好市多 (COST) 2005 Q1 法說會逐字稿

Good morning. My name is Maryann, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Costco Wholesale Corporation's first-quarter earnings conference call. (OPERATOR INSTRUCTIONS). Mr. Galanti, you may begin your conference.

Thank you, Maryann, and good morning to everyone. To begin with, our 12-week first-quarter operating results. Briefly we came in at 40 cents a share, up 6 cents over last year's first quarter of 34 cents a share. These results are at the top end of our guidance that we gave back a few months ago and in line with current First Call consensus of 40 cents.

As I will review with you later in this discussion, this quarter's 40 cents figure was negatively impacted with a charge of approximately $6.5 million or 1 cent per share, which is our estimated retention cost of the four hurricanes in Florida this past fall. This past fall most of it related to Hurricane Jeanne. Excluding this charge, EPS would have been 41 cents, up 21 percent from last year's 34 cents.

In terms of sales for the quarter, our 12-week comp store sales figures showed an increase of 7 percent, 8 percent excluding the impact of EITF 03-10. And in terms of our three retail reporting months of September, October and November, our reported columns were 8 percent in the five-week September month, 8 percent in the four week October month and 5 percent in the four week November month.

Other topics of interest I will review with you this morning. Our recent openings -- we have opened a total of 11 locations since the beginning of the fiscal year on August 30. Seven of these are in the U.S., including one relocation and one Costco home, so a net increase of six actually. Two relocations in Canada. One new location in Japan, which is our fifth location in Japan. And also one new location in Mexico. Of course, Mexico we account for on an equity basis, so it is not included in our consolidated numbers. So seven net new consolidated units to date.

Four of these openings have occurred in just the past six days, including Arboledas, Mexico; Des Moines, Iowa -- that was last week -- Des Moines, Iowa two days ago on Tuesday, and two in Michigan yesterday in Green Oak Township which is our ninth Detroit area location near Lansing, and this morning in Grand Rapids, Michigan.

I will also discuss with you this morning the one remaining EITF pronouncement that will impact our year-over-year percentage comparisons through the end of the second quarter. This is EITF 03-10. I will also talk about our ancillary business results, Costco online, our membership results, provide you with our balance sheet and lastly provide you with some updated direction for Q2 and the remaining fiscal '05 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, we will start the numbers here. Sales for the quarter, the 12 weeks ended November 21, were $11.3 billion, up right at 10 percent versus last year of $10.3 billion. And as I mentioned, on a 12-week to 12-week comp basis, Q1 comps were up 7 percent or normalized 8 percent, excluding the impact of EITF 03-10.

For the quarter, our 7 percent reported comp sales results which by the way was on top of an 11 percent reported comp sales increase last year in the first quarter, this quarter's results were a combination of an average transaction increase of about 5 percent for the quarter, and a little over 1 percentage point of that 5 percent was due to the weak U.S. dollar or strong foreign exchange -- foreign currencies relative to the U.S. dollar. And an average frequency increase of up around 2 percent for the quarter. Cannibalization year-over-year was about the same.

Let me give you some quick geographic and merchandising breakdowns for sales for the quarter. For the first quarter, our Northwest region was up 4 percent. That compares to being up 5 for last year, all of last year. California was up about 5.5 percent compared to all of last year up 7. Actually a pretty good showing given that last year we had the 20 plus week strike in Southern California supermarkets. Northeast up 6 percent in line with all of last year. Southeast for the first quarter up 14 percent compared to 12 percent for all of last year. Midwest 17 percent compared to 16 for all of last year, which would give you U.S. total of up 7 percent versus 8 percent for all of last year.

In Canada expressed in U.S. dollars we were up 4 percent in the quarter. Now on a local currency basis Canada was actually down 2.5 percent. That more than entirely relates to tobacco pending a rumored big tobacco tax increase in Eastern Canada last year during this period of time. During the 12-week period last year, tobacco comps in Canada overall were -15 percent, and Eastern Canada what they sent back to us was even greater. It was something like a $15 expected tax increase. So if you take that out, that unusual fee from a year ago, we should start seeing it get that back now compared to last year going into the second quarter. Other international was 14 on a dollar basis and up 7 percent in local currencies. So all told a 7 percent comp for the first quarter.

In terms of California as I mentioned we have now begun to anniversary the Southern California supermarket strike which began last year on October 11 and was included earlier this year on March 1. But we still believe we kept a decent chunk of that business.

In terms of merchandise categories, food and sundries in the first quarter was up 6 percent. That compares to up 9 last year. Again, that up 6 is distorted by these unusual things in Canada (inaudible) tobacco last year. Hardlines up 4 percent compared to up 9 percent for all of last year. Softlines up 3 percent both all of last year and for the first quarter. Fresh foods up 8 percent in the first quarter versus up 15 all of last year. And ancillary business is up 23 percent in the first quarter versus up 27 last year. I might add that the up 23 percent in the first quarter excluding gas was up 15 percent. Total up 7, of course, for the quarter.

In terms of some highlights, within food and sundries again, as I mentioned it is notwithstanding the tobacco comp in Canada. Hardlines the 4 percent -- the strongest subcategory was majors. I think all of you know that consumer electronics are quite strong everywhere by single digits.

Within softlines the strongest subcategories were domestics and women's apparel offset by slightly negative comps and what we refer to as media. Really no big hits this year relative to last year when videos like Nemo, Lord of the Rings and Matrix had come out. And ditto for camera, toned down slightly this year in terms of comps.

Now moving to the line items, and that is by the way the film side of that business.

Moving down the line items of the income statement, starting with membership fees. We had good strong membership fees in the quarter outpacing sales growth. We reported $238.1 million or 2.10 percent. That is up 12 percent in dollars or up $26 million and up 5 basis points year-over-year, a very good showing given our comp sales results.

In terms of membership, we continue to benefit from strong renewal rates, which I will go over in a minute. The continuing strength and penetration of our executive membership program where we charge our members $100 a year and also new market openings.

