好市多 (COST) 2006 Q4 法說會逐字稿

Good morning.

My name is Amy and I will be your conference operator today.

At this time I would like to welcome everyone to the Costco Wholesale fiscal 2006 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 session. [OPERATOR INSTRUCTIONS] On today's call we have Mr. Richard Galanti, Chief Financial Officer, and Mr. Jim Sinegal, President.

Thank you, Mr. Galanti, you may begin your conference.

Thank you, Amy, good morning to everyone.

This morning's press release covers two major items, our fourth quarter and fiscal 2006 year end operating results, and the results of our review by the special committee and independent board members of our historical stock option procedures.

As with every 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 call as well as other risks identified from time to time in the Company's public statements and reports filed with the SEC.

To begin with our 17 week fourth quarter of fiscal '06 operating results, for the quarter we came in at a reported $0.75 a share.

This compares to our August 30th release revised guidance of $0.68 to $0.71 and current first call of 73.

My guess is the first call number of 73 excluded the $0.03 amount related to a tax issue that we have mentioned in that August 30th release.

In last year's fourth quarter a reported $0.73 per share figure benefited greatly from a very low reported tax rate of just under 29% for the quarter.

As I discussed last year, using a more normalized tax rate, we estimated last year's fourth quarter earnings per share would have been $0.66 a share, and so in our view on a kind of apples-to-apples basis it would be a $0.66 a year comparison to this year's $0.75 number.

So essentially, quarter-over-quarter earnings per share increased, we estimated by about 14% on that normalized basis.

For the year we came in a reported $2.30 per share.

Again assuming a more normalized income tax rate for last fiscal year which included both the unusual tax benefit in the last year's fourth quarter, as well as a significant tax benefits reported in the second quarter of fiscal '05, as well as a one time non-cash charge for last year in '05 in the second quarter related to an adjustment to our method of accounting for leases, again we estimated earning for '05 on what we would call a normalized basis would have been $2.04.

So the $2.04 in our view compared to $2.30 which [inaudible] apply the 13% increase year over year.

In terms of our sales for the quarter, as previously reported, our 17 week comparable sales figures showed an increase of 8% and for the fiscal year also it increased 8%.

Other topics of interest I'm reviewing this morning is our opening plans.

As you may know we opened for the fiscal year ended on September 3rd, 27 net new locations during the year, 20 new in the U.S., 3 in Canada, 2 in the UK.

These 25 units are consolidated into our operating results.

As well, we opened 2 in Mexico which we account for on our equity basis.

In addition during fiscal '06 we had three relocations.

For fiscal '07 we are planning a higher level expansion and again this fiscal year began September 4th of this past-- of last month.

Also this morning I'll review with you our ancillary business results, our Costco on-line, membership trends, our balance sheet for the fiscal year just ended, and I know a couple of you already noticed and e-mailed us, a small reclassification issue that basically takes a small amount of money out of SG&A, something historically had reduced SG&A and adds it to sales, and we'll have some of those reclass numbers for you so we have an apples-to-apples comparison.

So, with that said, and before we get into the actual earnings results, let me review what was said in this morning's press release relating to the stock options.

And, again, I'm really going to be talking from the press release itself.

Following publicity regarding the granting of options, like many companies out there we initiated an internal review many months ago, our historical stock option practices, to determine whether our grant dates of options were supported by the Company's books and records.

As a result of an internal review, a special committee of the independent directors was formed.

The three members of that independent board committee was Mr. Dan Evans, William Gates and Charlie Munger.

This special committee engaged its own independent counsel and forensic experts, spent a lot of time reviewing all the equity grants, interviewing people, what have you, and all grants paid during year 1996 to 2000.

In late September the special committee reported its conclusions and recommendations to the board and these were adopted by the full board.

Importantly, the review identified no evidence of fraud, falsification of records, concealment of actions or documentation, or intentional deviation from generally accepted accounting principles.

The review did indicate that in several instances it was not possible to determine with precision the appropriate measurement date for specific grants.

In fact they concluded it was feasible only to identify a range of dates that includes the appropriate measurement dates or some dates in that range or after the recorded grant date.

Again, as the press release states the subject grants were made to over 1,000 of the Company's employees.

Including among others all of our warehouse managers and merchandising people and what have you.

And again it talks about the fact that none of the options reviewed identified any imprecision in the grant process were issued to our CEO, Jim Sinegal, our Chairman, Jeff Brotman, or any of the non-employee directors, with the exception of one grant in April 1997 about 9.5 years ago, where both Jim and Jeff received, as part of a broad grant to literally hundreds of employees, a grant that may have been subject to as much as precision -- that could have been benefited them up to $200,000.

Other grants subject to that in precision were made, of course, to me, as well as Dick DiCerchio, another director at Costco, Employee Director.

Based on the findings of the review we do not anticipate any restatement of previously filed financial statements, and consistent with the recent staff accounting bulletins issued by the SEC, we have transferred as of fiscal year end $116.1 million of net worth shown on our balance sheet from retained earnings to paid in capital and increased our deferred tax asset account by about $31.5 million.

Keep in mind that our total net income over this 10 year period reflected in these adjustments is about $6 billion.

In terms of fiscal 2006 stock option expense, we have increased it by about $2 million after tax as a result of this review, and that's, of course, included in the fourth quarter and fiscal '06 income statement.

As stated in the release given the lack of historical documentation it was not possible to precisely determine the amount of the adjustments that should have been made, the actual adjustments made and recommended by the special committee are based on assumptions that are more like, in their review, to overstate than understate the effects of the imprecision identified in the Company's option grants.

At present we believe the impact on the Company's historical Federal Income Tax filings arising from this review will be less than $2 million.

As also disclosed in the press release, the Company has in other respects generally taken a conservative position with regard to stock options.

Beginning as you know in fiscal 2003 the Company voluntarily expensed option grants prior to any formal obligation to do so.

Additionally and actually something we have been talking about for well over a year here and unrelated to this issue, Costco has ceased granting of options currently in favor of restricted stock units.

We've determined that established in the future we are also going to establish standing equity grant dates applicable to our RSUs, or option grants, should we do that in the future or in any form of equity type of offering, such that it will be set always in the fifth trading day following the release of quarterly or annual earnings results, and any exception to that policy would be with formal approval by our compensation committee.

As you would expect we have also informed the SEC of our own investigation and conclusions and have communicated with them, and needless to say we will cooperate fully in the event of an inquiry.

That's really all that can be said at this point, and again, we are here to respond but pretty much what you see in there is what we will be able to talk about.

In terms of the earnings and operating results, again, sales for this years fourth quarter, the 17 weeks ended September 3rd were 19.5 billion, up 19% from last year's fourth quarter sales of 16.4 billion.

Of course this year's fourth quarter had an extra week that partly explains the 19% figure.

On a comp basis, which was a light number of weeks-- a like number of weeks, fourth quarter comps were up 8%.

While our quarters are slightly different than formal calendar months, essentially the 17 weeks are comprised of most of May, all of June, July and August and a few days in September.

In terms of our 8% fourth quarter comp it's comprised of the 10% in May, a 6% in June, a 7% in July and a 7% in August so basically a 10, 6, 7, 7.

For the quarter our 8% comp figure resulted from a combination of an average transaction increase of about 7% and an average frequency increase of a little under 1% for the quarter.

Included in the average transaction increase of 7% in the fourth quarter was the continuation of strong FX, i.e. a weak dollar versus some of the foreign currencies where we operate.

This represented about 150 basis point boost to the quarterly comp number, not that different than what have we've seen of late.

Gasoline pricing, again, a lot different than what we've seen of late, has helped our comps during the fourth quarter by about 150 basis points as well due to higher year over year gas prices.

This of course reversed itself in September.

As you know we reported September comps last week.

As of a year ago we were anniversarying hurricane Katrina, which occurred in the last week of August, and throughout September there was plenty of gas price and gas availability craziness out there.

