好市多 (COST) 2008 Q1 法說會逐字稿

Good morning and thank you for holding.

My name is Bernice and I will be your conference operator.

At this time I would like to welcome everyone to the fiscal year 2008 first quarter 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).

Thank you, Mr.

Richard Galanti, thank you, he is the Chief Financial Officer.

You may begin your conference.

Thank you, Bernice, and good morning.

This morning's press release reviews our first quarter fiscal 2008 operating results, the 12 weeks ended November 25.

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; 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 12 week first quarter of fiscal '08 results for the quarter we came in at a reported $0.59 a share.

This compares to my guidance back on October 10 of something in the mid to high 50s and I indicated that 59 actually may be a shade high but we got there.

The First Call was at 59 at the time and actually I think it went to 58, recently has been bumped back by you guys to 59, so pretty much in line with First Call.

In last year's first quarter we came in as you know at $0.51 a share so EPS was up 16% helped in part by share repurchases.

There were three items that particularly impacted our $0.59 EPS figure that I'd like to point out.

Number one, a little over a $0.01 a share, actually about $8.9 million pretax was represented increased SG&A expense related to a planned sharing with our U.S.

employees for their help in controlling Health Care costs.

As you know four years ago we made some changes to healthcare and we told them that that with those changes they would bear a little bit more of the burden but we would expect them to pay a certain, about a certain amount.

We actually did better than that and we're choosing to give a little bit back to them.

Our income tax rate also, benefited the quarter.

So with the first one hurt the quarter by a $0.01.

Our income tax rate included a couple of discrete tax positives.

Usually those things tend to offset one another; there's usually three or four of them, very small items, in this case they all went the same way, that added about $7.7 million of reduced taxes so that's after tax $7.7 million or about $0.02 per share to the positive.

Lastly, the third point, as I mentioned to you on our October 10 call, the fiscal year ended, on the fiscal year end earnings call that we would be negatively impacted this year in Q1 as compared to last year's Q1 for a large profit swing that we would anticipate in gas operations.

As you know with prices continuing to go up until very recently the last couple of weeks we've seen a change there, but on a comparison basis we've had unusually strong profits last year.

This last item represented about $30 million pretax or $0.04 a share year-over-year swing to our EPS.

And certainly had a big impact on our margin.

Frankly, a little bit more than I actually anticipated at the time I mentioned it to you back in October.

So I think you'll see our earnings for Q1 are pretty good and the underlying results came in actually in our view a little better than we had expected and a pretty good showing.

In terms of sales for the quarter, total sales were up 12% and our 12 week comp sales figure showed an increase of 8%.

Certainly benefiting from gas inflation and the strong FX or a weak U.S.

dollar.

Our other topics of interest I'll talk to you about our opening activities.

We opened a total of 15 locations since the beginning of this fiscal year on September 3, 11 new plus four relos, so net of 11.

Under the 11 new locations, six were in the U.S., four were in Canada and one was in Taiwan.

Such that, now we operate worldwide 529 locations and, of course, that includes the 30 in Mexico, which we don't consolidate those figures into our financial results.

I'll also review with you today our ancillary business results, our online results, our membership trends, the impact for changes we made back -- the impact from the changes we made back in February and March to our electronics returns policy.

An update on recent stock purchases, our balance sheet and lastly provide you some updated direction for the second quarter and the year.

In terms of back to the discussion here, sales again came in for the quarter at $15.5 billion, up 12% from last year's Q1 of 13.9, as I mentioned comps for the quarter were 8.

The 8 was essentially comprised of a 6 in September, a 9 in October and a 9 in November.

And so essentially a 6, 9 and 9 equaled the 8 for the quarter.

As I mentioned, the 8% reporting comp benefit from gas inflation that was a little under 150 basis points and from the weak U.S.

dollar, which represented about plus 250 basis points.

So for the quarter -- so basically that 8 is on a total company basis is closer to a 4 plus.

For the quarter our 8% reported comp was a combination of average transaction increase of about 5.5% for the quarter, an average frequency of about 2%.

In terms of cannibalization, which we will always have cannibalization given our ramp up in expansion, basically that negatively impacted comps by about 110 basis points to the negative so you can add that back in if you choose.

In terms of comps by geographic region of all the high volume mature markets like the West Coast of the United States, principally, actually the northwest came in the strongest relative to where it has been tracking.

California a little weaker than it's been tracking and the further south you go in California the little weaker it's gotten, particularly the LA market.

The Northeast was fine.

Midwest was actually the strongest region but of course it has the most new units, it actually was in the low double-digits.

As I mentioned international was quite strong.

International, Canada while mid single-digit number on a local basis was in the high teens given the tremendous strength in the Canadian dollar year-over-year.

In other international not as extreme as Canada but mid to high single-digit comp on a lower currency basis and low double-digit on a U.S.

dollar basis.

In terms of merchandising categories, food and sundries actually was the standout -- food and sundries and ancillary businesses were the standouts.

As was fresh foods, frankly.

Hard lines was certainly positive but coming down a little bit from '07.

And soft lines was in the mid to low single-digits, nothing -- and I think that's partly a reflection of the economy and partly why we see our food, fresh foods continue to be strong.

Within food sundries by the way, I mentioned it was strong despite the fact that we still have a little bit of a negative swing, a negative comp in tobacco.

Tobacco is about 6% of our total company business and about 11 or 12% of our food and sundries sales.

If you recall back in Q4 because of the big swing in Canada as we were just in the process of anniversarying the reduction in tobacco sales in Canada when Imperial Tobacco, about half the tobacco sales up there decided not to sell through large distributors like ourselves.

And if you recall in Q4, tobacco comps alone were minus 14%, whereas in Q1 this year they are minus 5.

It has nothing, very little to do with Canada.

The big thing there was there was a price increase a year ago in the U.S.

we ought to see that come back a little bit in the next month as that anniversaries.

So beyond that not a whole lot to say about that.

Within the hard lines comp, electronics comps were in the high single-digits; with sporting goods up in the high teens, hardware, a slight negative comp although not a big dollar category at this part of the season.

Electronics continued to do very well, probably a little lower, it's come down from the craziness over the last couple of years.

An example would be televisions which still are showing price point declines on per television in the 20% range still having high single-digit comps.

Within soft lines nothing terribly thrilling either way, women's apparel was one of the stronger departments in the high single-digits, jewelry while positive not as positive as previously coming in the low single-digits and actually, weakening towards the-- throughout the quarter.

So, again, bigger ticket discretionary items having a little bit of an impact there, fresh foods, 9%, basically all departments were positive with standouts were deli, produce and fresh fish, actually.

In terms of going down the income statement, membership fees were up 13% in dollars, up $38 million to $338 million.

And up 3 basis points as a percent of sales.

Continued benefit from the remnants of the $5 membership fee increase we did about 16 months ago.

Because of the way the deferred accounting works.

Continue to have good renewal rates and also, well slowing down a little bit still increasing sales penetration of the executive membership conversion to the $100 executive membership fee.

In terms of membership base, we had 18.9 million Gold Star members, up about 300,000 from the end of the year, 5.5 million Primary business, up about 100,000, and 3.4 million business add-on, rounding to flat with 3.4 million at year end.

All told, 27.8 million member households which is about 400,000 above the end of the year 12 weeks earlier.