In terms of number of members at Q1 end, Goldstar members 15.3 million households at the end of the quarter. That is up about 300,000 from fiscal year-end. Primary business members 4.9 million, about 100,000. Business add-ons, 3.5 million, down about 100,000. Again, a lot of the add-ons tend to become their own members when they become an executive member. So all told in terms of member of households, 23.7 million are up about 300,000 from 23.4 million just 12 weeks ago. And including spouse cards right at 43 million members versus 42.4 million members at the end of fiscal '04.

(technical difficulty)--. We took a charge in the first quarter which impacted SG&A by about 6.5 million, or by about 6 basis points. Again, if you will just jot down a couple of numbers for the first quarter of '05 year-over-year, and again I will ask you to do all of '04, Q4 '04 and then Q1 '05. The line items would be operations, central, stock options expenses, EITF 0310, hurricane, worker's comp and total. Now the worker's comp is only in there because it impacted last year versus the '03 year.

The operations for all of fiscal '04 was better or lower by 6 basis points, and better means plus in my example here. So plus 6 basis points year-over-year. In the fourth quarter plus 23 and in the first quarter plus 19. Central both for the year and the quarter last year was plus 7. For first quarter it was plus 2. Stock options for all three columns minus 4, and as you know, this is now the third year that we were expensing options. We would expect to see, assuming we continue to grant options as we have in the past, you would expect to see like amounts of impact to SG&A for both this year and the next two years given the five-year vesting of our stock option program.

EITF 03-10, which was a negative impact for all of last year of 7 basis points, so minus 7. Q4 alone minus 13, and Q1 '05 minus 8. In terms of the hurricane, of course, no impact in '04 -- these are the first two columns -- and minus 6 basis points impact to Q1 '05. Again, minus being higher. And again worker's comp just to have the basics here complete was plus 6 and plus 6 in the first two columns and, of course, no impact in '01 Q1 '05. So all told fiscal '04 overall we had 8 basis point improvement in SG&A, Q4 '04 19 basis points improvement, and Q1 '05 3 recognizing that that 3 includes 6 detriment from the hurricane and 8 detriment from EITF 03-10 which will cease to be an issue after Q2. I guess the number that we are most pleased about is the core operations number of improvement of 19 basis points.

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 should help our year-over-year expense comparisons. Of course, the health care changes that are now taking effect through the changes that we made in our health care plan, the anniversary of increases in the front-end labor costs that we did a year ago in Q4, hopefully continued good comps and also hopefully some impact in worker's comp related to legislative changes made in California. As I've indicated before, many of these legislative changes voted in over the past year will begin -- are taking effect or will begin to take effect on January 1 of '05. But I have also, as you have known for awhile, we have been trying to be a little conservative in the outlook of those changes. Hopefully we will see some of that this year.

Next on the income statement is preopening expense. It was actually just slightly higher dollars year-over-year, 10.1 million last year, 10.4 million this year. It is actually 1 basis point lower this year. Last year in first quarter we had nine openings with no reloads. This quarter here in the first quarter we had seven openings with two reloads, and of course, the three weeks immediately following Q1 this year we opened four more units. No surprises in that number.

In terms of provision for impaired assets and closing costs, for Q1 '05 these costs totaled 2.8 million pretax. That compares to Q1 last year of 4 million even for the quarter. The 2.8 million is simply our ongoing relocation efforts -- costs associated with our ongoing relocation efforts, whereby the costs associated with closing the to be relocated units are expensed upfront once the decision to relocate is made.

All told operating income for Q1 was up $46 million over last year's Q1 figure or up 18 percent to 300.6 million this year from 254.8 million last year. If you add back the $6.5 million of hurricane, which God willing will be a nonrecurring charge, that would be up about 21 percent versus a year ago.

Below the operating income line, reported interest expense was up about $1 million year-over-year, 9.6 million this year in Q1 versus 8.5, and interest income and other was up significantly higher year-over-year last year 7.9 million, this year 15.6 million or up, therefore, a little under $8 million. Virtually all of this increase was due to much higher investment income related to higher cash balances, (inaudible) balances earning prior average interest rates.

So overall pretax income was up 21 percent versus last year's Q1 from 254.2 last year to 306.6 and again added back the hurricane impact, so it would be up about 24 percent.

In terms of our effective tax rate, it came in at 37 even for Q1. That is a little lower than I had given guidance and estimate for in October when I mentioned that we would expect it to be about 37.5 percent for the year. We did have a onetime benefit in that number related to some international taxes. I would still then guide you for the remainder of the year somewhere in the mid to slightly higher than mid-37, so 37.5 to 37.75 tax rate.

For a quick rundown of other usual topics, I will start with the balance sheet as of November 1, and later today we will post this -- we will send it out to those who have asked for it and posted it as well both the balance sheet and the cash-flow statement.

In terms of balance sheet, cash equivalents 3 billion 226, inventories 4 billion 495, other current assets 1 billion 06, total current assets 8 billion 387, and net TT&E 7 billion 455, other assets 569, total assets 16 billion 410. On the right hand side, short-term debt 10, Accounts Payable 4 billion 469, other current 2 billion 559, total current 7 billion 038, long-term debt 858, deferred and other 246, liabilities total 8 billion 142, minority interest 60, stockholders equity 8 million 208, again for a total of 16 410. The only notable thing I will point out is that we have a five-year note coming due -- straight debt note coming due in June of '05 for $300 million. That, of course, accounting as you would expect take it out of long-term debt and put it into other current liabilities, and we will be able to say just write a check for it, and that is why the long-term debt went down by about 300 million.

A couple of things to point out, of course. Debt to cap ratio under 15 percent, probably on financial strength. Our Accounts Payable as a percent of inventories on a reported basis a year ago at the end of the quarter was 95 percent as you can see from the AP almost equal to inventories this year right at 99 percent reported. On a merchandise AP basis, Accounts Payable includes other types of Accounts Payable like capital expenditure-related Accounts Payable. If you took out that and just looked at merchandising, it was 86 percent a year ago and 83 percent at Q1 end. Again, that always fluctuates a little bit up and down. Still a very good number, recognizing that we always work to take the most discounts by paying as quickly as possible.

