好市多 (COST) 2008 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the February sales release and quarter two earnings 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.

Galanti, you may begin your conference.

Thank you, Kela.

Good morning to everyone.

As Kela mentioned, this morning's press release reviews our second quarter operating results for the 12 weeks ended February 17th and our four weeks of February sales results for the Sunday ended -- four weeks ended March 2nd.

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 involves -- 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 second quarter.

For the quarter earnings per share came in at $0.74, compares to $0.54 or up 37% from last year, recognizing that last year had some one-time items This compares to our December 13th guidance at First Calls $0.74 figure at that time was doable and at the high end of a small range, I know you've heard that before.

In last year's second quarter, again while we came in at a reported $0.54 a share, as I explained last year and I'll do so again shortly, last year's second quarter, what I'll call normalized EPS was $0.66 a share.

So really this quarter's $0.74 figure represents a 12% year-over-year increase compared to that normalized $0.66.

As you will see, this 12% normalized figure, I think we feel it's pretty good given the slightly, a very slightly weaker comp in Q2 versus Q1 and frankly a few items that in the aggregate probably hit us by perhaps $0.01.

I'll talk about that later.

In terms of sales for the quarter, as previously reported, total sales were up 12% and our 12 week comp figure showed an increase of 7%.

I think, of course, our comp figures continue to benefit from gasoline inflation and strong FX primarily in Canada.

We're also reporting this morning our comp for February, it too was at 7%, including a 5% in the U.S.

Other topics of interest I'll talk to you this morning, our opening activities.

We opened a total of seven new units during the second quarter, four in Canada, one in the U.S.

and one each in Korea and Japan, such that fiscal year-to-date through Q2 end, those 24 weeks, we've opened 13 net new units, as well as four relocations.

Those four relocations all occurring in Q1.

At Q2 end we operated 531 locations around the world and since February 17th Q2 end we've since opened three additional units, Colorado Springs, Colorado, Woodland, California and actually this morning we are opening in Puerto Vallarta, Mexico, which is our 31st location down in Mexico and therefore our 534th unit overall.

Also this morning I will talk about ancillary business results, Costco online results, membership trends, the impact of changes we made back in last February and March to our electronic's returns policy, a quick update on stock purchases and a quick update on our balance sheet for the quarter just ended and lastly I'll provide you with some updated direction guidance for the third quarter and fiscal year.

Okay, onto the discussion here for quarterly earnings.

Again for the second quarter total sales were $16.6 billion, up 12% from last year.

On a comp basis I had mentioned they were up 7%.

The 7% reported comp figure for the second quarter, recognizing our quarter is slightly different than calendar month, but essentially it was comprised of a 7% in December, a 7% in January and a 7% in February.

So all three of those calendar months were 7%.

This of course compares to an 8% reported comp figure in Q1.

Again, as I mentioned, both on a quarterly basis and on a February basis, monthly basis, we're getting -- part of this -- a significant part of this increase relates to gasoline inflation as well as FX.

In the quarter, basically gas inflation represented a positive impact of 185 basis points, that's a little better than the 150 basis points in Q1 and the continuing weak U.S.

dollar relative to foreign countries, that strong FX in Canada as an example, all told that was a benefit in -- for the quarter of 220 basis points, which was a little less than the 250 basis points benefiting Q1.

So you take those two things together, essentially the same impact in Q1 and Q2, about 400 basis points for both of them.

For the quarter our 7% reported comp figure, it was a combination of, of course, the product of an average transaction increase and average frequency increase.

I am happy to say increase in the latter part.

The average transaction increase was about 5.5% for the quarter with the average frequency increase being a little better than 1.5% up for the quarter.

Including the average transaction, of course, of 5.5%, you again you've got the impacts of the FX and the gasoline.

Cannibalization, still a negative impact because we continue to infill markets.

There's about 100 basis points this quarter, a little better showing, if you will, there was 110 basis point negative impact in Q1, so essentially the same in both quarters.

For the month of February, again, as I mentioned the 7% reported comp, again almost like the quarter overall, average transaction increase while for the quarter was a little over 5% it was a shade under 5%, in the high fours, for the -- for the month of February and average frequency was actually a little better, increasing up about 2.5% for the month.

And I might say that there was a little bit of a pickup from December/January as well when we reported an increase in traffic of a little less than 2%.

Cannibalization, about 90 basis point impact in February, so again a little less negative, if you well, than it was for the quarter and for the last couple of months.

The other thing I was going to mention and we usually don't but it's a combination of a couple of things, we were impacted in eastern Canada and the northeast and somewhat the midwest by weather.

We estimate that the weather probably impacted us by 30 or 40 basis points.

More importantly, and even if you take that out, if you exclude that as an impact, the -- we did have two calendar shifts.

In Canada and Ontario there is a holiday called Family Day, which was a calendar shift and so it was one less day.

As well in Taiwan and Korea there is the lunar new year calendar shift, again one less day.

Those two very quantitatively are about 40 basis points as well to the four-week month.

So those again, as I mentioned, it was a little weaker for the quarter versus Q1.

Those things impacted February, although February was okay relative to the most recent couple of months, even with that additional negative, if you will.

Also included in the average transaction for the month, as I mentioned, was gasoline inflation.

Finally, we've seen a little pickup in comps during the trend in February.

Regarding February comps the first two weeks averaged a 5.5, the last two weeks averaged a 9.5.

The last two weeks actually where we had one week was better than that and one week less, and that just due to some timing of some mailings, but for the two weeks I think clearly that 9.5 number was a better showing than the first two weeks.

By the way, we're always asked to give the economy about any mixed change between business and Gold Star members, I think generally the feeling out there is the weak economy given that most of our small business members tend to be little restaurants and diners and the like and small businesses, there is concern about that.

The answer is there has not been a change.

In fact, in looking at both the last two quarters as compared to Q1 and Q2 a year earlier, there's been an ever so slight pickup in the sales mix to the small business member.

Less than a half a percentage point swing, but nonetheless certainly not going in the other direction.

In terms of sales comparisons geographically, in terms of what I'll call the -- the high volume mature regions like the northwest, like California, certainly the northwest is the strongest.

Our northwest comp both for the quarter and for February is darn close to the Company average.

At California, as I've mentioned in the past few months, is the weaker of those mature markets and some of that is what we hear about in Southern California with the housing issues, and the cost of -- of gasoline.

My guess is we haven't seen any detriment relative to -- it has come down over the last few months and it has pretty much hung in there at those slightly lower levels but nonetheless still positive comping.

We also, of course, hit California with a little higher level of cannibalization than others, as much of -- as a lot of our infill has occurred there.

So that could be a little bit of it as well.

Other regions, northeast is fine, southeast is fine.

New regions like the Midwest and others tend to be a little higher than the Company average, notably because of the -- the age of those locations and they are still continuing it grow nicely.

Canada, of course, in local currency is in the mid-single digits but in -- when translated into U.S.

is significantly higher because of the Canadian dollar year-over-year.

As I mentioned, California, it continues to be, in terms of the big volume, mature markets our toughest market for comp sales but again comping slightly positive.

No real change in February as compared to the last couple of months prior to that.

In terms of merchandising categories, as people have asked where do we -- how do we get our frequency up like that, certainly we think food is a big piece of that, the fact that people still eat, have to eat and they come in and we've got a lot of good things going on there on the food and sundry side as well as fresh foods.

Both food and sundries and fresh foods have comps greater than the Company overall, with hard lines and soft lines of course being the offset of that, being below that.

A little color on Q2's comps, within food and sundries, we still have a -- about 10% of food and sundries sales are tobacco.

That's really a drag on comp, even though the overall food and sundries with tobacco is still, again, better than the Company average and I think that's, again, a combination of the fact that we've anniversaried the Canada issue, it has more, I think, it do with the fact that in some locations we've curtailed tobacco sales, a limited number of locations, about 100.

And -- and it's really where we found virtually all the sales were small businesses coming in and just buying that and we've -- we've not seen any impact there.

The other thing is it's very expensive to buy a carton of cigarettes these days, so I think that you are seeing some diminishment there.

