好市多 (COST) 2009 Q1 法說會逐字稿

Good morning.

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

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

(OPERATOR INSTRUCTIONS)

I would now like to introduce Richard Galanti, Chief Financial Officer.

Sir, please go ahead.

Thank you, Rachel.

Good morning.

This morning's press release reviews our first quarter fiscal 2009 operating results for the 12 weeks which ended November 23.

As with that recall, let me start by stating that the discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and that these statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements.

The risks and uncertainties include, but are not limited to, those outlined in today's call, as well as other risks identified from time to time in the Company's public statements and reports filed with the SEC.

So to begin with, our 12-week first quarter.

For the quarter we came in at a reported $0.60 a share.

This compares to our October 8 conference call guidance range of $0.61 to $0.65.

First call at the time, as you recall, was at $0.64.

Most recently, it has been at $0.61 and then yesterday jumped to $0.62 as a couple of the data points in there had raised their estimates over the last day or two.

So essentially coming down, I think, I believe as analyst are responding to the slightly weaker sales trends in October and November as compared to September.

Last year's first quarter, of course, we came in at $0.59 a share.

As outlined in this morning's release, this year's first quarter results included several items, some healthy and other hurting -- others hurting our results for the quarter.

These include very strong gas profits this year in the first quarter.

Two charges to our P&L related to what's going on, I view, in the stock market and the credit markets, together representing a $34.2 million pretax, or $0.05 a share charge first quarter earnings.

Next item that I will term foreign exchange head winds as I had mentioned on the last conference call.

Our forward earnings results when converted and reported in US dollars essentially hit us in the first quarter by an estimated $0.03 a share.

That is assuming FX exchange rates were flat year-over-year, our foreign operating results, which is about 20% of our Company, would have been pretax $22.7 million or $0.03 a share higher.

We would expect that, assuming currencies stayed the same for the year, of course you're going to see that all year.

Additionally, the trend during the quarter of weaker comps are mostly on the non-food side of our business.

Needless to say, that hit earnings as well as the trend line from September to October to November was slightly down each quarter, the underlying comps.

And with those weaker sales results, I might add those were despite more aggressive pricing, conscious effort on our part, to drive sales during the quarter.

We estimate that to be a penny or two.

Also, while our inventories are clean and we believe well-managed during the quarter, some seasonal markdowns to keep them clean, I talked to our head of non-food merchandising and he estimated that somewhere less than a penny a share but, nonetheless, several million dollars of markdowns to get out of some of the seasonal stuff early.

LIFO was actually a small pickup.

I believe on the fourth quarter conference call back on October 8, we had estimated, and of course then it was before gas plummeted and the economy changed a little bit and we started to see an exact opposite of inflationary trends, we did get a pickup of $2 million in the quarter of LIFO income, LIFO credit, if you will.

I believe at last call we indicated that that could be about a penny a share hit.

That was a positive for the quarter.

And lastly, as it relates to our first quarter earnings performance, one of the other things that jumped out at us was health care costs.

Particularly during the month of October and into early November, and in talking to our third party administrators of the plan, they said they have seen this a lot of places around the country and putting two and two together myself, it's almost in sync with the stock market decline that we saw health care costs go up dramatically above and beyond what you see at the end of the calendar year anyway when people have just -- they have already hit their deductibles and they want to make sure they get their free eye exam in or their teeth cleaning.

In terms of sales for the quarter, as -- well, first of all, if you just add up the things I just outlined, the negative slightly outweigh the positives, but not by much.

In terms of sales for the quarter, as previously reported, total sales were up 4% and our 12-week comparable sales figure showed an increase of up 1%.

For the quarter, both total sales and comp sales were significantly impacted by the strengthening dollar.

The 4% total sales number includes a hit, if you will, of about 3.25% due to FX such that the four total sales increase and the 1% comp reported figures essentially would have been 7 and 4 without the FX impact.

By the way, gas inflation, or deflation now, gas inflation helped September sales pretty dramatically, was essentially a non-issue in October as prices were falling, and as they continue to fall, gas deflation hurt November sales, so essentially a non-factor for all of the quarter but certainly a big change in factor from where we entered this fiscal year and where we ended this quarter in terms of how that impacts sales.

Other topics of interest I will review with you are opening activities and plans.

We opened a total of eight new locations in the first quarter, seven net in the sense that we closed original Las Vegas location.

It will reopen in the first quarter as a Costco business center, but that is currently closed.

Net increase of 7 during the quarter.

We'll see that Vegas go back into the equation in Q3.

Of the eight new locations, six were in the US, one was in Canada and one in the UK.

As of quarter end, we operated 550 locations around the world which includes, of course, the 31 in Mexico that we currently do not consolidate into our figures.

Also this morning, I'll review with you our ancillary business results, which seem to be pretty good.

Online results which, as you might expect, have weakened along with big ticket electronic items and the like, and membership trends which remain pretty strong.

I'll also explain these two charges that totaled the $34 million.

The bigger piece going to SG&A and the smaller piece going to interest income, reduction in interest income, I'll mention that.

I'll go through the preliminary balance sheet, give you a few comments on the directional change of inflation to deflation and how that impacted LIFO.

I'll make a brief comment on Mexico operations and our partner, Commercial, you've seen that in the news with the issues that our partner down there has had.

Lastly, what I would call limited guidance.

I'm going to be conservative and perhaps a little more vague given it is so hard to predict given all the head winds and the tail winds out there.

Okay, to the discussion of our quarterly results, sales for this year, as I mentioned, were $16.0 billion, up 4% from last year's $15.5 billion.

Again, on a reported comp basis, up 1%, add 3 percentage points to each of those numbers to get to -- to account for the FX if you wanted to look at it in local currency the sales increases.

In terms of the 1% reported first quarter comp, it was comprised of a 7% number, reported 7% figure in September, a minus 1 in October for the Company, and a minus 5 in November.

Again, since monthly figures greatly impacted by both FX and by gasoline price changes.

If you just added up the two that Bob Nelson talks about each month in the monthly sales call recording, the sum of those two things in September was a positive 130 basis points.

In October, minus 400 basis points, and in November, minus 760 basis points.

So almost a 9 percentage point swing in just eight to ten weeks.

So quite a bit of swing in those things, which just makes it a little more difficult to understand the numbers, but that's what they are.

1% recorded comp, international comps and local currency, as you saw expressed in US dollars, our international comps for the quarter were minus 7%.

It was actually plus 7% in local currency and I might add that they were even stronger as the quarter progressed.

They are all positive in local currencies in November, both in November and the quarter and in the past couple of weeks.

As I briefly mentioned, gas -- which is, by the way, not the case as I've mentioned to you already in the US.

As I briefly mentioned, gasoline had no impact on -- essentially no impact on Q1 comps as price inflation, relative price inflation year-over-year during the first month, month and a half was offset essentially by price deflation relative to the year-over-year for the last six weeks of the quarter.

The average transaction decrease -- to get to our 1% reported comp, just in terms of simple math, it's an average transaction decrease of 1.5% for the quarter.