In terms of average inventory per warehouse, up about 5.5 percent, 6 percent from a year ago. A year ago the average inventory per warehouse which again of course we are now peaking at inventory. It is right before the beginning of Thanksgiving and the Christmas holiday season. A year ago at the end of Q1 it was 10 million 073 per warehouse. At Q1 end this year it was 10 million 677. Now that $600,000 average inventory per warehouse increase, the biggest components of that variance, about 200,000 per warehouse is simply FX, the weak dollar, a little under -- just under $200,000. About 200,000 is higher consumer electronics inventories, which again has been a boon for our business. Great stuff in that area. And also a conscious effort to grow our pharmacy business both behind the counter and over the counter, higher year-over-year pharmacy inventories of about 150,000 per warehouse. I might add that that is an area where the inventories are growing slower than sales as you know in the first quarter -- well, as you don't know. But in the first quarter, pharmacy sales comped at 17 percent year-over-year.

Really in terms of inventories flocking to the buyers, no inventory-related gross margin worries. Merchants feel our inventories are clean in terms of anticipated post-seasonal markdowns. So we are going into Christmas clean here.

In terms of CapEx '04, we spent in all of fiscal '04 we spent $702 million. Our original budget this year was right around $1 billion for something 25 or slightly more than 25 planned new openings. We actually spent in the first quarter 211 million. My guess is that will be right at or slightly below $1 billion, probably slightly below.

Next topic, Costco online. That is going great guns. We are up about 50 percent in the first quarter, and actually within the quarter that trend was up even further the last four weeks. And yes, it is profitable, and we will continue to grow that area.

In terms of expansion, last year as you know we opened 20 net new locations. As I mentioned three months ago in the quarterly conference call, our anticipation this year in the mid to high 20s net somewhere 25 to 27. A lot of it backloaded. As you know in the first quarter we opened seven new but three of them were reload, so only four new -- four net new to our consolidated numbers. We anticipate in Q2 to have an additional force '08. A lot of the additional expansion is in the latter half of the year with a lot of it skewed toward July/August. My guess is as usual some of those will fall out, but we are working hard to get as many in as possible.

My guess is that my previous direction of somewhere in the 25 to 27 might be 23 to 25, but again no change in what we're doing. Jim and Jeff are pushing the Real Estate Department here to continue to pursue opportunities. We've got probably more opportunities on the list. Many of them just take a little longer to get done.

In addition, we will open three units in Mexico this year, including Arboledas which we just opened. If you just assume again in terms of trying to translate this into percentage growth, if you took the, let's say, the 24 number you would be about 6 percent unit growth and about 6.5 percent plus square footage growth.

Finally, before I turn it back over to Maryann for Q&A, let me give you some brief direction on earnings guidance. As of our current First Call sheet in front of me data this past week, there is a First Call consensus of 54 cents for the quarter and 211 for the year. We feel quite comfortable that both of those are in the range of where we can achieve. Hopefully we can do a little better, but we're very pleased with the results so far this year. Again taking out the hurricane impact, earnings per share and everything else was up over 20 percent.

With that, Maryann, I will turn it back to you for Q&A. Thank you.

(OPERATOR INSTRUCTIONS). Deborah Weinswig.

Good morning, Richard. A quick question. You talked about the real estate piece, and I know there has been a conscious effort internally to ramp up expansion. Can you talk a little bit about your thoughts on why? I think that the new location in Des Moines was an out parcel at a mall, but can you talk about a lot of it was heavy on the real estate side, if there is a potential increase of this to go on a mall?

Well, that is an example of when -- and I think there will still be a few more examples of that in the near future. Again, I think the malls are new to us in the sense that they are becoming available as I have read and I'm sure many of you have read, that some of the mall traffic is down or weak. There are some outliers, and again when you're talking about mall as I understand, these are separate parcels, but we view that as an additional opportunity recognizing that there are plenty of malls out there. And as they view us as a help to that process of bringing traffic to the mall, that has become a positive. But I don't think it is a big seat change of the events that we are still working for all types of real estate, and certainly I guess it would be much like some of the vendors that used to not talk to us and now do and some of them even embrace us. Similarly with mall developers and others, some of them are talking to us and I am sure others as well.

Can you also give us an update in terms of what you're seeing on the inflation side?

Well, the thing on inflation, which was surprising -- I mean we would have all guessed -- again, taking gas out of it because it goes up and down so much every week -- but paper products we're still seeing what we had talked about six months ago, 3 to 5 percent inflation in many of the paper good products, be it toilet paper or Kleenex or Pampers or copy paper, things like that.

Surprisingly, not a lot of push related to the fact that metal prices had gone up and energy costs have gone up. We have not seen an across the board type of push. What we saw on the commodity side, food commodity side is some deflation in things like I believe butter, some of those types of items, that recognize part of that was -- I don't have my notes in front of me -- but last year we were talking about some of those things being up 40 and 50 percent. So if they are down now, I am making the numbers up of 10 or 20 percent, part of it is that.

Frankly, I'm surprised that it is a little deflationary, but it is what it is so far and again we booked nothing. We will see how it goes over the rest of the year.

Okay and then lastly can you also update us on your thoughts in terms of membership fee increase?

Well, the last quote I heard from my boss, Jim Sinegal, was, "not this year," and that means not -- and when he said it, it was back in June at a conference, and it was I think he was talking about this calendar year. We have not made any decisions. I think what we have said in the past still remains. There is no reason to believe that we could not do it successfully. At some point, we probably will, but we have made no decision as of yet when.

And you know, our feeling is that yes, comps are fine and yes, our renewal rates are great and we are at the top of our game merchandising-wise. But we also recognize the economy is not so hot and competitions out there is tough, and let's not be so arrogant that we think we can just do it anytime. So we will continue to look at it, and you will be the second to know.

George Strong.

George Strong. You know we can see that the supermarkets are investing heavy promotional dollars to bring traffic back to their stores in Southern California. I mean that is evident in Kroger, Safeway, Albertson's statements. You seem to be weathering that extremely well. Could you give a little bit more detail about any special steps that you're taking to retain share in California, particularly in perishables?