I might add that in terms of our sales productivity as you know in fiscal '05 the company-wide, including all countries, the average sales productivity, annual sales productivity per warehouse was $120 million.

Within the U.S. only it was 124.

For fiscal '06, which just ended, the 120 company-wide has become 127, and the 124 U.S. only has become 130 million.

And, again, that reflects, of course, part of the 8% comp that we experienced both for the quarter and the year.

As you all know, last week we reported September comps.

We came in at a 4% recorded comp.

As expected, we had a big swing from August vis-a-vis gas sales, both in terms of gallonage but more importantly in terms of gas pricing.

Again, it was last September when prices really skyrocketed with the effect of hurricane Katrina.

All in all just a shade weaker than the August 8% figure if you try to normalize the impact of gasoline.

In terms of sales with comparisons by geography, no real surprises in the fourth quarter.

Pretty consistent with what we've seen in the second and third quarter.

But the second and third quarter of course we were at 7% comps overall and the 8 the fourth quarter.

And again, as expected the reported number of 4 for the month of September would then impact, tended to impact, all the divisions most notably in the U.S.

In terms of merchandising categories, of the main four categories, food sundries, hard lines, soft lines, fresh foods, the bell weather, of course, has been fresh foods coming in at a low double-digit comp.

Food sundries has continued relatively strong.

Hard lines has some strength and some weakness in it.

Although the number for this quarter is similar to the last quarter.

Soft lines, while the weakest of the four components, historically over the last year, is up slightly.

Within the food sundries comp, also the categories were up year over year in the fourth quarter.

Within our hard lines comp we saw strength in majors, again a continuation of strong electronics sales as well as toys.

Those were the two strongest subcategories.

Within soft lines, housewares, domestics, home furnishings and small appliances were strong.

The strongest seller was like last month, women's apparel, offset by weaker comps in media.

Fresh food comps again has been the bell weather with particular strength in produce.

Moving to line items of the income statement, I'll start with membership fees, now membership fees reported in Q4 were $379.5 million.

In terms of dollars, up 12% or up $39.7 million year over year, however as a percent of sales down 14 basis points.

Usually I don't discuss this next little piece, but when you look at the reported figures here, for the first time in a long time it shows that membership fees as a percent of sales dropped by 14 basis points.

Typically it's about flat maybe even up a few basis points with the conversion of some members to executive membership.

This is mostly, this impact here in this quarter is mostly due to the impact of a 53 week year and of the 17 week fourth quarter related to that extra week this fiscal year and in the quarter.

Our reported book Q4 membership fee income is essentially one-thirteenth.

Again we remember we operate on 13 four-week periods with our first three quarters being 12 weeks each and our fourth quarter being 16 weeks.

Our reported book numbers, essentially one-thirteenth of each of the prior 12 four-week periods of cash membership fees, plus one-thirteenth of the cash fees we received in August, which was a five-week period.

Our sales figure, of course, is no deferrals, it's all the sales in the five-week month of August.

So if you have a lower reported book membership amount on all that sales you are going to have a slightly lower percentage.

Probably the best way to think about it is this: If you think about it in a sixteen-week typical fourth quarter, an extra week is about 6% more days, 6% more sales.

And 6% more sales, although on a deferred basis given that you've got 12/13 of your membership fee number coming from prior months which was four weeks you basically have a 6% reduction and a 2% reward which is about 12 basis points.

I know that's confusing to some of you.

The math works and we are fine.

So on a -- and probably the best way here is to show you on a cash basis.

Our fourth quarter membership fees were $386 million, or 1.98% of sales versus the cash membership fees in Q4 a year ago, $325 million, or 1.99% of sales.

So on a cash basis whereas on a book reported basis membership fees were up 12% in the quarter.

On a cash basis they were up 19%, or down one basis points.

And instead of being up on a book basis, $39 million, they were up $61 million.

Pretty much in line with what we've expected.

In terms of membership, we continue to benefit from the renewal rates, good renewal rates as well as the penetration of the $100 a year executive membership.

Recognizing the P&L benefit from the $5 increase that we initiated in May, the real impact starts in July because that's when it started-- it impacted renewals and we will say 86% of our membership fees in a given year are renewals, and that should grow given the deferred accounting nature of that $5 increase.

In terms of number of members at year end we had 17.4 million gold star members, up 400,000 from Q3 end, and up 1.2 million from last year end, 5.2 million business, primary business members, up 100,000 from last year and pretty much in line with a quarter ago, up slightly but no rounding to the nearest 100,000.

Business add ons, 3.5 million.

Total memberships, 26.1 million.

And including spouse cards 47.8 million members at the end of '06 up 800,000 from Q3 '06 and up about 2.5 million from last fiscal year end.

At fiscal year end on September 3rd, we had a little over 5.2 million paid executive members.

This is about 11% of our membership base.

This also represented about a 250,000 member increase, or 5% increase over the last 17 weeks since Q3 end.

So, still, even though the number of new executive members per week is coming down it's still 15,000 a week during the quarter.

I should point out that these roughly 11% of our membership base generate more than 50% percent of our sales.

I'm sorry, it's not 11% it's about 20% of our membership.

I'm sorry, my mistake, typo here, it's about 20% of our membership base generated about 50% of our sales, recognizing that about 10 percentage point of those sales are nonrewardable such as gas, tobacco and alcohol and if you look in our-- the reward as a percent of sales it's a little over 80 basis points which is apply about 40% of our sales or a little over 40% of our sales are rewardable.

In terms of our renewal rates they continue strong at an all time high.

At Q3 end our renewal rate was 86% which was comprised of a 91 business and an 84% gold star.

At year end the 91 has rounded up to 92 and the 84 has rounded up to 85.

Those aren't full integers in terms of it's more rounding, but at fiscal year end we were right at an 86-- is a reported 86 but right at an 86.5, compared to a year ago when our 86 was an 85.7.

So we've actually seen a little improvement over the last year on our renewal rate, again, that's consistent with everything we've done as it relates to executive membership penetration as well.

With the $5 increase historically we've seen a small reduction in renewal rate.

It's really too early to tell although early indications from our head of membership and marketing is they're not seeing very much resistance to the $5 increase implemented in May and beginning in July with our renewals.

Before going on to gross margin and SG&A, let me mention that we made a small reclass to our prior period income statements, whereby a small amount of credit to, an offset to SG&A historically is now being reclassified to conform with current GAAP accounting.

The impact in Q4 is, as in all prior periods, is a small hit to SG&A with those dollars being re-classed to sales.

So something that historically had credit to SG&A is now being added to sales.

With that many impact you are going to have a small increase in sales, a like amount of dollar increase in SG&A and bottom line profits of course are unchanged.

Not a big deal, it simply conforms with what we believe to be correct.

When it was a smaller number it really didn't stand out and as it's grown a little bit and reviewing with what our outside accountants we concurred that that was the right thing to do.

However with this small reclass, gross margin percent increases slightly because your sales are increasing slightly, and your cost of sales stay the same, offset of course by the same amount in the SG&A.

Our comparisons will be apples-to-apples and we'll provide you by about noon today pacific time, in the-- our Q&A which will be on the Costco web site.

We will show you, basically, the reclassified income statements showing the impact of the small impact of this on an apples-to-apples basis for the last two fiscal years, and by quarters, so you will see kind of the same two-year quarterly income statement presentation that you will see in our 10K in a month and a half and that will show you those little differences.

I know a few of you have already e-mailed me this morning, what's the 10 or $20 million difference there?

Going down the gross margin line, gross margin in Q4 was lower year over year by 12 basis points from a 1048 last year to a 1036 this year.

And again, we are conforming last year's quarterly and annual numbers to show the same reclass so we can look at apples-to-apples.

If you drop down a couple of small numbers here, we will just give you the last couple of quarters.

Merchandising is line 1, 2% reward is line 2, and LIFO is line 3.