Again, you would have to add the 3 percentage points of FX in there to get to kind of an underlying local currency transaction increase of 1.5 to 2.

And average frequency increase of just a shade under 3%.

So frequency has continued strong in the high 2s and low 3s for many months in a row now.

The terms of cannibalization, small impact of about half a percent in the fiscal quarter.

In terms of sales comparisons by geographic region, if you look at the comps as compared to back in the summer, again, they strengthened a little bit in September, were a little weaker in October and still a little more weak in November.

Again, I'm taking out FX, I'm taking out gas inflation and deflation.

Trend-wise, northwest has weakened a little more than average, although it has been the stalwart holding up a little more than average for a long time here.

California has been pretty much proportional to the overall US, still lower but the gap between California's comps and the rest of US not widening.

Holding up the best has been the northeast.

Internationally, all of Asia is doing great and local currencies in the mid teens are better with Canada in the mid singles.

In terms of merchandise categories for the quarter, within food and sundries, which is about half our business, high singles.

Again, I'm adjusting the detriment of FX out of there.

Tobacco continues to be mid-singles negative.

Otherwise, most -- virtually all sub categories were up year-over-year with dry groceries, canned goods and what have you being the strongest comp in the mid teens.

Just looking through the list I was surprised to see given all the craziness out out there that alcohol was flat, beer, wine and spirits.

Within hardlines comp, which has been in the mid to high single negative digits, nothing very thrilling.

Generally, everything is low single digit negative to as much as 20% minus comp in the hard lines.

The one bright point has been electronics, while still is an overall low negative comp, our television sales have been way up in November.

I'm not sure if Bob mentioned this on his recording, but we had unit sales up over 50% in the four weeks, but that translated into a dollar sales increase of only 3%.

If you go onto Costco.com, you can see that we're selling two packs of flat screen televisions for less than $1500 for the both of them.

And so we've seen a lot of -- we've been -- notwithstanding what's going on in the economy and with big ticket items, we have taken advantage and been opportunistic and going to vendors that have been stuck with inventory when other cancellations have occurred elsewhere and taking advantage of that.

Within the soft lines comp, again, in the mid to high single digits negative, kind of a repeat of hard lines.

Nothing thrilling.

Generally everything is in the minus 5 to minus 20% or 25% comp range.

Probably the one standout, again slightly negative, ever so slightly negative, but still standout relative to the other subcategories is apparel.

Again, I think it has to do with the fact of availability of branded items in that category.

Fresh foods, light food and sundries, positive, darn near close to positive double digits.

Produce is a standout in the double digits with all four of the subfresh fruits categories positive.

Clearly food is driving our business as it is others.

Moving down the line items in the income statement, we'll start with membership fees.

In dollars, we were up 6%, or $21 million, and as a percent of sales, up 5 basis points.

The 5 basis points seems stronger than the up 6%.

I think that again has to do partly with the FX issue.

If you had flat FX, our dollars would be up 9% to 10%.

Someone here asked earlier, we're talking about it now that it's positive.

I think part of that is the fact that the negative, as the dollar weakened over several years, it was always a small effective negative to us, but here in one fail swoop in a matter of six or eight weeks it's been a big change, so I felt I should mention that.

In terms of membership fees, strong renewal rates.

Still slight increased penetration of the executive membership.

Despite a weak economy and the apparent ramp up in membership marketing activities from the competition, our new member sign ups in Q1 were essentially flat year over year in the quarter, not withstanding the fact that we opened two fewer openings.

In terms of members at Q1 end, gold star, 20.5 million; primary business, 5.6 million; add-ons 3.4 for a total of 29.6.

That's up from 29.2 million at the end of the year 12 weeks ago.

Including spouse cards, 54.1 million cards in our system.

I would add about 2.8 million to that number to be actually at 57 million if you include Mexico.

At quarter end on November 23, paid executive membership topped 8 million, an increase of almost 400,000, or 5% just in the last 12 weeks or about 30,000 per week increase in the quarter.

So, again, it's still has been a big success for us in terms of converting members to that.

In terms of renewal rates, as I said, they continue strong, essentially our all-time high renewal rate.

Q1 '09 the numbers both business, gold star and total were the same as they were fiscal year end and rounding up a percentage point versus a year ago.

Business coming in at 92%.

Gold star at 86%, and total, a shade above 87.0%.

The -- continuing down the line.

Gross margins, year-over-year in the quarter they were up 32 basis points.

This is where we get on to drive you crazy a little bit with the explanations.

But basically coming in the a 10.97 year versus 10.65 last year.

As usual, we'll jot down a few numbers.

The line items will be core merchandising, the second line item ancillary businesses, the third line item, 2% reward, the fourth line item, LIFO, the fifth line item, other, and lastly, total, and then three columns.

All of fiscal '08, fourth quarter of '08, and then first quarter of '09 so we can see a trend here.

In terms of going across, merchandising core was plus 17 basis points for all of '08 compared to all of '07.

And Q4, on a Q4 over Q4 basis, minus 19 basis points and then in Q1 '09 versus Q1 '08 lower by 13 basis points, so minus 13 basis points.

Continuing across ancillary, minus 13, minus 6 and plus 46.

2% reward, minus 3, minus 2, minus 2.

LIFO, minus 5, minus 14, plus 1.

Other, minus 5 -- I'm sorry, plus 5, minus 4, and zero.

So the totals for all of '08 year-over-year were up 1 basis point, all of '08 versus all of '07.

In the fourth quarter '08 versus fourth quarter '07 we were down 45 basis points, and Q1 over Q1 we were up 32 basis points.

Now, as you look at that up 32, core merchandise business, which is again is a little over 80% of our business, food and sundries, hard lines, soft lines and fresh foods, it was -- we show here the core was down 13.

We still have the issue with gas and its penetration, notwithstanding the fact that its relative penetration, while still up a little bit, is not up nearly as up as it was Q4 over Q4 with the decline in gas prices of late.

Just looking with blinders on at just those four categories, based on those four categories margins and sales, Q1 was lower by 2 basis points.

I'll go through a couple comments on that in a minute.

But the aggregate was lower sales penetration of those categories made the minus 2 and minus 13 in our matrix.

Of the four major departments, fresh foods and soft lines were lower year-over-year.

Part of our conscious aggressive pricing was bringing down produce items to drive more business on the food side and bring people in.

With food and sundries and hard lines being higher year-over-year, I think the hard lines one would be a surprise to many given the weakness in some of those categories.

Again, I think we've improved in some categories like electronics.

Again, given non-food sales weakness and a few extra seasonal markdowns, not a bad showing at all in our view.

Our year-over-year gross margin in the retail gas business, as you might expect, was substantially up year-over-year.

In terms of outlook going forward, overall, margins are okay.

Keep in mind we will look for most to drive top line sales, which we have and may in the future, which have and may in the future still be a small hit to margins.

We're also, as you would expect us to be doing, is going back to vendors who are raising prices just several months ago to understand why they aren't coming down and we have been successful in that as well, as I would expect our competitors to be as well.