All the other subcategories within food and sundries were fine, on the high end our deli department again had the strongest comps again food related.

Within hard lines comps, electronics comps were actually decent, up in the mid-single digits.

Sporting goods actually the best of the larger categories, subcategories up in the low double digits, slight -- essentially flat to slightly negative in areas like hardware and office supplies and a little bit of weakness, slightly negative in lawn and garden and patio.

Again in talking to the buyers and the merchants, they feel a little of that had to do with weather.

In fact, in the last week the comment yesterday from our head merchant was they've seen that pickup.

No real concern on patio, maybe we end up taking an extra week or so to sell it but no real concern there.

Within soft line comps, nothing terribly thrilling, home furnishings was the weakest with a negative comp.

Similarly a negative comp in jewelry.

That's consistent with -- I think I've shared with many of you over the last few months, discretionary type of non-food items tend to be weakest in this economy, even though overall we're doing okay.

Our bright spots within soft lines included small electrics, media, which is of course movies, CD's and books, and women's apparel.

I think women's apparel is strong for a couple -- of a main reason is there's an availability of more branded stuff out there.

We, in fact, are seeing quite a bit more activity from some of the variety of non-food manufacturers that historically would not sell us directly and I think that's certainly a direct relationship to the fact that of what we read out there about weakness in mall-type sales and small apparel store-type sales.

Within fresh foods, again, a little bit better than the Company average comp.

Deli is on the -- is the strongest and produce -- actually, produce is the strongest, where again it stands out both deli and produce but all sub-fresh food categories were positive.

Two final comments on sales.

Overall, again as I mentioned over the last -- when people ask us about what's going on with the customer and the weakness in the economy, again where we've seen it is where you would expect to see it relatively speaking, in areas like furniture, home furnishings and apparel, home furnishings.

A little bit of offset in the apparel area, as I mentioned, is the fact that there is perhaps a greater supply of some previously unavailable branded stuff where we can get our hands on and you can all see that if you walk into the warehouse.

Also again weak furniture and jewelry, again, discretionary items.

Even within some strong categories like meat, which is about 6% of sales, what we call meat is meat, poultry, pork and the like, we've seen a little bit of a mixed shift over the last few months from higher, more -- from beef to things like chicken, not discernibly but -- but a slight shift.

All that is anecdotal but is consistent, I think, with what is going on out there in the economy.

Moving down line items on the income statement, membership fees you see we reported 342.9 million or 2.06% this year, that's up about 11% in dollars or about $36 million.

As a percent of sales its down slightly two basis points, still we feel a very good showing.

Our renewal rates are strong.

We're still getting increased penetration from the executive membership conversions and sign-ups.

At Q2 end we had 19.3 million Gold Star members, we had 5.5 million primary business members and 3.4 million business add-ons, so total member households of 28.3 million, up from 27.8 million at Q1 end and 27.4 million at fiscal year end.

If you simply divided that by the number of warehouses, and I believe this number excludes Mexico, is, since we don't console date those figures, about 56,000 members per warehouse both at Q1 and at Q2 end.

With spouse cards the 28.3 million households represents actually 51.8 million membership cards out there, including the spouse card.

At quarter end our paid executive members were 6.9 million.

We added about 18,000 a week in the last 12 weeks of the quarter, or 214,000 during the fiscal quarter.

Notwithstanding the fact that the program has been around for, gosh, six, five, six years now, we're still getting some increased penetration from that and we view that as a great long-term positive from the standpoint of member loyalty and sales growth.

These 20, roughly 24% of our membership base generate now over 50% of our sales.

In terms of renewal rates, we, again, fluctuate between 86 and 87 depending on how it rounds.

I think the end of Q1 it rounded ever so slightly down to 86, it was almost a 87.

It is now an 87.

And again, I think in this economy we feel good about the fact that we've been able to maintain our renewal rate.

In terms of gross margin, last year a 10.49, again that was impacted by some onetime things I'll talk about in a minute, compares to a 10.73 this year.

So up 24 basis points.

As you'll see in a moment when I ask you to write down a few numbers what I'll call the normalized gross margin, excluding those non-recurring items in last year's second quarter figures, show a year-over-year improvement as compared to the reported 24 basis points improvement, I think the more correct number to look at would be an improvement on a normalized basis of 13 basis points up.

Before I ask you to jot down a few numbers, let me give you an explanation of those items I talked about that impacted reported gross margin last year.

There were two.

One was a $10 million refund related to a decision in the federal excise tax, I believe, on telecommunications.

Just like you as an individual, got a small rebate.

We as a big Company got a $10.1 million rebate.

Of that amount about about $8.7 million benefited gross margin last year in the quarter.

We pointed that out last year.

So again we would take that out in terms of looking at a normalized number when we compare it to this year.

The second and much larger item related to an increase last year, as you recall, in our sales returns reserve balance, which we determined at the time was appropriate to do after we performed a more -- we performed a more detailed analysis of our historical return patterns.

Last year in Q2 this adjustment resulted in a decrease to sales of $224 million and a related pretax charge to gross margin of about $48.1 million.

As you will recall from last year, we had a similar adjustment as we completed that analysis in Q3.

So this should be a fun year to try it get all the numbers correct for you and -- and try to help you look at things on an apples-to-apples basis.

So with that I'll ask you to again jot down my little chart and we'll -- why don't we do three columns, Q4 '07, Q1 '08 and Q2 '08 and the line items would be core merchandising, the second line would be ancillary businesses, the third line would be 2% reward on the executive membership, the fourth line item would be LIFO.

The fifth, sixth and seventh line items would be these -- some adjustments related to these last year's second quarter, the first of those three would be IRS, federal excise tax claim, so just excise tax claim, the next to last item would be the returns adjustment and how that impacted gross margin, and the returns gross margin adjustment and then the last line item would be returns sales adjustment.

As I mentioned, not only do you have the direct impact of hitting gross margin for the 48 million but by having the anomaly of having a reduction in reported sales of 224 million to increase the sales return reserves, that too had an impact on that calculation.

And then of course total and I'll read across and plus is good, that means year-over-year in that quarter we had an improvement in basis points, so as an example core merchandising in Q4 '07 was 34 basis points better year-over-year.

In Q1 '08 44 basis points better.

And in Q2 '08 29 basis points better.

I will point out that both in Q1 and Q2 included in that 44 and included in that 29 is a small amount of basis points benefit related to the -- the sales returns reserve improvement from the change we did last year in our -- in our -- in our electronics returns policy.

So within that 44 in Q1 there was about three basis points we estimated that benefited from that and in Q2 two basis points.

A small amount but I wanted to point it out because some of you have asked that.

Ancillary businesses, in Q4 '07 that was a positive one basis point year-over-year.

In Q1 it was minus 30.

You recall in the quarter ago in the call where we talked about the fact that we had a huge swing year-over-year in the profitability of gas, much of that minus 30 is that.

And then in Q2 improved from the minus 30 but nonetheless negative, a minus 12.

2% reward minus 4 in Q4, minus 5 basis points in Q1 and minus 4 in Q2.

Simply a -- an increase penetration of sales to the executive member who gets a 2% reward.

LIFO we'll leave it on here because at some point in the future we may actually have a number in there but that would be zero, zero, zero.

And then again the last three, which are adjustments or are things to get things to apples to apples year-over-year, the federal excise tax claim Q4 would be a 0, Q1 a zero and Q2 '08 minus 6.

Returns gross margin adjustment plus 7, zero and plus 33.

And returns sales adjustment, and again that has to do with increasing -- reducing the sales report of last year, zero, zero and a minus 16.

Now you add all that up Q4 '07 showed a reported 38 basis point improvement in margin, Q1 a reported plus 9 and Q2 a reported plus 24.

Now as you -- as I started this gross margin conversation I talked about the fact that on a normalized basis we felt that Q2 showed a -- a normalized number of plus 13, not the plus 24.

That's simply taking those -- those last three numbers, the minus 6, the plus 33 and the plus 16 -- and the minus 16, which together add up to a plus 11.

If you take that plus 11, which is really the apples to apples improvement, if you will, off the 24, that's where you get the plus 13.

