好市多 (COST) 2005 Q3 法說會逐字稿

Good morning.

My name is Meredith and I will be your conference facilitator.

At this time, I would like to welcome everyone to the Costco Wholesale Corporation quarter three earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] Thank you.

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

Please go ahead, sir.

Thank you, Meredith, and good morning to everyone.

As usual, I'd like to review with you several items.

To begin with, our 12-week third quarter fiscal 2005 operating results, this is for the 12 weeks ended May 8th.

Briefly, we reported earnings per share of $0.43 for the third quarter, at the high end of our recently revised guidance of $0.41 to $0.43, and $0.01 above current First Call of $0.42.

These results were up 6% on a net income basis and up about 2.6% on an EPS basis.

I should mention that last year's third quarter results included a $12.2 million pretax real-estate gain from some real-estate sales.

Excluding these gains, net income was up 10% and earnings per share were up 7%.

In terms of sales for the quarter, our 12-week comp sales figure showed an increase of 7%.

As you hopefully know, we have finally anniversaried the impact of EITF 03-10 as of the end of the second quarter and we're now back to apples-to-apples, year-over-year comparisons.

In terms of the three retail reporting months most closely aligned with our fiscal third quarter, that would be February, March, and April, our reported comps were 7%, 7%, and 8% for those three months.

And as you know, we will report the four weeks of May next Thursday, June 2nd.

Other topics of interest in our review this morning, our recent openings.

We opened a total of 15 locations since the beginning of the fiscal year, last August 30th, ten in the U.S., including three relocations, and one Costco Home as well.

Three openings in Canada, including two relocations.

One new location in Japan. which is our fifth in Japan.

One new location in Taiwan, that being our fourth in Taiwan.

And one new location in Mexico, which we account for on an equity basis.

I will also discuss the other things that we typically discuss, ancillary business results, Costco Online, membership trends, our balance sheet for the fiscal quarter just ended, and remind you of our updated direction and guidance for Q4 and 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, I will start with sales.

Again, sales on a total of sales basis were up 10% from 10.7 billion last year in the third quarter to 11.7 billion this year in the third quarter.

And again, on a 12-week to 12-week comp basis, Q3 comps were up 7%.

For the quarter, our 7% reported comp, which by the way, was on top of an 11% recorded comp sales increase in Q3 last year, were a combination of an average transaction increase of about 5% for the quarter, which by the way, included about 1.5% from the benefit of a weak U.S. dollar, so about 3.5% of that 5 percentage points was local currency, if you will, average transaction increase.

And also about 2% average frequency increase in the quarter.

This by the way is the first time in awhile that we've been above the '01 frequency level, a 2% increase in frequency.

Cannibalization about the same year-over-year.

Let me give you some quick geographic and merchandising discussion.

In terms of sales by geographic region, the strongest regions were in the Southeast and the Midwest.

Canada was also very strong in U.S. dollars, but that's because of the weak dollar, excluding that in local currency, it was slightly below the Company average.

And other international, both in the U.S. dollars and in local currency, were above the Company average.

In terms of merchandising categories -- in terms of merchandising categories, where as the Company's overall Q3 comp was 7%, hard lines and fresh were essentially in line with that figure.

Food and sundries and soft lines were below the Company average, and ancillary businesses, both with and without gasoline were above the Company average.

Within food and sundries, there really were no major outliers within hard lines.

The strongest sub categories were what we refer to as majors, which is electronics, automotive, and hardware.

Within soft lines we saw strength in domestics, home furnishings, and jewelry and watches, offset by slightly negative comps in media and camera film.

Moving down the line to the line items of the income statement, we'll start with membership fees, another strong showing with membership fees, we reported in the third quarter membership fees of $249.8 million or 2.13% of sales.

In dollars that was up $25.3 million or up 11%.

And as a percent of sales, since that increase in dollars was greater than the top-line sales, we were up two basis points in terms of membership fees as a percent of sales.

As usual, a very good showing given our 7% comp results.

We continued to benefit from strong renewal rates and increasing penetration of the $100 a year Executive Membership, although that penetration, now that we've anniversaried Canada, it's still increasing but at a lower level.

And while as of Q3 end we're actually three fewer new openings year-to-date versus fiscal '04 Q3 year-to-date.

That would be a little bit of an offset to the negative there, but nonetheless, we saw very strong memberships.

In terms of number of members Q2 end -- I'm sorry, Q3 end, we had 15.9 million, that compares to Q2 end of 15.6 million.

Primary business, 5.0 versus 4.9 at Q2 end.

Business then on remained relatively constant at about 3.55 million, so all told 24.5 million at Q3 end versus 24.1 million at Q2 end.

And including free spouse cards 44.6 million at Q3 end versus 44.0 at Q2 end.

At May 8th, which was the third quarter end our paid Executive Memberships continued to grow.

We had just under 3.9 million members, an increase of about 250,000.

So just in the quarter versus Q2 end, just in the past 12 weeks, we add 6% increase in the number of paid Executive Members, or about twenty and a half thousand new Executive Members per week, recognizing a good number of those are conversions from the regular membership.

In terms of membership renewal rates, they continue strong, at an all-time high of 86% overall.

Our Business Members were 91%, our Gold Star 84, the remaining at 86 for the Company told.

You might note that at the prior quarter end, our business renewal rates were 92.

Literally that's a matter of basis points rounding up or down to 91 or 92.

They're both roughly 91.4, 91.5.

Now going down the gross margin line, our gross margin reported was down two basis points at 10.59 this year in the third quarter versus a 10.61 last year.

In terms of merchandise, the merchandising component of that, as you know in Q1 and Q2 on a year-over-year basis in each of those quarters, the merchandising components of those two items were plus 12 basis points and plus 9.

In Q3 it was plus 5.

Our 2% reward, which has a detriment to this reported margin line and, of course, it helps comps in overall business and it helps membership fees, but as it relates to gross margin, the 2% reward, which in Q1 and Q2 were minus 12 and minus 11 basis points, was a minus 9 basis point.

We'd expect that to continue to be slightly negative, but on a reduced basis as the level of penetration slows a little bit.

LIFO, which in Q1 was 0, in terms of the year-over-year comparison, in Q2 was minus 2 basis points, and Q3, in fact, was plus 2.

That has more to do with the fact that last year we had a slightly higher LIFO charge.

In this quarter as well we had a LIFO charge.

And then again, both the EITFs that we've talked about adding an item [ph] for the last year, year and a half, have now anniversaried, so if you add up in the quarter the plus 5 in merchandising, the minus 9 in 2% reward, the plus 2 in LIFO, you get to the minus 2.

As you can see, our overall merchandising gross margin was better Q3 over Q3 by 5 basis points, a continuing trend from last year and from Q1 and Q2 of this year.

The favorable comparison reflects higher year-over-year gross margin percentages in three of the four primary departmental categories, those being food and sundries, soft lines, and fresh.

And slightly lower year-over-year reported gross margins in hard lines.