The impact from increasing executive membership, a very small hit, as you see, 2 basis points.

LIFO, given how we started out the fiscal quarter, again, I think on October 8 at our last quarterly conference call, we mentioned that we could take a charge in the quarter of perhaps a penny a share, $8 million to $10 million pretax.

Now, however, with the expectations for lower inflation, again we actually, looking at our LIFO pool calculations as of Q1 end, we did bring back a couple million dollars.

I should point out that the moderate LIFO benefit recorded in Q1 excluded the effect of significant gas deflation that occurred during the quarter.

That's because we're not -- remember, LIFO is not just looking at index quarter end.

It's trying to guesstimate what it's going to be year end and adjusting accordingly.

We're not sure which way gas prices are going and how low, whether they will go up or down, but we felt that looking at it mid year but, nonetheless, there's a decent LIFO credit that is still there, potentially there if gas prices remained low.

We will realize that in the future.

Now moving on to SG&A, our SG&A percentages, Q1 over Q1 was higher by 31 basis points, higher means bad, so it's a minus 31.

Coming in at 10.46 this year versus 10.15 last year.

Again, a very simple quick table helps to look at it better.

The line items are operations, central, stock compensation, quarterly adjustments, and total.

Going across the same three columns, fiscal '08, Q4 '08 and Q1 '09.

Operations was, in the first column would be a plus 5, meaning it was better year-over-year by 5 or lower by 5 basis points.

Q4 '08, plus 21.

Q1 '09, minus 16.

Central plus 3, plus 3, minus 3.

Stock compensation minus 2, minus 3, zero.

Quarterly adjustments plus 8, minus 6, minus 12.

For a total of plus 14, so all of '08 we were lower year-over-year by 14.

In Q4 '08, plus 15, or lower by 15.

And Q1 '09 minus 31 or higher by 31.

Now, operations was higher by [16] year-over-year.

Let's face it, this is all about sales levels and about 6 to 8 basis points related to that health care spike that I mentioned.

We've seen that subside, by the way, in the last couple of weeks, but we'll see what happens tomorrow.

Nothing really unusual -- in central, nothing really unusual in the dollars.

It's really the same story.

A little weaker sales and the challenge of leveraging or deleveraging that.

Our stock compensation expense was flat year-over-year as percentage.

It's really a slightly higher number of [RSUs] being granted to more managers and more people in the organization, but done (inaudible) at a lower price than a year ago, so the sum of those two essentially was a wash in terms of expenses as a percent of sales.

Overall, not a thrilling SG&A performance, but to be expected with sales weakness and of course lower gas prices.

I will mention lastly the minus 12 basis points of quarterly adjustments, the charge we described in this morning's press release that hit SG&A, of that $34 million that was in the press release, $28.4 million, or 18 basis points, minus 18 is in this minus 12.

We also have a pickup year-over-year of plus 6.

If you recall last year in Q1, we took a $9 million reserve for a give back to our employees last year in first quarter for health care, which we don't have a comparable number this year.

So looking at that, that's -- you got the minus 18 is really the nonrecurring amount of that.

And then of course the nonrecurring, the plus 60 offset to that.

Let me go over briefly these two charges.

Again, one which is the bigger of the two which relates to SG&A and the one that will impact interest income and other, but I'll go ahead and talk about both of them now.

Of the $34 million we talked about in the press release, the $28.4 million pretax charge related to the, essentially to the stock market's free fall and the mark-to-market impact on the cash value of life insurance policies covering just over 800 Costco members of management.

This was a charge to SG&A.

For 18 years, we have utilized split dollar insurance to provide for life insurance coverage for our warehouse managers and above.

Using this traditional insurance product as the cash surrender values and the underlying policies grew, that asset, if you will, which is on our books as a long-term asset has been invested in a diversified portfolio of both fixed income and equity type market funds.

It's always mark-to-market at the end of each quarter.

Historically, at least until this quarter, the plus or the minus to our quarterly P&L was generally zero to $2 million or $3 million, couple of outliners beyond that, but nothing huge.

And just part of SG&A, nothing really to talk about historically.

In Q1, the mark to market value of these policies went from a little over $90 million to $61.7 million, or a loss of $28.4.

That was a 32% decline in value.

I don't need to explain to you guys that we've got a diverse portfolio from fixed income to S&P 500 to small cap growth and we all know what happened in October.

I can tell you that as of the beginning of the quarter, the portfolio was about just under 30% in what I would call non-equity-type funds, fixed income and the like.

It's now about 60%, including about incremental 30% in money market funds and just to be out of that craziness and go forth with running our business.

So I would hope and expect that to be relatively one time and we'll go on from there.

The second charge, a $5.8 million pretax charge to interest income and other, I spoke to you about that on the last couple of quarterly conference calls and on October 8 on our year end conference call as well.

Very quickly, if you go back to a year ago in early December 2007 we had about $1.1 billion of our cash in what was referred to as enhanced money market funds spread among six or seven of them.

We received a call in early 2007 from one of those funds saying the fund was stopping redemptions and the fund would be allowed to float [DNAV] from a dollar.

That hadn't happened in a number of years, over 15 years prior to that.

We immediately requested redemption from all the funds which, at the time as I mentioned, totaled a little over $1.1 billion.

As of last week, we've redeemed just under $1 billion of it, which is reinvested in government funds and has about $137 million remaining among three of these six funds and those are being done through orderly liquidations as these things mature.

All three have restricted redemptions in the process of undergoing that orderly liquidation as they mature or can be sold by the portfolio managers.

With this $5.8 million charge, I think we've taken right around $10 million against the $1.1 billion, if you will, but most of it's been in one of those funds.

But, nonetheless, about 1%, a little under 1% hit to that original $1.1 billion we had in these what we were thought were safe money market funds.

We don't expect big changes in that.

Again, we are down to the final throws here and what's left is not the bad stuff.

It's just when these things mature.

And could there be a few million here or a couple million there?

Sure, but we don't see any -- we certainly don't see or expect a big charge like the $28 million again.

Could we get a couple million here or there over the next four to eight quarters, I wouldn't be surprised but nothing big.

Again, this has been more of a liquidity issue for us.

We don't have a liquidity issue because we got plenty of cash, but this has not been about a risk of principle, thankfully, it's been more about just getting our money out of these things.

In terms of the SG&A outlook for the remainder of '09, it really relies on sales trends.

No big changes expected plus or minus.

We don't have anything up our sleeve to try to drive you guys crazy in the next six months, but we'll have to see what sales trends are.

Moving down to preopening, preopening was quite a bit lower, $8.6 million lower, coming in at $12.8 million this year versus $21.5 million last year.

We did open ten openings last year versus eight this year.

More, probably more importantly, we also had several openings that occurred in the early parts of Q2, in December last year, late November, early December last year, where we have -- I don't think we have any plans for openings in Q2 this year.

So, again, some of that is that's the reason.

As well, last year we had about $3.5 million more within this number, more in remodel and newer house business additions than we had this year.

No real surprises when you look at the underlying components of it.