And, of course, a total, line 4.

In Q3, you had merchandising gross margin up by 1 basis points [inaudible], 2% reward was a negative 10 basis points contributor.

LIFO was a plus3 basis points contributor.

So in Q3 year over year we were lower by 6 basis points in margin.

In Q4 we were minus 8 basis points on merchandising, minus 9 on 2% reward, plus 5 on LIFO, and a total of minus 12, and for the year, the third column, minus 4 for merchandising, minus 10 for reward, plus 3 for LIFO, from minus 11 year over year.

As you can see, our overall merchandising gross margin was lower Q4 over Q4 by 8 basis points and year over year by 4 basis points.

Our core merchandise business which is about just under 80% of our business comprised of food and sundries, hard lines, soft lines and fresh foods, so it excludes ancillary businesses such as gas, pharmacy, optical and one hour photo, these were up year over year in Q4 by 4 basis points.

Now this compares to the same core departments being up year over year in Q3 by about 14 basis points, the difference is things that we talked about on the August 30 conference call which followed the press release, a little extra markdowns in things like furniture to blow-through furniture to year end, and more importantly, some additional costs associated with electronics returns.

So that's really the difference you see there.

So even though these departments are up 4 basis points in Q4, with a little less sales penetration these categories given the strength in things like gas, it still had a slight negative-- it was still a slight negative contributor to total company gross margin.

Our year over year gross margin in the gas business was actually about flat in the fourth quarter.

It started off strong for much of the quarter it was weak and the last week or so it had re-strengthened as gas prices fell.

But it's still a very low gross margin bill as is relative to the rest of the Company.

So again, and then as well, our Q4 gross margin was impacted by the negative 9 basis points from the executive membership program, higher penetration are there, again, the continued growth and success of that program, and by an improvement LIFO in Q4 last year we had $7.4 million LIFO charge, we have no charge this year in Q4.

In terms of our gross margin outlook going forward, reported gross margins could probably be up a little to start the year due in large part to the falling gas prices, although, again, you have to compare that to what penetration in gas is going to do and it's really a guess at this point.

So it is could be up a little bit or down a little bit.

My guess its going to start up a little bit because of the strength, what we talked about with September and Katrina from last year, so we will see how the rest of the quarter goes.

The impact from increasing executive membership should still be a small hit to reported gross margins but less than the 10 basis points last year.

LIFO, again, right now we're only a month into the year, of course, and with big deflation in gas, and really nothing to speak about inflationary in the rest of the business, a little bit meat, a little bit some nuts, but nothing dramatic, and again it's only four weeks of the fiscal year so far.

So LIFO is an assumption, 0, my guess is 0 at best, slightly negative at worse.

We think, overall, our core merchandising group, again, food and sundries, hard lines, soft lines and fresh foods should be okay.

We still have the challenges of electronics, as well as we want to see where sales trends and what the economy does this current year-- upcoming year.

Before going into SG&A, in terms of ancillary businesses, we ended the year with 401 pharmacies, 452 food courts, 450 one hour mini labs, 442 optometry shops, 9 print and copy centers, 196 hearing aid centers and 250 gas stations.

These businesses are generally doing fine, no big issues.

We've talked ad nauseum about gas, and you know what happens when the price of gas goes up and down.

In total for Q4 our ancillary businesses, comp sales were up 20%, up 8% without gas.

Moving to SG&A, our SG&A percentages in Q4 over Q4 were lower or better by 1 basis points coming in at a 958 this year versus 9.59% of sales in last year fourth quarter.

Again, quickly [dragging] down a few numbers here.

The line items would simply be operations, central, stock options and total.

Last, again, we'll just start for the last couple of quarters in Q3 and 4 and for the year, a plus means it's better or lower.

So plus is good here.

Operations in Q3, '06 were better, or plus 8 basis points, central, plus 3 basis points, stock options, minus 3 basis points, total, up 8 basis points.

So year over year, again, comparing apples-to-apples percentages based on that small reclass was better by 8 basis points.

In Q4 '06, operations was higher or negative 1 basis point, central was plus 7, stock options were minus 5, for a total of plus 1 or slightly better, year over year better by 1 basis points in SG&A.

For the year, plus 5 basis points in operations, plus 4 in central, minus 5, options, plus 4 year over year.

So SG&A, reported SG&A year over year was better or lower by 4 basis points.

In terms of a little editorial, I'll point out the following; operations, showed as you see here, showed a detriment of 1 basis point year over year.

However, about 6 basis points of it is the fact that we internally hit our bonus numbers this year, which impacts about, well about 2,000 people, adding the-- about 1,000 people this year, so, about 2,000 people this year, and that was about a 6 basis point year over year, as last year we did not hit all the goals.

So that's about 6 basis points of that.

Also, we benefited in lower Q4 over [inaudible] SG&A improvement in our largest expense category, payroll, which improved year over year by 7 basis points.

Of course a chunk of that essentially is that same 6 basis points.

Finally, our stock option expense which was 5 basis points year over year, going forward we don't expect to see that be a positive comparison year over year but, unlike the last three fiscal years, 03 -- last 4 fiscal years, '03, '04, '05, '06, since we began expensing options, this has been a constant drag on year over year SG&A comparisons.

It really should be essentially flat going forward.

In terms of SG&A outlook for '07, we could be helped by slightly lower expense percentages and payroll benefits and Workers Comp.

Really the big question is sales trends and where those go over the next year, not unlike what I said on the August 30th call and what we said at the end of Q3 as well.

With respect to benefits and Workers Comp., as you know we've seen some good improvement in those numbers over the last two, three years in terms of benefits it related to some changes we made in late calendar '03 really impacting beginning of calendar '04.

We are near the tail end of those benefits.

Should get a little bit more this year.

With regard to Workers Comp, the big issue there was changes in legislation in California's Worker Comp. laws which really started benefiting us-- which was hurting us for a few years if you recall but started to benefit us starting mid calendar '05.

We've really seen a lot of that benefit already, maybe get a little bit more this year but not much.

On terms of income statement, preopening expense, last year fourth quarter was 10.4 million or 6 basis points, this year 15.1 million or 8 basis points so 4.7 million higher and 2 basis points higher year over year.

No big surprises here.

Last year in the fourth quarter we had six openings, this year we had nine and, of course, this year we also have plenty going on in the beginning of Q1, some of which preopening falls into Q4, probably on a relative basis a little more this year than last year.

In terms of provision for impaired assets and closing costs, last year in the fourth quarter we had a $6.6 million charge, looking back at my notes from last year, I mentioned that about 3.9 million of that was a little bit of anomaly related to the closing down of some minor food manufacturing businesses we had into Q4 this year, that was 3.9 of the 6.6, about 2.7 million was the rest of the provision.

This year in Q4 the number was 1.6 million.

All told, operating income in Q4 was up 10% year over year from 467 million last year to 514 million this year or an increase of $46 million.

The operating income line reported interest expense was lower year over year, Q4 '06 coming in at 3.2 million, a little less than half of the 7.3 million in last year's Q4.

This of course reflects both the June 15, '05 payoff of a $300 million debt amount and lower interest expense on our convertible debt as more of our holder convert into our dividend paying way in the money-- common stock compared to the way in the money of the convertible debt instrument.

Interest income and other was a bit better higher year over year by 5 million in the quarter, up from 43.8 million last year to-- up from 38.6 million last year to 43.8 million this year.

This $5 million higher income figure was higher due to higher interest rates being earned on our investments, somewhat offset by a slower-- slightly lower investment asset balance as we continue to repurchase stock.

So overall our pretax income was up 11% year over year in the quarter from 498 million last year-- yes, 498 million last year to 555(ph) million this year.

In terms our tax rate, there's really no need to jot down a table here.

Recall in Q4 '05 our tax rate benefited due to some unusual income tax credit in the amount of approximately $34 million or $0.07 a share.