And including spouse cards right around 51 million cardholders out there.

If you looked at the 27.8 million member households and just simply divided by the number of warehouses we operate, the average warehouse has about 52,500 member households per location.

That represents any of the average locations that do 100 -- our company average 130 million in sales and probably 15 plus years old.

One of the things that was a standout of late was we had an opening in Asia recently that had paid sign ups equaling that number as of opening day recognizing we usually allow people to come and in and sign up during the eight or so weeks prior to opening when we have people on premise.

In terms of executive memberships we had 6.69 million at quarter end and that was actually a fairly big increase from 12 weeks earlier; an increase of 360,000 or about 30,000 a week, probably that [whole] number jumped quite a bit.

I should point out that these roughly 24% of our membership base they generate about now over 50% of our sales.

In terms of renewal rates as I talked to you in the last two or three quarters, it teeters at 86.5, one month it's 86.4, the next month it's 86.6, so it rounds to 86 or 87, as of quarter end it was 86.4, so essentially, though, for the last three quarters it's been right there at 86.5.

In terms of gross margin, we were up by 9 basis points and reading some of the calls out there this morning, reading some of the things that were put out from sell-side, some concern about that.

I think -- let me ask you to jot down a few numbers and we can talk through it.

We are going to have seven line items here, going down the left-hand-side, we'll have core merchandising margin, and what this chart is for those of you who are new is simply a year-over-year basis point variance and how we get to the 9 basis points where the margin was higher year-over-year by nine.

So the first line item would be core merchandising.

Second line item would be a new one, ancillary businesses, and we are separating that out simply because gas was such a big swing and the third line item would be 2% reward, fourth line item LIFO, the fifth line item would be Federal excise tax claim in the IRS, this has to be with a benefit we had in '07, but just bear with me here and the last two would be related to the sales returns adjustments that we did last year in Qs two and three, and we try to help you understand we are getting a little benefit from the change in electronics returns policy not only the fact that returns in absolute dollars are coming down but also the accrued amount of the sales returns reserve and the associated margin reserve adjustment to that is improving slightly as we go forth.

So it would be returns, gross margin adjustment would be the next line item and the last one would be sales, returns sales adjustment and that again had to do last year with the adjustments.

And then the total.

I will let you write down basically three columns.

All of fiscal '07, would be column one.

Fourth quarter of '07, would be column two.

And first quarter of '08, would be column three.

Now going across core merchandising, it was plus 6 basis points for all of '07.

It was plus 34 basis points for just the fourth quarter.

It was plus 41 basis points for fiscal '08.

Ancillary businesses, plus 1 for all of '07, plus 1 for the quarter, and minus 30 for the first quarter of '08, 2% reward, minus 7, minus 4 and minus 5.

LIFO, 0, 0, 0.

The Federal excise tax claim we received on telephones, in '07, it was a basis point to the positive and, of course, 0 and 0 for the next two columns.

The sales returns adjustment, again if you recall in '07, we had charges and increases in that number both in Q2 and Q3 on a total year basis that was minus 12 basis points to the total year margin.

In Q4 as you recall from my last call, it was plus 7 basis points.

And in Q1 it's plus 3.

And then the return sales adjustment, and again this had to do with the fact that when we reduced sales to adjust our sales returns reserve it had the effect of on a reported basis of reducing sales a little bit so the percentages were higher.

That was a plus 8 in '07 and then 0 in each of the next two columns.

So if you add all that up and bear with me here, all of '07 margins year-over-year versus '06 were down 3 basis points.

In the fourth quarter of '07 they were up 38 basis points.

And in the first quarter that we were just reporting they were up 9.

So let me go through this.

I think the first thing I can clearly point out is that our overall merchandising gross margin while it was, the whole quarter was higher by 9, the core merchandise the four major departments, food and sundries, hard lines, softer lines and fresh foods was higher year-over-year by 41 basis points.

All of these four major departments were higher year-over-year ranging from 22 to 69 basis points better.

Hard lines of course was the top one there and that had the added positive impact by the reduction in returned items in electronics.

This is both an improvement in the returns reserve which is that 3 basis point number I gave you, as well as just in terms of getting returns back each day and what goes into the current quarter results as more prior sales are passing -- more previous sales are passing the 90 day returns threshold.

Our year-over-year gross margin retail business, as I mentioned in on our fourth quarter conference call back in early October, would be down, and, again, it was down this year but as important it was very strong last year.

So it was a combination of that being whipsawed.

And most of that, nearly all that 30 basis points is in the gas with a small amount being in a couple of other departments that are ancillary businesses.

But when you look at gas you had significantly lower margins on something that's 8% sales penetration.

In terms of our gross margin outlook going forward, I think it's positive at this point.

We shouldn't see the big negative gross margin variance from gas as we did in Q1.

We shouldn't see that in Q2.

I guess it has actually turned the corner for now.

As well, last year in Q2, we had a big slow down in profitability in gas as well so we will be comparing against a pretty normal number last year and starting off although we are only 2.5 weeks into the quarter, pretty well.

General merchandise is doing fine.

We are coming out of our seasonal stuff cleanly.

We don't expect any big markdowns.

And again we will still see a small negative impact to margin from the increasing executive member business.

But that's getting to be as you said a smaller and smaller hit.

And, of course, it's positive to the company in other ways, such as sales, membership income and membership loyalty.

LIFO, we assume very little if not zero impact from inflation.

I know we hear about things going on every year.

Through the first quarter there's, of course, what's driving the deflation in our case is electronics but we are not seeing a heck of a lot elsewhere either even in the first three months.

So that seems to be not a P&L concern this year from a reporting standpoint.

Before we go into SG&A, in terms of ancillary businesses, in the quarter we opened 5 Pharmacies to be at 434, we opened six Food Courts to be at 488, six One Hour Mini Labs to be at 486, six Optical, Optometry Shops to at 478.

We remain at eight Print and Copy Centers.

We added eight Hearing Aid Centers to be at 245 and we added nine Gas Stations to be at 288.

Not a whole lot to say.

These are all good businesses and we continue to open them where we can in most cases.

As I mentioned earlier ancillary business sales comps were up 16%, up 6% without gas.

And again that was gas inflation principally.

Moving on to SG&A, our SG&A percentages Q1-over-Q1, were higher by 17 basis points coming in at 10.15% of sales this year compared to 98 -- 998 last year.

Again, if will you bear with me in the second and last table that I'll ask you to jot down, the line items will be as follows - - Operations, second line item will be Central, the third line item will be Stock or Equity Compensation, the fourth line item will be, I'll just call it 409-A, this has to do with the stock option issues from last year and some remnant expense there, Sales Return, which again, impacts '07 is the next one, and lastly Quarterly Adjustment, and finally, Total.

And, again, for the three columns, all of '07, Q4 '07 and Q1, '08.

If you look at Operations -- and in this chart, by the way, for those of you who are new, minus means bad or higher, so these are basis points year-over-year.

So going across the top, Operations was minus 4 in all of '07, or 4 basis points higher for the entire year.

And in Q4, '07, minus 23.

And in Q1, '08, minus 9.

Central, minus 2, minus 2 and plus 2.

So in Q8, we actually did a little better year-over-year as a percentage.

Stock compensation for all of '07 was minus 4, for Q4, was plus 2 and for Q1 '08 was minus 1.