In terms of the provision for impaired assets and closing costs, last year in first quarter we essentially were flat, $79,000 charge.

If, as you recall from last year in the first quarter, that essentially flat number, zero number, was about $3 million of expense, normal expenses for impairments, closing costs offset by a nearly like amount in real estate gains.

The first quarter this year we had a charge of $6.8 million, a little over two-thirds of which is related to the relocations that we've got going on.

So all told, operating income in the first quarter was up 7% year-over-year from $394 million last year to $420 million this year.

That's on a reported basis with all the stuff that we've talked about here.

But as I mentioned early on in the call, a couple of -- one big positive gas profits and a small positive, LIFO credit relative to expectation essentially offset by other things that I mentioned.

Below the operating income line, reported interest expense was slightly higher year-over-year, essentially the same $24.6 million versus $23 million last year's first quarter.

This made virtually all of this -- nearly all of this is the interest expense on the $2 billion debt offering we did in February of '07.

Interest income and other significantly lower year-over-year.

Year ago in the quarter was $33.3 million.

This year came in at $18.2 million, or $15.1 million lower amount.

Virtually all was lower interest income, not other, which of course this $15 million includes the $5.8 million hit I just talked about.

And, as you might expect, much lower rates of return on our cash balances.

Somebody asked this morning were we investing in any of these negative return treasuries.

No, the answer is no, we haven't.

Overall, if you take all of this into account, pretax income was up 2.3% from $405 million to $414 million this year.

Our tax rate, a good tax rate higher than last year, probably something I forgot to mention early on, last year we had a 35.3% tax rate for the quarter.

There were a few extra discrete items that were to the positive for us.

36.7 is actually includes a small amount of discrete positives.

I think we started with kind of a basis rate assumption of about 37.25 so again, but nonetheless, a little over a percentage point higher than a year ago.

In terms of quick rundown on the balance sheet, which we will also include in the Q&A, which goes out in a few hours, we'll keep trying to get this thing to you at the same time, but we want to get it right before we send it out.

Cash and equivalents.

This is our November 23 balance sheet, cash and equivalents, $2.816 billion.

Inventories, $5.933 billion.

Other current, $1.351 billion for total current assets of exactly $10.1 billion.

Net PP&E $10.192 billion.

Other assets, 721 million for a total assets of $21.013 billion.

Short-term debt on the right-hand side of the balance sheet, short-term debt 169 million.

Accounts payable $5.847 billion.

Other current $3.522 billion.

Total current $9.538 billion.

Long-term debt $2.196 billion.

Deferred and other, 327 million for total liabilities of $12.061 billion.

Minority interest, 85 million.

Stockholders equity $8.867 billion again for a total of $21.013 billion.

Some of you have asked in the past, could we also give you our depreciation and amortization number.

For the quarter it was $155 million.

Let me play out a couple of things.

Again, our debt to capital ratio came in at 21%.

That's after buying back nearly $5 billion of stock in the last 3-1/2 years and back in early 2007 adding $2 billion of debt to our balance sheet, plenty of financial strength.

Accounts payable, if you just take what's on the balance sheet, take accounts payable as a percent of inventories, a year ago on the quarter end it was 93%.

This year it's 88%, down a little bit.

Again, it's all goes back to a little bit of sales weakness and inventories in local currency dollars up slightly.

If you look at the average inventory per warehouse, last year at quarter end it was 11.687 million.

This, of course, would be the highest of our quarterly numbers each year anyway because it's a month before Christmas.

This year at quarter end it was down 256,000 per warehouse to 11.431 million.

But again in fairness, you need to look at the FX impact with the roughly 18% or 20% of our business that's outside of the United States.

Of that 256 lower number, if you had flat currencies year-over-year, that's 600,000 of the 256.

So in fairness, the increase per warehouse is about 350,000 across the board.

There are no issues.

About half of it is actually -- about 40% of that 350 is food and sundries, just increased food and sundries.

And, as Bob mentioned, Black Friday was a week later, so that could be part of it as well.

Seasonal is fine.

I want to emphasize that.

We took markdowns early in the season on trim a home and trim a tree and things like that and we feel pretty good about coming out of that with no surprises there.

So no inventory concerns.

Again, I think we did a good job of taking more accounts early and reducing commitments on certain seasonal items that we know we don't want to be stuck with at the end of the season.

In terms of CapEx, first quarter of '08 we spent $437 million, a little more than a year ago first quarter of $378.

However, I would estimate that for all of '09, I think last quarterly conference call we mentioned -- I'm sorry, we spent less this year, about $378 versus $437 last year.

My guess, I think on October 8 we mentioned that for the year we expected '09 to spend about $1.6 billion to $1.8 billion.

My guess is that with just a few things slowing down, not consciously on our part, just delays in getting a few things done, we'll probably be in the 1.5, 1.6 range.

That notwithstanding talking to Jeff Brotman and Paul Moulton who, Jeff, of course, our chairman and Paul who runs real estate, we are starting, as you might expect to see opportunities out there and we will be opportunistic, but it takes some time and we think there will be plenty of opportunities.

All you have to do is pick up the "Wall Street Journal" and read about real estate opportunities.

Our dividend, this past May we increased our quarterly dividend from $0.145 a share to $0.16 or $0.64 per share annualized dividend.

On an annual basis, that represents a cost to the Company of about $285 million.

Costco online, which is both Costco.com as well as Costco.ca in Canada, it's been a great business, very profitable.

Year ended, as you know was $1.7 billion sales.

Comps, again, for the quarter we're in the high single, very low double digits negative skewed in October and November.

It's actually come back a little bit, but not -- but still a negative number.

Again, we, too, are being opportunistic there.

If you go to Costco.com right now you too can get two flat screen televisions for less than $1500 total price.

Also like to mention, let's see here, again, September was good.

It was off in November and October, and consistent with what we see generally in big ticket, non-food items.

In terms of expansion, I mentioned in the quarter we opened eight, closed one, so a net of seven.

That closure will come back to us in Q3 when we open Las Vegas as a business center, the old Las Vegas unit.

We have no openings in Q2, six planned for Q3, and seven for Q4, actually again, eight plus one relow for a total of 22 new, two relows for a net of 20, plus two in Mexico, which we don't consolidate, so we expect to currently have 22 units which so far so good we are actually pretty much in line with what we said at the beginning of the year, something in the 20 to 25 range.

In terms of square footage, some of you have called back and asked for square footage.

At quarter end, our total square feet of retail operations were 79 million.

I'm sorry, 72,994,390 square feet.

So all told for '09 if we add the 20 net units net of Mexico, that would be 4% unit growth and about, just under 5% square footage growth.

Two final topics, Mexico, not a whole lot to say there.

As many of you know, we and the third largest supermarket chain in Mexico, Commercial Mexicana, each own 50% of a stock of a company called Costco Mexico which operates 31 Costco's down in Mexico .

We actually manage the operation out of our San Diego office, but have very good management down there as well.

We -- we've gotten questions about what's going to happen with the challenges that the other partner have.

We'll, like you, we'll have to wait and see.