As well, we had higher year-over-year gross margins in our ancillary businesses except, of course, gasoline business, which negatively impacted our year-over-year gross margins, and which of course we had talked about on the April 22nd conference call, whereby we revised our earnings guidance to where it was up until today.

Overall, the underlying gross margin trends continued to show improvement during the quarter despite weakness in our gasoline margins.

As a side note, I already mentioned this, we anniversaried the implementation of EITF 03-10 as of the end of Q2 so that there's no impact in this quarter.

Again, as it relates to the Executive Membership reward, while that negatively impacted reported gross margin by 9 basis points, as I've stated in the past, the positive effect to our income statement for Executive Membership is increased membership fees, increased comp sales, increased renewal rates, offset by lower reported gross margin due to the membership rewards reducing the sales line.

And again, the minus 9 basis points is a little lower than Q1 and Q2's minus 11 and 12, and in fact, lower than the minus 15 in Q4 of last year.

So again, we'll see that continuing -- that negative impact continuing to trend down, I would expect.

In terms of LIFO, I mentioned we did take a charge this year.

It was 3.5 million in the quarter.

That compares to a 5.5 million LIFO charge in last year's Q3.

Overall, a very slight inflationary trend this year when you net everything out, recognizing that in gas you've got quite a bit of inflation.

In terms of our gross margin outlook for the remainder of the year, probably not unlike trends in Q3.

Gas has strengthened a little, but we are only through three of the 16 weeks in the fiscal fourth quarter, so I'm not making any bets yet.

As always, it's very competitive out there, it remains competitive, but we believe we are the most competitive and can still improve our gross margins over time.

Before going to SG&A, in terms of the number of ancillary businesses during the quarter, we added two pharmacies to be at 370 pharmacies.

We added two food courts to be at 421.

Two mini labs, photo labs, to be at 417.

Two optical shops, to be at 408, optometry shops rather.

We remain at ten print shops.

We actually added eight hearing aid centers to go from 155 to 163.

And one new gas station, so we currently have 219 gas stations.

Moving on to SG&A.

Our SG&A percentage year-over-year was up or higher by eight basis points.

Actually not bad as I'll explain in a moment.

In Q3 of '05, as you'll see, our SG&A came in at 991 this year versus a 984 last year.

Again, if you would please jot down the following components.

And I can add some color to that.

In terms of the operations, core operations itself, whereas in Q1 and Q2 that benefited a lower year-over-year SG&A of 19 and 16 basis points, in Q3 it was only better by 1 basis point.

Central, which in Q1 and 2 was better by 2 and 1 basis points respectively, was actually higher year-over-year by 1 basis point.

Stock options, which again we've expensed options now for -- this is our third year of expensing, and so incrementally as they vest , we take a bigger hit for that each year, for the five years.

Stock options were minus 4 and minus 4 basis points in Q1 and Q2.

In Q3 it was minus 7.

The big reason there is the fact that the stock price had increased dramatically, and on an annual basis, that impacts the valuation for the grant that we made in early April.

EITF 310, no impact, again, that's anniversaried.

So you add up the plus 1, or the lower by 1, or better by 1 operations SG&A component, the little worse by one1 basis point central, and then, of course, stock options year-over-year minus 7, again that's a noncash charge of the stock options, you get to the minus 7.

In terms of a little editorial, first for our Q3 SG&A results, these are the first results after benefiting in each of the previous four quarters from the benefits of the changes we made in early '04 to our healthcare plans.

As I had indicated about a year and a half ago, about half of the expected savings from the changes we made would come in the first 12 months after the implementation.

The other half would be spread over years two, three, and four subsequent to that.

Well, this reported third quarter number is really the first quarter of year two now having seen pretty dramatic benefits in each of the prior four quarters.

We did see some benefit in Q3 this year as well.

Secondly, in the quarter, I might add that our payroll percentages were actually down slightly year-over-year, but not a lot.

Finally, there wasn't any -- in looking at the details in terms of how do we compare to the last couple of quarters year-over-year, there really weren't any big negative year-over-year items other than the stock option expense.

A couple of -- but there seemed to be a lot of little things that impacted the quarter.

A couple examples would be, as an example, we started recently our Canadian E-commerce start-up.

Year-over-year that was an extra couple of basis points in the quarter.

We also increased -- we've seen the big increase in state tax-related expenses.

I'm not talking about income taxes, but sales used property as the states have become much more aggressive in the auditing process.

Again, I think we saw a couple of basis points there.

In addition, as you know, we are at August year end, not at calendar year end, so whereas many companies experience the joys and costs associated with Sarbanes-Oxley 404, near the end of last calendar year, we're enjoying the dramatic ramp-up in those expenses as we close in on our year end.

In the quarter we saw at least an extra $2 million ing the quarter related to the start-up of -- to the costs associated with this.

We would expect that over the 18 or 20-month period that started in fiscal '04 and will end at the end of -- as of the end of fiscal '05, probably about upwards of $10 million with that being -- with the majority of that being in Q3 and Q4 of this year, the fiscal year.

So, again, that was a couple of basis points in the quarter.

So there were a lot of little things that seemed to line up all negative.

Overall, I think we had a good showing in the key items like payroll.

And that's a good showing.

In terms of SG&A outlook for the rest of '05 and into '06, it will depend, of course, on where comps come in.

As I mentioned in our April 22nd earnings guidance, I believe we're conservative -- we remain conservative on our SG&A assumptions until we see what happens in Q4.

Hopefully we can do a little better.

Next on the income statement is pre-opening expense.

Last year in the quarter we had $4.6 million, or 4 basis points.

This year, 9.5 million, or 8 basis points.

So a $4.9 million higher number, or a 4-basis-point swing to the worse.

There was higher pre-opening related to more new warehouses be opening, four this year versus two last year.

Recognizing of the four this year we had two relos.

As well, we had a little over $2 million or 2 basis points of pre-opening related to some upcoming projects.

As well, we saw an increase in some of our Asian operations as we've had a couple there.

Nothing out of the ordinary again, just again, one of those things that's a couple million higher than -- because of the activity we have going on right now.

In terms of the provision for impaired assets and closing cost line, for Q3 '05 these costs totaled 3.0 million pretax.

In Q3 last year closing costs were actually 8.5 million of income comprised of 3.7 of actual closing and impairment costs, which was more than offset by what I previously mentioned, $12.2 million in property gains in last year's Q3.

Excluding the 12.2 million of real-estate gains, these dollars simply relate to our ongoing relocation efforts whereby the costs associated with the closing of these to-be-relocated units are expensed up-front once the decision to relocate is made.

So whereas reported, operating income was up only 1.9% in the quarter excluding these real-estate gains of 12.2, operating income in Q3 was up 6%.

Below the operating income line, and again we had the impact of the gasoline margins, which we discussed on April 22nd, below the operating income line reported interest expense was down 500,000 year-over-year, coming in at 8.5 million versus 9 million a year ago.

Higher expenses, we experienced higher interest expense on our floating rate senior notes.

We have two $300 million senior notes outstanding.

As those -- we had swapped those into floating and have greatly benefited over the years, but as interest rates have come up, those have come up as well.