And for all of '05 for the year a little over $70 million in related credits, which impacted all of fiscal '05 by about $0.14 a share.

In Q4 '06, as you recall on our August 30th conference call, we indicated that in a press release, we indicated that this year's Q4 tax rate would be a negatively impacted by about $14 million, but other items essentially-- but since that time since August 30th, other items have essentially offset those negatives.

An example would be just a couple of weeks ago we received a letter from a foreign taxing authority saying that a position where they previously assessed us for something, therefore we continue to accrue for it and the total amount in U.S. dollars was about $5.4 million to the tax rate, we received a letter just two weeks ago, and again it's related to several years of history here, that they agreed with our position.

So normal adjustments just came since August 30th and when he a few of those happening.

In terms of our effective tax rate going forward, again, I am still going to assume somewhere above 37, 37 to 37.5% to start off the year, although one could look at the prior couple of years and taking all the noise out of these big adjustments that we've experienced something slightly less than that.

For a quick rundown of our balance sheet, again, this will be part of the Q&A thats posted by noon pacific time on our website.

Cash and equivalents at September 3, 2.833 billion, inventories, 4.569 billion, other current, 801, total current assets, 8.203 billion, net PP&E, 8564, other assets, 699, total assets, 17.466 billion.

On the left-hand side, short term debt of 350, that of course includes 300 million that will come due this spring, which is another small debt instrument we had out there from I think five years ago.

Accounts payable, 4.581 billion, other current liabilities, 2.865 billion, total current liabilities, 7.796 billion, long-term debt, 215, which is principally the remnants of our convertible debt issue.

Deferred and other, 248, total liabilities, 8.259 billion, minority interest, 63, stockholders equity, 9.143 billion, for the right-hand column, also totaling to 17.466 billion.

Our balance sheet is strong, arguably we've seen a little reduction in cash with the stock buybacks.

Plenty of financial strength.

Accounts payable as a percent of inventories on a reported basis is 100%, down slightly from the 105% a year ago.

That includes of course accounts payable related to nonmerchandise for all the construction we have principally.

If you took out that and looked at just merchandise payables, a year ago the number was 87% at year end this year, 83%.

So still 83% of our inventories-- our trade inventories are being financed, despite taking as much anticipation and early payment as we can for discounts, our paid accounts payable as a percent of inventories are being funded with trade payables by 83%.

Our average inventory for warehouse a year ago at year end it was 9.293 million.

This year it was 9.975 million or up about 7%, probably a little piece of it is the fact that it's a week later, last year ended a few days further behind Labor Day as we built up for the holidays here.

In terms of where it is, about 60,000 is due to the continued weak dollar in terms of FX.

We have about $165,000 higher balance in consumer electronics.

Within about 10,000 of the same type of delta at Q3 end.

Same with jewelry and toys, about 130 thousand higher year over year, again, the delta year over year at Q3 end was about the same, I think about $10,000 different.

No real inventory concerns at this point.

In terms of CapEx, in '06 we spent 1.2 billion.

This figure by the way included in the fourth quarter of '06, 455 million, some of which of course relates to '07 ramped up level of openings.

So we are always going to have some carry over, but again as we've ramped up our expansion probably a little more than a year ago.

I would estimate that our '07 CapEx will be higher than last year's figure, and I will give you a wide range here because a lot of it depends on timing in the fourth quarter of what we've got going on in Q1 and beyond in fiscal '08.

But we would estimate probably a single-digit estimate of 1.5 billion with a range of 1.4 billion to 1.6 billion, up from the 1.2 billion in '06.

In terms of dividends, this past May we increased our quarterly dividend from $0.115 a share per quarter to $0.13 a share, on an annualized basis this $0.52 a share annualized dividend represents across the Company of about $240(ph) million.

In terms of Costco Online, it continues to do quite well, for the fourth quarter it showed sales increase of 53% and 62% for all of fiscal '06.

Sales for '06 were 902 million, again up from 558 million last year.

E-Commerce is profitable, and needless to say we have lofty goals for it this year as well and could do well over $1 million.

In terms of expansion, as I mentioned in the beginning of the call ,the year just ended we opened 27 net new units, 25 consolidated plus 2 in Mexico.

This fiscal year I am going to give you a single point estimate of 35 net new units plus 2 in Mexico, so 37 including Mexico, plus about-- probably 2 relocations, maybe 1 more but I will assume 2 for this point.

I think at August 30th we mentioned that between September 3rd and calendar year end we plan to open 20 units, it looks like that's going to be about 18, maybe even 16 or 17.

That's simply 3 or 4 units with various construction delays and zoning issues moving into the first few months of calendar '07, no big deal there.

We would expect to open a net of 12 in Q1, a net of 6 in Q2, a metal of 7 in Q3 and a net of 10 in Q4.

Plus that would equal a single point estimate of 35 and plus 2 in Mexico.

Now, if you asked us, we would probably say 35 to 40, but as you and I know, year as year end some seem to fall into the following year, so 35, I think is good as a single point estimate.

In terms of '08, my guess is the number would be a little higher from there, perhaps 5 more.

In terms of our stock repurchases, we really began in earnest back in June of '05.

Since that time we've repurchased approximately 40.4 million shares.

I think that's about 10 million more shares than we have repurchased as of the last conference call at the end of May.

So we've spent a little over $2 billion, about 40.4 million shares, with our current authorizations out there which authorization expires in November of '07 we still have authorizations of $2.49 billion.

Finally, before I turn it back to Amy for questions, a little direction for Q1 '07 for '07 overall, where first call was as of, before today's announcement, first call was of course $0.50 for the first quarter of '07, and what I'll say is, we'll give you a little wider range than we normally do, probably something in the $0.48 to $0.51 range, and again we are hedging our bets, want to see how the economy continues through Christmas here.

For the year, first call is at $2.59 and again I would put probably about a 15%-- $0.15 per share range on that, with it skewed a little lower-- little more lower than higher, perhaps a $2.50 to $2.65 range.

Again, it's a long year ahead of us.

It's a strange economy out there and as we've tried to do in the last few quarters, we've tried to look at it optimistically as we run our operation but cautiously as we view our numbers.

With that I will put it on the speaker phone here and turn it over for q&a.

Amy?

[OPERATOR INSTRUCTIONS] Your first question comes from Charles Grom with J.P. Morgan.

Good morning, Richard.

Thanks.

You are on pace I think you said 35 stores next year.

Could you remind us of the new versus existing store mix and historically what the productivity is for both those type of openings?

Sure, those stores are-- I don't have the exact number but I'm willing to bet it's 90% recognizing as we open a 6th unit next month in Atlanta, it's not new anymore or a 14th unit in Chicago this coming year, so some of what was new is not. 90 is probably a little low, frankly.

In terms of sales productivity if you go back to '01, '02 when we opened a lot of new market units and went into several new states in the U.S., first 52 weeks of a new market unit had probably averaged somewhere in the low 50s, whereas a new, an existing market unit today might start off in its first 52 weeks in the low 100s, 110, 120, perhaps.

If you net cannibalization out of that existing market our best guess is probably somewhere around 80.

And we've had extreme examples of units doing 150 plus in their first 52 weeks which again, net of cannibalization might be 110, but on average, probably a net of 80.

Of course, in existing market unit, you generally have a little higher margin in a new market, but frankly, there's not as many new market units today.

Can you elaborate a little bit more on your comments if sales trends improve towards the end of the quarter?

And more specifically, what you're seeing today in some of the more discretionary categories?

I don't recall saying sales trend improving at the end of the quarter.

What we did say, at the end of the quarter, I'm not sure what I said about end of the quarter.

Just in the press release you said the last five weeks got a little bit better and that's the reason why you think you'd beat it by a couple of pennies exactly what you're seeing, and I guess more importantly, what you saw in September related to some of the discretionary categories, furniture, CE?