Costco Mexico is currently operating profitably.

We have a good partner down there, and we'll have to see what tomorrow brings.

Last thing, yesterday or the day before we announced we were adding a board member to now have 14, a gentlemen named Jeff Raikes who is currently CEO of the Bill and Melinda Gates Foundation.

I think he has been CEO there for about three months.

Prior to that, Jeff was, for a little over 25 years, key member of management at Microsoft and we welcome him to our company's Board.

Finally, before I turn it back over to Rachel for Q&A, I'm going to give what I -- called earlier, a conservative, vague estimate of guidance.

First call is at $0.75.

Clearly, in our view that's going to be on the high side.

Again, we haven't seen sales improve.

Again, the trend during the quarter was lower, not higher.

We still have the FX head winds.

That hasn't changed.

The one bright spot, of course, after Christmas is that you traditionally have lower -- higher food penetration in January-February versus non-food, big ticket discretionary items, so given the strength on that side.

Hopefully that helps you a little bit, but we're not betting a lot on that, and we're going to continue to price aggressively to drive business.

We've got a lot of good things going on merchandising-wise.

We're not going to go crazy here, but we are looking ahead to what the business looks like after we get out of this economy.

For the year, it was October 8 when we had our conference call at which time First Call's estimate for the year was at $3.25.

Happy to report that all you guys did a good job bringing it down to $3 as of today.

Again, I'm going to have to punt on that one.

What we have seen is it's very hard to predict nine months out much less next month.

And, again, there's a lot of good things going on here merchandising-wise, operationally we're in good control in terms of our fiscal inventory, our shrink numbers.

We think there's some more real estate opportunities coming down the road over the next several months, and -- but that being said, trying to predict what's going to happen eight, nine months from now is very hard right now.

So in talking to Jim about that, we wanted to defer.

Again, if you think about it, if just currency rates stay where they are now relative to where they were last year, that alone is a $0.10 to $0.15 hit for the year which, three, of course, we identified in Q1.

A little under half of that was in our number to begin with, but quite a bit of it's not.

Again, those are the types of difficult predictions that we're going to try to just run our business right now.

With that, I'm going to turn it over to Rachel and answer any questions.

Thank

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Deborah Weinswig with Citi.

Good morning, Richard, and thanks for all the color on the quarter.

Lot of questions these days on food disinflation and how we should expect that to impact your business in 2009.

My guess is it's going to got other way.

I mean inflation was a short-lived word, at least right now.

I'll give you just a little color, random examples.

If I look at -- as an example, if I look at our various LIFO pools, what we call food and sundries, in Q1 it was still up about 0.5% in pricing, and sundries it was up about 0.5%.

In electronics and computers and what have you, it was down 2.5%.

Gas was -- which also includes sporting goods, office, automotive, was down all because of gas, and tobacco, beer and wine was essentially flat.

But if I just, again, look at some examples, in something as basic as ham and bacon and butter are all down about $0.50 on $9 and $10 price points, so down 4% or 5%.

These are recent price decreases.

Cheerios down $0.50 on a $5.50 item.

Canned tomatoes down $0.80 on a $7.50 item.

$0.40 down on juice, orange juice.

A year ago, rib eye eye -- New York steaks were $7.99, they are now $5.99.

That's all because of lower demand, but we're doing a heck of a job with that stuff.

On the nonfood side, I'm looking down a whole list here and picking out a few -- Kirkland signature diapers and Kirkland signature baby formula are both down a couple of bucks on $20 and $40 price points, so 5% to 10%.

So we are seeing some of this come now.

Gas, of course, is way down.

You feel like you forgot to fill up your tank when it only says $38.

Right.

Again, who knows what tomorrow brings?

When you read the paper, there's nothing in the world going on that's going to change this very dramatically, so my off-the-cuff guess, and it's truly a guess, is we'll probably have a LIFO credit for the year whereas just three months ago we -- in our own budgets, we're adding $0.03 or $0.04 to the number for the year of a hit.

So my guess is there's going to be very little, if any, and probably little again head wind, if you will, in pricing.

Okay, and then just being in the (inaudible) increase in terms of the instant manufacturer rebates, which I believe are vendor-supported markdowns, can you talk about the trend year-over-year in terms of what you're seeing there?

Well, there's a lot of what we call IRCs, instant rebates.

And what it is is manufacturers who have a lot of inventory pushing it out.

And we, of course, are well known for taking large quantities, large, massive quantities of big ticket items.

I think the television example is a great one, but whether it's a high end vacuum cleaner or high end luggage or apparel, we're getting some great brand names out there and big quantities and that stuff is selling, by the way.

It's not selling like it was, but it's still -- we can push through that with great confidence.

And so my -- I don't see that changing other than the fact that I'm sure some of these manufacturers haven't continued to build as if things are getting better next week.

So maybe there's a little less availability next year, but certainly going into Christmas and certainly the pressure on the buyers here, as you would expect, among other pressures like going back and saying the price should be coming down now, is to find those items that, that we could either divert or buy indirectly, director buy direct.

Okay, and then on the last question, on the SG&A front, I was actually pretty impressed at your performance in the quarter, especially in the past where would you have had mid-single-digit comps -- I thought it was a very strong performance.

Can you talk about anything different in terms of your business model now versus, let's say, three or four years ago where we could expect continued SG&A performance as such on a weak comp?

I've always said that there's not a lot of silver bullets out there.

There's little things.

Last several years, I think we certainly improved in healthcare other than the spike last month, but we've certainly improved in healthcare with the changes that we implemented back in late '03, early '04 that had a four-year tail to it because of how those trended, those changes to the health care plan changed and that helped us.

I think we've done a great job on workers comp.

We've brought in a couple of great people about three years ago that are getting people back to work safely and more quickly and getting them off workers comp, and I think we have not -- aside from the great changes in legislation in California that was killing us five, six years ago, we are seeing still little improvement in workers comp and I think, again, that's being proactive on that side.

We continue to, believe it or not, I only hear from you guys or my in-laws or anybody, or my own friends, when they are backed up in a line and there's ten lines closed at the front end.

But I got to tell you that we continue to improve the speed of the front end.

That helps you a little bit.

There's some other things that help margin and SG&A that are little things.

I think the example I gave recently was you're seeing a lot of square packaging.

What used to be a round bottle, a round tub of detergent is now square.

It's now triple concentrated.

In milk, you've no doubt seen the new Costco milk carton which, again, you can get more on a pallet and, therefore, less freight per item.

A lot of that goes into -- those are all little things and we don't quantify them, but all of that goes into -- I know in our annual manager's meeting in August we had an example and on the slide it was 12 or 15 bulk high volume items like paper towels and toilet paper and facial tissue and water, and just in terms of changes of packaging, much of which is being done by the manufacturers but with help from us and other major retailers, I'm sure, just in those 12 items in the United States, we were going to save on like volume reduce our pallet throughput by over 200,000 pallets.

Now, that's a lot of trucks that you don't have to spend money on.

A lot of that goes -- the freight goes into reduced costs of sales, but it also means that 200 -- forklift operators aren't [schleping] 200,000 pounds through the warehouse.