This is more than offset by lower interest expense on our zero coupon convert, as a significant chunk of the convert, about half of it in fact, over the last -- has converted over the past 12 months.

The fact that half of it is converted, we believe is because it's so far in the money, break even on that is in the high $20 range, and of course, the stock is in the mid-40s.

As well as a year ago, year and a quarter ago is when we initiated the dividend.

So I believe, in terms of reported interest expense, the higher floating rate on the senior notes was more than offset by the reduced interest income on the zero coupon converts.

By the way, I mentioned the two $300 million senior notes that we have outstanding.

One is a five-year note that actually is payable on June 15th, so we'll write a check for 300 million to pay that one off.

The other one is due in calendar year 2007, and we would expect to do the same then.

In terms of interest income and other, this was significantly higher year-over-year, 30.2 million this year versus 14.2 million last year.

Most of this increase was due to much higher investment income, a combination of higher cash balances earning higher average rates of return as interest rates have gone up.

So overall, pretax income was up 7% versus last year's Q3, from 315.3 million last year to 337.8.

Again, up 11% without the real-estate gains of last year of 12.2 million.

In terms of our effective tax rate for the quarter, as I mentioned last quarter, we expect it to be a little higher in the second half of the year.

It was exactly where we had indicated, coming in at 37.9%.

A quick rundown of the numbers for the balance sheet as of May 8th, cash and equivalents, 4.051 billion; inventories, 4.040 billion; other current, 478; total current, 8.569 billion; net PP&E, 7.630 billion; other assets, 583; total assets, 16.782.

On the right-hand side, short-term debt, which includes that 300 million of currently payable long-term debt, but the short-term debt would be 350; accounts payable, 4.134 billion, that's about 90 million higher than our inventory level; other current liabilities, 2.387 billion, for total current liabilities of 6.871 billion; our long-term debt, 716, again that would be comprised principally of the other $300 million senior note, plus about 250, I believe, of the convert, plus a little bit of debt in some of our foreign countries; deferred and other, 275, for total liabilities of 7.862 billion; minority interest, 58 million; stockholders equity 8.862 billion, for total liabilities and shareholders equity, 16.782 billion.

At quarter end, our -- again, the ratio of accounts payable to inventories was 102%.

If you take out non-merchandise payables, because again, we've got a lot of activity going on for construction right now, the both at Q3 and last year at Q3 end this year merchandise inventory -- merchandise accounts payable as a percent of merchandise inventory in both quarters was 84%.

I might add that the average inventory per warehouse is up about 7.4% or 652,000 to just under 9.5 million per warehouse.

About 150 -- of that roughly $650,000, about 150,000 is just the impact of FX, the fact that in the foreign countries with the weak U.S. dollar it shows higher numbers there when expressed in U.S. dollars.

We also have planned higher consumer electronics inventories of about 200,000 per warehouse.

Again, that's a conscious effort on our part in an area that's continuing to grow well, as well as more vendors willing to sell us.

We also have higher year-over-year pharmacy inventories of 90,000, recognizing that's not behind the counter, that's more over the counter as we continue to succeed and grow in that area.

Probably the one area that has to do with weather and a little slowness is higher lawn and garden by about 100,000.

We finally saw the weather broke on the West Coast over the last couple of weeks and we're starting to see that come down.

But as of quarter end, we had about an extra 100,000 of lawn and garden per warehouse.

The good news is, you know in our businesses we get into the season early and out of it early, so we don't expect any major mark-down issues there relative to normal for us.

In terms of CapEx, for all of '04 CapEx was 702 million, where as our original budget for this year was 1 billion, with planned openings in excess of 25, year-to-date we're at 630 and we would expect to be somewhere between 800 and 900 million for the fiscal year.

In terms of Costco Online, it continues to grow well, up 37% in the quarter.

It's profitable.

We've had probably a little bit of notoriety with some of the unusual items we've sold, this past few months we've sold a couple of $40,000-plus Picassos, one a little below 40 and one a little above.

We have one Online right now that's for sale for about 130,000.

We also sold a 190,000 diamond ring Online.

The average ticket, even if you exclude those items, is in excess of $400.

So again, it's a little unusual site compared to other e-commerce sites, but a good showing and a lot of excitement, and a lot of acceptance of it.

In terms of expansion, as of Q2 end, we indicated that we would expect to open somewhere around 19 or 20 units.

That's net of relocations.

And net of the couple or three units in Mexico since we account for those on an equity basis.

In Mexico, by the way we -- we're getting a third one in under the belt for the end of the fiscal year.

I think one of them got moved up, which originally was going to open in the first part of fiscal '06.

But in terms of the numbers, and in terms of consolidated reported numbers excluding Mexico, we had indicated 19 or 20.

It's going to come in at 17.

Two units have been delayed that will open in September and November now instead of April and July.

That was San Luis Obispo, California, where we've had some issues with -- I think it was some type of butterfly, literally, but it's being worked out, and that will open.

And then a unit in Ontario, Canada, which was originally scheduled to open in July, will now open -- because of construction delays, open in November.

More importantly, and as I mentioned on the April 22nd conference call, our expansion is deliberately and definitely ramping up, and we would expect at least 25 to 30 units in fiscal '06.

In fact, we have many more already underway now as compared to a year ago looking ahead into the upcoming fiscal year.

In addition to the two, the San Luis Obispo and the Ontario, Canada, before calendar year end we've got one in Lahabra, California, as well as two new Arizona locations, all of those in October.

In November, we have a unit in Quebec, a unit in the U.K., a unit in Calgary, another unit in the Portland, Oregon area, a third or fourth unit in Las Vegas, another U.K. unit, all those in November.

So all told under construction already, we have 11 new units that will be in the first 12 weeks of the first quarter of '06, as well as we're already in for permitting for six more and we'll see if we get lucky on any of those before calendar year end.

So we're way ahead of the game.

We've got more that are being for permit over the next couple of months.

I can hopefully and finally say with confidence that we're going to see some good expansion next year.

We've got a lot on the schedule going forward for '07 as well.

We've got a lot of activity going on.

Finally, before I turn it back to Meredith for Q&A, some direction for Q3 and fiscal '05 overall, we're really not going to change what we said on the April 22nd conference call.

Our guidance there for the quarter -- for the fourth quarter was 63 to 67, which would imply somewhere around $2 to $2.04 for the year, which would be 8 to 10% increase, excluding the real-estate gains, it would be 9 to 11% increase.

Hopefully we could do a little better than that.

As I mentioned, gas has improved a little, but we're only three weeks into the 16-week fourth quarter and we'll see where we go from there.

With that, Meredith, I'll turn it over to you for Q&A.

Thank you. [OPERATOR INSTRUCTIONS] Your first question is from Emme Kozloff with Sanford Bernstein.

Richard, have you started to record any benefits in terms of Workers' Compensation yet, either in terms of reducing existing balance sheet reserves for the prior claims or accruing at a low expense rate for the current claims?

And what kind of magnitude in basis points could this deliver?