I think probably the biggest step we have taken is the continued reenforcement and warnings from Jim at the budget meetings every four weeks to the operational merchants down there, let's not give any of this back. Let's -- as we reinforce the time of the strike, let's make sure we are in stock and full-service and on our best foot forward and then some during the strike. Let's make sure that we are out there focusing on it. There is nothing unusual we're doing in terms of marketing there versus anywhere else.

The other thing is we had a very successful visit to one of your clubs this week, and we learned that the company is testing an iMac POS system in four units, and this is supposed to allow for more rapid scanning. Could you comment on how this test is progressing and what you might hope the new scanning technology would accomplish?

Well, I think it was random that you happened to be at a location where it was done. We are testing things in different locations all the time everywhere. Our focus over the last couple of years, particularly as we focused on SG&A and recognizing 70 percent of SG&A is labor and benefits, and probably a third, not quite a third, but close to a third of that is front-end labor, maybe 30 percent of it. And so anything we can do to speed up the (technical difficulty)-- we have tried.

As you may recall, about three years ago we spent $15 or so million on -- or $12 or so million on faster printers for the register tapes that saved 10 or 12 seconds per transaction or something like that. As you well know, last year we spent -- we devoted the equivalent of $40 or $50 initial million a year to increasing the number of callers per -- the ratio of callers to cashiers in the front end to push people through the front-end faster, recognizing it's not just getting people through the line faster in many high volume locations. It's getting another card available for the next customer. It's getting another parking space available.

One of the things that we're doing is we are constantly looking at all types of POS technology as it relates to scanning, as it relates to payment processing, be it debit, credit, all types of things like that. And recognizing that from our view given that our average unit as an example in the U.S. is over $120 million, which means you've got a lot of units at $150 to $200 million as well, anything we can do to speed up that line we're going to try.

So in terms of the progress it continues. We are probably -- your example of this one test is probably a half-dozen different types of things going on with front-end stuff.

Greg Melich.

Two questions. One, could you just give us a little more detail on Canada and why the comps there you think are softer once you back out the FX and even adding back the tobacco stuff in the U.S.?

And then second, some more detail on the improvement in operations SG&A? How much of that 19 basis point increase, if any of it, is the health care plan already? And have we already seen in your opinion some of that or to give us some flavor as to how big that has been so far?

In local -- in Canada in local currency excluding tobacco, we're in a little bit better than mid single digits. The weakness in Canada is more so on the non-food side. I just talked to Joe Paturo (ph) who runs East Coast in Canada two days ago on something else, and I said, so what is going on in Canada knowing that the tobacco was the big thing?

The feeling is that it has been a weaker economy up there. I might add and I have gotten this question from some of you on a one-on-one basis, how much of this is an impact of Sam's who as you know entered the Toronto area and one other location. That is frankly a very very small piece of it. Because it is so few units being impacted by it and frankly the impact per unit in that competitive issue is not that great as it is anywhere. Us versus them or them versus us frankly. We generally take new business from other retailers, not from one another a lot.

So really as we scratch our head, we're ever diligent in trying to be competitively priced, not only with another warehouse club out there in some limited markets, but also the likes of Lob Law's (ph) and Real Canadian Superstore and all the good retailers that are up there. And there are several good retailers. I think overall when push comes to shove, the food business is strong which means we are getting the customers in the door. The non-food business is weak, which means discretionary income is probably a little weaker up there than it is here. We continue to work at it.

And on the operations improvement?

The operations improvement? A little over 10 basis points is health care. You know our plan when we implemented it back in October of '03, we recognized that the big impact -- that just meant that new people going into the plant were impacted in October. All employees would be impacted come January 1, and given that there it is a lot of health care related activity -- in other words, people taking themselves and their kids in to get that last dental appointment or that optometry appointment, that eye test right before the end of the calendar year, because if they don't use it by the end of the calendar year they lose it -- what happens is other than for sickness, you have got a lot of health care expenditures and usage in the last couple of calendar months and then it falls off in January and February. So what happens is it is really March-ish before we saw the big impact. March for us is the beginning of Q3. My guess is that -- and then in terms of our program, the changes we have implemented are staged over four years with about half of the improvement coming in the first year and then about 1/6 coming in each of the next three years. So again simple extrapolation would indicate that we should get another decent pickup related to health care, all things being equal, in Q2 and Q3, more so in Q2 probably than in Q3, at which time that kind of anniversaries a little bit more going forward over the next couple of years.

Now it depends also when health care inflation occurs. I read every day about there is some trend to see it coming down a little bit. We will see. So that is where it is. Again, the next biggest chunk is payroll. And again payroll is a function of a lot of things including comps, including the anniversary of the front end one-on-one, not at a company now, but it is not hurting us anymore, and you know speeding up the front end.

Emme Kozloff.

My question is on membership fee. It looks like the income continues to grow double-digits even the total membership grew only about 2 percent. How much of this is coming from currency gains and how much from increasing penetration of executive membership? I'm trying to get a sense of what could keep the membership team number moving up without an increase in the base membership fee?

I had to calculate off-line the increase from FX. Frankly, very little of it I think is FX. The biggest chunk is going to be the continued penetration of executive membership both in the U.S. and in Canada, and then, of course, in Canada a little of it is FX.

I bet you -- I will do it off-line, but I'm willing to bet that if membership fees were up 5 basis points, it might still round to 5 and at worst-case it would round to 4. So in other words, it is still growing at a rate faster than total sales dollars at this point.

The big catalyst, needless, to say is going to be executive membership. What continues to surprise us, and I think good news for that program also, is that you would expect the no-brainer executive members to sign up for it. The customer who is already spending 25,000 a year and says, hey, I can pay $55 and get a check for $500. At the cusp somebody who is spending about $2500 a year, $2700 a year, it would be about a breakeven. But we are seeing more more of those people plus and minus that cusp signing up for it, partly because we are marketing to them in the warehouse. And once they do, affinity programs play well, that we see better comps than those guys. So I think that is the first order of business.