Whew.

Okay.

You can go back and look at that chart.

As you can see, the overall reported gross margin again was higher by 24.

I will point out that within the plus 29, the core merchandise business and that's our main four categories, food and sundries, hard lines, soft lines and fresh foods which is close to 90% of our Company, that was higher year-over-year in Q2 by the 29.

All four of these major departments were higher year-over-year ranging from just slightly higher in the manner of basis points to as many as 79 basis points up.

But, again, the average of those four is the 29 weighted average.

Hard lines, of course, was positively impacted, as I mentioned, by the reduction in returned items in electronics.

And I guess the other thing is, again, unlike in Q1 when year-over-year our overall Company's gross margin was very negatively impacted by the negative swing year-over-year in gas profitability, in Q2 gas didn't hurt our margins like they did in Q1, however other ancillary business, gross margins and penetration in the quarter compared to Q1 were down a little bit.

As an example, in pharmacy we've seen some ongoing pressure, a little bit of it in talking to the pharmacist, scripts are fine, volume is fine in terms of quantity, what we're seeing though is a continuation of Medicare part D, which caps what a Medicare recipient has to pay for -- for drugs to the government.

And -- but we have to -- charge for that.

As well, there seems to be a increasing number of generics with not a new flow-in of -- of new branded items and so there is a little bit of a trend there that will come and go.

We're seeing a little bit of pressure in our food court.

Most of that is because, as -- as you would expect, we have not changed the price of the hotdog or the pizza, most notably the pizza where you have huge increases in -- in cheese prices year-over-year.

And that is our view of how we're going to run it right now.

But that has had a small impact.

And again, the same thing in optical, a very small impact.

Lastly, during the quarter, and we didn't -- I didn't point this out earlier, there was a small legal settlement in Q2, about $5 million and it has -- it has to do with when a member downgraded from executive member back to Gold Star member or just decided not to renew.

The way -- we always historically wanted to mail them their reward check as part of their renewal notice to get them excited about getting that reward check and getting them excited about renewing.

In those cases where that did not occur, and in that sense though the renewal check in that first year only covered about 10 to 10.5 months, I think, because it included -- about 10 months because the renewal notice sent out prior to the end -- to the renewal date.

And of course going forward you'd get 12 months, the last two of that year and the first ten months of the next year.

If you -- there was somebody that noticed that, we changed it a number of years ago.

A few years ago, but as life has it in this society, we have agreed on a settlement to basically send out hundreds of thousands of checks which we estimate will cost us about the $5 million.

That has an impact of reducing sales because it is part of the 2% reward, so the real direct impact is 3 or 4 basis points to margin.

That's within these numbers but again that was a slight negative that is an onetime impact that is already incorporated into these numbers.

In terms of our gross margin outlook going forward.

Again, no real changes.

It continues to be positive in terms of the initiatives that we've undertaken.

Gasoline is up and down, all over the board and will continue to be that way, but a great value proposition for our members and, again, over any 12 month period it has been profitable.

It does require a little bit thicker stomach lining though as a Company.

General merchandise, as I mentioned, is doing fine.

Again, we should continue it benefit a little bit, and I don't think this is a big impact relative to the economy but it is certainly a tempering offset to it is the fact that our non-food buyers are seeing more availability of what I'll call branded non-food items where historically we could not get our hands on and somebody just the other day mentioned huge availability in the apparel, things like name brand jeans and name brand women's apparel and Crocs and the like.

The impact -- and we're seeing some of that even on the furniture in home furnishing side, getting those calls.

The impact from increasing executive member business should still be, again, a small hit to reported gross margin as it relates to the fact that as we increase the sales penetration that reward reduces sales which impacts gross margin, although again that is a long-term positive we feel in terms of value of that customer to us.

LIFO, as I mentioned, we are starting -- actually I didn't mention, we continue to see a little bit of inflationary pressure out there from vendors, certainly in paper goods, in other manufactured items like plastic bags and -- and -- I think overall over the last few years, whatever inflationary pressures were out there, and there have been with energy costs going up, I think retailers generally have had the stronger hand.

What we're seeing over the last year, and over even recent months, is more and more vendors are not talking to you, they are just announcing what the price increase is going to be because they've held on to it so long and so we just see a little bit of pressure out there.

We still have an unused LIFO credit and so we don't expect any LIFO charge this year, but we'll see what happens next.

Before going on to SG&A, ancillary businesses, we opened five pharmacies in the quarter to be at 439 at quarter end.

We opened seven food courts and seven one hour photo labs.

We now have 495 food courts and 493 photo labs.

We opened six optical shops to be at 484.

The print and copy shop at some point I'll take this off, we -- we actually closed one, so we now have seven.

If you go back to fiscal '04 we had ten.

Basically where we do have them, they are modestly profitable, it is a service but the trend is we're not opening any of those.

Hearing aid centers, we opened seven in the quarter to be at 252 and gas stations we opened 2 to be at 290.

In total for Q2 ancillary business comps were very strong, up mid-single digits if you exclude gasoline, so that strength was a lot of gasoline and the inflation.

Although, gallon comps were up slightly too.

Now moving to SG&A.

Our reported SG&A, again, on a reported basis, which showed lower by 33 basis points coming in at a 972 this year versus a 1005 last year.

However, in the last year's second quarter again you had some non-recurring items.

Specifically in Q2 last year we had a $46.2 million pretax charge was recorded and that was as a result of our decision to protect our employees from negative personal -- from possible negative personal tax consequences that may have arisen as a result of our fiscal 2006 internal review of our historical stock option grants.

As well the decrease in last year's reported sales figure as a result of the $224 million increase to the sales returns reserve, again that reduced last year's sales number which made last year's reported SG&A percentage slightly higher.

Again as I do, I'll ask you to jot down a few numbers to help you better understand our SG&A and again we'll have three columns, Q4 '07, Q1 '08 and Q2 '08.

The line items will be operations, number two will be central and number three will be stock options, number 4 will be 409 A, that's the -- this big adjustment that I just talked about, the 409 A is the IRS piece of the law that talks about how to address it.

The next line item would be sales return, again related to something that happened last year in terms of trying to get to apples to apples.

And the -- the next to last item would be quarterly adjustment and then finally total.

Going across, operations Q4 '07 minus 23, the minus here means higher, so SG&A was higher year-over-year by 23 basis points, Q1 '08 minus 9 and Q2 '08 minus 11.

Central, minus 2, plus 2 and plus 2, so slightly higher year-over-year in Q4 and a little bit better year-over-year in Qs1 and 2.

Stock options, plus 2, minus 4, minus 3.

That's going to fluctuate around zero, I think it was a little higher in Q1 and Q2 simply because our last grant -- the big grant that we do every year of our issues now is in the fall and it was at -- near a high price, so again if the stock is going up it hits us a little harder, if it is going done it hits us a little less because it is based on the stock price on the grant day.

409 A, zero, zero and plus 30.

Again the plus 30 relates to the fact that a year ago in Q2 we had that big charge, again, that just offsets it there.

Sales return zero, zero and plus 15.

Quarterly adjustment, zero, minus 6 and zero.

If you recall in Q1 the minus 6 was the roughly $8 million, $8 million, $8.5 million give back to our employees for -- for performing well in our healthcare plan.

And as you know, we actually just recently paid that out to our employees in the form of a $100 to each-- to -- $100 each into about 82,000 or 83,000 employees 401K plans.

The total then would be a minus 23 in Q4.

Again, that's what we reported as our SG&A year-over-year.

Q1 was a minus 17, so higher year-over-year.

And Q2 '08, of course, was plus 33, lower -- better year-over-year.

But, again, if you take the plus 33 and take those two adjustment items, the plus 30 and the plus 15 out, you, again, get back to what I think is a more appropriate number on an apples-to-apples basis for SG&A.

Within the minus 12 normalized SG&A year-over-year, so higher year-over-year, operations, as I mentioned, core operations was higher by 11.

Keep in mind, as you recall last year in March we increased the bottom of scale a $1.00 a hour in the U.S., that had an overall impact between wage and benefits of 6 basis points.