Separately, I know you just talked about the gas business, I mean, on the conference call a month ago you indicated that your Q4 guidance embedded profitability for gas no better than it was at the time, like you said, trends are getting a little bit better, so should we assume that there is still embedded a very conservative outlook on profitability for gas in Q4?

And then maybe by telling us what the gross margin detriment was from gas in Q3, we can get beater sense of how to gauge that.

Thanks.

In terms of Workers' Comp, in terms of the ongoing annual, quarterly accrual for incidents that occurred in the quarter, we've actually seen a little improvement in California in terms of dollars, offset by a little detriment in the other 37 states where we continue to see inflation, although the savings in California is slightly better than the offset in the other 37 states.

So a little pickup.

Less than a couple million bucks, I think.

In terms of the balance sheet accruals that are in the high hundred million, between 175 and 190, I believe, we really haven't adjusted and looked at adjusting that yet.

We want to -- we look at it actuarially every quarter.

We want to remain conservative on it.

I personally think we will see some benefit from that over the next couple of years or even the next several quarters, but you're talking about maybe a half a penny to a couple of pennies in the aggregate over a year and a half.

I think the good news is it's probably a positive and not a negative, but we'll wait and see.

In terms of what I mentioned on the call, I would say you use the word very conservative.

I would say that certainly our guidance on April 22nd was conservative and a wide range.

We said 63 to 67.

There's a lot of play in that 63 to 67, so as you and others on the phone call have known us well long enough, we don't sandbag our numbers, even with this quarter, the $0.43, our honest expectation was between 41 and 43.

We weren't just sandbagging the number.

Similarly, the 63 to 67, somewhere in the middle or even -- not the low end but not the high end either, it was our best guess, to the extent gas is a little better, and I stress the word "little," we'll see.

But gas could be a little better and still fall within that range.

And then in terms of the gross margin detriment from gas in Q3?

Just so we can understand that.

Well, we don't give -- we want to keep -- for competitive reasons, not for trying to hide anything from you, what we said on the quarter, and on the April 22nd call, relative to our recently updated budgets, we missed gas by about $0.03 a share, a little under $0.03, but it rounded to $0.03, but it was a little over $20 million.

So in a business that's roughly 5% of our sales, that's 2.5, almost, what, 2.8 billion, 2.7 billion.

So on a quarterly basis, that's 600, let's say, because this is a 12-week quarter versus the fourth quarter which is 16 weeks, so 600 million, 20 on 600 is whatever it is.

Okay.

Thanks.

It's -- I don't have the number in front of me.

I was trying to do it in my head.

Our next question is from Adrianne Shapira with Goldman Sachs.

Thank you.

Richard, just to clarify that, as you said, the conference call about a month ago you would expect about $0.03 of the $0.04 to come from the shortfall in gas, is that basically how the quarter ended up?

It was consistent with what we said on the call.

Okay.

So the mix shift that you alluded to last month seems to still be under control, abating?

Could you give us a sense of margin in other categories?

Overall, margins are fine.

Again, the last couple of weeks have been a little better in gas.

I think maybe even the 12th week, we were down, April 22nd we were two weeks -- two and a half weeks before, or about two weeks before the end of the quarter.

I think we did a little better in the 12th week than the 11th week, and a little better in the 11th week than the 10th week, but that was less than a half a cent of delta.

Again, looking at our inventories, notwithstanding that we're a little heavy on lawn and garden, we're finally seeing that dissipate in the last week, and again we're still well ahead of the curve because we are in the season early and it gives us time to get out.

I don't see any markdown issues, I don't see any shrink issues.

In terms of competitively, I think I indicated that three of the four major categories, those being food and sundries, soft lines and fresh foods, were all up year-over-year in reported gross margin.

Hard lines was a little down, recognizing that those areas aren't growing as fast as ancillary business is and as foreign.

So or really as ancillary business is.

So penetration-wise you could have margins up slightly, but because gas is increasing penetration at a lower margin, that hurt it a little more than the others helped.

I'm not trying to be vague.

It's just you're talking about small amounts of basis points.

We feel good about where we are.

Again, we've had a little bit of a hiccup here, but our goals are the same and we feel very good about our business.

Okay.

And then just apparel, you had called that out about a month ago.

Any update there?

I'm sorry, the what?

Apparel category had been problematic, a little bit higher markdowns there.

No, nothing's changed since then.

Yes, I think I mentioned on the call -- again, I was more throwing out some examples.

I think our apparel markdown was 1 million, 1.5 million higher than the year before.

Again, you're talking about basis points, if we were regular retail company and had a problem in apparel, it would be tens of millions of dollars.

Then just the buyback question.

Well, we -- you'll see in our 10-K -- when we release our 10-Q we'll disclose that.

As I indicated in April, we're looking at it, and again, I'm not trying to be cute, I would expect to see us start to do things.

I can't right now indicate whether we have or haven't, but each quarter we'll report what we do.

Richard, just for the quarter, there was a week of opportunity.

Is that true this past quarter?

Week of opportunity.

Well, we have our own blackout guidelines would be we'd wait until the second business day after a release.

We don't have a lot of time this quarter because our blackout period for -- which we hold our Company accountable to as well, is a week for sales and quarter -- actual quarter end.

So May 8th, which was a Sunday, May 6th that Friday, would have been the last day.

So there wasn't a lot of time.

Then May 6th was right when we were reporting April comps.

So we had that week off.

So there weren't a lot of days in the last -- since April 22nd that we could have done something.

Okay.

Thank you.

Your next question is from Deborah Weinswig with Smith Barney.

Good morning, Richard.

Few questions.

One, on the inventory front going forward, how should we think about inventory increase versus sales increase?

Well, in terms of top-line sales, I'd say pretty consistent.

I mean, we have shown, if I look back over the last 12 or 16 fiscal quarters, on a year-over-year basis the average inventory warehouse is probably -- is definitely increased, but it's been our conscious effort to increase it.

We have consciously increased our health and beauty aids and over-the-counter items in pharmacy, that's a strong area for us.

We have consciously and dramatically increased consumer electronics, for two reasons.

One, it's a hot area.

Two, there's much greater availability of product, both availability of plasmas and DLP and digital cameras and what have you.

You also had mentioned that you're seeing a slight inflationary trend this year, even excluding gas.

Can you maybe elaborate on some of those categories?

Tobacco is up.

My controller, David is sitting here -- coffee is up, nuts, gasoline.

Gasoline at this point.

But coffee, nuts, and gasoline, and there was one more you just said.

Oh, tobacco.

Okay.

Then last quick question, in terms of, you gave us a very positive outlook kind of for fiscal 2006 with respect to new club openings.

Can you help us understand why in fiscal 2005 you ended up being so back-end loaded?

Well, they're always back-end loaded.

If you looked at our schedule, our actual experience over the last 20 years, what you're going to see is, if we can open every unit the week before Labor Day we would.

You've got the benefit of Labor Day, Halloween, back-to-school, Christmas, Thanksgiving, you name it.

New Year's.