The other order of business I got to believe is the press that we get constantly on a one-off basis, whether it is the local news consumer advocate or Oprah or Ellen DeGeneres or you name it in terms of their shows where they are mentioning Costco, and the good articles fortunately that we have gotten in magazines and newspapers like USA Today and Wall Street Journal and Forbes and Business Week.

So basically the double-digit increase, though, it sounds like if you can see this executive membership go from -- it went from 14 to 15 percent penetration -- if that just continues to eke up, we should be able to see relatively decent growth in fees irrespective of an increase in the base membership?

Absolutely. Absolutely. For how long we will see, but yes.

Daniel Barry.

You mentioned you are still the price leader. Could you just give us a little flavor on the competitive environment out there, not just among B.J.'s and Sam's, but just are you seeing any competition anywhere in the supermarket or the electronics guys?

Well, first of all in terms of on the food and sundries side, I mean we price check supermarkets, but not needless to say as diligently from the standpoint that we are not going to do loss leaders for their weekend sales and frankly the value savings is dramatic a lot of times because of the bigger backside to Costco and the value.

I think what we saw in Southern California, which again has given us a little confidence in that regard, is a lot of the business we picked up, we kept partly because is that typical customer that always shot to Costco, but never bought their meats at Costco because they bought them at the neighborhood butcher or at the fancy supermarket nearby. When forced to do so, they liked it and they continue to do so. So a lot of it is that blocking and tackling and getting out there with exciting items. What was the other part? I'm sorry.

Just the pricing versus your main competitors and then versus electronics, which has been a hot area?

We find we like the home improvement category, dominant retailers. You know, a lot of times we will have different items. We might both sell the same name brand of a high-end cordless drill, but if there is -- that manufacturer has 10 SKUs of it, if we are selling two of them, we find the other guy choosing to sell the other eight because they don't want to sell it 10 percent or whatever.

I think again on commodity items we are all tough. We all work on low margins, on copy paper and things like that. There is so much disparity in model numbers and how many megahertz or gigahertz or size of screen, that sometimes it's hard to compare. What we have found, though, is again it is getting back to that customer trust, our members trust us partly because we are so fanatic about being trust capable, and that is just reinforced every time out there.

In terms of our direct competitors, needless to say we're competing most feverishly with them. More so probably in the Sam's and the B.J.'s as B.J.'s themselves have acknowledged that they have expanded their product mix and gotten in some cases out of certain categories. We and Sam's -- I think they would say the same -- we're both fierce competitors.

I have seen -- one of the questions I get sometimes is that, hey, Costco, you and Sam's both say you're a price later. How can that be? Well, it's how you look at it. We are both going to fight tooth and nail on commodity items, on basic branded items. We have different sizes sometimes; we have different brands. In our view we tend to trade the customer up to the next level of quality. So sometimes the pricing differential might be to the extent that we are little more expensive, we have a different product. We still consider ourselves the absolute price value leader, and I think it is evidenced by the sales productivity of our locations and the comps at our locations.

The good news is we're both gaining market share. We both have -- all three of us, frankly, have pretty healthy comp shows at the retail. So we are taking it from others as well as fighting amongst ourselves.

Okay. So from what you are saying, the fact that you did not have any inflation first quarter is more a function of no increase in cost as opposed to a more competitive environment?

Completely because that is really a cost issue, not a price issue.

Got you. Okay. thanks.

Todd Slater.

One of the things I noticed in our last store visit was that we got solicited by an employee for executive membership signup, while waiting at the checkout line, and I'm just wondering if you guys are making a more aggressive effort to upsell on the executive membership side in lieu of a Goldstar membership price increase?

And secondly, just as it pertains to the toy assortment, we did not see as strong an assortment as in the past in toys, especially on the girls side. And I'm wondering how important toys is in December and how is that business performing?

And then my last question is about warehouse club openings. With the eight clubs planned in the first half and 16 the second half, if you could give us a sense of the number of openings in existing markets versus new markets, especially with an eye towards your thoughts on cannibalization? Thank you.

Okay. In terms of Goldstar versus executive, there is probably an ebb and flow in terms of executive member marketing and it is an ebb and flow regionally. It depends on where a given warehouse manager or a regional manager is deciding to put what I will call their marketing dollars, which is the people that are out there doing sometimes the new American Express co-branded card, sometimes the executive member.

Clearly I mean we believe in the executive membership program, and clearly we believe that every new one we sign up now is even more important because it is more closer to the cusp of breakeven from day one instead of having to depend on what the comps are going to be in the future.

And as it relates to that, saying, hey is that more of the focus instead of thinking about raising the fee? No. Please don't put a lot of energy into trying to figure out why we have it or when we will do a fee increase. There has not been a lot of brainpower on our end spent trying to figure out went to do it or should we do it. Our feeling is historically we felt comfortable that when the value proposition is there, it gives us the ability to do it if we so choose, recognizing that as always we will use some of it to be more competitive in other areas. And that level of confidence and being able to do it is the same as it has always been.

I think our competition is tougher. Why give our competition any additional leg up. Why be arrogant in an environment where we have -- we are having good numbers and the economy is not so hot? So I don't think there is a lot of understanding of why we have not done it yet, other than we have not done it yet, but it has nothing to do -- there is no relationship between doing that and marketing the executive membership.

In terms of toy business, I'm just looking at comps for the quarter here. Bear with me a second. Our toys business is actually right around flat year-over-year in terms of a comp basis, and actually the toy business is up a little seasonal -- that department for us is toys and seasonal, but which includes toys, electronic and nonelectronic, as well as Trim-a-Home and wrapping. It is the Trim-a-Home and wrapping that is actually slightly down and toys is slightly up.

I think given there has been the deflation in some of the electronic stuff, we have been selling some of the hottest things like iPods and Nintendo DS, but like everybody else you put it out there and it is gone in two hours and it is limited supply.

I cannot respond to your thinking about the girls' toys. Off-line, Todd, I will find out and give you a call after I talk to the buyer.

In terms of openings and how many of them are existing markets versus new markets, without doing an exact calculation, I would say at least three-quarters or 80 percent are probably -- at least three-quarters are existing markets.