That's -- that minus 6 is within that minus 11.

And the good news is is we anniversarying that about two weeks into the beginning of March, about two weeks into Q3.

So we have a ever so slight negative impact, our feeling is, in Q3 and then be out of the equation.

Again, central expense, nothing exciting there, slight improvement.

Stock options spend I mentioned, minus 3, or higher year-over-year.

So overall not that different from Q-- Q1, slightly better in terms of trends.

In terms of the outlook for the remainder of '08, again, we'd love to have some stronger sales.

We're -- at least in the last couple of weeks of February we've started off a little stronger but who knows what tomorrow brings.

We will be, as I mentioned, anniversarying the bottom of scale but the big question mark there, as I've told many of you over time, there aren't a lot of silver bullets out there, we're pretty efficient.

We want to drive top-line, that is the best way to improve SG&A or to mitigate any deleverage.

Next on the income statement line is pre-opening, last year it was $7.5 million, this year $9.7 million.

So a little higher, $2.2 million higher or 1 basis point higher.

Really no real surprises last year in the quarter, we opened four openings, this year seven.

There's always some fluctuation, timing of those costs as they are incurred over several months prior to opening.

In terms of provision for impaired assets and closing costs line, we actually year-over-year benefited in that area.

Last year in the second quarter we had a charge of 3.5 million.

This year we had income of 2.9.

Basically there was very little in the way of asset impairments this year, about 0.5 million.

But those offset by $3.4 million gain on our property sale in Canada related to a relocation.

So that benefited us a little bit through the year.

All told, operating income in Q2 was up, again reported basis up 40% from 361 million to 504 million, or an increase of 143.

Recognized, however, again excluding those unusual items, this year's second quarter operating income was up 13% or $57 million.

Just one side comment, getting back to the asset impairment line here, we do have three or four relocations coming up.

We might see a slight higher negative number in Q3 or 4 as several of those relos are about to get approved and commenced.

Can't tell you when.

I'm not talking about tens of millions, I'm talking about threes and fives of millions, but my guess is in Q3 or 4 we'll tell you that there was an extra $0.01 or so in one of those quarters related to that.

In line with our budgets and nothing surprising, even though I wanted to mention it.

Below the operating income line, and similar to Q1, reported interest expense was substantially higher year-over-year.

Of course that relates to the fact that last year we, in mid-February we closed on our mid to late February we closed on a $2 billion debt offering.

In Q2 '08 interest expense was $23.5 million, up substantially from the $3.6 million a year ago.

Interest income was up slightly.

It was at -- interest income and other was up -- we reported $40.6 million this year in the quarter, up $4 million from $36.5 million a year ago.

Of that $4 million delta or better, about half of it is higher interest income, even though it -- rates are coming down a little.

And the other half is increase in earnings from our 15% interest in our Mexico operations.

Those are the two big chunks.

I will mention, though, when I talk about there was a $2 million year-over-year increase in interest income, the interest income component, actually interest income was -- was higher than that.

Within -- within this number we took a charge of $2.8 million this quarter, I related to an impairment loss recorded on some of our cash investments or cash equivalent investments.

In the more than $2 billion of cash and cash equivalents we have on our balance sheet at fiscal year end, we had about $1.1 billion, $1.2 billion invested in what was known -- what is known as enhanced cash money markets or enhanced cash funds.

Generally portfolios of mostly Triple-A rated securitized assets that historically have acted like traditionally money market funds, i.e.

they trade daily, there is daily liquidity or T+3 liquidity, and traded at a fixed $1 net asset value.

Our $1.15 billion was in line with our investment policies, which we felt were conservative, and spread between six separately managed funds, including well known names like B of A and Black Rock and Merrill and UBS and the like.

In early December we received a call from one of the funds that the fund was stopping redemptions and that the fund would be allowed to float.

That -- that has not happened, I understand, since the early '90s in terms of one of these funds -- more than ten years one of these funds actually allowing the NAV to float.

We immediately requested redemption of all funds to stay on the sidelines.

I'm happy to report that as of Q2 end we redeemed almost $800 million of the $1.15 billion and have put it -- reinvested it in government-related funds at a 20 to 40 basis point lower yield but nonetheless it is on the sidelines in government funds.

And of the $384 million remaining among these funds, and these are the ones that where they basically had a run on the bank, if you will, and they are -- going forth with orderly liquidation of those.

All three have restricted redemption as they are in the process, again, of undergoing an orderly liquidation of these underlying investments as they mature or can be sold by the portfolio manager.

Some of them go out as far as 2010.

The $2.8 million write-down reflects an impairment loss on a few of the investments among the more than 250 separate investments within these three portfolio funds.

While no one knows what tomorrow brings in terms of the credit crisis, at present we believe the issue at hand for us is one of liquidity and not credit quality.

Based on the remaining investments that comprise the $384 million at Q2 end, approximately $114 million or 30% will be -- expected to be redeemed by fiscal year-end.

In all but perhaps a 50 to 90 million of remaining should be redeemed by fiscal 2009.

When I say it is more of a liquidity issue, they are performing fine so far.

Again, we don't know what tomorrow brings.

Two thirds of the existing -- of the remaining funds, or over half of the remaining funds of the $384 million are still trading among the two portfolios at $1.00 NAV.

One of them, again, has slipped to about a 98 whatever and that is the $2.8 million that we talk about here.

Recognize there are no guarantees as to what happens in the credit markets tomorrow, what I can say is that we took what had been considered a conservative investment policy and now it is more conservative, in that all short term funds are being invested in government related funds at again 20 to 40 basis point lower yield.

Lastly the $384 million in funds in terms of our balance sheet have been moved on our balance sheet from cash, cash equivalents to the following, about $225 million is now classified on the balance sheet as short-term investments, you will see that when I call off the balance sheet.

And $159 million classified as other assets simply because it -- those things in terms of when they mature, they mature after 12 months.

So overall pretax income -- again, summarize all that, I'm happy to report we do not have or did not have any auction rate preferreds or any of the other things that you read about lately.

These are, again, literally a few hundred or -- more than 250 separate funds, many of which are still Triple-A.

Again, some of the ones that aren't there anymore were Triple-A to start with but we feel pretty good about it at this point and we think that we've taken the appropriate charge.

Overall pretax income on a -- on a reported basis, again reported was up 32% but, again, on a normalized basis this year's pretax income was higher by 9 basis points -- by 9%, up 478 million, up to 521 million.

In terms of tax rate, tax rate was actually where we estimated it would be for the year, although we've generally benefited in the last few quarters by being a little under that because I would like to think that we've been appropriately -- appropriate in our estimates and we've been fortunate that some things have -- some discreet items on a state and federal basis settled and have settled slightly in our favor.

For the quarter we had a 37.1% tax rate, that compares to 36.7% a year ago.

Again, about a half point higher year-over-year, 40 basis points higher, but within that range.

In terms of the balance sheet, as of February 17th, cash and cash equivalents $2.267 billion.

Short-term investments 833.

I mentioned part of that is a reclass of these.

The rest of that is, again, simply some other funds, secure funds, government related funds that are, again, not technically deemed cash and cash equivalents.

Inventories, $5.236 billion.

Other current assets, $1.333 billion.

Total current assets $9.669 billion.

Net PP&E $10.048 billion.

Other assets $951 million.

For a total asset column of $20.669 billion.

On the right-hand side, short-term debt, which includes the current portion of long-term debt, $138 million.

Accounts payable of $5.338 billion.

Other current 3.693 billion.

Total current 9.169 billion.

Total long-term debt 2.182 billion.

Total deferred and other 298 million.

So all told, total liabilities $11.649 billion.

Minority interest 74 million.

Stockholders equity $8.946 billion.

Again, a total of $20.669 billion.

Depreciation, amortization, and some of you call back to ask for that, for the second quarter was $146 million or roughly a little over $600 million annualized.

Let me point out a couple of things on the balance sheet, our debt to cap is at 21%.

That's after buying back, of course, over $4 billion of stock over the last three years and adding $2 billion to our debt and so we have plenty of financial strength continuing.