So inevitably what happens is, to the extent we can push things to get open in late summer or even into the fall, we do them.

Something on a normal schedule would open in January.

We're going to try like hell to get it open in October or November.

Then we catch our breath in January, February, March, and then there's a new round.

So it seems like we tend to have a lot of units opening in Q4 and Q1.

That's just how it is.

And, look, we self-inflict ourselves.

We try to be aggressive, not, frankly, as you know, to please you guys, but we try to get units open because we're trying to grow our Company.

Clearly, real estate efforts are -- have doubled, if not tripled around here in the last few years, but the challenges of real estate have also increased.

It's harder and harder -- first of all, in markets where we're infilling, you're taking a rifle shot instead of a shot-gun shot because you already have a unit in three areas, you want one now right in the middle of it instead of just somewhere generally there.

In addition, there's increased traffic mitigation and civic issues with regard to neighborhood issues.

We're working on more units to get the same number of units open relatively speaking.

I think on the April 22nd call, as of April 22nd we had done a little study of if you look back a year, April 22nd, '04 what we had in the pipeline that were done deals for fiscal '05, which began in September last year, was about 10 or 12 units.

As of April 22nd this year, at the end of that conference call, we had nearly double that number of units that were done deals, either under construction or in for permit.

So we've got clearly a lot more done deals going on and I mean, if Jim were he would say he'd like to open 35 units in '06, recognizing we're going to push for that, but our number is probably going to be somewhere north of 25 and south of 30.

But I guess I can say with a little more conviction that I think we're going to get there this time because there's so many things now already underway.

So we -- our enthusiasm for opening units has not swayed at all in the last few years.

I think we've gotten although more stringent on ourselves in terms of hurdle rates over the last couple of years.

I think, when I talk to Jeff Brotman, who charges up the real-estate effort, with his real-estate people, and Paul Moulton, if you would ask them, from the time you decide to do a deal and file the permit to the time you start construction, what did it used to take to get a permit and all that stuff done, and traffic mitigation issues, and what does it take today.

A few years ago -- and this was an experienced off-the-cuff remark from them, but they said a few years ago it was about six months and today it's two-plus years.

So clearly a lot of the efforts, perhaps a little bit of the stagnation over the last couple of years is indicative of that, but a lot of my comfort that we got, we finally are seeing that pot full of potential units start to actually come to fruition and I'm encouraged by that for the next couple of years.

Okay, great.

That was very helpful.

Thanks, Richard

Your next question is from Mark Husson with HSBC.

Yes, Richard, back to the gross margin question.

Could you talk maybe not so much in this quarter, but general trend information, about where you're sourcing product, the percentage of it's coming from Asian markets and whether or not there's an increase in trend from direct to indirect sourcing from those markets?

We haven't seen any big changes as of yet, we do report quite a bit, recognizing quite a bit of what truly is sourced over in Asia comes through U.S. trading companies.

I mean, a lot of the electronics we buy from the U.S. trading company, Panasonic, as an example.

It's really not the electronics, but the apparel and some of the domestic items -- domestics and things like that.

Okay.

When you say quite a bit comes from Asia, are you -- you obviously sell a lot of food and food-type product, which is very sort of domestic, but of the rest of the stuff, is there sort of a ballpark number we can think about?

Mark, I don't have it -- if you were to e-mail me, I'll find out.

I'm willing to bet it's 10% or less.

Great.

Thanks.

Jeff Elliott is sitting here and he wrote on a piece of paper that that's exactly what Jim said in a different conference call that I wasn't on.

At least you're consistent.

Well done.

Thanks.

Your next question is from Mitch Kaiser with Piper Jaffray.

Hi, Richard.

Just curious, on the store openings, did you say -- just want to make sure I'm clear on this -- then you'll have 17 for net stores for 2005?

17 net of the -- that excludes the three in Mexico.

Okay.

We've always talked -- again, we talked in our press releases about how many we're opening, including Mexico.

Right.

On a consolidated basis, we don't consolidate those.

Okay.

And then it sounded like in the first quarter of '06 you'd have 11 open?

Yes, I believe that's our best --.

I can go back to the transcript.

Not to beat a dead horse, but I was just curious about the gas.

Obviously, you saw the article in the Journal yesterday talking about where they thought your margins were.

I was wondering if you could just comment on that with the expectation for the fourth quarter be that things would kind of continue in that maybe $0.12 range, if that was, in fact, a good proxy for where things are at?

Help me with that.

I must have missed that article.

Oh, okay.

It said that your gasoline prices over the last 40 days, the profit per gallon was $0.12, a full $0.10 higher than estimates for the first quarter of 2005, and I believe they were referring to the calendar quarter, which would kind of overlay with your second quarter.

I wouldn't even comment on that.

Not to hide anything, I don't know where they would get those numbers and I'm not going to tell you whether they're right or wrong.

All right.

Thank you.

Your next question is from Gary Balter with UBS.

Thank you.

Hi, Richard.

Could you talk again about the confidence you have in delivering 20 basis points a year over the next five years?

Well, I asked Jim yesterday, is our goal over the six-year period which started a year and a quarter ago, to increase our -- to approach that 4% pretax, and he said yes.

So I am confident we can get there.

As we've seen this quarter, there will be ups and downs in it, and -- but business is strong, and it's going to be up to him to lead us in that direction.

I am confident.

And how do we -- when we look at this quarter where you did 7% comp and we saw no leverage in expenses, or 1 basis point in expenses.

How do we reconcile that?

Is it all going to come from gross margin?

Are there things you will be able to do in the future that will help expenses?

Again, I don't want to sound trite, but there were lots of little things that impacted this quarter that were unusual.

It seemed like, if I had to add them up, and I haven't, but I bet you in terms of all of the little things, again, on 12 billion in sales, roughly $1.5 million is 1 basis point -- 1.2 million is a basis point, I bet you if I took all the little things, plus -- and there's probably 30 of them that are in the 0.5 million to 2 million range that could either help year-over-year or hurt year-over-year, all kinds of things, including a couple examples I gave, I bet you overall there was probably 7 to 10 basis points that just, the moons lined up that way.

So I am not terribly concerned about that.

I did not see -- when I look at payroll, which is over half of our SG&A, payroll alone was better by 7 or 8 basis points.

Okay.

In our warehouses.

So that gives me encouragement.

I guess the $64,000 question, Gary, would be if less of it came -- whatever the Company's plans were, X was going to come from membership and Y was going to come from margin and Z was going to come from expenses, and I think if you asked the question, if less of it was able to come from expenses, would the Company be prepared to get a little bit more margin, the answer is going to be yes, subject to us maintaining our competitive position, and we're not going to do anything to jeopardize that.

I feel good about the fact that our toughest competitor is ourselves, and we've shown that we -- I don't think Jim would have said at the December analyst meeting a year and a half ago if he didn't mean it.

And, again, we'll have to see what happens over the next couple of quarters to make you feel a little better.

And when -- just one last thing on a different topic, I notice in the unit near me you moved up the consumer electronics closer to the front, the very strong displays, the plasma and LCD.