All those things, a million here, a million there, it doesn't add up to a lot of basis points, but at least helps you a little bit.

We are not, as you would expect, changing our wage rates.

We are not, as you would expect, going to charge our employees a lot more for health care.

Those are the types of things we have in place and what we pride ourselves in.

But we aren't giving up.

We're looking for where we can save money.

But it certainly is tough when you've got comps being weakened.

So should we assume, then, that you need a lower comp to leverage going forward than you have historically?

Well, I don't know, and I say that because even here it sounds so easy when I finally give it to you today on the call.

It does sound so easy, Richard.

I got to tell you, just in terms of understanding it, just with -- think about it, in Q4 a year ago, five quarters ago, gas sales, which is a sub 1% SG&A business, was 8% of our sales.

In Q4 this year, it was 12.

In Q1, it was a little over 9.

It's still rounded to 9.

So directionally it still impacts it.

It still hurts a little bit, but not nearly as much as it did a quarter ago.

So there's a lot of screwy things going on that make it hard.

But when I look at just basic payroll in the warehouses, I think we've done a pretty good job with the lower comps not getting as deleveraged as we could have in my view a couple of years ago.

But, again, I think it's a lot of these little things and I would like to say yes with a slightly lower comp than we thought a few years ago.

We still get a little leverage, but it's hard to predict.

Okay, great.

Thanks so much for the color and best of luck.

Thank you.

Your next question comes from the line of Dan Binder with Jefferies.

Yes, I had a few questions.

First, just sort of following on Deb's question.

If we were just work comp, I guess recently you've talked about 4 to 5, sort of that magic level of where you can achieve expense leverage.

If we look at something more like a 3, what would you say is a reasonable range of expense deleverage in terms of basis points for every comp point under 4?

Is that something you think you can address if you are just looking at core comps?

It's very hard to address.

A different way to look at it, and this is truly back of the envelope, if you think about it, what is 1 percentage point of comp up or down versus what you think or do?

On $71 billion in sales last year, 1 percentage point is $710 million.

When we've done our own regression analyses, if you will, is what is that on the margin.

It's been a long time, by the way, since we've done a regression analysis.

But the fact of the matter is best guess, and it's a guess, that incremental dollar of sales, be it a loss or gained, is about 4.5% pretax profit.

I don't know if its 4% or 5%.

Let's say it's 5% just to make the math easy.

On $700 million, that's $35 million.

At right around $7 million a penny, that's $0.05 a share.

I'm not sure when comps go up or down how many basis points margin changes and SG&A changes, those are the two critical ones, but I know I have more confidence in guesstimating how the bottom line changes and then you decide where you want to put the basis points.

Hopefully that helps you a little bit.

Yes, that's helpful.

Can you talk a little bit about what you're doing on the pricing spots in the club?

I know you did some things in November on some of the higher profile items.

I guess just, one, why did you feel the need to do it?

How much are you doing?

How deep are the cuts?

What areas of the club, any color you can give us on that front would be helpful.

Well, basically, I think as one of the analysts put in a comment a few months back, it's in our DNA that our first order of business is to drive sales.

A company with a 5% minus comp versus a 5% plus comp operates completely differently.

You're spending your time worrying -- employees are spending their time being cut hours and laid off and we want to do everything possible to drive sales.

In a given month, in the last month of the quarter I think we came, the head of merchandising came to Jim as Jim had asked for, I want mark downs on key items, be it produce or high profile items like, and I don't even know if these are the items we did, but it could be soda pop.

It could be Tylenol.

It could be butter.

It could be Tide detergent, who knows.

But at the end of the day, it was a couple of cents a share and we're still doing a little of it in this quarter.

It's not $0.05 and $0.10, but it's not zero.

Are you pleased with the results that you're getting on the items where you've been able to cut prices in terms of unit increases?

If you ask Jim, absolutely.

If you ask me, I'm not sure.

I mean it's hard to quantify what it would have been with and without.

I can tell you anecdotally when the operators, and I've talked to several the operators, when they are going around, as an example, we took our famous rotisserie chicken back to $4.99 in many markets.

We saw a big pickup in unit sales of chickens when we did that.

And that, by the way, even for a [nay sayer], which I can be sometimes myself, was wow, that really worked.

We're -- there's a little bit of awe shucks retail merchandising in us.

This is what we do for a living.

We're going to drive business.

By the way, we're also going back to vendors.

It's not like -- we start by doing it and then going back to vendors.

But there's a little bit of head wind there and that's what we do for a living.

Just a few final things.

On the health care side I heard recently from a company that they were seeing this spike as a result of spouses becoming unemployed and getting on the other spouse's health care.

Is that something you're seeing and is that what may be causing it and does that mean it could continue and then the final question was regard to the full-year guidance.

I understand your reluctance to put a range, but if we were to assume just to get somewhat of a handle on it, if we would just assume that the dollar does stay where it is, that comps stay, core comps stay at about 3%, and that some of the trends that are in place on pricing stay where they are, are we talking about something closer to like 280, 290 or just under 3?

Any additional color there?

I haven't fallen off of my chair but I want to stay away from giving exact numbers.

Okay.

On your first question, as it relates to health care, two comments.

One, we seem to have a lot of married people here that are married to each other, but the -- a much bigger reason and a real reason I don't see that being -- we have not seen that and I just talked to our benefits people yesterday when I was gathering information for this call.

We tend to be the -- when you think about it, first of all, 90% of our employees are hourly and many of them who are married, we have on average, our average employee who is in the plan, there's a little over two people covered by that person from that person.

So there's an extra like 1.25 people, be it spouses or children.

A lot of them are already in our plan because we're the plan of choice.

If their spouse is working in a comparable job for another company and, again, some of them are working here, so that's wonderful from that standpoint.

But if they are working for another company in a comparable job, eight or nine times out of ten, they are coming to our plan because it's a much more favorable plan.

We've already been hitting ourselves with it forever.

Okay, thanks.

Your next question comes from the line of Charles Grom with JPMorgan.

Good morning, Richard.

Just wanted to follow up on Dan's question and maybe ask it a little differently.

If $0.75 for the quarter is too high, let's just say $0.70 to make the math work.

That would suggest about 20 basis points of operating erosion and EPS down about 5%.

Just wondering if in your models internally does that feel right and if that seems like a good yard stick for the second half of the year?

Charles, as much -- you know I love to talk.

I've got all my keepers here in the room as well, and we're just trying to stay away from it.

It's not unlike in July when we -- for the first time ever we announced we're going to miss Q4, if you recall, and we said we would be way below.

We're not saying that here.

I'm just saying back then when we said that, that was the first time we didn't quantify something.

And we're trying to wean ourselves of this qualification, particularly in this time when it's so hard to predict.

Okay.

I understand.

That's fair.

Yesterday Kroger talked about some changes they are seeing in their perishable business with a little bit more shift to frozen product away from fresh.

I am just wondering if you guys are seeing that in your mix at all?