Keep in mind, August 30th , what we said in the press release on August 30th when we got it downward what were the deltas that made us, that caused us to do better than that, again, there was the tax, some positive tax things occurring as well as the negative one we already mentioned, that included some year end accruals, expense accruals being better than planned.

We also indicated that until we actually closed the period which was ten days later because we had one more week of the fiscal period, it's a five-week period, you never know how a $5 billion period is going to come out, and you can easily-- we did better than we planned even though we have a pretty good handle on it., until it's over it's not over.

So that was really more of the earnings trend in the month of August.

Again, in September, I think as some of you have reminded me have said it, we warned everybody a lot about it, but with the Katrina issue you had this giant impact in September and to some extent in October, I think our reported comps in September were 11 and October were 10.

So you are going to see, again, looking at just the bottom number for September over September, October over number, you've got to kind of-- we tried as best we could take out that skewing due to the craziness with gas and the improvement that it helped last year.

What I did mention today was is that even if you take that out my guess is where we showed in September a 4% comp versus this month earlier August an 8, the real change from month to month is not 4 percentage points, it's probably 1, downward a little bit.

And not unlike what we've seen out there.

Okay.

Great.

The last question is just on the TV returns, can you walk us through how the accounting works on that?

Is it entirely accounted for in the gross profit margin line, is there any in SG&A?

And can you give us an update on the concierge test?

It's entirely in margin, of course there's SG&A because somebody has to handle it at the front desk but that's de minimis.

The concierge test is something we are doing in Southern California and it's really two-fold.

First part of the roll-out was simply having an 800 number where somebody can call and get quick, high quality advice a lot better than frankly some of the underlying manufacturers if you call their 800 numbers.

And it was just -- Jim is here so he knows a little bit more about it than I do.

We are in the process of expanding that to a greater portion of California.

We would have hoped that by the early part of the first of the year we would have that in all the California.

Great.

Thanks, good luck.

Your next question comes from Deborah Weinswig with Citigroup.

Good morning, Richard.

Once again on the return policy, the customer electronics area, can you talk about any update there based on what you saw this quarter?

Well, in terms of returns, again it's probably getting, it gets more attention because we mentioned it but it's been meaningful.

Again as we said in August, it was exacerbated perhaps a little bit over the summer with the continuing declining prices and with some of the passport items.

What we have said, and time and again, is the last thing we wanted to do is change a return policy.

That being said, we are trying other things first and we have not made any decisions and we continue to talk about it and when we know, you'll know.

I'm not trying to be cute there, it's just that we want-- his concierge service is addressing some of the issue, not all of it.

Part of the concierge service is not also not just answering the phone and helping somebody through something, but also offering an installation service, if you will, a white glove service, something that we are already doing online with electronics.

Right now is there opportunity for your customers to, let's just say, obtain additional information online or is that an additional opportunity to maybe stem some of the returns as well?

I will have to get back to you on that.

I'm sure there is an opportunity online.

I'm not [inaudible] information.

I mean ,really, we are taking some of the burden off the manufacturers and so they like it.

We like it because these are people that are, I'm making this up myself, but these are like level two people, these are people that are higher, so we could answer hopefully more of your questions on the first round.

By the way, 40%, I think it was about 40% of the calls we are getting, Jim, are for televisions?

The other 60% are for everything else.

As I'm sure some of you know firsthand, when you got yourself or your kid an IPOD, how the hell do I make this thing work, it may seem simple to some but it's not to many.

I've been there.

And then last question, just in terms of, can you talk about inflationary or deflationary categories different than what, obviously outside of fuel, different than what you expected in the quarter?

I'm sorry, Sandra, what was that?

Inflationary or deflationary categories in the quarter?

Hold on.

I have a little sheet here.

What I have in front of me is really for the whole year.

But it's, from what I remember it's not changed that much.

We've seen some continued increases in the prices of beef, and nuts.

On the deflationary side, everything ends with LCD or ultra or plasma or megabyte, for the most part, or in gas -- well not in the fourth quarter, in the first quarter we will not doubt see deflationary gas. [TALKING IN BACKGROUND] Dave [Kutterson] is here, our Controller, very minor inflation in the fourth quarter in gas.

And expect a deflation in Q1.

Big negative of course in September.

That will subside but my guess is it will continue to be negative.

Thanks so much.

Your next question comes from Jeff Stinson with Cleveland Research.

Richard, could you talk a little bit further about the gasoline as far as the gross margin impact it had last year, and kind of what that delta should be this year?

If I look at the numbers by the time we get to, I think, the end of your fiscal first quarter gasoline prices if they stay where they are should be fairly flat with last year.

It's really hard to predict.

I'm not trying to be cute here.

Even our guys in the gas department here from one day to the next can't tell you which direction it's going to go.

And last year, I know in the first quarter and in the second quarter, we indicated that it was the penetration of gas not the margin of gas hurting us.

In Q4 it tended to be a little of both.

Yesterday I read that it's going to be a mild winter.

If it's a mild winter that helps reduce gas prices which is a positive, but it's really very hard to predict, Jeff.

And the penetration, Richard, if we were to look at it, end of the fourth quarter this year versus last year what do those numbers look like?

I think penetration in Q4 '06 versus Q4 '05 was clearly up, probably over 100 basis points.

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

My guess is in Q1 it's going to be down.

Now the bad news is its down and it effects comps and effects sales.

The good news is it may help profits a little but, again, we had a pretty strong first quarter of gas a year ago margin wise, profitability wise, so we'll have to see.

We started off the first few weeks okay, but as I said, at the end of the third quarter we had a first couple of good weeks in gas margins but that could be fleeting and it was.

Usually you do get the cyclical benefit of between extreme heat and cold seasons here so September and October should all things being equal in the world with the craziness should be okay.

And Richard one follow-up question, if you look at the change to the restricted share does that change at all from the impact from an accounting standpoint on numbers?

Not really.

Historically, when will we granted options, we use a Black-Scholes model and they have invested one-fifth a year so the impact would go one-fifth a year.

Where it is showing one-third, the formula is if a recipient historically received X options, they are not now going to receive one-third as many RSUs.

On a Black-Scholes model relative to where the stock price was on a date of the grant, and it's on the date of the grant that you determine even over the next five years what you are going to book for book purposes, the impact is about the same because typically the Black-Scholes expense if you will calculated expense was about a third of the stock price on the date of the grant with RSUs it's the stock price on the date of the grant.

You can be up or down a little bit but not much.

Thank you.

Your next question comes from Gregory Melich with Morgan Stanley.

Hi, two questions.

One is on the SG&A.

Richard, you mentioned that the Workers Comp. and other expense accruals were one of the things that changed in the last five weeks.

Was that all in the SG&A [opts]?

Was that the improvement in payroll basically?

Actually it's not payroll but it is in an opts.

I will give you a silly example.

In Canada, everywhere in the Company, we accrue, based on our -- based on salary dollars we accrue based on vacation accruals, sick leave accruals-- use vacation for a minute, an employee in the U.S. gets, earns one week of vacation during their first year of employment.

So during the year we are accruing a week of that, we are certainly accruing a certain number of days for sick leave and what have you, in years two through five of employment we accrue two weeks, so we're accruing two weeks during their year of payroll, and then in year six through ten, three weeks, and beyond ten, four weeks.

This is a small piece of this number but in central Canada with the oil boom going on in Alberta, we had a lot more turnover in those locations.

When we have turnover you are having people that were leaving high paying jobs to get hourly paying jobs double and triple and more by traveling hundreds of miles north and working for the next year or two.

The short term impact for us is we didn't change dramatically our accruals but you picked up some serious dollars because over in the last year.

Now we look at these things on a quarterly basis, but the numbers are so big now with thousands of employees, something little like that could be a couple million dollars.

That's just one little example.

When you say payroll is better by 7 basis points, that is basically --

The payroll better by 7 basis points, a chunk of that was the fact that our bonus accrual, and I'm talking about management bonus accrual for about 2,000 employees company-wide, there's a company half and an individual half.