Is that something you're doing across the chain?

I know in the locations, two or three locations I shop here it is up front, so I don't know how it was in the location you went to.

Clearly, we have made a conscious effort.

You think -- I was looking at some numbers a few months ago, looking at like the last three Christmas holiday seasons, and if you look at just something as basic as plasma TVs, standard 40 or 42-inch, whatever it was, plasma TVs, three Christmas's ago they might have retailed for 5,000, we might have sold them for 3,900 or something, but we couldn't get any, and maybe we had a few million dollars of sales of plasmas.

A year later, they're retailing for 3,500 or 3,800 and we're at 3,200 or 2,900 and they're a little more available and maybe we did 20 million.

This year there were items that we did 20 million in at Christmas in the plasma area.

They were greatly available, and they were 1,900 to 2,400.

And as many as you wanted.

So we probably, I don't have the exact number in front of me, well over 60 million, upwards of 100 million.

I don't have the exact number.

So I think we have definitely made a better presentation.

The other thing you'll note is that we have gone to, I believe, either satellite or cable consistent presentation on all the screens, whereas each warehouse is not just setting them up so that one may be off and one may be cloudy and one may be on a different channel.

So you're seeing a much better consumer-enticing presentation of more stuff at great prices.

Yes, I noticed that.

You should have more hockey playing on the units.

They're on strike.

Well, you could get it from Europe.

I'll let somebody else ask a question.

Good luck in the future quarters.

Thanks.

Your next question is from Chuck Cerankosky with Key McDonald.

Richard, are you doing anything different in how you're pricing the gasoline and moving the cost through so that you don't have these margin surprises?

No.

We are looking at some alternatives.

Historically when we looked at trying to smooth out the profitability, and you can perhaps do that by hedging a little bit, because it's a relatively low margin business to start with and hedging is not perfect, a disproportionate amount of that margin would be used in hedging.

It would be nice to smooth it out, but it's not necessarily as smoothable as one might think.

We are not going to be embarrassed on pricing, as you know, but we are looking at -- we're relooking at some of those hedging alternatives, but nothing -- we're not changing our pricing mentality.

We are taking advantage when prices do lower, and we can save the customer more, but also make more ourselves, we are seeing that, and that's, I think, what you've seen in the last few weeks.

But that's going to be more on -- the market giving it to you back as opposed to changing the management of the process, and it looks like that could continue to be a stumbling block going forward to raise the overall return on sales of the Company.

In a given quarter, it could be.

I think we have to look at that over a year period.

In addition, we are looking at some alternatives of how to perhaps smooth that out a little bit, recognizing you can't just smooth it out.

You've got do what's correct for accounting.

It is -- I don't want to -- keep in mind a couple of things.

We have seen in the last -- up until the last couple of weeks where there's been a slight reduction in gas prices, in the last 10 or 16 weeks, we've seen an unprecedented, yet another unprecedented move upward in gas.

That's not going to happen forever.

Maybe it happens a couple more times, and maybe in the next -- assuming we do nothing to change, as you describe, the management of that profitability, maybe there's a couple more times in the next couple of years where we have to share with you that we missed something by $0.02 or $0.03.

Maybe not.

But it can't happen forever, in terms of these kind of increases.

In addition, this is a business that drives traffic.

There's not -- well, there's one other thing, pharmacy.

Those two items, we get so much positive press on that by consumer advocates, on news channels, newspaper articles, around the country, every week.

Clearly it is something that drives our business.

And all things being equal, would our Company comp be where it was without gas, I'm not just talking about the increment of gas, but what it does to the warehouse itself.

It's a value proposition, people talk about it, people are loyal.

There's a reason that we're doing twice the volume of our competitors.

All right.

Thank you.

Your next question is from Bob Drbul with Lehman Brothers.

Good morning, Richard.

Two questions actually.

Around the new store opening plans, can you talk specifically on cannibalization trends and your expectations for cannibalization as you look forward?

And relatedly, can you talk a little bit about on the openings that you have on the books now for the rest of this year and for next year, new markets versus existing markets?

Sure.

In terms of cannibalization, when there's a lot of cannibalization it tends to be upwards of 100 basis points of impact.

When there's normal cannibalization, it tends to be about 50.

I think in the last several months, last couple of quarters it's ranged from 60 to 75 and I don't see that changing dramatically.

Maybe it inches up a little bit to 80.

Recognizing we have a big base of warehouses now.

But when I look at the openings we've got coming up, let me turn to that page again, I would guess that there's very little in the way of new markets.

The ones I mentioned, both Ontario and San Luis Obispo are existing markets;

Lahabra is L.A.;

Arizona is existing, one's in Phoenix, and one's outside;

Quebec is done;

U.K. arguably could be a little new;

Calgary is existing;

Hillsboro, Oregon is existing;

Las Vegas is existing.

I would bet, Bob what would you say, 90-plus percent is existing next year?

International is the question mark.

Whether it's the high 80s or the low 90s, let's say 85 plus.

Okay.

Great.

Thanks, Richard.

The next question is from Michael Exstein with Credit Suisse First Boston.

Good morning, Richard.

And thank Gary for the opportunity not to talk baseball.

Could you give us an idea what depreciation was for the quarter, number one?

What percentage of the comp in the quarter came from gasoline?

And three, the interest income issue, what do you think that might look like in the fourth quarter?

Thanks.

Hold on a minute.

Comps, the comp related to gasoline, Jeff, was -- how much was the comp related to gasoline inflation?

What has it been running?

We'll get that for you in a second.

Depreciation -- hold on. 70 basis points on comp of gas.

Depreciation year-to-date is 330 through the third quarter.

Do you have the second quarter number there, guys?

Go run and get a Q2.

What was the third question?

We're getting that.

The interest income number was pretty surprisingly large.

Well, there's two things.

One is is that the interest rates have gone up about a quarter percent every month it seems lately, and on $4 billion, let's say year-over-year it's what, been up 1.5 to 2%, six or seven increases, so 1.5% on 4 billion is 60 million, so let's say even 50 million, that's 10 or 12 million a quarter.

What will bring it down is we're writing a check for 300 million in a couple of weeks to pay off the debt.

What will bring it down is if and when we buy some stock back.

Other than that, the little increases that Greenspan is doing needless to say helps that line on a sizable number.

Depreciation in the 12-week quarter was 112 million.

112?

Yes.

I'm just looking, on a year-to-date it went from -- year-to-date through the second quarter was 218, year-to-date through the third quarter is 330, so that's the 112.

By comparison, last year, it was 104 million.

A little higher.

About 8 million higher.

Thanks.

Your next question is from Christine Augustine with Bear Stearns.

Thank you.

Richard, it does look like the share count was down a little sequentially, so if you weren't buying back stock would it just have something to do with the variation in timing of how options are exercised?

And then my second question is, for gasoline, how many members who come to the club and buy gasoline convert into people who actually go into the club and purchase merchandise?