AP as a percent of inventory, in terms of recorded basis, both last year and this year, it stood at 102%.

If you take out of accounts payable non-merchandise payables, like construction payables and what have you, the underlying merchandise accounts payable to inventory would be last year 82% reported, this year 84%, so slight improvement there.

Average inventory per warehouse up ever so slightly.

Last year was $10.341 million a warehouse.

This year at Q2 end it was $10.450 million so up $109,000 or 1%.

Actually in terms of what is out there it is down slightly.

Of that $109 million -- of that $109,000 per warehouse average $233,000 of it, or more than twice of that amount, is due to the weak U.S.

dollar.

And so FX -- the U.S.

weakness makes FX higher.

And if you took that out of the equation, we'd actually be lower by over $100,000 per warehouse.

Where we've seen the reduction is the three big reductions, again these are small numbers so there's really nothing to talk about, but toys are about $50,000 lower, lawn and garden year-over-year $50,000 lower, despite what I mentioned about being a little weaker this year, women's apparel $27,000 lower, that's despite having more availability of goods.

No real inventory concerns.

We came out of mid-year inventories fine and not a lot of concerns out there about markdowns.

In terms of CapEx, in fiscal '07, as you recall, we spent about $1.4 billion.

We estimated at beginning of this year that for this year we'd spend about $1.7 billion or $1.8 billion.

In Q2 we actually spent $339 million, such that year-to-date for Q1 and 2 we've spent $775 million.

A little lower than -- pretty much in line but slightly -- a tad lower than our original budget.

I would estimate currently that our budget for '08 rather than being $1.7 billion, $1.8 billion is more like $1.6 billion, $1.7 billion.

A lot of that has to do with timing.

As we have pointed out when asked, we've not slowed down our expansion.

In fact, if anything, we're seeing a few more opportunities of late as some other retailers have dropped out of some sites as well as some large tracts of land where developers are trying to build new family units, new houses, 1500 house type tracts of land are flipping back to the banks and so we're starting to see some availability out there of things that actually I think will help us achieve a -- a decent number of openings next year as well.

And we don't see any slowdown there.

No giant ramp up either but that 30 type number.

Also want to mention our dividend.

In each of the last three or four year it is has been May when we increase it, so it was a year -- almost -- about nine months ago when we increased our quarterly dividend from $0.52 a year on an annual basis or $0.13 for the quarter to $0.58 or $0.145 per share per quarter.

This $0.58 per share annualized dividend, just based on the number of shares outstanding, it is a shade under $250 million a year.

Costco online, we started off the quarter being fine, but a little less fine than we were in Q1.

In Q1, as you'll recall, our dot.com sales were up 45% and we were running a good healthy number, but closer to 45 than zero, but nonetheless not the 45.

It must have picked up because when I looked at it yesterday for the quarter we're actually at 45 again.

So both for the quarter and the half and the first quarter we're at 45%.

Again, we should -- should exceed the 1.5 billion for the year.

And it is nice and profitable.

Next on the session list expansion.

In Q1 we opened six net new units.

We actually opened ten but as I mentioned earlier there were four relos, in Q2 seven, so a total of 13 net new units so far.

In Q3 we opened -- we plan to open eight units, including two relos, so six net.

As well we plan to open a new Mexico unit, which is not consolidated.

In Q4, which is a 16-week quarter, we plan to open nine net new units plus three relo's, so all told if we accomplish this it will be 37 new units, which include nine relos for a net of 28 net new units, 29 if you include the Mexico unit.

But, again in terms of consolidating numbers it looks like we're going to come in at 28 net new units for the year and importantly relocate nine units this year up from zero last year, so we're back on that four or five a year average.

Assuming -- recognize in '07 we added 30 units, which at the time was on a base, excluding camp Mexico, of 458, so it was about 6.5% unit growth.

In '08, adding the 28 units on a base of 488, it is about 6% unit growth, closer to 6.5% if you recognize that the relos are increased size units and new units we open tend to be higher than the Company average, closer to 150,000 compared to an average of a shade over 140.

Again, several of you called back to ask about total square footage at the end of the quarter, and this excludes Mexico, and again at the end of the quarter we would have 531 less 30 so 501 consolidated units, in that number.

We had 70.704 million square feet of warehouse clubs.

Lastly, stock repurchases, since June of '05 we've now bought back $4.254 billion as of Q2 end or 80.4 million shares at an average price of $52.93.

We still have repurchase, existing repurchase authorization of about $1.5 billion as our total authorization over the last few years is $5.8 billion.

And again the $5.8 billion compares to the little over $4.2 billion that we've bought back so far.

We continue to buyback on a regular basis as stocks go up, as our stocks goes up we buy a little less, as it goes down we buy a little more.

Certainly we had an unusual strength in our stock price in the first half of this year and in some of those instances we were -- we were purchasing under what's call a 10 B 51, where you set it up in place before you go into blackout.

And so there are actually a few days in Q1 where we didn't even -- or in Q2 where we didn't buyback stock and in Q1.

Our stock purchases since Q2 end have continued.

As the price has come down slightly we've increased slightly our amount, but overall if you take for the first 24 weeks on an annualized purchase we're a shade under $900 million.

Actually, if you take the last few weeks we're a shade over $1 billion.

But, again, if I had a crystal ball it is trending for the fiscal year a little bit at or slightly above the $1 billion is my guess compared to $2 billion last year.

Finally before I turn it back for questions and answers, some direction for Q3 '08 and Q -- and fiscal '08 overall.

For Q3 First Call, I believe, is at $0.65.

You've heard this before, we feel that's an okay number, perhaps the high end of a small range.

That would, of course, compare to a normalized number last year of $0.56.

So that would be a -- a nice increase if we can get there.

We'll have to see.

For the year, First Call is at $2.99, which of course implies $1.01 for the quarter First Call.

Again, we feel comfortable currently at that number at the high end of a small range.

And you want to be cautious given what is going on in the economy, although again as I've tried to share with you during the course of the conversation, there are some things that have been pretty good.

Despite slightly weaker sales this month -- this quarter, we -- we felt we did pretty well on our -- our bottom-line.

We still feel pretty good about our margin initiatives.

We're starting the quarter off at least with a couple of decent sales weeks.

But it is only two weeks out of 12, so we'll see.

And there's a little bit more availability of branded merchandise.

But there's that terribly thing called the economy out there too, so we will have to see.

Lastly, supplemental information will be posted on our investor relations site later this morning.

I know it is done, so we'll try to get that out there quickly.

And with that I will open it up for Q&A and turn it back over to you, Kela.

(OPERATOR INSTR4UCTIONS) The first question comes from the line of Deborah Weinswig.

Good morning.

Richard if you think about new club openings for '08 and what you've done already, can you talk about what percent will be back fills and what percent will be new market and also should we expect cannibalization for the rest of the year to be what we've seen in the first two quarters.

I think there's more of the same in terms of infills, we're probably there, we're certainly north of 75 -- in terms of infills, existing markets were north of 75%.

Not all of those are technically infills.

But I would say it's more of the same there, again, at -- even though Q-- the most recent quarter had a disproportionate number of locations open in Canada, I think we timed it that way so in the dead of winter we can go up there once and hit three openings in one week and -- and it just -- again timing of when construction starts, that -- we were -- we were afforded that opportunity.

I would say maybe a slight increase in existing versus new, recognizing some things that were new are not new anymore.

You know, Chicago is not new.

Atlanta is not new.

And Texas is not new.

So -- not Texas or Chicago might be a little harder than L.A.

because we're so strong in L.A.

But nonetheless we're getting off to better starts there.

Okay.

In terms of private label, can you talk about some of the trends that you are seeing there, maybe specific categories and also what penetration level are you at currently?

I -- we have to update.

I think we're about a 17% on private label, 16% to 17%, maybe a shade higher.

It continues to grow.

The biggest categories tend to be on the, what I call the supermarket or -- and drugstore side.

It is health and beauty aids, it is canned goods, it is bottled goods, it is paper goods.

And the other standouts, of course, would be in areas like apparel.

Some of the private label might be in areas -- may not have [current] signature on it but some of the like leather coats or whatever.

