has to do with different items sometimes.

We believe that when we do our price shops all I can tell you is that we believe we are the price leader on key commodity items, things that count.

We are both very aggressive in terms of being competitive with one another and I think we respect one another in that regard.

But not every item is the same item.

And we are going, I am sure they would say the same thing we are going to be fierce out there and both consider ourselves the price leader.

Some of you out there have done your own price studies and some of them show that we are, some show that they are.

Of course, I am biased my way and I am sure they are biased their way.

Thanks Richard.

You next question comes from Gregory Melich of Morgan Stanley.

Hi, thanks Richard.

Just a little bit on the cash-flow and what you might do with that next year.

Basically it's a question of what is the CapEx increase I imagine is all because of the new clubs?

Yes.

Nothing else going on?

No.

That's essentially it.

And in terms of the free cash-flow it still look likes you have 2 or 300 million next year.

Should we still assume that that basically goes into increased dividends or share buybacks?

Well, we will have to see.

I can only tell you what honestly we've talked about recognizing that it's not like we've sat down - - we have actually done some analysis but I think it's but summed up as we are having the dividend discussions over the last couple of Board meetings that we are just starting that process.

Well have to see where that goes.

Ideally over the time I think companies like to show that they can improve their dividends and hopefully improve it in a consistent manner over time.

I think it's one of the reasons that we started where we did with it.

I remember one of the Board members a couple of Board meetings ago had said, where do you really good value over time, assuming you have net free cash-flow in excess of what your expansion needs are, and recognizing that we typically haven't gone out and done any major acquisitions, the comment was, "wouldn't it be nice if you looked out 5, 7, 8 years from now and would the investors value a dividend that consistently improved and even some stock buybacks over time on a consistent basis?"

Recognizing that we've only bought back stock only once to the tune of 3 million shares a few years ago.

And again we're stepping lightly.

We have a share buy-back program authorized although we have not done anything of late.

But I think over time those - - given that we typically haven't been terribly acquisitive, given that we are going to ramp up expansion hopefully if earning growth continues, in that mid teen or low to mid teen area that that would be, we would still be net free cash-flow positive, we have to do something with it and so those would be the 2 likely alternatives.

We haven't made any formal announcement that we are going to start a buyback program or we're going to increase the dividend but hopefully over time we can do both.

And just on inflation, you said that wasn't as bad as you thought it was going to be in the quarter.

Which categories was it not as bad as you thought?

Well, again, you are looking at a point in time when we talked in late May, that was a point in time and then of course the real calculation comes at fiscal year end point in time.

And I think some of the commodity crude items had gone up a lot and come down.

So for the whole year they were up a lot but not as much as they were through 9 months or 10 months.

That would be the principal area.

Okay.

Great.

Thanks, Richard.

Your next question comes from Deborah Weinswig of Smith Barney.

Good morning Richard.

You stated on the call there was a conscious effort internally to ramp up expansion.

Can you share with us how your real estate department is approaching this strategy differently than they have in the past?

Well, I think the only difference is is it's more.

Of course under Jeff Brotman, our Chairman, and Paul Moulton, EVP of Real Estate Operations, we have a large group of people out there that are out there in many communities looking for sites.

Part of the challenge is is gearing up over the last few years.

And in the last couple of years of focusing again on more existing markets where we think that we have plenty of opportunity and frankly opportunity that when do you open, you can see bottom line profitability a little more quickly.

I think it's simply more effort out there.

And trying to get more locations open.

I don't think we've changed our confidence level in terms of our ability that there's more opportunity out there.

As we've shown you in the past starting back in December a year ago when we had that analyst meeting out at our place and of late, in recent investor presentations that we think that there's plenty of opportunity over the next 8 to 10 years and we could easily go from whatever, 330 or so U.S. locations to close to 600 in the next 10 years.

A lot of things have to happen.

We have to keep being successful.

But when we look at markets in seeing how we can space these units closer to one another, we could open up more units and markets which a few years ago we thought were approaching saturation and to the contrary not only have we opened a few in those markets but we've increased the future expectations of additional units that those markets.

So, I think it's just more effort.

If anything, perhaps there was a little lull over the last couple of years.

One is we were digesting the '01 and '02 new market openings and the doubling of expansion from 15 or 18 units a year up to roughly 30 a year in '01 and '02.

And then of course, we had fewer in '03 and '04 per year.

And a little of that had to do I think given that we had opened in so many new markets I think if anything Jeff and Jim had become a little more stringent.

So notwithstanding the fact that we are perhaps a little more stringent on looking at budgets in terms of hurdle rates and expectations what a unit can do: we have more effort focused on out there in getting them open, not a big, not anything more than that.