409-A was minus 6 in '07, that's when we took a big reserve or charge for that, what we were doing to protect our employees.

Q4 '07, 0, and Q1 '08 minus 3, and I will talk about that in a second.

Sales Returned minus 7 in '07 and then 0 and 0.

And lastly Quarterly Adjustments, plus 1 in '07, 0 in Q4 and minus 6 in Q1.

And I'll talk about that in a second.

So the Total of those are, all of '07, SG&A was higher year-over-year by 22 basis points.

In Q4, it was higher by 23.

And in Q1 '08 it was higher or negative 17.

A little editorial.

As you can see first of all operations was higher by 9 year-over-year.

Recall first and foremost that the $1 an hour bottom of scale pay increase that we did back in March, including benefits that's about 6 basis points of the 9.

That as I mentioned to you before, will pretty much anniversary after the second quarter, I think it anniversaries about three weeks into the third quarter.

So the little remnant effect of that to the negative in Q3, but essentially that is an anomaly that should anniversary shortly.

Our central expense improved by 2 basis points, nothing big to say there.

In terms of Stock Compensation expense of minus 3, I'm sorry, minus 1, that's as I mentioned before we now are, there's a full amount of vesting or five years of 0.2 vesting in this number, combination of previous stock option grants plus, in the last two years RSU grants, restrictive stock units, that's going to fluctuate, up or down a basis points, nothing big.

The big reason I think it was higher year-over-year by a basis point is the stock as you know had moved nicely upward so on the date of Grant on this year's, we do our big annual Grant back I think in October, so that had the impact of just picking that up a little bit, not a terrible issue there.

And lastly the 409-A., this is to increase the accrual that would cover adverse tax consequences for options held by our employees.

Now these relate to the employees outside the U.S.

While the U.S.

has government has come out with what was called the 409-A issues, some of the other governments where we have employees oversea options, not all the rules are finalized and basically there's a small impact there.

It's essentially non-recurring.

We might still get little remnants of it over the next few quarters as that's resolved but we don't expect that to be a big issue.

The next one and I mentioned to it in the first part of my call here was sharing of some of the savings with employees and benefits.

You basically as you know for those of you who have followed us for a long time, in late calendar '03, and effectively the beginning of calendar '04 we changed our Health Care Benefits, such that after nine or ten years of not charging our employees-- not passing on any of the Health Care increases we went to them at the end of calendar '03 and said, we do have to pass some of it on to you.

And rest assured we will do everything to mitigate it.

Really it's been a combination of some of the changes we made but more importantly our employees being better consumers of Health Care.

And as you might expect we felt that given the performance in '07 of those Health Care looking at it after the fact, of course, that we felt that part of that should be shared with them.

That's about $9 million just a shade under, $8.9 million or about 6 basis points.

There's no guarantees in the future.

But that certainly is an anomaly in this quarter.

So if you look at the 17 overall -- by the way that last comment was related to that quarterly adjustment component of my little chart of minus 6.

If you look at it overall you've got the $1 an hour pay increase of roughly 6 basis points of this number.

You've got the 409-A of 3.

You've got the benefit sharing of 6.

Which arguably even if you thought you could do it in the future and there's no guarantees, if this is a whole years worth of that in one quarter.

So it would be a lot lower.

But the 6 and the 3 and 6 is 15 of that 17.

So certainly we did a lot better than we did in Q4 relatively speaking.

And that's quite encouraging.

Next going down the income statement line, preopening expense was about $1.2 million lower year-over-year or 2 basis points better coming in at $21.5 million.

And that was prices there, last year in the first quarter we opened 12 units.

This year we opened ten, six plus four relos, but they all have preopening.

And we also of course in those numbers are some small expenses are related to upcoming openings after quarter end as we incur those, as we do prior to opening.

In terms of the provision for impaired assets closing costs, for Q1, our last year we had a $4.3 million charge.

This year it was essentially flat, $79,000 of cost.

Roughly about $3 million of closing cost expenses are things like that impaired assets offset by nearly like amount related to a couple of real estate gains we had on some dispositions or closings.

All told operating income in Q1 was up 12% year-over-year, from $353 million last year to 394.9 this year or an increase of about $41 million.

Again, if you look at the benefit sharing and the $1 an hour increase that should-- as part of that we feel that's a pretty good number.

Below the operating income line, interest expense was substantially higher of course with the $2 billion debt offering we did back in February.

In Q1 '08 it came in at $23 million versus only $2.1 million last year.

And again that's virtually all the interest expense on $2 billion of debt.

Interest income and other was better, higher year-over-year by $6 million coming in at 33.3 versus 27.1 last year.

Most of that virtually -- nearly all of it, not all of it though is higher interest income.

This is the other component of that title of this line item, is increase in earnings from our 50% interest in our Mexico operations since, again, we don't account for that on a consolidated basis but rather on an equity basis and any change in our half of those earnings goes to this interest income in other line.

So overall pretax income was up 7% versus last year's Q1, from $378 million to $405 million and, again, that number includes the impacts of the Health Care cost sharing with our employees as well as the other things I mentioned.

In terms of tax rate, again I mentioned that was a little bit of an anomaly to our benefit in Q1.

A tax rate came in at 35.3 versus 37.4 last year.

I think frankly the 37.4 would be what I would budget for the year, recognizing you are always going to have discrete items in a quarter based on solving or completing audits with varied State, Federal and Country Taxing Authorities.

Usually they all go, a few go one way and a few go the other and it's not a big issue in this case we benefited from two or three of them-- the two or three that occurred all going in the right direction.

In terms of the balance sheet and, of course, this will be out shortly on the wire and our Web site but I will give it to you now, cash and equivalents of $3.210 billion, inventories of $5.773 billion, other current assets of $1.319 billion, total current assets of $10.302 billion, net PP&E, $9.920 billion.

Other assets, 782 for a total left-hand side of the balance sheet of $21.004 billion.

On the right-hand side short-term debt of 37, accounts payable of $6.168 billion, other current liabilities of $3.489 billion, for total current liabilities of $9.694 billion.

Long-term debt of $2.182 billion, of course, the $2 billion relates to what I mentioned earlier about a debt offering we did back in February.

Deferred and other, 295; such that total liabilities are $12.171 billion.

Minority interest, 70, stockholders equity, $8.763 billion for a like total of $21.004 billion.

Let me point out a couple of things on our balance sheet.

I haven't actually talked about a debt to cap ratio in a while but now that we have the (inaudible) debt, the debt to cap ratio at quarter end was 20%, not bad given that we've in the last 2.5 years have bought back over $4 billion of stock and added $2 billion to our debt side.

So certainly a little bit of different complexion than as-planned to the balance sheet over the last 2.5 years.

Still plenty of financial strength.

In terms of a number that we always look at as accounts payable as a percent of inventory, on a reported basis it improved from last year's Q1 end at 103 to this year's first quarter end at 107%.

Recognizing that the payable, well, the denominator in this calculation is merchandise inventories, the numerator is a combination of merchandise payables as well as other accounts payable most notably construction related payables.

So backing out construction related payables, we still showed improvement last year first quarter end, 86% this year first quarter end 88%.

Average inventory per warehouse, at last year at quarter end there was 11.401 million, this year quarter end there was 11.687 million or up about 2.5% or 286,000, nearly all of the 260,000 is the simple calculation of assuming that your currencies were flat rather than -- your foreign currencies were flat rather than strong relative to the dollar.