When things are good all of the company half is paid and most of the individual half.

When things are good but not great the good chunk of the employee half is paid and anywhere between all and none of the company half is paid.

Last year, this year relative to our original budget we did better than we did in '05.

And what were payroll hours up?

Just to look at it another way?

I don't know off the top of my head.

If you want to call me.

This is one for Jim because we've gone there we've got him there, your balance sheet is very strong and I'm just sort of curious as to, Jim, your thoughts on what sort of capitalization or debt levels you think the Company should have or cash levels to run the business effectively?

Again, are we going to continue to ramp up the business.

Our intention, as I think we've mentioned to you in the past, is to open more warehouses than we have in past years.

This year Richard showed you that, including Mexico, we would expect to have about 37 warehouses.

We would hope that next year that number on the basis of what we see in the pipeline at the moment would be exceeding 40 warehouses.

Obviously that's going to determine on deals getting done, and the fact that we can get permission to do business in those places, but that's where we intend to spend what money we have available and the cash flow we have available.

Just given that there's been a lot of other companies really looking at being public or private, to run your business well and help your members is it better to be a public or a private company?

What's your take on that?

I mean you could argue -- that's a long -- I would have a long protracted answer on that but let me just tell you that we have no trouble with the system.

We think the system works and being a public company means you have to disclose a lot more and some things you can't do but --

You have to deal with people like us which can sometimes be a pain.

Yes, but life can sometimes be a pain.

There's a lot of things that don't work perfectly but on an overall basis I think we feel pretty good about being a public company.

Thank you.

Your next question comes from Todd Slater with Lazard Capital.

Thank you very much.

Just trying to understand the apples-to-apples EBIT number for the fourth quarter this year and last year.

If we take out the LIFO charge from last year-- we add back the LIFO charge to 468 and get about 475, is that a fair sort of number that doesn't have a lot of noise in it from last year's fourth quarter?

Yes.

If you look at -- yes, yes, you can take that out.

And so this year there was no LIFO adjustment, right?

Right.

So the 514 then, of the reasonably, fair-- accurate assessment of the operating line this year or is there any other noise in it we should-- I mean there was an extra week in there, right?

There is an extra week, yes, other than that, above the operating income line, there was no lease issue, lease accounting issue, other than LIFO.

How much do you think the extra week added in EBIT dollars, would you guess?

One hundred fifty second [sic].

One hundred fifty second [sic].

For the quarter?

Well given that the fact that there was some gas benefit in the margin there at the end, would it have been a little bit more than average?

It's so hard to say, Todd, I mean if you think about the 17 week fourth quarter on the one hand an extra week is 6% of the weeks.

On the other hand, a chunk of fourth quarter every year is all the accrual through ups, which are big-- and shrinkage, taking inventories at mid year and year end.

You are talking about tens of millions of dollars.

On a year over year basis there shouldn't be big deltas because we've done it the same way for 20 years but, I don't know --

514 is a reasonable number based to grow off of for '07?

Well, I would hope so.

If you notice the direction for the year is a number that, in terms of earnings growth is anywhere from a high single-digit to a mid-teen digit number.

We got to wait and see.

So, if you take out, sort of both-- the noise from both numbers you get about, I get about a 25 basis point decline in operating margin, despite an 8% comp in the quarter is that a reasonable way to look at it?

Are you talking about for next year?

No, just for the fourth quarter this year versus last year, I'm just trying to understand sort of what the deleverage was in the quarter on the-- earnings just simply divided into the revenue.

Well, again, the big difference I think to start with is this membership issue that I talked about early on.

Because of the extra week the same exact thing happened five years ago in that quarter.

In fact we were looking at it and said what happened this quarter because membership fees as a percent of sales have been so consistent for so many quarters how could it sudden will be down 14 basis points?

Well in fact it's not.

It is on a book basis, you are going to see that.

So, half of your-- more than half of your thought there is thrown out the window.

Okay.

So it's only about half that much.

And then when you are looking forward into '07, what type of, are you expecting operating leverage on the operating income line in '07 versus '06, what kind of a comp do you need to generate to gain operating leverage, do you think?

It's hard to say, Todd.

When we look at our own numbers and our own budgets for the whole year which is within that range of that 250 to 265 if you will, that implies close to flat pre-tax earnings, up a few basis points, down a few basis points.

Where it is on there, who knows.

I want to go above pre-tax.

I want to go to the operating line, take out the interest expense issue and stuff like that.

Just their operating line.

This is more detailed.

I will be happy to chat with you offline.

Everyone of you has a different model and looks at different things.

The interest expense and income, which should be a small pick up in basis points, as it seems to be, reduced that impact, though, is reduced by continuing to buy back stock as we've continued to do, although that helps your earnings per share growth rate so that's kind of a wash.

Beyond that, there's the challenge of running the business.

And a lot of it depends on sales, as you mentioned.

If comps are six instead of five or four instead of five you have some [inaudible] different numbers.

So, do you have a sense of what the sensitivity is on leverage on the operating line, what kind of comp growth would you need to generate to get some basis point?

I stopped predicting that about six years ago because again there are so many moving targets.

What we're best at predicting, sometimes, is the bottom line, and sometimes you can get to the bottom line three different ways based on which basis points.

As you well know on 60 plus billion in sales, 10 basis points of anything is a lot of cents a share.

Are you going to change at all your accrual for LIFO for '07 versus '06, or how you've done in the past, or how are you looking at --

We haven't changed the way we've done it for years.

I think the difference is we had some LIFO charges for a couple of years, we've also had LIFO credits going back a few years ago.

My best guess, again based on 28 days, is that it will be zero.

We can hedge ourselves a little bit.

There's always concern about inflation but that's always muted by the fact that the economy isn't so robust.

So, you're guess-- we don't have any economists here.

Right, but you accrue it-- I'm assuming it more than zero or is that incorrect?

We accrue it.

We have 6 LIFO pools, we look at them end of every month relative to where it was at the end of the prior month, and we'll make a small amount of accrual at each quarter end if we feel warranted, recognizing whatever you do mid year at end the Q1, 2 and 3, is going to still be based, not only on what's actually happening, but what you think it's going to be going forward.

So, if our buyers have knowledge that, 'hey, yeah, prices of plastic goods have gone up a lot, but there seems to be a [glut] now and they're going down', I'm making this up-- example up, by the way, you might mitigate that a little bit.

It's kind of easy to figure out right now simply because there's not a big change either way.

Okay, great.

Your next question comes from Virginia Genereux with Merrill Lynch.

Thank you.

Just three quick ones if I may, Richard.

First, dumb question on the membership fee.

If you have, if you basically have 16 week, fourth quarters, right, you have four of your four-week periods, why is it membership-- why doesn't membership income always grow faster in the fourth quarter?

You know what I mean, how come it's always sort of consistent, I would have expected it to be up, if it's been running up this year, kind of 10%, I would expected it would have been up 13% in the August quarter.

Well, we're always comparing to the like number of weeks to the prior year.

If you looked at-- why with an extra week is it higher, is the percentage a surprise relative to Q3, it gets back to this impact of the 53 week year ,and how we accrue, how deferred accounting works with our month, keep in mind we generate monthly renewals not four and five week renewals.

Understood, but I'm asking, forget the 17th week, but I'm just talking about in any, in any August quarter, I feel like your membership fees should be up basically, they should be growing about, about a quarter faster than they grow in the prior three quarters because you've got an extra-- because you have an extra-- or a third faster because you have this extra four-week period.

My guess is, I'm sorry, my mind is a little discombobulated here, I think part of it has to do also with is the timing renewals.

If you look back historically, we have more renewals in the fall than we have in the summer.

Summer is seasonally slow.

Historically we -- I don't have the exact number but I bet you half of our units have opened between Labor Day and Christmas, because anything that's possible, ideally you like to open every location a month before Labor Day so it has the benefit of back to school, Labor Day, Thanksgiving, Christmas, New Year, every holiday that you can imagine.