And then you referenced back to the analyst meeting I was going to question, Jim had stated there this kind of 6 year goal of reaching an EBIT margin of 4%.

Obviously you've made significant progress in that direction.

Is there any update there?

Or any change in thought process in terms of the time?

No.

The only thing I mentioned kind of tongue in cheek at the time was is we could do 0, 0, 0 and then 40, 40, 40, because nobody would be around in 3 years to listen to us.

And least we've gotten off to a good start over the last 3 quarters since that December presentation.

Okay.

Great.

Thanks and congratulations on the great quarter.

Your next question comes from Robert Drbul of Lehman Brothers.

Hi.

Good morning Richard.

Could you talk a little bit in terms of the gross margin, do the private label efforts really drive that initiative and can you give us an update in terms of where you shall with that SKU count or penetration levels?

I don't have those numbers in front of me but we are roughly at 15% of our sales are private label.

And I think it's about 8% of the SKUs.

But that stands to reason, these are highest volume items and a lot of commodity items which tends to be high volume like paper goods and things like that, of that nature.

If you go back 5 years ago and I don't have the exact numbers in front of me but let's say the penetration of private label is 8% or 10% and we said 5 or 10 years from now maybe it can be in the mid to high teens.

Well today it's at 15 and we are saying 20.

I actually have heard in, whether it's in merchandising or hearing Jim talk that it could be in the low 20s.

I think maybe it's gotten a little higher than we expected in terms what have we see it ultimately it ending up at.

That's partly the success of those items but we have illusions that we still want to a branded supplier of goods.

That's where we show great value.

But we want to pick those opportunities where we have the ability to show greater value to our members and also protect some of our own margin and we will do that.

So, I'd say that it's ramped up a little more than we would have thought 5 years ago but I think that's all for good reason.

And looking today, if it's a 15, we are going, where could it be 5 to 8 years from now?

Probably 20 to 20 plus.

Great.

Can you give an update in terms of the Canadian market for you in terms of the profitability and since Sams has really gone in there what you are seeing?

Well, as we would expect that they would do when we entered places like Texas, we would expect the same the other way when they entered Toronto, we want to make it as inhospitable as possible.

And that has both a function of improving the locations, expanding a few, remodeling, adding couple.

I'm not sure if it was a couple or just one, before they entered and also what we already had very, very aggressive pricing, make it more aggressive.

And we are going to fight the battle.

We are still in Canada profitable recognizing Canada overall as an economy has been weak.

Again the local currency it's about flat plus or minus a couple of percentage points over the last year.

And that has not just the impact of that market where they've entered.

I urge all of you to go walk our warehouses and theirs up there and see what we are both doing.

We feel good about our fight and we are going to continue to make it as inhospitable pit apple as possible and focus on opening more units throughout Canada and make it more difficult on our competitors not only Sams but Loblaws and everybody else up there.

We have a great franchise.

I think the roll-out of the Executive Membership over last year which if you recall when we did that in the U.S. it has an initial negative impact because of adverse selection.

And but that's good that means that people are buying it.

And we've actually gotten off to a faster start up there in terms of the percentage of members taking the, opting for the Executive Membership and that locks them in.

And so we think we have some good competitive advantages up there and they are not going away and we respect them and we're going to keep on fighting.

Okay.

Thanks Richard.

[Caller instructions.] Your next question comes from Dan Binder of Buckingham.

Hi.

Dan Binder.

A couple of questions for you.

With regard to your expectations for next year, what are you including in the comp assumption?

And then once you've got that, I guess, where do you think you get SG&A leverage?

Is it a 4% comp next year, 5% comp?

I kind of have stopped predicting what percentage.

You take out a few of the things like the new market locations or some craziness with Workers' Comp last year but when we were trying to predict that last year.

But we still feel something in the 4% to 5% range on comparable warehouses, not new warehouses, not adding any impact of that, we can do.

In terms of our gross - - in terms of our own internal estimates for comps for this coming year, I think it's a little north of 6% plus.

Recognizing that we go from very, very slight inflation last year to a little higher expectation for inflation this year, still not a big number but, you know, a point here and a point there help, that underlying expectation.

We've just gotten off to a good start the first 5 weeks of the year.

Hopefully that will continue.

In terms of, what was the second part of the question, Dan?

Oh, the leverage factors.

The things that are helping - - that will help us is for a couple of quarters we get a little bit of a help from the roll-out a year ago in August of the increased labor commitments at the front end.

We went from about half a caller to every cashier or .5/1 ratio to close to 1/1 throughout the Company.