Other things of note within inventories electronics was about, a little over $100,000 higher, tobacco was about $67,000 per warehouse lower, a big chunk of that relates to Canada, and some of it relates to a couple of locations where we've reduced our tobacco given that we weren't seeing a lot of ancillary benefit from it.

And hardware, down about 42,000.

Those were nothing meaningful to most of those numbers other than the FX.

As I mentioned earlier we feel good about coming out of Christmas clean as relates to inventories so we don't see any issues there at this point.

And in terms of CapEx, in '07 as you know we spent $1.4 billion.

And my guess is this year it will be in the 1.7 to 1.8 range.

In the first quarter of that 1.7 to 1.8 anticipation we spent $436 million.

Dividends not a whole lot to say, you've seen it, we increased this past May, we increased our quarterly dividend from $0.13 a share per quarter to $0.145, this $0.58 per share annualized dividend represents a cost to the company just right at $250 million.

Costco Online actually did better than we had planned.

It's continued to do very well.

During the first quarter on top of a 40 or 41% increase for all of '07 versus all of '06, Costco.com in Q1 was up 45%.

We should well exceed $1.5 billion in sales this year which is better than our plan.

In terms of expansion, as I mentioned in the first quarter we opened ten locations, four of which were relos.

Currently we expect to open seven in Q2, a few of which we already opened, I think five of those have already opened or will have by the end of this week.

No relos, so net of seven for Q2 compared to a net of six for Q1.

In Q3, we anticipate opening seven including two relos, so a net of five.

In Q4 we plan to open 15 less three relos so a net of 12.

Which would put us at 39 including nine relocations or a net of 30.

As we any of these estimates particularly looking out to Q4, there's always a few that slip but it looks like now that our best guess is the 30.

In addition we anticipate opening one additional unit in Mexico this year.

If you look at the 30 on our beginning base of 458, now the 458 is a consolidated number so the 458 does not include Mexico, but 30 on the basis of 458 would be about 6.5% unit growth.

And a shade over that in square footage growth recognizing the new units tend to be a little bigger on average and the relocations, of course, always are bigger because you are relocating from a smaller unit.

In '08 that was '07, by the way.

In '08, we are also adding 30.

So now 30 on a base of 488 is about 6% unit growth and then a slight increase on that for square footage.

In terms of stock repurchases, since June of '05 we've repurchased about 78.4 million shares at an aggregate purchase price $4.125 billion, or about $52.62 per share.

We currently -- for those of you who have been keeping count , we had total board authorizations under a few different authorizations of 5.8 billion.

We had 4.5 and another 300 million and then more recently 1 billion.

So of the 5.8 we suspended 4.125 billion so have about 1.7 billion left.

Notwithstanding the stock price being up we are buying but at a lower amount, usually on a regular daily basis.

We haven't in the last couple of weeks simply because we buy through blackouts using the 10-B with 51 filings.

Those of course have to be in place a few weeks before quarter end and three or four weeks ago the stock was substantially lower than it was yesterday.

And so there have been a few days here where we haven't bought any.

I would say on an annualized basis for the first quarter we are clipping more at the $1 billion or shade over $1 billion on an annual basis.

And in terms of, before I turn it back over to Bernice for Q&A a little direction for Q2 and '08 overall.

I think that First Call today is at 74.

You've heard this like a broken record, that sounds good, probably at the high-end of the small range.

And hopefully we will do better than that.

In Q3, we at least have gotten off to a good start on the gas but we think that the 74 is a good number.

Q3 -- I don't talk about Q3, all of the whole year, I think First Call's at 299, again I think that is a fair number, again I will be a little cautious given the craziness out there in the world that that's at the high-end of the reasonable range.

Lastly, supplemental information will be posted on our Investor Relations site later this morning.

Just go to Costco.com and in the bottom corner where it says Investor Relations click on that and you'll be able to see that.

With that I will open it up to questions and I will turn it back over to you,

Thank you.

(OPERATOR INSTRUCTIONS) .

First question, Charles

Thanks, Richard, good morning everybody.

On the TV returns over the past couple of years, could you speak to at what points during the calendar year you experienced the greatest spikes in those TV returns particularly over the next few months if that was a high period?

And if you also could speak to how this has trended since the policy change went into effect, if you could essentially speak to July going forward, the 90 days from the April 1 change.

In terms of calendar issues, generally I think we ourselves exacerbated the issue over the last few years with the two coupon booklets that we do, the 12-week summer passport and the 12-week winter wallet.

As prices continued to go down my old story line was is a year earlier when a customer bought a flat screen TV and it had finally gotten down to $2,200 he came in and bought it for $2,200, a year later he gets a passport or a winter wallet and not only has our normal price gone down to I'm making this up but say $1900 but there's a $250 or $300 coupon.

So that's effectively $1650 or $1600.

That individual is coming back and returning a TV for 2200 walking out with a new one for $1600, guess what, we had a big write down on the one we had originally sold for $2200.

In terms of the trends, it should be incrementally a little better.

Recognizing that the sales -- most of the improvement that we see should be in the core number because that's just the returns we get in the quarter, they are actual physical returns and how we account for them based on, does it go back to the shelf which in electronics is rare.

Does it, is it disposed of via salvage at $0.60 on the $1 or $0.20 on the $1 or $0.80 on the $1?

And, of course, in electronics given the ongoing obsolescence issue that was always an issue.

The reserve piece is I think reflective of, your second part of that question, that's based on the lag.

And what happens now is here we are in September, October, November sales for Q1, we now have a chunk of sales from roughly mid March to now that every day a higher percentage of future anticipated returns relate to more recent sales, that that should keep clicking up.

It's hard to model what it's going to be.

Frankly if you recall back in Q4 it was a 7 basis point improvement and in Q1 it was, I think, what, 3.

Three, yes.

And frankly I was surprised at the 7 and I think a little bit has to do with just how our estimate model works.

It is still based on daily lags of historical stuff.

All I can tell you is, I'd probably go back to what I said to anybody that had talked to me about six, nine months ago.

If you took roughly $4 billion in departmental sales and looking back over a five-year period we saw a realized margin in that area go down over 400 basis points or $160 plus million dollars, and even though we still have 90 days which is longer than most, mostly all and we had more than -- and we installed a concierge service which has a cost and we added a second year warranty to TVs and computers, which has a cost the way I kind of dialogued it to anybody who had called was, hey, we are talking buy a number that is $160 plus million even if we get half of it back and it takes two or three years that's 10 to 12 cumulative basis points, maybe 3 or 4 a year.

I guess that's still my best guess and I'm sticking to it but it's hard to know exactly.

But again the bigger piece I think is in the core number and if I just look at dollars, the dollars -- in the first quarter if I look at total sales dollars in electronics and total dollars of returns of electronics, irrespective of if it's a go back to the shelf or disposed of for salvage, in absolute numbers as a percent -- electronic returns dollars and percent of sales dollars in the first quarter year-over-year is down by almost, down buy about 20%.

Okay.

How did that compare to the fourth quarter then?

I don't have it in front of me but I would bet it's less, it would have been less impact full.

So the benefit is getting bigger then?

Just switching gears on the pricing side, Sam's Club has said publicly they are not interested in fighting the penny war with you going forward.