But it does grow more in the fourth quarter but I think that may be a little of it.

Again, I'm not trying to be defensive, but if you want to e-mail me your question I'll give you a call next week.

It's not something I'm terribly concerned about.

I'm not either.

Second question--

-- this other issue we talked about membership fee, until we sat down and looked at it it's sort of counterintuitive.

Right.

Second question, if I may, are you seeing any impact on your-- it's probably too early, on your pharmacy business in Florida?

I don't think you guys have any Tampa locations but from Wal-Marts, the generic initiative there?

By the way, it's Florida wide now.

We've matched them.

Keep in mind, these generics, I think they indicated that it represented about 30% of the pills they sell, which means in my view it's less than 15% of the dollars, if not even lower.

Same thing with us, it's a small piece of the action, although we are matching it.

Where you can mitigate that issue is, they are doing it on a 30-day supplies for $4 meaning a three-month supply would be 12.

We have two prices.

We have a -- three prices, 30, 60 and 90-day supplies with the cheaper price per pill at 90 days.

Some of those instances we are actually cheaper than $12 on those and others we weren't and we are matching them.

We've seen some of the-- some of the negative impact to us has already been in for a year now with Medicare Part D. Different issue but we really haven't seen a big impact.

If you had a gas, what is the negative impact if it impacted us?

Maybe it's a penny a share.

But that's a wide guess.

Lastly, sir, the openings and sort of the-- you started to comment about the outlook for SG&A, and I would think that with the acceleration in openings this year and what it sounds like is going to be a like increase in fiscal '08 that you will face some SG&A pressure as those stores, as those stores launch at higher SG&A rates effectively?

Right.

That's correct.

However, in terms of that rate of pressure it's diminishing.

In '05 we opened 15 or 16 locations.

In '06, 25 consolidated, '07, 35 -- 25 on 16 is -- 25 on 15 is greater than 35 on 25, and 40 on 35 is less than that.

So, and so I think that, yes, there's continued pressure but that's the nature of our business.

One of the things that you don't have, and one thing, again, that's pressured our SG&A over the last couple of years, is for the last three-- four fiscal years, '03, '04, '05 and '06 is option expense, that's something that essentially goes to zero.

It doesn't help you but starts it stops hurting you.

As I mentioned already, we probably get a little benefits still from Workers Comp. and benefit related things but not a lot.

And so, yes, I think you are right, probably a little less extreme than you think.

That's fair.

Thank you.

Your next question comes from Mark Husson with HSBC.

Hi, this is [Nora Conan] for Mark Husson, you were cycling some difficult comps early in the quarter, and just was wondering kind of on the state of the consumer in your opinion and what trends you've seen in higher ticket discretionary items, particularly has that changed as gas prices have started to come down at all?

I don't know if we've seen it that quickly that fast.

The thing we mentioned a month ago was, and again this is more logical to us, where we saw some weakness was some areas are big ticket and discretionary, like furniture, like some of what we call collectibles, the $400 crystal candy dish.

Interestingly, not as much of an impact is things like diamonds, maybe a little more impact on some watches.

And again, and I think any consumer electronics company will tell you, still not a lot of impact in electronics just because the dang stuff is still so popular, every day they are coming out with something new.

And in particular in California where we've seen kind of a slow down in housing prices, the region hasn't been on one of your strongest that you list-- comps on a monthly or quarterly basis for awhile, what are you seeing there, are the stores just aging or is there something else going on?

I don't think the numbers are long enough, it hasn't been as long a period of time and we are probably not smart enough to figure that out yet.

The single biggest reason is our cannibalization is probably most impacting California.

I don't have the exact number in front of us, but if on a company basis, as an example, in September cannibalization was 175 basis points and in August was 155, so call it 1.5 to 1.75 points.

I bet you in California it's double that.

And again you've got high volume units.

That's the short term bad news.

A year later, you've got not only the new unit going into the comp for the first time but you have the two cannibalized units [inaudible] being rejuvinated.

That's part of doing business.

In terms of your merchandising margins, have you seen any improvement in sort of your buy-in gross margins, what you're able to get on different sourcing?

I think that we've seen that every year honestly for 20 years.

Our buying power is such that, and recognize our buying power probably, just looking at our sales dollars, is, understates our buying power because we are perfectly happy to have one brand over another.

We are not going to carry all three brands of something.

And the additional pressure, if you will, on prices related to private label.

So I think that's, put another way, the issue of Costco store has been, we know you have great buying power and it's improving every year and how much are you going to give to the customer?

And, ours, historically, we give most of it to the customer.

We've shown that we're prepared to drive our business.

So no, kind of near term changes?

I don't think there's any-- certainly, as we continue to increase the penetration a little bit of private label that helps a little, but a lot of the low hanging fruit has occurred over the last 10 years as we've gone from hardly any private label to 15 or 16% of our sales.

Your next question comes from Mark Miller with William Blair.

I was wondering how much you think you got in the way of incremental in store traffic in fiscal '06 with the surge in gas prices?

My understanding from club managers is that about half the people that go to the gas station go into the club to make a purchase?

Is that roughly the right range and how much more difficult do you see the comp hurdle in fiscal '07 from that?

No, clearly if you look back at the 11% comp in September, at the time we guesstimated there was probably a couple of extra percentage points related to gas itself and at least another percentage point related to people coming into the store.

Now that happens-- one or two happens to be 50% I'm not suggesting I know that exact number off the top of my head.

A few years ago when we looked at what would happen when we added the gas station we felt that for every dollar of gas, when gas was a lower price, it added maybe $0.40 in store.

This is a little different.

Anecdotally we always see, not only more frequency, but new sign ups when we are on a local news station saying, hey where's the best place to by gas, it's at Costco.

During the month of September it was on every news station in every town three times a day so certainly that helped us.

My guess, I don't know if it's-- it's probably not more than half, it's probably 40 to 50% is as good a guess as anybody.

So I think you are implying that September that hurt the underlying comps by about three percentage points from the prior trend.

What are you expecting here in October?

You alluded to more of a difficult comparison there?

Well, simple math would be, we were at 11 in September and at 10 in October, so call it 2 instead of 3.

By the way Jim mentioned that our gas stations typically are open about five hours a day longer than the warehouse, as we have employees starting a few hours before in the bakery and stocking and receiving goods and usually there a little bit afterwards the gas station stays open longer.

During those five hours we don't get the benefit of frequency in store.

Thank you.

In your range for fiscal '07, 9 to 15% EPS growth, what roughly would be the underlying comp range in that?

It's really hard to say.

Our own guesstimate of what comps could be this year are in the mid single digits.

I think it's save to assume that range, somewhere in the middle of that range is that number.

But it's, I'm not sure if it's a little higher, near the high-end or low end of that range.

My final question is --

there's so many moving parts.

My final question is, on the cannibalization, it's come up a little bit over time and I guess I'm wondering in your new store development plans do you assume cannibalization more or less stays the same?

Do you assume it comes up?

And if it were to come up would that impact your thinking at all for club growth?

Thank you.

No in a way the more cannibalization the better, and we are opening more units, because we've gone from, the last three years we've essentially opened existing market units, 80 plus percent.

If you think about, if we've gone from '05 opening 15 or 16 units to '06 opening 25 to this coming year opening 35 that's going to increase the cannibalization number from 50 basis points to 120 to 180.

It could very well be a year from now approaching two or if not a little over two.

That's okay.

I don't think that's going to impact what we do.

If we can get 15 sites opening tomorrow in Los Angeles, it would really impact our cannibalization but we would do it in a second.

The comfort and the reality is it ain't going to happen that fast.

It's hard work to get these things open, and I think the better way to look at it is is, simple math would say the number will continue to inch up a little bit so where it's been 170 basis points it's going to probably inch up above 200.

Unless we -- and then it will probable flatten out and then come down a little bit once we flatten out.