I'm trying to think.

Are there any other things, guys, on the private label side?

I would say more of it is on the supermarket side then on the non-food side, but that is nothing new.

We still feel co-branding is more prevalent.

We're probably -- and that is part of what I would call the private label.

We've been doing several co-branded items with -- for Martha Stewart to Quaker Oats to the Quaker Company, to Jelly Belly, I mean some of the more exciting items out there.

Okay.

And then can you also -- you talked a little bit about Mexico.

But can you also give us some more color on the performance of your international markets?

International is doing well.

Overall if anything UK was a little bit anemic for the last couple of years and it has finally started to show a little life.

It is not -- I would not call it a growth Company yet but it is growing and profitable.

Probably the three standouts are Asia, Korea, Taiwan and Japan.

Korea and Taiwan are nuts.

We opened a unit in Korea and a unit in Japan three or four weeks ago.

As I mentioned we have about 56,000 paid members per warehouse and that means our whole Company exclusive of Mexico, where the average warehouse does 130 plus million and the average warehouse probably has it as 15 to 18 years old I guess.

And usually in any opening for the six to ten weeks prior to opening we'll have a tent outside and people can come by and sign up in advance so they do not have to wait online.

We opened that location in Korea with almost 56,000 members.

It had a five in front of it, paid members.

Now recognizing you are talking about cities with 20 million people where there's four or five locations.

We've had -- this is more anecdotal than anything that can you invest in but at our budget meeting earlier -- late -- last week Mike, who runs our Canada operations, was over and was talking about their -- I'm sorry, Japan.

What did I say?

Canada, I'm sorry.

Japan operation.

There is a show in Japan that is a national TV show, quite popular, that is similar to a show here called something -- "Clear eye for the straight guy" or something.

And anyway over there it's translated it is called girlie man.

I'm not joking.

And apparently they filmed at Costco because they love shopping at Costco, these two people, and over there it was on national TV at prime time.

And it was their most highest rated show in the few years they've been on national TV.

And we got a big pickup from it.

So we'll take anything out there, guys.

But I would say our standouts are Asia, UK is coming back a little bit.

And Canada has, frankly, over the last year in local currency has come back a little bit.

It had been a little bit anemic for the last couple of years and then last year it has been in local currency low to mid-single digits, which is just fine.

All right, Richard.

Thanks so much for the color.

I really appreciate it.

The next question comes from Chuck Grom.

Thanks, good morning, Richard.

Any sense for why you think sales improved in the back half of February and was this driven from both the U.S.

and international, or one or the other?

Well, again, I did point out we had a mailer, what we call a multi-vendor mailer, but that was, again, that was more of a week off in timing.

For the two weeks the impact was in both -- both years.

In looking at, let's see here.

Total international -- if anything, international -- the last two weeks in international, in U.S.

dollar, was on average a little better than the first two weeks but not as extreme.

I mean, it was like mid-teens versus high teens.

Okay.

So the strength was more U.S.-driven.

Yes.

Okay.

And then when -- when you look at the four merchandise categories, I believe in the first quarter the upside was -- ranged anywhere between 22 to, I believe, 69 basis points.

In this quarter I think you said slightly higher to 79 basis points.

Can you give us a little more color on the changes there?

Are they sequentially the same within the buckets or is one moving higher and one moving lower?

The changes aren't that big.

I would say -- I don't have last year in front of me but I would say hard-lines has shown the most improvement in both Q1 and Q2, maybe even a little more in Q2.

A lot of that has to do with that well-known category towards -- called consumer electronics.

I know that in -- when I look at just that one department, which is all of 6% of our total sales, so whatever, 20-plus percent of hard-line sales, if I look in Q1 '05 to '06 and '06 to '07, we were down 100, 200 basis points year-over-year and in '08 Q1 we were up 1.5 percentage points.

Similarly in Q2 '05 '06 and '06 '07, we were down on average about 150 basis points in this quarter and we're up 200 plus basis points.

So, again, I think that has to do with the fact that not only the reserve, a small improvement from the returns reserve but more importantly less things being returned and that helps you a little bit.

Yes.

And again the basic supermarket category is overall strong.

Fresh foods, I don't -- again, without having it in front of me it fluctuates, one quarter the meats are up a little bit, the next quarter they are down a little bit, again year-over-year, still strong.

One quarter produce is fine and the next year blueberries and grapes were late and fewer and so that impacted you.

It is a little stranger.

Okay.

And then just one last one, the core was up roughly 40 in the fourth quarter and in the first quarter and this quarter it looks up like 29.

Some speculation out there that -- that Jim's backing away from wanting to earn a little bit more.

Could you comment on this?

It doesn't appear to be the case but wanted you to at least address it.

Yes, it is not the case.

As I've said, again, what probably spooked me the most was when I saw Q1 myself.

And -- I'm sorry, Q4.

Like, how am I going to temper everybody's enthusiasm, because nothing will be linear.

My sense, and it is a guess, is that -- well, first of all it is not a guess.

We feel comfortable that things are continuing as they have been.

It is going to fluctuate.

It is not linear.

As I said to many people over the last couple of months, whatever X is on average there will be times when it is X plus ten and there will be times when it is X minus ten and when it is X plus ten I'll try to keep you from extrapolating it outward and when it is X minus ten the concern will be, oh, no, it is over.

And that is not the case.

We still have some opportunities.

The other question that I hear of late is what happens when we cycle Q4 and with that it will be a tough comparison.

Yes, it will be.

I -- I don't know what it will be.

I still think that, again, this is not like we took all of our gun powder and said let's try to do everything at once.

Some of this stuff is seasonal.

It changes every year.

Again, I think getting back to Jim's comments historically is is we are a great Company and deserve to make more money.

We're not going to do it if it impacts us competitively but we are -- we think that we are smart enough to finally figure it out.

It took a few times and so I don't see any big changes at this point, other than it will fluctuate.

Great.

Thanks very much.

The next question comes from from Bob Drbul.

Hi, this is Hillary Morrison calling for Bob.

I was hoping you could give us a little more detail on the makeup of your membership revenues, including renewals and sign-ups between new stores and mature stores.

I really -- I don't have that in front of me.

We historically haven't given that out.

What I personally look at the most is the renewal rate after one year.

Keep in mind, even on a -- every month in our budget meeting when Paul Latham, who is our VP of Membership and Marketing, gets up and presents numbers one month new Gold Star sign-ups might be a little weaker than planned, a little weaker than it had been running.

The next month business sign-ups might be weaker.

And then when you look into it it is because the limited amount of what I'll call marketing budget that each warehouse has, these are the employees that go out and canvass small businesses, go to bigger businesses to try to get a large employee group to do an event or get them to sign up.

And -- but there are several weeks a year where with our relationship with American Express, for example, you will see tabling activities for the American Express co-branded card.

Well, again that is not additive, that is substituting.

And, sure enough, we are somewhat reactive.

We're -- when something shows a little weakness, we put a little more effort in and the next month it is fine.

But overall I think the renewal rate has been a good indication that things are fine at this point.

Great.

And also how much of the increase in average ticket would you attribute to inflation?

Like, where were you able to pass increased commodity costs on to the consumer?

Well, it is a little hard to say.

Recognize, surely gas inflation it is easy, you see it.

Certainly (inaudible), is easy, you see it.

Those are big chunks.

I would argue that as we increase penetration of private label there's number -- many examples, the one that comes to mind was a few years back it was a 24, 30 pack of Gatorade we sold for, I think, $15.99.

Overnight enter a competing product, (inaudible) power drink, right next door, same bottle, same colors, different manufacturer, same number of ounces, same packaging, you name it, and at $9.99.

Almost overnight half the unit sales went to ourselves.

More importantly or as importantly over the next few months the price point that we sold Gatorade went from $15.99 to $14.99.

Now this is about three years old, this example.

But there is an extreme example of where huge deflation out of the yield seasoned LIFO and you really don't -- and by the way increase in gross margin dollars but nonetheless you see that deflation.

So my guess is while there certainly is more inflationary procurement costs and that is increasing, my guess is there is an offset to that that is kind of hard to measure.