Okay. Would you expect any sort of increase in cannibalization given the existing market openings from last year and the ones that you're planning this year?

No. You know if I look at the first quarter I would say it was about even. Maybe it was 10 basis points to the detriment. Some months it is 10 basis points to the positive -- not being positive year-over-year -- just positive year-over-year versus how it impacted us a year ago.

Not really. If anything, if my memory serves me well, in the first half of last year we probably when we did that calculation, which simply just takes all the cannibalized units out and says what is comps with and without those cannibalized units? I think at its peak cannibalization was somewhere around 90 basis points. In November cannibalization was 71 basis points, and it was higher a year ago or nine to 12 months ago because if I recall correctly within the cannibalization we had opened six units in the Bay Area over a six or eight-month period time which impacted 12 other high-volume units. I, frankly, don't see anything that extreme, so my guess is that I do not see an impact greater than we have seen currently.

Could it be 80 basis points instead of 90? Sure. But I am sure it will fluctuate between 50 and 90 as it has over the last few years.

Great. Thanks for that.

Gary Balter.

Two questions if we can. One is, if you would remind us about share buyback if you have one, and are you doing any first of all?

Well, we have one. We have it. To be honest we did buy some stock back in the low 30s a few years ago. I remember last August, August of '03 actually, and we all remember when we announced -- we reduced our guidance for the quarter and we saw stock go from the high 30s to the low 30s overnight. Our intent was to wait a few days to be consistent with our own blackout policy for employees and to wait a few days after the release to let the market digest the news.

And frankly, I was caught a little offguard in the sense that stock -- I don't have the exact numbers -- but let's say the stock went from 37, 38, down to 31. Within a couple of days, it seem like it rose about a dollar a day for three or four days. So all of a sudden it was back to 35 or 36. In hindsight, we should have done it.

In talking to the board about it, in terms of more importantly what do we do with cash given that even as we ramp up expansion a little, our cash flow -- our operating cash flow should outstrip it. My guess is that in discussions that we had nine months ago when we initiated the dividend was that wouldn't it be nice six or eight years from now to look back and say, hey, the Company has a dividend, it continued to improve it and the Company on a regular basis bought some stock back.

What we're not going to do -- what we would do is be opportunistic. What we are not going to do is just do it so we can make an announcement for one day. And I would expect that over time we will buy back stock, although we have not pulled the trigger on it. As the stock has shown such great strength over the last nine, 10 months, given perhaps a little naivete on our part, we have not pulled the trigger. So that sounds like a weatherman, a definite maybe.

But yes, we have a program in place I would expect us to use at some point. I would expect us also to be opportunistic, but hopefully we don't have the opportunity to be optimistic. So stay tuned.

And then the second question, or I will make it 1B and then I will ask that question, you mentioned the tax rate is going up. Did I get that part right?

Well, what we said three months ago was that for all of '04 -- actually it was right at 37 percent -- and that included in that were some issues internationally that helped us a little bit, that we would expect the tax rate for this year in terms of budgeting purposes to be closer to 37.5 -- call it 37.5.

The first quarter we actually calculated it out as you are required to do, of course, and all the little things, and it actually came in right around 37 percent. So we booked 37 percent. In talking to our tax director, she believes that looking forward for the next three quarters that it is probably going to be best guess, and again all she can do is take the numbers that Bob Nelson and Jeff Elliot and I provide her by division, by country, by state, if you will, because the state income taxes, and do their best guesstimate, if you will, of what the rate will be. Her best guesstimate at this point for the remainder of the year is something in the 37.5, 37.75, which would put us at the year closer to that 37.5 direction that I provided.

Okay. You talked at the analyst meeting a year ago or a year and a half ago, Jim talked about 20 basis points a year in margin improvement. Then when you just play with the model, 20 basis points this year, assuming that we are on a consistent basis, would get you to more than the current estimate guidance. Why wouldn't we be higher than the 211 type number?

Well, we could. Again, I think it is kind of funny, somebody a couple of weeks ago was out here and asked, Richard, what do you lose sleep over? What do you lose sleep at night over as it relates to the business? I thought for a minute and I said, and not to sound arrogant, but frankly I'm too busy to lose a lot of sleep, but things are going pretty well operationally, merchandise-wise, competitively.

What I lose sleep over and not a lot frankly is more as it relates to the short-term stock price movement because short-term stock price movement is impacted by expectations and the fact that at some point, and perhaps this quarter is a good example that we just announced, that if you look at Qs 2, 3, and 4 last year, we beat those by a little bit. We looked at the members feeling that we did pretty darn well, particularly if you take out the hurricane and given that comps came down a little bit from -- still strong, but came down a little bit. So we're showing that even on a little lower comp we can show SG&A improvement and basic payroll, not just the health care changes. And there is no reason to feel that we cannot beat those numbers.

The economy is not exciting, and I'm not speaking about any impact on us over the last few weeks, so don't read anything into that. But the economy is not exciting, and we want to see where it goes. We are doing great as it relates to merchandising and competitiveness, and you know I would still stand by Jim's goal of a six-year period to see that improve on average 20 basis points a year.

So then we are sticking with our estimate. Thanks.

Steve Baumgarten.

Most of the questions have been asked, but maybe if you can just answer -- talk about the kind of initiatives you're taking to release speed the lines of checkout. I know you mentioned to George's question a half-hour ago that you have some of these tests going on. But in terms of this Christmas, are the noticeable things that are going on aside from adding the second person as you speed through the lines to expedite the customer experience?

No, the biggest thing clearly is adding the additional person or an additional half a person on average because we went from about a ratio of .5 to 1 or up to about 1 to 1 or some high-volume warehouses may be 1.1 or 1.2 to 1.

A lot of the other things are just that test. We are doing some automated checkout. We are doing some tests I think similar to what Home Depot did in terms of self checkout. We are doing some things as it relates to -- I know at many retailers you actually don't sign the receipt for the store, you sign a PIN pad, and we do that in our pharmacies. We have not done it at the front end as of yet, but we are looking at things like that. We again are testing a couple, three different register systems as we always do, although we are currently and are very happy as an IBM shop in that regard. And then we continue to look at things that they offer us as well as some of their competitors. So there is nothing earth shattering that is going to happen between now and December 25 other then focusing on that.