On the share question, the single biggest factor is the average stock price during the quarter, and as you know, we -- a big part of the compensation of the top 1,100 or 1,200 people at Costco is a combination of, of course, cash compensation, but the stock option grants to a wide range of people, and so given that the stock had languished in the 30s for three or four years up until recently, you'll see using the Treasury stock method, as the stock increased, a fewer number of those shares can be repurchased with the assumed exercises of those options, and that more than anything, has caused the average number of share count to gap.

I'm sorry, I just meant down sequentially from 2Q.

I assume that was -- it's the stock price.

The average stock price, I don't have it in front of me, but I would assume the average -- the way the math works, usually the Treasury stock method on stock options assumes that any in the money option is exercised, then the proceeds of those are used to bay back shares.

Therefore, you have a net increase in shares related to that.

The average stock price in Q2 was a little higher than the average stock price in Q3.

It's that simple.

Now, to the extent we buy back stock, of course, that would reduce it as well.

What was the other question?

I'm sorry.

For members who come to the club to buy gasoline, how many of them actually convert into people that go into the club to buy merchandise on that same trip?

I don't have those numbers in front of me.

If you want to e-mail me I can find out.

I know I've heard those numbers in our budget meetings before.

When we've studied it, from the terms of what does gas add to the comp aside from gas, which would kind of be the same thing but in terms of percentages, that all things being equal, if you took a $100 million warehouse, and let's just make this up, it was comping at 5%, so you expect for the upcoming year to do 105, instead, you add a gas station at the beginning of the year, you'd find it doing about 112.

An extra five from gas and an extra two to the normal comp from increasing those people going in.

That's not the question you've asked, but it's a different way to look at it.

If you e-mail me I can find out.

Thank you.

Your next question is from Peter Benedict, CIBC.

Hey, Richard.

Three questions.

First, could you speak to what you're seeing in terms of your food margin trends and how you kind of think about that going forward?

Secondly, the comp benefit from any type of commodity price inflation, meaning more on the meat and dairy side, not the gas.

And then third, on the stock option expense, how should we be thinking about that going forward?

Not just the fourth quarter but also into next year if you can talk to that.

Thanks.

I'm sorry.

Would you repeat those?

Stock option expense I got.

What was the other ones?

Just the comp benefit from meat and dairy inflation, then the -- what you're seeing in terms of food margin trends recently.

Thanks.

Well, food margin trends are up.

If you had to say one area where nobody can touch us is in food, fresh food.

I mean, it helps when you're doing two and three X the volume of your competitors.

You can make a much better looking presentation.

Our members, we've traded up, we've cultivated the best member and they're buying the best stuff, and a lot of our benefit is from the fact over the last few years, particularly on the produce side, we've gone to much greater global sourcing.

In looking at those areas, let me look here real quick, I mean, the sales penetration of those areas is increased, in other words, their comps are greater than the Company as a whole, and their margins have increased.

Year-over-year in the quarter our margins in fresh foods are up 25, 30 basis points.

So there's no -- now, in terms of inflation, I don't have the detail of that in front of me for those specific departments.

I don't think there's anything, you know, there's some things that are up and some things that are down.

As a company, the ones that David mentioned to me before, nuts, coffee, and tobacco were the ones that stood out in his mind, and gas.

In terms of stock option expense, I would expect, when we first announced this, starting in '06, first of all, we have to adopt 123R, R for revised, right?

FASB 123R.

There may be a slight increase, you're talking about a couple of basis points and that hit year-over-year, and then it should subside after '06, because we will now anniversary the full effect of a full year of option grants in a year.

We are looking -- historically we have used the traditional Black-Scholes model, which arguably is the most conservative, i.e., the biggest hit to the number because it doesn't take into account as FASB has come out with additional guidance, although not specific guidance, unfortunately, but additional guidance in terms of other alternative methods and how to hit the P&L and value stock options for expensing.

There's -- you may have heard there's lattice models and binomial models.

We have engaged some outside help to look at those.

What it may do in the future is lower the hit from a given option grant as compared to Black-Scholes, but again that wouldn't be until any grants in '06.

All right.

Thanks, Richard.

Appreciate your comments.

It's going to be -- the stock option is going to be a continued little hit, something in the mid-single digits for the next few quarter, and then disappear, as a year-over-year Delta.

Your next question is from Danielle Shoenbaum with Highland Capital Management.

I just wondered if you're seeing any pressure on real-estate prices as you're trying to infill and market, if that's affecting your ability to open new stores?

It's not affecting our ability.

It is more expensive.

On average, if you looked at land building and site work, three years will ago, let's say, two to three years ago, it was probably 20 to 22 million, and maybe now it's 23. 24 in some instances, on average.

So, yes, it's gone up 5 or 10%.

I think the bigger difficulty is things take longer, cities aren't rushing to welcome you in.

The whole concept of sales tax abatement to entice you into their community for political reasons is not an issue anymore, that doesn't happen.

We, unfortunately, get caught in the anti-big box issue in some initiatives in some markets, although we're not the ones they're look at, and we do our best to fight those things, and we've been pretty darn successful at doing so.

So, again, I don't think that's a big issue.

In fact, when those issues raise their head, like in California, we seem to still be able to still get in.

I think it's because we pay high wages and provide great benefits to our employees and it's very hard to argue against that.

Thanks.

Your next question is from Ed Ross with Banc of America Securities.

I was just wondering if you see much impact from higher diesel prices on transportation of product to the clubs.

Not particularly.

If anything, fuel prices has not -- if I -- when talking to the merchants, and even to our traffic department, the big thing, as we've seen some inflation, I think it's become more from commodity issues and from packaging issues, i.e., corrugated, and the price of paper has risen over the last year, year and a half, than it has from fuel issues, interestingly.

We have not seen a lot of fuel surcharges.

Certainly, there is a cost to it, but again, I think on a relative basis, since we're selling -- excuse me, I'm getting over a cold -- we've seen relatively speaking, we're pretty darn efficient in shipping the stuff and probably have a higher value per cubic foot than a traditional supermarket example because of the things that we sell.

Makes sense.

Second question, you've talked a little bit about inflation that you've seen so far.

Appreciate the color.

Going forward, it sounds like consumer product companies, a number of them are talking about passing through some more pricing.

Do you see much of this?

Do you anticipate feeling some of the impact?

Well, our policy is always going to be first of all to fight it as long as we can, as is every other major retailer.

Again, anecdotally a good example was last spring when for several months the paper goods companies were talking to the big retailers, be it Wal-Mart, Albertson's, Safeway or us, talking that the cost of paper was rising and they're going to have to do some of this, and we like others, successfully held them at bay, and then come last May, it wasn't a question of discussing anymore, they sent out announcements saying that effective June 1st or June 15th, these items were going up 4 to 6%, each item was going up a certain amount, and they weren't asking or discussing anymore, they were announcing.

And as you might expect, within about two or three weeks every single major paper company did the same thing.

When I say paper company, I'm talking about everything from copy paper to diapers to toilet tissue and paper towels.

It was across the board.

On commodities, like coffee, I think that gets hit a little harder faster because it's a commodity and it's just out there.