Both are strong and looking just at our fresh, our comps in fresh have remained where they have been.

So I think that -- I don't know if it's -- I haven't been aware of a shift there.

The only shift I've seen is there have been some shift from meat to poultry and things like that.

But that's not just in the last month.

That's been -- and we've seen anecdotally, in our food court, we've seen a huge jump in take-home cooked pizzas.

I mean where can you get -- that's, again, people I think instead of eating out are coming to supermarkets and cost Costco's to have dinner and for $9.99 you get this oversized, over capacity wonderful pizza that you bring home.

Okay, and then one last one.

Any sort of color post Black Friday sales trends similar to November or maybe a little bit of a down tick because of the increase in discretionary that naturally happens in the month of December?

Again, I think the comment I made earlier in the call was simply that there has been a downward slight trend from September to October, November.

There's been no change -- there's been no up tick since then.

Okay.

Fair enough.

Good luck.

Thanks.

Your next question comes from the line of Adrianne Shapira with Goldman Sachs.

Thanks, Richard.

Richard, just talking about traffic has remained strong despite the fact that gas has pulled back.

Kind of walk us through your thoughts there.

Is that a function of the lower food prices is now what is the traffic driver as opposed to lower gas prices?

I mean, again, I'm shooting from the hip here.

I think we're the value proposition.

I think that the fact that people aren't eating out -- again, clearly you don't see the press every night talking about $4 gas prices.

Now that it's -- I filled up my tank, it was $1 -- Washington has high gas prices because we have no state income tax.

There's a lot of tax on the gas.

It was $1.89 for high test yesterday and $1.99 a week ago.

Nobody on the news is talking about that anymore.

It's old news.

I think that food in general, and the fact that we've got great cheap stuff, good quality cheap stuff is helping.

And I think people's habits have changed.

Some of them are good habit changes.

Some of them like I don't really need that sofa, is not good.

But at the end of the day, food is, clearly if you look at other forms of discount where companies that have embraced more food than not food are being helped -- holding up better.

Okay, so the fact that traffic is holding up and gas perhaps is not as much of a driver, that's not surprising.

I mean you wouldn't expect--

I would have guessed -- if you had said six months ago, Richard, if gas priced halved, do you think your frequency would still be around 3?

I would have said no, it doesn't make sense because you're not getting that press out there every day saying where is the cheapest place to buy gas.

It's gratifying, and I remember even two years ago when gas prices were rising, people come to Costco because, A, it's a further trip and, B, they say, gosh I can't get in there without spending a lot of money.

Well, they seem to have figured out how to do both.

And I guess my follow-up question is in light of the fact that gas doesn't present that type of driver, you're now using food to maintain traffic levels.

Is that the strategic decision, or is it more a competitive response and that's the thought process in terms of taking prices down, others are being more aggressive out there?

I think it's just us.

I don't think we -- strategic is too flattering.

It's just -- that's what we do.

Keep in mind, on gas, our comp gallons -- what are our comp gallons recently?

Our comp gallons are still positive mid singles.

Maybe it was positive high singles or low doubles at the peak of $4 a gallon or something, but it's still holding up pretty well.

Okay, and then are you seeing any competitive response?

If it is just you taking prices down, what are you seeing from Sam's and BJs as you are taking prices down?

Sam's particularly is very fierce when we're down the road from each other.

As I've mentioned in the past, it's -- you take a big market basket of highly competitive commodity items and branded items and there's, we both are in each other's places every day.

So, yes, but we want to be first and we're going keep being aggressive.

And then the vendor conversations that you're having, should we expect whatever you get back to be reinvested in price or should we see some fall to the bottom line?

All of that will be reinvested in price.

And, again, but on the stuff that's just us doing it, it's just picking a few things to try to drive business.

Okay, and then just last question, on the buy back, we're seeing obviously Wal-Mart has suspended their plans to buy back stock.

Let me -- last comment, Adrianne, on what we were just talking about.

I'm sorry.

Oh, pricing, we are doing other things.

I still feel pretty comfortable generally about our margins, notwithstanding a few things because sales have fallen here a little bit and we want to get it in the right direction.

We're still focusing on private label expansion, which helps margins.

We still are looking at certain initiatives that we've talked about in the past where we can make a little margin.

And so this is not all a one-way street.

But at the end of the day if it costs a penny or two in a quarter to try to drive a little extra business, that's what we want to do.

We owe it to our customers and we owe it to our employees and we owe it to our long-term business.

Okay.

So the core -- the margin that you talked about, that is down 2 basis points.

In the past you had said that we should see a positive sign in front of it.

Obviously that's switched.

So going forward it should be?

My guess is it's -- my long-term guess -- my long-term statement is still that it's positive.

Okay?

Whether it's positive last month or next month, we'll see but, again, we're not going to be down here forever with the economy as well.

Now, getting back to stock purchase, we did see that announcement.

In terms of ourselves, we currently -- when we stop buying, I think in mid-September, we've held off.

Again it gets back to liquidity, just keeping our gun powder dry.

And long-term, we are a buyer of our stock and I'm guessing that we're not going to rush into it until we talk to probably have our typical informal conversation at our next Board meeting which is at the same time of our annual meeting in late January.

So I don't expect anything.

Now, if the stock plummeted from here, all rules are off, but there's no rush right now.

I would expect something in the future.

I don't mean the long future.

A lot of it had to do -- like everybody out there in the world, we got as much "(inaudible)" half of that $3 billion is not, it's marketable, it's monetizable but it's not -- debit and credit card receivables and monies tied up in our viva trust and things like that.

So the $1.25, $1.5 billion that's truly cash, we're now down to $140 billion or so that is in those enhanced money markets that will keep coming out.

That's good news.

We had that one government fund lock up on us a few months back with $320 million.

We got about $140 out of that two weeks ago and all of the rest of it is -- we've been notified and the money fund is announced, all of it without any impairment in net asset value, the dollar net asset value will be forthcoming in the second week in January.

So that will make me breathe a little easier.

But when you started seeing things like government money market funds halt redemption you say, hey, there's -- whether we buy stock today or tomorrow, let's wait a little bit and just see what happens in the craziness of the world.

Thanks, Richard.

Your next question comes from the line of Robert Drbul with Barclays Capital.

Hi, Richard.

Two questions for me.

The first one is on the opportunity for gross margin and continued to expand it, the private label penetration from a consumer standpoint, are you seeing much around there?

And I guess your cobranded efforts within private label, should we continue to expect more products like that coming out, or how are you thinking about it to this point?

Yes, it's going up a little bit and, yes, you should expect to see more.

And, again, the brand is there.

The quality is there and the margins are there, but I think Jim has said it best all the time, it keeps inching up, but we still see ourselves as a provider of well-known brand names and great savings, too, and as much as we sell the heck out of a gift pack right now of Belgian chocolates, we're thrilled to have the ability to sell Godiva chocolate or C's candy and the same thing goes as much as we sell out of a Kirkland's signature jean.

We had some jean over there yesterday that was in for $140, which apparently -- we had [Zeniad] men's dress pants for $229 across the street.