What sort of opportunities can this open up for the company on the margin front down the road?

Tell them thank you.

Clearly you have to recognize that we are both fierce competitors and given that we both overlap in many markets we are both good at, probably half or more of our sales are what I call commodity, maybe not half any more but roughly half are commodity items whether it's Snicker's Bars or paper towels or milk or butter.

While I'm glad to hear that but we'll see.

We still -- as I'm sure they do us -- we still shop them every week in every market if not more frequently and I think we will always play that fierce -- we will always be very competitive.

Whether to the extent they have chosen not to go down by a penny, great, then we won't have to do that either.

But who knows.

I don't think we have really ever done that a lot but we've always, we and them have always been very competitive on the half of your sales that are those branded core commodity items.

Thanks very much.

Your next question comes from Deborah Weinswig.

This is actually Susan Anderson for Deborah Weinswig.

Can you talk what you are doing from a promotional perspective and also how the Black Friday handout went and maybe if you can provide some additional color on membership revenues?

It seems the growth is a little bit slower this quarter.

I'm sorry ask the first part.

Promotional perspective if you can talk about it a little bit and how the Black Friday hand out went and secondly if you can provide some additional color on the membership revenues.

Sure, well, Black Friday of course is the few days, is the week after, was the week after -- no, no, it was the last week, I'm sorry, it was.

And it was, we started doing a hand-out coupon hand out in store the week prior to Thanksgiving about three or four years ago.

It did as expected.

It was good but there was not, in terms of a year-over-year change, nothing positive or negative.

In terms of membership fees, again, I know I heard that, again, at the Wal-Mart analyst meeting they had indicated they saw some challenges with member sign ups, thankfully we have not seen it.

We are still growing our mature warehouses slightly, covering -- slightly more than covering the renewal to non-renewers.

Again our renewal rates have held frighteningly steady plus or minus a tenth or two of a percent from 86.5.

I think that will continue.

The fact that we had a little bit more executive membership conversions in Q1 than we have had on an increase year-over-year that helped it a little.

Come each month now going forward through July when we'll be at the second anniversary of the $5 price increase, and because deferred accounting takes it all the way out there in terms of how you see incremental benefits from it, my guess is if you look into '09, one, executive membership penetration while it will still increase a little but it will increase less, and as you've seen historically if you just took our historical track record we don't raise the basic membership fee every year, in fact, on average it's been every five years.

If you assume in '09 we did no increase, and I'm just making observations here, we haven't made any decisions or even discussed it, but if you assume there was no increase there and you assume there is increasing penetration of executive member but less increasing penetration, then you probably see membership fees as a percent of sales start to flatten out if not go down a basis point or two.

If you go back 15 years ago when there was no executive membership the only thing that analyst counted on to see that member change as a percent of sales was that $5 increase about every five years and what you would see is a big jump there as a percent of sales membership fees and it would dwindle back to where it was because in theory the fee stays the same but the customer buys more each year.

My guess is that we've enjoyed because of executive membership roll-out over the last five years, the fee increase two years ago or a year and a half ago, we've enjoyed an increasing membership fees as a percent of sales continue to show improvement.

My guess that number on the income statement as a percent of sales is up this year, is up or flat or close to flattened out in '09 and who knows beyond that.

Great.

Thank you very much.

That's very helpful.

Next question comes from Christine Augustine.

Good morning.

Richard on the core merchandise margin expansion of 41 basis points, I just wanted to do clarify something.

Did you say the majority of that was because of the change in the return policy so it was reflected through the hard lines margins?

No.

Okay.

I said of those three core components, of those four core, food, sundry, hard line, soft lines and fresh foods, I said the range each of those departments were up year-over-year and in fact the range was anywhere from 22 to 69.

Normal deduction would say the hard lines is 69 because of the benefit in the electronics.

But hard lines is, what, 15% of total sales or 17% of total sales, something in the mid to high teens as a percent of total sales.

That is not the driver of the whole number at all.

So what are the drivers?

Is it price increases?

Is it better sourcing?

Is it a higher penetration of private brands?

Yes.

All of the above?

Yes.

And I guess the way I want to -- and I think we tried to be pretty open with people over the last nine months as we talked about initiatives, we are not going back and raising prices on anything.

As new things come in and we feel we can make a fair margin and our definition of fair as you well expect is lower than many of your definitions of fair out there, we are still going to be fiercely competitive.

And penny game or not 50% of your items are fiercely competitive to start with.

Private label does help.

Getting a fair rate of return on our cross talk operations which means a slightly higher cost or a profit center for certain items which allows the buyer to mark the good up such that it covers the return on that value to us.

I'm not trying to be cute but that's how it works.

So we are not looking for margin by saying, let's take up the can of corn $0.10 and let's raise this a $0.05.

Going forward particularly with seasonal stuff where you don't compete on a lot of items directly because they are all different brand names, all different sides, they are not commodities, our savings are so stellar relative to a traditional retailers that we can make a fair margin and show improvement to the company.

And on the $9 million roughly that was that quarterly adjustment for the Health Care benefits, is that effectively some sort of rebate that you give to the employees that runs through your SG&A or how do the employees see the benefit?

It was an after the fact thought and that's why we didn't charge last year frankly.

But once we decided last month and in reviewing '07 and looking at our Health Care plans into '08 and '09 and not only what are we doing for the employees, how can we improve the existing benefits there was a little extra, extra cost that we used to improve other aspects of the plan that will cost us a little money.

But this is, we haven't said to the employees, how we are doing it yet.

It will be something that we will get to them in February or March but since it relates to how we all including them performed on Health Care during the '07 year it's an appropriate time to accrue for it.

Thank you.

Your next question comes from Adrianne Shapira.

Thank you, Richard going back to the core merchandise margins last quarter when you reported the 38 basis points you cautioned us not to expect that pace of improvement, obviously you've exceeded that this quarter and I'm thinking as you head into the second quarter and as you point out gas should be less of a drag, why, what is a reasonable sort of run rate, shouldn't we expect that continued opportunity at least at these levels?

Well, I hope so.

I guess, the fourth quarter it was, frankly, my goodness, that's a lot and that's how each month we saw it improving.

We just kind of looked at it and human nature is how can this, how can we get there so fast.

And the fact that Q1 is, I agree with your question, I would still probably temper it maybe not temper it as much as I did in Q4, temper my comments.

Because what I told somebody recently on a phone call and using their model and I will make the example up here let's say they assumed that over the next three years margins were going to be you be X basis points a year and I said, fine, and only thing I can tell you that's going to happen is that on a quarterly basis year-over-year to achieve X, there will be quarters on a year-over-year variance where it will be X minus 10 or 15 and it will be quarters where it's X plus 10 or 15.

I certainly agree with you that we now have two quarters of very strong core margin improvement and certainly I agree we should continue to do quite well.

Again I probably would still temper it but temper it less than I did as I looked at Q4 into Q1.

That's great to hear because also heading into Q2 given that the mix should also help with general merchandise growing as a percent of the mix obviously a holiday quarter and as you point out the 22 to 69 basis points with hard lines being strengthened would you expect that mix to grow as well in the coming quarter, that also should probably a benefit?

(inaudible) will be fine.

I don't know if there's that big of a mix change.