The -- clearly just last month -- just three or four weeks ago two of the largest consumer product companies out there on -- on -- on certain paper goods, again, didn't say, hey, we'd like to talk to you.

They've been doing that for two or three years with small increases occasionally.

They basic came out with on a variety of items, not every item but a variety of items 4% to 6% increases effective between last month and the next couple of months.

And, as you would expect, we will, like many retailers, we'll try to buy in where we can.

But there is a limit to how much you can do that to at least maintain the price for a couple of extra weeks and be competitive.

But at the end of the day we and others will fight those battles, we and other retailers.

Ultimately some of that has to be passed on but we'll have to see.

Great.

Thanks so much.

The next question comes from Gregory Melich.

Hi, thanks.

I guess following up on that inflation, just to put some numbers on it.

Obviously there is the private label mix that really does impact and bring deflation effectively but if you were to look at the like for like brand of products can you come up with a number, is it 1%, 2%, 3% that you are seeing blended?

I really can't.

I mean, when you look at list of 100 different things, there is a 1% and a 13%.

There is a lot more 2 to 5s.

But even on the 2 to 5s there's -- there's items that are missing, that aren't -- that aren't being included.

Right.

And -- and I think there's one little added benefit, I don't know how important it is to us, but that we have versus, let's say, the Safeways and the Albertsons of the world or even the Targets and Wal-Marts is that we don't have to carry every size and every brand.

And if -- if one manufacturer, whether it is paper goods or toothpaste or cans of peas wants to try to push through an increase, we're still going to be opportunistic.

And if the other brand out there is holding their price a little longer, all our purchases are going that way for the next month.

And I think that probably helps us a little.

In the long term, it is happening.

I mean, it is in the just here.

You see it out there.

And as we all pay twice as much for gas then we did a couple of years ago, it costs as much to run those facilities and to manufacture those goods.

Sure.

And on the ones where it is, it is what it is, right?

Let's say a basic paper towel or something, on that -- on that sort of stuff, is the -- is the objective ultimately to pass through the gross margin dollars and -- and let the rate fall?

I would say yes, if not a shade better.

Some of it has to do the price points.

Let's face it, as much we're not a retailer in some things we do, we are a retailer.

What happens sometimes, if it is a calculated percentage, is, I'm making this up, is $14.12, rest assured we're not going to be at $14.12 or $14.19, we're going to be at $13.99.Similarly if something calculates out to $13.83 it could very well be it is going to be $13.89 or $13.99.

My guess is those fall both ways.

I would say historically I would say it was more true that the dollars would stay the same and the percentage would fall.

I -- given our margin initiatives, probably there's a little less pressure to do that.

But I'm not suggesting or trying to be cute that it is definitely the same margin percentage.

I -- I don't know if I -- we know yet.

Okay.

Fair enough.

And a last thing on that, you mention at LIFO there is nothing yet because you've got the reserve but that what's -- with what's going on next year that could change.

How big is the reserve or can you give us any more insight on that?

I -- it's -- it's not -- it's bigger than a bread box.

I've got my people here going, no, we don't talk about that.

And I'm not trying to be cute.

It's -- it's a number that you would have to have more than 3% or 4% average -- more than a couple percent average inflation.

Okay.

But that you might work through that into -- the way that you see trends now you could work into that by middle of next year?

Was that what you were trying to say before?

That's a guess, sure, but it's hard to say.

What I'm really saying is I don't think it's this year and whether it is next year or the year after, depends what happens out there.

Great, thanks.

And by the way, the girlie man comment got the laugh out loud here so thanks for that.

No problem.

We got a laugh at our budget meeting too, when I anxiously look at seeing who is going to bring the video to the next budget meeting.

The next question comes from Peter Benedict.

Hi, Richard.

Was hoping you could update us maybe on your latest thoughts on the membership fee structure now that you guys are coming close to cycling through the positive impact of the -- of the increase you did back on the gold star members in '06.

How should we be thinking about the outlook for that fee income growth line in second half and also any updated thoughts on how do you see that $100 executive fee trending over the next couple of years?

Thanks.

Well, first of all, there's no -- there's nothing on a -- on anything I've seen on anybody's agenda here to discuss it right now.

I think particularly given the -- certainly when we, as you know, when we did the $5 increase on basic memberships a little over two years ago now or about two years ago we kept the $100 executive intact in part because in theory that took 3 million -- about 2.5 million members based on their prior 12 months of purchases above the breakeven and so some portion of those might be incented to convert to executive.

I -- I would say at the time we did that, at some point we recognized that that 100 may change.

Given the economy and given -- I think we don't want to lose sight of the fact that we don't want to be arrogant or not appreciative of -- of what we're doing there.

So I don't see any real change in the next couple of -- in the next year, for sure, beyond that who knows?

And as it relates to the $5 increase on Gold Star, history has shown that we do that every four to five years.

One of the dictates there is California where over a third of our U.S.

membership is.

And they have some new rules that a membership fee is not sales taxable unless it relates to two-tiered pricing or is deemed de minimus.

They define de minimus currently at 50.

Up until two years ago for the prior five years they defined de minimus as 45 and five years before that 40.

So you get my drift.

My guess is is that recalibration, if and when it happen, is on a five year tranche in the state.

So again, the economy, certainly I think, dictates right now nothing but we historically haven't done anything other than every four, five years there and on the executive I don't see anything in the next year.

There's no discussions going on.

That's is helpful.

Then just your thoughts on kind of how the membership, the income growth would trend maybe in the back half of the year.

I know it has been decelerating, should that continue, does it level off at some point?

Well, I -- a little bit has to do with opening schedule.

I think we're opening a few more in the second half than the -- a couple more in the second half than in the first half, that helps a little.

I think the fact that we've cycled through the whole 23 months now, including deferred accounting, for the $5 increase.

Used to be before we had executive membership and when we did about every five years a $5 increase, you'd see a spike for a couple of years, a spike during those first 23 months because of deferred accounting, and then over the next few years it decelerate as a percent of sales a little bit each year, implying that on that same fixed fee that each customer is buying more.

I don't see any difference in that trend.

Maybe there's a little tempering or offset of that, that's the conversion the -- frankly I'm surprised we keep getting $10,000, $20,000 -- 15,000, 20,000 new member -- new gold -- new executive members, which many are conversions, every week.

We've had it out there for six years.

So I view that as a -- that will offset it.

But I think in fairness it's probably, given those two things, it's close to flat this year and probably down slightly as a few basis points next year.

But we haven't looked at next year yet.

Okay.

Thanks so much.

The next question comes from Christine Augustine.

Oh, thanks.

You mentioned during the call that there was a greater availability of brands and Sears has recently announced a restructuring where they are going have effectively brand managers and they will look for ways to maximize some of their top brands like Kenmore and Craftsman.

So I'm wondering if you all would be interested in carrying those brands through Costco.

Have you explored that idea at all?

Have you had any talks with Sears?

I -- I'm not sure what talks or lack of talks have been had.

Personally I love those brands.

We have some good brands ourselves in a couple of those categories.

I assume -- I really don't know what we've done or if there has been any conversation of us calling them or them calling us.

To the extent -- our phone is always open.

We'll see but I don't know.

Thank you.

The next question comes from [Jeff Farenkowski].

Good afternoon, everyone.

Richard, if you are looking at the club mix between traffic and ticket, what evidence do you see that you're -- you're picking up customers trading into the club or devoting a bigger percentage of their wallet to shopping at Costco because of the economy or whatever they're seeing out there?

You know, Chuck, as you've known us well, we don't have a lot of statisticians sitting around here.

We -- you look at our comp number, the fact, relative to other retail, I think that we've shown that we're picking up a little bit.

Our frequency is, covering is, as I've said many times over the last ten years and 120 monthly sales reports or however many years we've been doing it, when we -- whether the comp was a 11 or a 5, reported comp, within that -- the product of transaction and frequency, frequency was never, if ever -- rarely if ever below minus one and rarely if ever above plus two.

Frankly, as we've seen some relative weakness in comps as compared to history over the last six months, it's the first time that I've seen some 2.5s positive.