The other thing is that we try not to do anything in the front end that is slows it down in terms of price lookup. Things like, you know -- the other thing actually we are doing, there have been some efficiencies over the last year on the networks that we use to process debit, credit types of items. We frankly had a little snafu a couple of weeks ago with a value-added card for phonecards which simply was related to the fact that like a debit and credit card payment, that card with no value has to go through the front end and out to our service provider to be initialized with the minutes that the customer is buying. And because of the huge success of some things we have done in that area, we overloaded the system a little bit.

So one of the things that we constantly are watching is, let's make sure as we do things like accepting membership renewals and membership upgrades at the register, which was a big benefit of our member rewrite system a year ago, make sure that those things don't overburden the system.

So a lot of blocking and tackling and continuing to talk to vendors. You know the whole question of RFID is still a few years out as I'm sure many of you read and what is indicated by others out there, both retailers and suppliers of this technology, as well as manufacturers. It is going to impact the back-end first -- the receiving end. We do a lot of that already. The RFID is not going to be as impactful to us. Where it will be more impactful to us is at the front end, but that is still probably a few years away.

Theresa Donohue (ph).

Follow up on Gary Balter's question before, could you update us on your thoughts as to your cash which is obviously growing? I know you would say CapEx, etc., but even, so it seems as though you have a very high-class problem here.

Well, what we're not going to do is go out and make any strategic acquisitions so not to worry about that. There's not a lot of magic to it. We're not going to double our dividend tomorrow. We're going --I would assume and I would hope over time that we would at least on an annual basis review it and the board will review it although that's not up for another three or four months.

I guess April is when we initiated it a year ago. So I would assume we will increase it over time but that again is going to be book just as they say a very small impact relative to expending cash. And we will try to ramp up CapEx but that's -- that is going to be limited to what we can find and what we want to do qualitywise and not change our standards.

So really, you're right. We have the $3 million debt payment in June. We have another $300 million debt payment in '07, I think it is early '07, so there is 600 million of it to take to use.

But beyond that you're right, stock buyback. And I would suspect at some point and not tomorrow, but at some point we will become a little more disciplined, or we will start a process that would be more consistent. But I cannot tell you when -- I can tell you that and, hopefully, again we don't have that -- but we would be a little more opportunistic and less naive if we stumbled.

But that certainly is not in our budget to stumble.

(OPERATOR INSTRUCTIONS). Sheri Ebert.

I just wanted to talk about returns on capital for a minute. Obviously we've seen some improvement over the last years. The operations have improved. But still relatively low, relative to some of the other off the mall retailers.

I was just wondering what your goal is there in terms of returns and then any programs you have in place to improve those?

Well, I understand how the return on assets and return on invested capital and return on equity models were. Our basically -- we're going to -- I think the biggest improvement is going to be on driving the bottom line as Jim had indicated last -- a year ago at the analyst meeting to try to get that on average 20 basis points a year improvement. Clearly we've got to do something with our cash.

We're not just going to go out today and buy $1 billion of stock back though, so I would just ask you to be patient on that. Again the biggest driver is going to be earnings, probably the second biggest driver is going to be the other two things I just mentioned to Terry on in terms of trying to get some more sites going.

We have got a lot in the pipeline, and ultimately, getting on a regular course to buy back some stock. But again we have not pulled the trigger yet.

Okay. And just the second question, I did not know if you could give us any more specifics in terms of what tabled comps you are including in Q2 or including in the year when you're indicating the comfort with current consensus. And then any read on the holiday that you have at this point -- the Christmas holiday.

Our original budget for comps was a little north of 6 -- I mean it rounded to 6. And you know without a lot of magic here and I would say, still, that is our direction and comfort level. I probably had a little comfort below that a little bit. And more comfort a little above that.

In terms of -- the last couple of weeks have been fine. We have, again, if you look at November, I think it was Bob mentioned it on his audio conference call regarding monthly sales, that I think it was week three when this big rumor in Eastern Canada -- it was like a $15 a carton anticipated tax increase. Went on for several weeks. So we saw wholesale and our retail customers -- the small -- the retailer customers -- you know the convenience store owners that come in and buy $5, $10, $20,000 a week in tobacco, coming in and buying 30 and $40,000 a week because when the tax increase would ultimately occur they would keep that savings themselves because they'd raise prices.

And so we saw that unusual thing. Again that at some point will anniversary and that will help us a little bit for a couple of weeks. But taking that out, the last couple of weeks have actually been fine.

Bob Toomey.

Just a couple of questions I don't think anybody has asked. Richard, you mentioned earlier that you still feel comfortable that you can continue to see improvements in gross margin. I'm just wondering obviously buying economies are part of that, but are there -- where would you see looking forward the biggest impact you would see in improving gross margin? And then I had another question on your use of cash.

Well in terms of -- again improving gross margin -- first and foremost we're going to remain competitive. And as many of you who know Jim would chuckle, he would be looking at you right now and saying "don't ever lose sight of the fact that we are going to do whatever is required to be out there and be tough. But we're also going to be looking at a private-label, and we are also going to stand out in terms of the types of items that we sell, which -- where you can discern a difference -- I mean copy paper is copy paper. But you know, Heinz catsup is not Hunt's catsup. So we are going to continue to -- and cashmere sweaters are not cotton sweaters. And so we're going to continue to upgrade our merchandise. We are going to continue to excite the hell out of you with fresh foods expansion and continue to try new things. Throughout the country we have got lots of things going on in different markets as it relates to fresh foods. And all of which are little things, but all of them add up to the equation that we have built over the last 20 years. So I think we will continue to be able to do that.

Okay. And then as you mentioned earlier there were a couple of questions on your cash position, which is growing because of your free cash flow. I guess my question would be would you see yourself accelerating your store expansion, or would you see yourself potentially looking at an acquisition of some sort?