First of all let's say hard lines penetration will -- well, let's say, in hard lines you have all of Christmas but then you have January and February.

Yes, my guess is without trying to step my foot too far out here that should give you some comfort, I'm not sure if it's actually goes a lot in one direction.

Okay.

Thanks, Richard.

Lastly on the, you talked about bigger ticket and discretionary items perhaps being impacted because of the environment.

Can you talk a little bit of the small business customer is, are they sensing any difference, are you seeing any difference in terms of buying patterns and any resistance there in terms of some of the initiatives that you've taken on the margin from that customer?

Thanks.

No.

The business member I would have thought the small restaurant owner might have been impacted a little bit but we haven't seen any change to our business penetration.

And the improving pricing structure in certain categories is a nonissue.

There's been nothing that we have seen there, I mean the biggest impact there as Jim is traveling everyday visiting warehouses are calling up and yelling at buyers and saying, when did we go up on that?

Why are we here?

And bringing a few of them down and that's fine.

That's what he's in charge of.

Great.

Thanks.

Best of luck.

Your next question comes from Mitch Kaiser.

Good morning.

I was hoping you could comment on the TV pricing declines you saw or the deflation in November.

What we've been hearing is that supply has been pretty tight both on LCD and Plasma so I was hoping you could decompose the price declines a little bit in terms of LCD versus Plasma and maybe small versus large screen TVs, if you would have that.

I mentioned there was 20% deflation on like items, those are exact like items.

Recognizing probably the price point deflation per item is not as big a drop because people are trading up as well to something bigger.

I think some of the pressure on price is not to go down as much because of tight supply in flat screens, mostly the LCDs.

That is consistent with what our buyers and GMMs told us and told a few of you because you happened to be out here that day, when they just spent two weeks in Asia, this has to be six, seven months ago -- six months ago -- and indicating that despite great increase in manufacturing capacity LCDs have picked up strongly and there is so much more demand now coming outside of the United States for this production capacity that it's holding prices.

What our buyers told us at that time was they pretty much have locked in declining pricing through the end of the calendar year based on commitments we had made back in June and July for this season.

The manufacturers, again I'm referring back to this conversation six months ago, manufacturers would like you to believe and had led and discussed with our buyers that they would anticipate in calendar '08 little if any deflation if not a little inflation.

The buyers perspective was that's probably directionally right but a little bit of wishful thinking.

Now throw into that the economy and who the hell knows what's going to happen.

But I would say overall the average price point is coming down but not as much as -- like item deflation because people have traded up.

Again in electronics, we really, we've seen a slow down in units but it's a slow down, in other words not as big as an increase but heck for two, three years you were having 30, 40% unit increases and now it's 20 or something.

Or the high teens.

So it's still pretty healthy.

I wonder when it will run out of steam.

I already have enough TVs and cameras.

But I want to contrast that to jewelry.

We've always, I remember for the last few years you'd see (inaudible) diamond sales were up 15 and now they are flat.

And we were still up 15.

Instead of 20.

And just in the last few months we've seen a big deterioration in jewelry.

More so in non-diamonds, more so in watches and pearls and silver which I would say call maybe a little more discretionary, diamonds, people still get married, people still have anniversaries for earrings and whatever else, or upgrades of diamonds, and , we, again, it has softened but not as much as other types of

Okay.

That's fair, I was wondering if you could talk about the MP3 category within electronics?

I know had you some outages on the iPod last quarter, I believe it was.

You are feeling pretty good about the stock there and the demand or sell through on those?

That was more of a transition .

Since Apple doesn't price protect the retailers when they are switching it's up to the retailer to basically bear that cost or make sure -- in our case given there similar margin to begin with we opted, if you recall back in August, to bring down our inventories and forego I think we estimated about $25 million of iPod sales in August and wait for the new ones to come out.

The new ones are doing

Thanks and good luck.

Next question, [Ete Warner].

Hi, Richard.

I was very impressed with the gross margin increase you just reported and I was wondering whether you see further gross margin increases as something of a step change this year with a flattening out over following years or whether you think we are going to see similar improvements happening year-over-year?

It's so hard to know.

Again if I had a crystal ball I would have guessed that we wouldn't have gotten as much as quickly.

Clearly we are not going to get incrementally this much more next year and the following year but it would lead me to believe that whatever my original thoughts were for a couple of years, 2.5 years out will be better than that just because we started off so strongly.

I will be the first person also to caveat that and say that's based on not compromising our competitiveness and not having a major recession where all of us are impacted, perhaps us a little less than traditional retailers but nevertheless impacted.

But we are not -- we still have a focus on being the best value and driving down prices where we can as well.

So it's a balancing act.

I think the good news for us is that I share with some of you is that we are, what people have always asked me over the years who is our toughest competitor and my answer is us.

It's us.

And I think that that's does give us a little movement, a little room for movement here but we are going to still look to see how, make sure we are wowing you every day, my guess is that based on what you guys collectively thought or I thought, recognize we only go one year out any way about if you looked at two or three years getting off to a good start makes me feel better but certainly not take this year's X and multiply by two or three.

When you were looking at these gross margin opportunities were you trading that off against some increment on comps?

No, honestly and many of you guys no us, we are not that analytical and smart.

We are not going -- I would say that if we felt that, if any price change would hurt a comp we would not change it.

And you never know exactly what it is but you are not talking about big numbers here also.

You are talking about new items, improving your margin on new items, seasonal items.

So so much of this not discernible.

It's not a big change in perception.

Because if it were you would see a change in comps.

Great.

One more question related to do Internet business, Richard.

What's the sales mix that you are observing there?

Is there any shift and also what's the gross margin or operating margin of the Internet business relative to your store business if you can talk about that?

On the first question clearly electronics dominates or anything electrical whether it's electronic games or game consoles.

As you know we have similarly about 4,000 items on line but only 10 or 15% are in the warehouse so it's clearly more heavily skewed to nonfoods and bigger ticket items.

I would say that given that there are some manufacturers that are willing to sell us online that aren't prepared to sell us in store that has he said us grow that as well.

In terms of margin we don't disclose exactly what it is.

It is a lower gross margin overall than our company, than the warehouses, and a higher pretax as you might expect because there's not a lot of major overhead.

Thank you.

Next question, Mark Husson.

Could you talk a little bit about the impact of currency on earnings and if you were to look at the gross margin matrix and the SG&A matrix that you've given us in remarkable detail, thank you, would currency be a meaningful impact on the way that the gross margin or SG&A is mixed and does it impact the overall EBIT number?

I would have -- I don't have that -- I haven't done that in front of me.

Certainly it's a positive.

Given that all foreign countries I believe are positive now, a couple of the newer countries are slightly positive.

But given that and the fact that the currency is particularly in Canada going the right way I think it would clearly help EBIT, I think it's not a discernible to the percentages because all your percentages are impacted, your sales dollars per Canadian dollars are higher expressed in U.S.

dollars than it would with a flat currency as are your expense dollars up there are as your earnings dollars.

Probably you guys could do as easily an example as I can, if you look in the, like in the 10(K), it has the segment reporting in the back, I think it has three, four columns U.S., Canada, other international and total.

And so you can take Canada and other international and shave it by the average currency over, what is it, Canada, it's for us it's predominantly Canada because Canada is about 12% of our company and the other foreign countries are an incremental of 4 or 5.