Initially if you recall some of our conversations in the past we estimated that was an initial hit to SG&A of 11 or 12 basis points.

But over the first 3 to 6 months we have gotten a little better about it and better scheduling that came down to maybe 6 or 7 basis points.

So now we are at let's say 6 or 7, we are going to anniversary in August, September, October, again so 10 to 12, you get a few basis points there and then it flattens out.

So, it goes from hurting us to helping us by a quarter or two by a couple of basis points and then not being an issue.

That's a little piece.

The healthcare is certainly still the big one.

The biggest impact to healthcare is over the first 12 or so months of the, once we've seen the impact and that big impact started in earnest in Q3.

A little towards the ends of Q2 but really Q3.

And then we will get a little more in the succeeding 12 months but not nearly as much as we had in the first 12 months.

And then we still have our fingers crossed in terms of we saw a little bit in Q4 with Workers' Comp.

But again I am not going to bet on that one until we see what happens actuarily in the upcoming quarters.

But logic would indicate that given the legislative changes, the craziness that we were impacted by that Workers' Comp over the last several years should subside a little bit.

So I think that those are the kinds of things that help.

And the blocking and tackling.

We've had some great initiatives at front end over the last couple years to drive costs out of the front end.

I know somebody is going to ask about RFID so I will address that.

We are working on it as are others.

We don't see - - the big impact from what I read at least is going to be a year or two out.

Perhaps even a little longer in the back end; at the receiving end, the distribution area or in our case, cross stock area, we have a lot of that benefit already based on what we've done given that structurally that will we are essentially pallets in and pallets out on 70% plus of our goods through our depots.

It will save a little bit of labor sticking stickers on but we already have if you will, online realtime knowledge of where that stuff is and is going and predestined for.

I think it's several years out before you see it happen and benefit the front end which is where we will get more relative benefit.

But getting back to the basic blocking and tackling, we are taking, we are looking at everything and I think that certainly healthcare and Workers' Comp were some big ones.

A little bit of front ends improvement in terms of speeding up registers, increasing the number of transactions per hour that we've succeeded in doing with the roll-out of some changes to the front end software systems.

Those are the little things that help.

I would be lying if I didn't say that we certainly are depending on having comps continue.

And certainly from a merchandising standpoint we feel we are at the top of our game.

Just a follow up to that.

Does the 6 to or 6 plus comp assume any benefit from currency or gas or is that just pure?

I don't think we are that scientific about it.

It's very much a bottom up approach so everybody is involved.

The warehouse managers, the merchants, the ancillary business operators and it all seems to work out.

Implicit in it I would assume is some of the assumptions I mentioned to a few of you over the last several months many of the paper suppliers weather it was James River Corp. or Scott Kimberly Clark or P&G with the various paper goods that they sell and the other consumer products that sell paper goods, all of these companies basically after talking about cost increases basically put out in April or May, this is going to be the 4% to 6% increases across the board on many items.

Now, that's on those items, not on the whole Company.

You are still seeing, a lot of deflation in electronics, that's deflationary, we create our own deflation as we switch an item from branded to private label at least for a short period of time.

The assumption on gas - - and I don't have the detail in front of me but I would guess the assumption on gas was its not going to rise percentagewise like it did this past year, it's probably not going to be any lower, it could be a little higher.

On the topic of gas one of your competitors today reported that the volumes were actually down recently, maybe in part because of the hurricanes but maybe because actually gas prices have gotten so high.

Anything that you can say on volumes or maybe some of the other extraordinary items that affected your comp in September?

Let me see here. 15%.

Well, I mean our gas volume comp was up but not up as much in September but not up as much as it had been in July and August.

So relatively speaking, yes, we saw a decline on that but it is still a positive number.

I honestly can't tell you off the top of my head why.

Okay.

Anything on currency or -- ?

Currency, I know there was month or two this past fiscal year when the impact of sales on currency was close to 300 basis points and for the year it was like 180, 190 basis points.

It's now about 100 basis points, I think about 110, 115 basis points.

That anniversary, 2 year anniversary I think that we don't again seeing - - we don't expect to see a lot of strengthening.

But just kind of of an easing of that year over year change because even if it stays the same it will ultimately get to 0 in terms of a year over year delta.

Thanks.

At this time there are no further questions.

Mr. Galanti, are there any closing remarks?

No.

Thank you to everyone.

And I am actually making this call from out of town on business but Bob Nelson and Jeff Elliot are back in the office and thank you all for listening.

Good bye.

That concludes the Costco Wholesale Corporation 2004 fiscal year end conference call.

You may now disconnect.