So I don't know if -- and arguing against that is the fact that gas costs more and people would try to shop, try to make fewer, bigger shops.

So I'd like to think that there's some positives out there.

We certainly, unlike that one TV show in Japan, we certainly are still getting positive impact from, I think, on a little basis, when the consumer advocate on a local news station talks about where is the best place to buy pharmacy or gas.

Just two weeks ago there was, I understand, a 30-minute episode of an evening magazine type show called "Eye on the Bay" in the Bay Area, which as I understand is going to show one more time this month how cool it is and how fun it is to shop at Costco and how do they do it?

And it's a -- as you know, we don't have a PR department.

So I think -- I think it's positive.

The numbers indicate it -- it's -- the comps are better than others.

And so we're encouraged by that.

But I can't tell you a whole lot more.

Well, that's helpful.

Thank you.

The next question comes from Neil Currie.

Yes, good morning.

Thanks for taking the questions.

I wonder if you could just give us a flavor as to what is going on in consumer electronics between pricing and volumes in your stores compared to the trend of the last year.

Well the big item is -- is flat screens.

The big issue there is if you look back, not only a year ago but two years ago, and I'm, again, I'm -- these are broad brush stroke numbers, but it seemed like units were up 20% to 40% and dollars were up 20%, or your units were up 30% to 40% and dollars were up 15% to 20%.

And a lot of that had to do with while the average price point was coming down it wasn't coming down as fast here because people were still trading up.

Maybe a given TV was coming down in price, but people would be going from the 37s to the 42s, or the 42s to the 50.

The prices continued to drop.

I think if you look at it in recent months, your units are up a small amount, dollars are flat to even down some given the week and overall I would guess it is close to flat over the last several months in dollars and -- but units -- but units aren't plus 30 or 40 anymore but they're still plus.

I don't know if that's the fact that everybody has three TV's now and six cameras or it is the economy.

By guess is it is a little of both.

Okay.

And in terms of the health of the Gold Star member versus the business member, what have you seen in the past quarter that makes you -- makes you think about the health of those two sets of customers and what's your outlook if we -- if the economy continues to be weak?

Well, you know, our -- our comps still, even net of inflation and FX are positive.

Our frequency is up at the higher end of that small range of late.

Those are positives.

Again, when I look at the percent of business done by business member versus Gold Star member, this year, last year it is essentially flat, a slight improvement in the mix to the business member, but again, less than -- less than a half a percent delta.

So again I think -- and, again, I don't want to overemphasize, but I think that the -- the positive press we get out there helps -- helps that as well.

So you read ten weeks or so ago in the "New York Times" food section about where the elite and the beltway shop for food.

And it was talking about all the power people in Washington, D.C., that they are all going to Pentagon City Costco to get their food for their fancy dinner parties and that week I understand it was the most hit article on NewYorkTimes.com site, despite everything else going on in the world.

Any part of that is an affirmation that one member sees it, they send it to their friends and saying, see, isn't this cool?

That stuff helps.

Look, I'm cautiously optimistic and very naive, but I hope the economy doesn't die and -- and I -- all I can feel most confident about is is whatever is happening out there in retail, we'll tend to do a little better than that.

And what would your experience be in past slowdowns or recession you might actually get a boost to begin with.

It is really hard to know because the last real recession, if I have my facts right, was in the early '90s.

And, gosh, in the early '90s that was two years before Costco and Price Club merged and I know on the Costco side we were running regularly 10% to 15% comps.

So if we went from a 15 to a 12, was that the recession?

I don't know.

So we really don't have a lot of good data on that.

Okay.

Well, thanks a lot anyway.

Why don't I take two last calls.

The next question comes from Dan Binder.

Good morning.

A couple of questions for you.

Two merchandise questions and then the first question is on AMEX, which is more the financial question.

What are you seeing in terms of your AMEX cardholder spend versus the rest of your transactions and then on the merchandise side you talked about the greater available of brands, I think you mentioned Crocs, I was curious is that now a direct buy or is that coming out of the grey markets?

And then the second merchandise question was on office supplies, you indicated, I think, that that category was down, I was just curious what that looks like as a -- in the overall mix.

Okay.

Let me answer the first question and I will ask you to tell me the second question again.

In terms of AMEX, here I've got a sheet here, if I look at AMEX year-over-year -- .

First of all, AMEX is higher than the average individual.

AMEX with the executive is the highest.

And if I looked year-over-year for the first six -- for the first 24 weeks, as an example, the average ticket and cash is exactly the same year-over-year.

The average debit transaction is up $1.00.

The average check is up $2.00 and the average AMEX is the same.

All those numbers are like one or two percentage points -- zero or to 2 percentage points, so I would say it is essentially the same year-over-year.

We certainly have more sales to AMEX through the AMEX tender.

That's up from 30 -- in the U.S.

35% to 30% -- from about 34.5% to 36.5% of our sales penetration.

That's the trend.

That's because there's more people with the co-branded card.

As you may have seen on our gas pumps, if you use the co-branded card you get a extra 3 -- on top of anything else you get an extra 3% off on your gas purchase

Okay.

And then on the -- on the brands, you mentioned Crocs, I was just curious is that now a direct relationship or --

We -- we -- we try not to say.

Some are direct, some are diverted and some are indirect.

And we -- we don't discuss what's direct and not recognizing some manufacturers would prefer us not to.

I'm not suggesting we are or not with them, I just -- all I'm suggesting is that there's more available of stuff out there.

And then on office supplies, is that -- how does that look in the overall mix?

I think you said the comps were down there.

Yes.

Now keep in mind what I call office supplies excludes PC's and printers and monitors.

Office supply, this is pencils and -- and scotch tape and pendaflex folders and some furniture, some of your desk chairs and stuff.

Overall it is down slightly.

I do not have the number in front of me.

Is that sort of like a low single-digit number in the mix overall?

Hold on.

Everybody is looking.

Hold on.

Well, actual for the quarter it was down slightly, for February it was up 5.

So when I was talking earlier I was talking about the quarter.

So, again, my guess, it fluctuates a little bit.

But for the quarter I think it was down slightly.

Okay?

Okay.

Thanks.

Your last question comes from Wayne Archambo.

Thank you, BlackRock.

Could you talk about the competitive environment, specifically in the northeast as you overlap with BJ's.

It seems like they've rationalized the SKU's and since Zarkin's come in a year or two ago they seem to be performing much better.

Are you seeing much more competitive environment with them?

Yes.

I think in fairness there was -- it recognized we really compete with -- we only compete with them, of course, on the east coast essentially, where -- where we overlap.

In fairness, I think, for three or four years there up until a year ago I -- I wasn't -- I'm not so sure how often we even competitively shopped them anymore on a regular basis because it had gotten out of hand.

And we were so -- so much under on a lot of items.

They are -- they are tougher now.

It is still on a relative basis not as extreme as Sam's and we really, again, think it's a little bit of a different customer.

On a macro basis if they are closer it is an impact but, again, we do monitor them more closely now as we used to for many years and I think there's plenty to go around.

Great.

Thanks, Richard.

Yes.

Oh -- oh, one last comment though that Bob mentioned, as you look at our comps, even from the last month or two, in the northeast relatively speaking northeast has picked up a little.

I don't know why.

And I'm not suggesting it is BJ's but -- so we're doing fine against them.

Do you think you are taking share away from grocery perhaps?

Yes, I think we take share away a lot from a little.

Clearly, if you look at our merchandise mix, 60% of it is what I'll call supermarket and drugstore and health and beauty aids and paper goods and food and the whole bit, which includes also the institutional side of that business.

In addition to a three-pack of -- of cling wrap we'll have a thousand foot roll of it for the deli.

But, yes, certainly I think over the years a big chunk of that business has come out of -- out of the supermarket with lesser pieces from everybody else.

Thanks.

Any closing remarks?

No.

Well, thank you.

We're -- Bob and Jeff and I are around today.

So thank you for my long-winded explanation of things and we'll speak to you soon.

Thank you.

This concludes today's conference.

You may now disconnect.