So total .

Is in the high teens.

So you take that, those numbers and if the currencies are up 15% or whatever or an average for all of last year they weren't up all that much they were up 10%, I'm guessing hereby the way you could look at

It helps sales by a couple percent overall and very probably helped EBIT by the same amount maybe a little bit less.

Without analyzing it I would say the same amount but I would have to look at it.

Thank you very much for your help.

Your next question comes from Bob Drbul from Lehman Brothers.

Hi, Richard.

Two questions for you can you elaborate a little bit on the comments you made earlier on California and any trends that you really do see discernible in that state for you?

And the second question is, did you do any hedging in gas during this quarter and just are you still dabbling in the hedging side of it?

Let me answer the first, no, a couple thing happened last year since allowed us to try it.

Most importantly is its still a low margin business and the cost of hedging has probably gone up some because of the volatility in gases prices.

All things being equal, at the end of the year you'll make on average the same but you'll spread out your P&L a little bit better instead of having these ups and downs and that was never a big concern of ours but if we could do it, fine, without a big cost but given that the cost of hedging is higher and the margins to start with are lower, it didn't make sense.

In terms of -- if I look at the LA region, if you go back over the last couple of years, generally speaking and I'm making these numbers up but if you U.S.

was let's say a 6, within that U.S., California which is 38%, I believe in the U.S., or 40% in the U.S., was probably 2.5, so call it -- or 3, I'm sorry, 3 versus a 6.

So -- 3, 3.5, so 250 to 300 basis points lower if you will just looking at the metric, that gap.

It's not other U.S.

versus LA or California, it's or versus LA, it's LA versus the total which includes LA.

And that 250 or 300 basis point gap, over the last several months has gotten up to maybe 450.

So another couple of hundred.

And so relatively speaking while everything has come down a little bit from a couple of years ago, LA has come down a little bit more.

And now as Jeff Elliot here pointed out cannibalization is probably half of that Delta because we certainly have done a disproportionate amount of our cannibalization in California over the last two years.

But even with that out, maybe it's 100 basis points.

But I don't know why, I mean it's all reasons that we all suspect, first of all traveling is a hassle in some markets like that, gas is more expensive, the housing market arguably has been harder there than in some markets.

The housing market has been hit in other markets that hasn't been as impacted.

That's what we know.

Thank you very much.

Next question, Dan Binder.

Hi, Richard.

Just a follow up on the California question.

Do you see, you said about half the gap is maybe macro related, half a Delta change.

Is that something that was getting worse through the quarter or is that fairly stable?

I think it was -- I'm looking at we talk here, I think it was pretty stable.

I mean, California comp, if I look at September, October and November it was actually, the lowest number was in September.

Now, it was probably lower in August because as a company we had a pretty crappy number in August.

Basically California comp was almost flat in September and both in October and November up 2 plus percent.

So it's coming back.

Okay.

Then there's about 12 to 15 basis points of the SG&A increase that we could point to as being perhaps one time in the quarter and I know in the normal course of business there's all kinds of one time things that come up from one quarter to the next and let's just say for the benefit you strip that out right now and look at the SG&A on a fairly strong comp, I guess I'm a little bit surprised there isn't more leverage on an 8% comp or even if you want to do look at it on a 4% comp at the core, is there any sense that we would be able to get more leverage going forward on those kind of comps?

It's hard to predict.

I would say it's difficult.

Given that energy costs are going up and, again, taking out the anomalies, even the ones that we cause ourselves like the bottom of scale or the sharing of a Health Care savings, it's as I've said before, there are not a lot of silver bullets out there.

It's not like we have very inefficient and we can proof efficiencies greatly so we do need some comp.

I would like to see, as I've said a little inflation wouldn't hurt and I hope it's not a lot.

And although when you read the news every day there's certainly some inflation coming and arguably that helps.

That helps this lag.

And, but, no, I would say for the last few years I always felt that that is, as I look back to last year when I will say consensus analysts estimates out there given margin initiatives and given other things was that, hey, the Costco story out there was if I had to, again, summarize consensus was that the company can get 9 or 10% top line growth, it can get 4 or 5 or 6% from EPS accretion and on top of that if it can get 10 or 15 basis points of anything recognizing 10 basis points is about 3.5 to 4% earnings growth, earnings per share growth, that 10 to 15 gets this to be a story that's in the mid to high teens.

And I always kind of looked at that consensus as acknowledging that expenses are hard and they aren't necessarily going to improve but aren't going to go up a lot if we do our job right and we can improve margins of that amount.

As you recall in Q4, we beat one and got hurt by the other so we still ended up with about the same number of basis points.

I think if you take out the tobacco anomaly here and again take out a few of the things that you see that are not completely one time but a little bit one time, that the net of the two should be a little better than that consensus 10 or 15 but with most of it if not more than all of it coming from margin, at least over the next year.

It's, other than that, that's the general story line that we look at.

I guess as you look if we look out over the course of a year, gas may not continue to be a huge contributor depending on what happens with prices obviously it's hard to predict but it's, if let's say the comps come down because gas or currency isn't an issue or as much as of a contributor or if the core business slows a little bit what's the ability to adjust the expenses down?

I guess I'm trying to get a sense if we are not going to bally able to see a lot of SG&A leverage on a mid to high single-digit comp at least is there some protection on the way down to adjust?

I don't think there's a lot of protection.

I think the FX thing helps and or hurts all lines of the income statement.

So that really shouldn't be impact.

Gas should -- to the extent, gas is not falling out of bed overnight, by the way, but it's decreasing a little but even flat would be okay on a year-over-year basis.

I think that's our toughest number.

Right.

Then just with regard last question on the discretionary side you've talked about jewelry, TVs, any other areas of the club where you would sort of set a discretionary area that is showing any kind of more change in trend?

Well, some thing like small electrics, I didn't mention it earlier, but small electrics are actually in the mid to high single-digits and I'm not talking about entertainment electrics, I'm talking about clock radios and hair dryer and alike.

Housewares are okay.

So furniture this past summer was okay where we bring in some big ticket furniture items during the seasonally slow June, July and before back to school.

So I would say for the most part it's those two.

Okay.

Great.

Thanks.

Your next question comes from Gregory Melich.

Thanks, guys.

Two questions, really, I think or probably one, I want to do get into the basket a little bit about the inflation and what portion of that ticket increase is inflation versus other stuff.

So stop me if I'm wrong here, if it's a 5.5% ticket and 2% traffic once you take out the FX and the gas, you are probably that 4% comp was half ticket, half traffic, is that fair.

Yes,.

So then that 2% how much of it is just regular pass through inflation, not that you guys are raising prices but basically passing through increased costs on the commodity type items that as you describe and I think Richard before are not new items where you are getting a little extra margin but the 70 or 80% of the items that were existing items where you are seeing some pass through.

I will look at it two ways with you.

Once again through the first quarter our LIFO index is a few basis points below 1.00, so that would indicate there is no inflation, recognizing you've got electronics which is down and everything else which is up a shape.

That's all on inventory, of course.

If you look at look at, if I look at specific items within inflation, I'm just looking down the list here, cheese, cashews, blueberries, grapes, coffee, some of these items are in the 10 to 20% range.

Not on the deflationary side, let me see something that is not electronics -- pistachio, I think we bought in well, that's down in the mid-teens, of the top 30 LIFO items that's the only one that's not in the electronics department.