Thank you.

Your next question comes from Robert Drbul from Lehman Brothers.

I am -- good morning, good afternoon.

Richard or Jim, I guess could you just give us some of your thoughts as you head into the holiday season around the competitive environment or any major merchandising initiatives that you are excited about, new brands or anything that we should be looking for?

Obviously, it's always a guess when you are looking at Christmas.

We are only judge on the basis of what we see selling at the moment.

And the initial reaction to products like toys has been very favorable.

On the other hand reaction to some of the trim items for holiday have been a little lower than we expected.

So it's kind of a mixed bag there.

Toys, strong.

The reaction to some of the winter goods that have come in, the cashmere sweaters and the outerwear has been very strong at this point, which would kind of imply despite the fact that we've had warm weather up here in the northwest and certainly in California and Arizona, would imply that your heading into a pretty good season.

So at the moment we think that Christmas looks promising, certainly more promising than we would have guessed five or six weeks ago, but that could change very quickly.

But some of the things we see happening relative to electronics and relative to apparel and to toys encourage us.

Great.

Just one final question for me would be, with respect to the consumer have you seen a big change in response on couponing or any sort of initiatives that you guys have been running throughout the clubs?

No.

It's been running pretty much the way we had anticipated.

There are times when certain categories become more important than others.

Electronics are always a very important categories.

But we are in the process of having multi-vendor coupon that will go out this week and we expect that it's going to be very well accepted and our experience has been that it's, it all depends on the items you select.

If you select the right items you get good sales.

If you make the wrong choices the sales are not so hot.

Great.

Good luck.

Thank you very much.

Your next question comes from Craig Harris with Seattle Post.

Good morning.

Can you clarify for me how many stores you had open at the end of the last fiscal year?

And I want to make sure I'm doing my math right that that would include 27 new units, then you have 37 planned for fiscal '07?

Okay.

We internally include Mexico since we operate [inaudible].

We have at the end of fiscal '06, we had 433-- we had a total of 433-- okay we had 433 units consolidated into our operations plus 27 in Mexico for a total of 460.

Assuming we were to open-- that was the beginning of '06.

In '06, we opened 25 in our consolidated area and 2 in Mexico so we ended fiscal '06 with 458 and consolidated into our operations plus 29 in Mexico for a total of 487.

So as of fiscal year end September 3rd we had 487.

For '07, our guess is 35 into the 458 consolidated number and adding 2 or 3 to the 29 in Mexico.

If we added 37 to 487 we would be at 524.

And as the number, the 27 that you opened in '06, was that a record at that time, was that a record for the fiscal year?

No, I know in '01 and '02 we opened 29 and 32 -- or 32 and 29.

I think the record that we remember most was in our fourth year of operations in fiscal, '88, when on a base of 22 units we opened 15 or -- 20 that year and 15 or 16 in 12 weeks.

Okay.

And the last question I have is I'm not quite clear on the statement you had in the release that talked about on the grant, that one grant subject to imprecision, I'm not clear what that means.

I'm having to chat with you off-line as well.

Okay.

Basically there's not a whole lot I can say other than what's in the press release.

Imprecision simply means is that the committee-- given that there was some lack of data in certain instances, imprecision in my view implies that you can't calculate with certainty what it was.

I think in the press release it stated that the committee felt they made estimates based on a number that would overstate conservatively rather than understate the number.

Here's my last follow-up question, then.

Considering that you were so open about this, in the press release Jim talks about taking full responsibility that it did not live up to standards but it seems that nothing done was wrong, so I'm curious on the statement where Jim talked about it didn't live up to the standards yet it didn't seem that this was as huge of a problem as you're seeing at other companies that are on-- from Wall Street?

I think, again, we take any issue very seriously as people who have known us for 25 years, whether it's a safety issue in a warehouse or it's a payment issue or it's this issue.

Certainly this is a very important issue.

We don't take it likely.

It certainly has gotten a lot of press in the last year with many, many companies out there.

And we feel it was handled like anything should be handled.

You look at it.

If you feel it's something that is a potential issue you have outside people look at it.

And again, as stated in the press release, we've gone through that process.

But by no means should the issue be diminished.

Jim's here, he can talk for himself.

We always try to take the high road on anything we do, whether it's with our customers, our employees or products that we sell, and we continually operate on that basis and any time we don't meet our own high standards we are disappointed.

Thank you.

That's the sum.

Okay.

I will take one last question.

Your final question comes from Dan Binder with Buckingham Research.

Hi, it's Dan Binder, just a couple of quick questions.

First, on the TV cycle and the impact that you expect on gross margins going forward, have you-- do you have a rough sense what that should look like as we move through this year?

And then secondly, given that the square footage growth is accelerating a little bit this year, do you have a sense of what the operating margin impact is as a result of that acceleration?

In other words, are there 10 basis points of the incremental expense pressure between maybe lower expense leverage on those newer stores and preopening?

Or is that too high?

In terms of-- in terms of the TV pressure or the gross margin pressure, we think there are some things that can be done to mitigate what our experience has been this past year.

We were very enthusiastic about what we can do with this concierge program and we think that there are-- we can do a lot better job in terms of educating our customers on these products.

Someone mentioned earlier that fact that perhaps online information would be appropriate.

We agree.

So we are looking at all those types of things.

So we have -- we have a pretty good feel that we are going to get a grip on some of this stuff and we will see as we move forward whether or not that indeed is the case.

The fact of the matter is this is very complicated equipment and you all know you get lots of questions about it.

Many of you have been through the same thing yourself relative to hooking up a television set or any type of sound equipment.

In terms of the issue relative to what happens with these new units, it's pretty much a wash.

It is-- despite the fact that we have cannibalization when we open in infills those units start out significantly better and generate more dollars, and so opening a unit in Los Angeles or in the Puget Sound area is going to be significantly more profitable and have better leverage than opening one in Columbus, Ohio, where we happen to be opening Oregon, Louisville, Kentucky, where we will be opening.

Those will be tough relative to SG&A.

We think that the infills, although they are painful from a cannibalization standpoint, start out better and don't have as big an impact on the overall SG&A.

And then the mix of new versus or infills versus what you would consider maybe newer markets, is that different than last year.

No, it's, we'll it's actually, I think it's more infills this year than this past year.

So, the majority of what we're doing this year-- as we spread across the country there aren't as many units, as Richard alluded to earlier, when we go to Atlanta, which was a new market, that's no longer a new market.

We go to Chicago or Minneapolis where we are going to open this fall and in Minneapolis and in Chicago, Chicago in the winter and Minneapolis in the fall, those are no longer new markets for us.

Those are infills.

Okay.

So, I mean are we 100% infills this year, is that--

No, we still have the Louisville, Kentuckys and we have Columbus, Ohio, which are new market.

Certainly, you could argue that Toledo, Ohio, is going to be a new market for us.

But by and large most of the other units, Vancouver, Nashville you could perhaps argue is going to be new because we only have one unit in the Nashville market.

That's probably neither fish nor foul.

We have a Cumberland, Atlanta market, Cumberland mall market in Atlanta, Montana, California, LaQuinta California, Quebec unit, all of these are existing markets.

We are going into Helena, Montana, you could say, well, that's new because it's 50 or 60 miles away but we are very well known in Montana.

We would absolutely consider that an infill.

Okay.

And then just in-- in late August, I guess, you commented on the competitive environment heating up a bit, is there any significant changes there one way or the other?

No, I think it's probably at the moment where it was in August or maybe a little better than where it was in August but that goes back and forth.

That's a moving target that we check on a week-to-week basis.

And we get antsy every time we look at it, whether it's good or bad, so there's no question that we are going to continue to find tough markets and tough competitive situations and I don't think it's any worse, maybe slightly better than it was in August.

Okay.

Great.

Thanks.

Thank you very much.

And we'll talk to you soon.

This concludes today's conference.

You may now disconnect.