I would say the latter is most unlikely. Our MO has been to grow our sales and to do what we know how to do best, which is open warehouse clubs. Jim and Jeff are pushing real estate -- and Jeff is real estate recognize, but they are pushing the real estate department to keep doing more. Again it is tougher to do these days. But we have got probably two or three times as much stuff in the pipeline as we had two or three years ago to get 10 percent more stuff done. But now that the pipeline is full, I would think and hope that over the next couple of years you will see that easier for us to increase the number of units because we have certainly identified them.

And you're not concerned about saturation?

No. Again I don't mean to sound arrogant. Every time we open a unit in an existing market we just knock the cover off the ball of late. What we find is when you're 10 to 15 minutes away from your customer instead of 30, you get a few more to sign up and you get those that are already members coming in a lot more often and buying a lot more stuff.

Okay. My phone is going off. Sorry about that. (indiscernible), I have a question on depreciation and amortization expense in the quarter. Do you have that available?

And again, it will be hopefully later today on our Web site. But let me give that to you. Do you have that handy? Hold on we are pulling it up here. For the quarter .09087, which is up from 97.3 million a year earlier. So on annualized and for all of last year it was 440. We see that number rising around 40 or $50 million a year, so somewhere just under 500 million will be the number this year is my guess. Recognizing that 109 is for 12 weeks, but our fourth quarter is always 16 weeks.

Dan Binder.

Just a couple of questions. First maybe you can give us an update on these business service centers that I guess you have been building in terms of how successful they have been? And how many you have currently in, and what your plans are? It sounds like the last time we spoke they were doing okay. I just want to get an update on that. And then secondly just on the SG&A trends, I guess as you come up against the health care benefits that you're seeing now, I guess March sounds like that's when you start to anniversary this. How should we be thinking about SG&A in the back half of the year versus the front half of the year just maybe directionally in terms of the kind of basis point leverage, maybe relative to what we just saw ex the hurricane?

Well, the second question is harder. I mean we would hope that it continues. When you're talking -- I would assume the same but I could be off by 10 basis points. I'm not trying to be coy about it. Clearly the bigger impact from health care will be -- will continue to be in Q3 -- Q2 and Q3 -- not as much as in Q4. I would hope to see some impact positive from worker's comp by starting in Q3 and Q4, but again we will wait for that to occur. The other thing of course which is a freebie is this EITF 03-10, that will be again as it was an 8 basis point hit -- I think 8 basis point I said hit -- whatever I said before -- hit to Q1 SG&A. It will be a roughly light number in Q2 and then go to zero by definition. So that again should be a net help in terms of year-over-year deltas in Q3 and 4. So it sounds -- again from the 40,000 foot level it sounds and feels like we should be able to continue what we have done.

Okay and just on the business service centers, anything new?

Yes. We have four of them. They are doing fine. We are not going -- I would guess we will look to open another one or two over the next 12 or 18 months. And we keep tweaking it, and they are profitable but it's not like we're looking to go and open 20 a year next year. We also did just open our second Costco Home in Tempe. The first one we are happy with. The second one is off to a better start, recognizing it is located next to 100 -- significantly more than a $100 million warehouse right on the same property. So you get the added benefit of having those three or so thousand customers that are transacting at regular Costco every day in the parking lot. And so we're excited at what we see, but we are learning from it. If Jim were here he would say first and foremost let's talk again in six or twelve months. Let's see if we want to open another couple. Let's see where they go from there.

Are those included in -- as you open those up, are those included in your store opening plans for this year? Or is that pure Costco --?

Yes they are. But recognize for all of fiscal '05 it includes the one Costco Home.

Okay. Just the last question. On the front end labor as you've lapped that -- interestingly your traffic turns the last couple of months have been a little bit soft. I'm just curious if you think it is strictly just the supermarket strike coming up against that or the end of that, that has impacted traffic? And is it just in California or do you think there's additional front-end labor that helped you for the last 12 months -- has just created tougher comparisons on the traffic side?

I don't think it is the latter. I think the California thing is a little bit of it. You know, unfortunately not all retailers break out their comp in terms of how much is traffic and how much is transaction. I would like to think that our number still is a little better, and a lot of it is -- probably some of it is what I will call frequency enhancers or related. As we now have pharmacies in most of our locations. As we now have 210 or 15 gas stations, not 100. All those things were, going back 10 years, have been frequency enhancers. We are still adding a few but not as many percentagewise. And we're opening many more units with them. So that is already in that comp number. By the way, another thing is I think we start off better in markets both new and existing where we open the unit, so in terms of the year-over-year Delta, we used to open a new market unit -- you know you might do 30 or 40 million in the first year and then it jumped 30 percent for a couple of years in a row. Now you do 50 or 60 and it jumps 15 percent in the next year. That by definition would slow that calculation down a little bit. But I don't, rightly or wrongly, read a lot into the last two months other than part of it -- I think some of it is the economy.

Okay.

That is what I have said for a year by the way. I mean I'm not trying to suggest that that's an excuse. You know, we are helped -- on the one hand you would argue that a weaker economy or people that are already fully loaded with debt and home equity loans, and then interest rates are going up a little, that you would see some big ticket items slow down. That has been offset of course over the last year by such great new cool stuff in consumer electronics at ever-lower prices. So you've got some diverging trends there. You know I guess we need to have the conversation again next quarter to see where it goes. Because again, the last couple of weeks have been great and we don't view that number as being concerned about anything at this point.

Lloyd Beadman (ph).

My questions on Costco Home and the traffic were taken, so I would still like to know could you tell us what the online revenues were in the quarter? I believe you gave us just the growth rate.

Yes. It was, I have it right here -- it was (inaudible) year-to-date sales -- just under $90 million. And our budget last year was about -- our sales for all of last year were three -- 367, 370. And our budget for this year was in the low to mid fives, and so far we are beating it a little bit.

Great. Thank you.

At this time there are no further questions. Mr.Galanti, I will turn it back to you for closing remarks.

Thank you everyone, and we will be here today to answer any additional questions. And we look forward to seeing and chatting with you in 12 weeks.

Thank you. This concludes today's Costco Wholesale Corporation's first-quarter earnings conference call. You may now disconnect.