That being said, we're always going to be the last to raise the price and the first to lower it.

So when prices are going up, we'll do what we can to buy in, but for us buying in might say instead of having a -- I'm making this up because I don't know the exact term, but instead of having a three-week supply of coffee, we'll have a six-week supply of coffee, and we'll hold the price down for six weeks, or five weeks, because we're the last one to hold it down, everybody's coming into us, but that's good.

Thank you.

Your next question is from Daniel Binder with Buckingham Research.

Good morning.

Couple of questions.

First, with your earnings guidance for the fourth quarter, what is -- what kind of comp guidance does that imply?

And then is there any kind of a calendar shift that we have to worry about between May and June?

Lastly, how should we expect your inventory to look at the end of the year in terms of a -- on a year-over-year basis?

In terms of -- there's no issue -- Memorial Day issue, I don't believe, it's essentially the same time each year.

In terms of year end, I guess my best inventory -- my best guidance for inventory is that we were up year-over-year at the end of the third quarter $650,000 per warehouse, 100 of that is lawn and garden, so let's say that dissipates, I would expect to see the 90 or so in over-the-counter pharmacy to remain because we've built that business up.

I expect to see consumer electronics remain.

To the extent that the dollar strengthened a little, some of that 150 would come down a little.

So my guess is, I mean, pick a number, half a million year-over-year higher, with most of it being conscious effort on our part.

The implied comp on that still about 7?

Mid-singles, 5 to 6.

On the earnings guidance you gave?

5 to 7.

Okay.

To the extent, it sounds like maybe with the gas margins going the other way here in recent weeks that you're looking at the guidance as maybe being conservative.

If we think about potential areas of upside in the fourth quarter, would it be primarily gross margin or expense driven?

I think it would be more gross margin driven, but given what I shared with you in Q3 with expenses it could be a little expense driven.

The thing I want to reiterate about gas is that if we made money, X dollars in gas last week, three weeks from now we could be losing Y dollars.

It's a fickle area based on how we price for competitive reasons.

This is week three of a 16-week quarter.

So within that range of 63 to 67 there's conservative and realistic and not aggressive numbers.

Okay.

Just in terms of the Northeast, which has been unseasonably cool, you guys probably sell a lot of air conditioners this time of year, is that a category that continues to be sort of price protected in the event that the units don't move as quickly as you expected?

Which category?

I'm sorry.

Air conditioners, fans, things of that nature.

Generally speaking, there's some return capability, but we would get hit with a little bit of it.

Where we protect ourselves is we bring in the stuff earlier, and again the last couple of weeks it's starting to sell so I don't see a big issue there.

When I define a big issue for us, could there be another couple million of markdowns in an item like -- in a category like that?

Yes, maybe there could be, but you're not talking about 10 million.

And if it were a couple million, I think a couple million with a 16-week quarter would probably be 1 basis point, so I don't really see these things as a big issue.

And the next major reset would be what, mid-July?

What's that?

The next seasonal reset would be like July in terms of having to have product out of the way to make room for the next reset?

Late July.

Great, thanks.

Your next question is from Gregory Melich with Morgan Stanley.

Two questions.

One is on the real estate, Richard, you said one of the big challenges is just actually getting it done.

I'm wondering, have there been any shifts to accelerate the club growth in terms of what you're willing to build in terms of a slightly larger, slightly smaller box or with different amounts of acreage for parking, et cetera?

Are you going to remain reasonably strict in terms of flexibility?

Generally speaking, in terms of size of facility, we prefer bigger, and with few exceptions, we will stick to that.

So not a big change there.

I think with the acreage and the parking clearly we are open to that.

While we'd like 11 to 14 acres we've done them on four and done them on eight and done them on ten.

Yes, I mean, clearly Brooklyn and Queens aren't thrilling parking lots, but people in Brooklyn and Queens are used to that, frankly, because it's everywhere.

And somebody in Seattle wouldn't stand for that, but that's life because that's what you get.

The one thing we try to fervently stay away from is double-decker facilities and secondarily double-decker or multi-deck parking.

It's expensive.

Parking is expensive to build, but once it's built, and it's a little more expense to maintain, double-decker facilities, like in Port Chester or in Korea and Taiwan.

Well, in Korea and Taiwan, that's life, in Tokyo, that's what you're going to have to do.

You might have three levels of parking and two levels of retail straight up.

So a five-story stack.

It's going to be lot more expensive.

But I'll give you an example, there was a location that we had been looking at pretty seriously and gotten pretty far down the road on in Atlanta about a year ago, and it was a site that was going to -- if our goal was to have 900 car parks, this was a site that was going to have about 600 car parks on two levels, and one level of retail but that level of retail was going to be like downtown San Francisco, it was going to be above parking.

So there were going to be these like long walking ramps where people could literally like 80 yards long one way, then 80 yards back zigzag to get down to the parking lot.

When push came to shove, we opted not to do it because that's a market that was, we felt we were pushing the envelope in a market that we should be able to find other stuff that could be on one floor.

So the bias would be to let the traffic per club go up, even if that made it a bit more crowded, than do a club that just wasn't going to be a great shopping experience?

Sometimes.

How's that.

Yes.

And then second is just on the payables.

If we're going to get more clubs open in the future and there's more stuff in the works, will the payables structurally stay at this sort of 20% higher due to in-project work than just regular merchandise payables?

How should we think about that as we model out a couple of years?

I guess the non-merchandise component over the next few years will remain higher, maybe increase a little bit, then balance out at that higher level.

Then, the merchandise payables to inventories, which was 84%, there's going to be some seasonal fluctuations.

We're kind of at our seasonal low period now between March and May.

We're in our seasonal high period probably in Thanksgiving and Christmas, where just the merchandise payables are upwards of 95-plus percent.

As we open units, you might get some extra deals for the first two or three months of an opening, but then on average if it's at a lower volume, in our own simple simplistic planning, we assume that other than maybe some extra extended terms you get on a new opening for a few months, your merchandise payables might be 60 or 65% then increase up to the Company average over the next couple of years.

But for the project stuff we should still assume that you can run at that over 100% because there's always going to be work going on.

Close to it, yes.

Okay.

Thanks.

Your next question is from Peter Benedict with CIBC.

Richard, one quick follow did you know.

With the big store opening plan, I guess for the first quarter of next year, can you give us a sense of what kind of pre-opening expense you're expecting in the fourth quarter?

Thanks.

I don't have that in front of me.

I haven't looked at an update yet for the last two months of the quarter.

Bob, do you have anything with you?

Call me and I'll -- I need to go through the openings for the first six weeks of Q1 and come back with a better update.

We do a rolling three-month update so we haven't looked at August that closely yet.

We will in the next couple of weeks.

Fair enough.

Thanks.

At this time, there are no further questions.

Okay.

Well, thank you.

Last comment would be the Q&A that we put out each quarter, that will be posted on the Internet on our website starting later today, and that will have cash flow and balance sheet and some other summary informational items.

Thank you very much.

Thank you.

This concludes today's conference call.

You may now disconnect.