So we are seeing a little bit.

Things that aren't in LIFO are taking a market away from a branded item into a private label.

Something as basic as a item that we had-- I think we introduced three or four months ago which is kind of like the Vitamin Waters, it's called, there is a regional bottler out here that does a water called Taking Rain, and now they do VitaRain, (inaudible) and I don't know let's say the 18 pack of the Vitamin Water is $20, the 18 pack of the exact same bottles, the exact same colors, the exact same sizes with different signature on it and again it's a different manufacture to our spec, is more than a third to 40% lower price point.

So, and by definition if we always sold the first one and now all of a sudden I'm not sure what the penetration is even if it's as low as 30% of the unit sales that had a deflationary impact.

I would say net/net we haven't seen a lot, we are starting to see some more basic food items, whether it whether it's or basic what I will call supermarket either items whether it's sundry or paper towels or canned goods or what have you.

It sounds of the 2% ticketing increase you say the bulk of it is stuff that you are doing.

I would bet it's stuff that we are doing -- we always trying to increase the pack size.

In fact my guess is that 18 pack is now a 24 pack.

I know toilet tissue which sequentially over four, five years I think has gone from a 24 pack to a 30 to a 36 now.

I think so.

But again there are several examples out there.

We still try to increase the price points.

Then second I guess related we talked about the margin that's sort of longer-term progression and Jim, went around the clubs and calling back with things that need to roll back effectively.

How does Jim look at the comp deceleration at 4%?

Do you look at it on absolute basis?

In other words, we don't, if that got to 2 for you guys you might pull back stronger that would be evidence that it was impacting comps or do you look at it on purely a relative basis versus the markets and competition?

Without knowing exactly what he would say my strong guess would be it would be the latter.

If the underlying normalized comp for us was a 6 when the world, U.S.

retail overall was a 3 and U.S.

overall went to a minus 5 I think if we were zero we would be thrilled.

But, or Wall Street would be less unhappy with us than others.

I would say that's the way he would look at it more.

But he would also look at it, what he does not want to see is the weekly comp shops we do with our direct competitors.

And on those, but recognize those are the items that are, what we are looking at are like items and like competitive items that the customer has a at top of mind, whether it's a consumer or business customer, it's milk, it's paper towels, copy paper, Coca-Cola and Pepsi Cola, it's Advil and Tide.

And those are quite competitive.

So I again I remember after talking quote, unquote about some initiatives and then we came in with an August comp of 2%, I know shortly thereafter we were, Jim and I were in New York at a speech and the question of the day was, well does this change your mind about pricing, about margin initiatives.

And the answer was no.

That's more of a competitive reaction.

If we felt that competition was changing comps is one thing but we think we are doing just fine right now.

Thanks.

Thomas Sport.

Hi, Richard, two questions, the first one was when we think of gas sales you talk a lot about the gross margin impact but I wanted to know what to what extent you can leverage them on an SG&A front?

What we can do on SG&A?

To what extent, when we think about margins overall, operating margins on gas sales, you've talked about the negative impact and how they can drag the gross margin down but is there a certain level of gas sales where the comp can actually benefit the SG&A where you can leverage the SG&A on the higher comp sales due to gas sales?

Clearly I think we are, our SG&A, notwithstanding that it's higher year-over-year, all things being equal it would have been even a little higher if gas wasn't inflationary right now.

But that's a small driver of that number either way.

And the second question was I wanted to know if you were seeing anything different on the competitive landscape?

No, now -- I don't think, if things have gotten tougher at all, I mean it's been tough for a long time.

We were always competitive and as again we talk about competition certainly our biggest competitor is Sam's, in terms of number of locations we compete with somebody on and we are both warehouse clubs.

They got a lot tougher about five years ago when they had a management change.

They have remained tough.

Again I'm happy to hear that they commented that they are not going to play the penny game but by the same token neither of us are going to fall asleep at the wheel here and we are both in each other's locations weekly if not more frequently and I don't see a big difference there.

I don't see it getting any worse but it's not like it's going to get any better.

Great.

Thank you very much.

Peter Benedict.

Hi, Richard, first on the fee structure you noted that you increase fees on the base members every four to five years and keeping that in mind considering that you didn't move the executive fee last summer and I don't think you ever increased that fee how should we think about strategy with respect to the executive fee going forward?

When we talk about it we talk, we look at the menu of what we could do, I remember even when we went to 45 to 50 we looked at various alternative, keep it at 100 because it's a nice rounds number, go up five which is kind of an odd number, go up more than five but then try to figure out what else you can give back to kind of implicitly say it's five and feel it's five and at the end of the day we looked at it and said if we kept it the same, break even on a 2% reward we would go from $2,750 to $2,500, in other words 2% of the $50 difference instead of the $55 difference.

By doing so we would be about 2.5 million members that are in theory are now above the break even threshold on executive member, not to say that we are going to get a lot of them but even if we can get 10% of them that's another quarter of a people of a million people that we can switch that will spend more and buy more and be more loyal.

It's really not been a topic of discussion for the last year nor do I expect it to see it as a topic in the next several months, beyond that who knows.

I think at some point we will look to increase it and assuming this continues to be successful but I don't anticipate that in the next year at least if not longer.

Fair enough.

Understanding you said your renewal rates overall have hell up pretty well is there any regional variance you have seen, any pockets in the country where you are seeing some pressure?

Not really the only thing we ever see regionally each warehouse has a certain amount of payroll that we call marketing.

Now, marketing is a lot of thing.

It's the membership desk when you walk in to get signed up, it's the employees that go out and canvas, it's the small business or to the large employer groups for their employees.

It's the people that have had RF hands held device that go up to you and scan your card while you're waiting in line and let you know that based on your last year's purchases you would have made out well on the executive membership.

So it's, and what you'll see sometimes on a month to month basis a given region might be weaker in executive member diversion but stronger in gold star sign ups, while they spent that month focusing in that.

Or they might be weaker in general sign ups, well that month included two weeks of AMEX code branded membership brand credit cards doing two weeks of tabling activities for that.

So overall I would say the answer is no.

You'll see some regional differences sometimes just because of the actions that a given regional marketing manager in a given region is taking.

Great that's encouraging, quickly some clarification on the buy back did you say that we should expect to you buy back just over $1 billion worth of stock this year or that just that you're current pace of buying is at that rate?

I didn't say current pace of buying, I just took the 12 weeks of Q1, the dollars expended and multiplied by 52 and divided by 12.

And, again, keep in mind that given the run up in stock, and the fact that it takes about 3.5/4 weeks now we've been in blackout we have file 10-B-51 in advance of that when in quote, unquote, there's no material knowledge that we have, and that was done when the stock was in the 65 to 67 range I think so the matrix didn't go much above 67 or 68 I think.

And so we'll have to revisit that next week when we are at a out of blackout.

My guess would be that we would continue to buy but not go crazy and see what happens with the economy, too.

Great.

Thanks so much.

Todd Slater.

Would, this call has gone on a long time so I will speak to you guys off-line.

I am going to take one last call.

Theresa Donahue.

Hi, guys, my question was answered.

Thank you.

There are no more questions in queue, sir.

Well, thank you everyone.

We'll be around.

This concludes today's conference.

You may now disconnect.