Now, most people think that's crazy, as do I, but I bought a pair because I know they retail for $400.

So that's out there.

All right.

And then, Richard, can you talk about membership fee, just the sign of trends or just your ability to sort of rejuvenate membership fee income growth and sort of your plans around that?

Well, I'm -- again, on a local currency basis, membership fee dollars were up 9.5% when total sales in local dollars were up 7%.

So actually, a little bit of that's the conversion to executive member conversion.

We're actually thrilled.

The question I've been asked, Bob, and I know Bob here and Jeff Elliott have been asked ten times a week in the last several months is that BJ's and Sam's are doing lots of marketing and lots of advertising and lots of membership deals, ten weeks for $10 and all this stuff.

And we've actually curtailed some of our membership marketing from a year ago.

It was about six months ago that we were off campus 10 or 15 executives for two days and the topic was one of the visitors to that meeting to present was the head of membership marketing to outline all the things we're doing everywhere in the country and how to consolidate them and do less.

So not to say we're not marketing, we are, but, if anything, the pendulum in Jim's view had swung a little bit.

We're doing a little too many of these $10 off here, gift cash card or those kind of things.

Let's get back to what we do best and merchandise and the value of the membership.

So I view us as being strong now and we're going to not rejuvenate, but continue to juvenate it, if you will, by having great stuff out there.

Thank you.

Good luck, Richard.

Your next question comes from the line of Uta Werner with Sanford Bernstein.

Good morning.

Wonder if you can update us a little bit on the expansion goals for '09 and beyond in terms of the different geographies and where you might want to go?

Well, in terms of infill, we continue to think that there's plenty of opportunity in the US and Canada.

We think that with the challenges -- our bet is if we're in six or seven malls right now, and when I say we're in malls, we're usually in the parking lot with a breezeway entrance into the mall.

In some instances, one example would be in Atlanta, Cumberland Mall, they literally, the mall toward down I think JC Penny, we redid the parking lot, we have a gas station and a full Costco with no direct attachment other than a breezeway into the mall.

But no doubt we're there because we bring destination shoppers of high end to that mall and it's been a great location for us in terms of somewhere we weren't invited to even come to the party.

And so I think you can see more of that going forward, and many parts.

As you know, we're opening in Australia next June or July.

We have been -- as evidenced by the comps and the membership sign-ups and the profitability of the three Asian countries we're in, we're going to push that a little harder, but a little harder means maybe we'll get in those three countries three open a year instead of one and maybe four or five a year, four or five years from now.

But still that's a net positive.

Jim Murphy, who runs international, continues to look at other parts of Europe and -- but there's -- I don't -- again, my crystal ball tells me it's more likely to be in more malls before we get into Western Europe.

Specifically, I think there was a quote out there that the international business might double over the next few years.

I just wondered how committed you are to that.

Well, if you say the international business ex-Canada because Canada's a pretty mature property.

We've got 80 units and clearly -- we're growing a lot more than we would have ever guessed five years ago up there.

We're opening two or three a year.

But ex-Canada, I think that's possible.

Okay.

Again, a few years might be five or six, not three.

Okay.

A different question, if the core merchandise comps were to stay relatively moderate, what kind of ideas might you have for how to work on operating expenses in order to get them closer to leveraging?

We don't do very well in addressing that question.

I mean -- and again, I don't want to be cute about it.

We're not going to change our wage rate.

One of the things that we have had continued to test, we've always put in a warehouse -- a warehouse manager could lower their payroll if they got to use all part-timers.

We have a rule that at least half the people in the -- hourly people in the warehouse have to be full-time and we have a second rule, that every part-timer's guaranteed a minimum of 25 hours if they so choose.

And we have a third rule.

Even if part-timers that don't want minimum of 25 hours -- I don't know the exact number, but no warehouse can have more than a certain small number of people that work less than 20 hours.

Now, all of those things make SG&A and expense control harder, but it's, A, most part-timers want more hours.

We do help ourselves a little because you have the employee that used to be full-time, got married, has three kids and all five of them are on our health care and they are working 8 hours a week one day a week.

By having that 20-hour minimum, it eliminated some of that, lot of that.

But we are still -- we still promote internally where we -- where an employee in the warehouse figured out how to save money doing something.

I think there's a lot more savings right now on things that impact margin like the freight issues, the pallet issues, the packaging issues.

Again, there's some labor involved in that, but a bigger savings is on the freight side and the space, how much space it utilizes.

I think we're going to spend more time focusing, Uta, on what else can we bring in the table in merchandising.

Okay.

That was helpful.

Thanks, Richard.

Your next question comes from the line of Peter Benedict with Wachovia.

Hi, Richard.

Thanks for taking the question.

A couple things.

First, when we're thinking about gas, I think you said it was a little over 9% of the mix in the quarter, was that right?

Yes.

Thinking about the earnings impact for this quarter versus let's say last year, gas alone, on an earnings basis, how much do you think it added year-over-year?

I'm not trying to hide anything.

First part of this call we talked about all the pluses and the minuses and the net of the two was a slight negative or something.

That gives you kind of a sense of where it is.

It will be less of an impact -- it will still be a positive impact in Q2, but not as big because we're still more than average profitable, but we were crazy profitable for several of those weeks when gas was really going down fast.

Sure, okay.

Fair enough.

On the core margin, when you talked about the four core merchandising categories being down 2 basis points, can you remind us how that number compares to what you saw in the fourth quarter and then knowing what you know right now about the second quarter, where should we see that?

Is that something that can go down 5, 10 basis points for the second quarter or what's your thoughts there?

I'll start the answer by saying what I said earlier.

Figure out what your bottom line is, then decide where you want to put the basis points because it is hard to estimate.

In the fourth quarter, our margins, looking -- putting your blinders on, looking at core sales and core gross margins, I think we were up in the high teens compared to that minus 2 but, again, just take the -- a little extra mark downs I mentioned, take the more aggressive pricing, take the weakness in non-food, and you're more than there in that regard.

Again, one tail wind, if you will, even if things stayed as weak as they are today you still have in January, February by definition a traditionally higher penetration of non-discretionary items, food and health and beauty aids and what have you.

Right now you have a traditionally higher penetration, an increased penetration relative to the whole year, of non-foods, which is weak.

That alone I hope will help us a little bit, but we'll have to see.

Okay.

That makes sense.

And then two more quickly on the international front.

International margins versus last year's on the segment basis, I think last year the international business did about a 3.53 operating margin.

How did it compare this year?

That will be in our segment analysis.

The FX doesn't impact that because FX changes every line item on the income statement from sales to cost of sales.

My guess, it's going to be fine just based on the fact that comps and local currencies are very strong in Asia and decent mid singles in Canada.

At least so far, I wouldn't see any detriment to that.

Okay, perfect.

Lastly, of the $22.7 million of FX hit, how much would have been related to the Mexico joint venture profit?

Very little.

Very good.

10%.

I'm -- off the cuff, I'm guessing very little.

Okay.

All right.

Thanks so much.

Thank you.

We'll take one last question.

Your final question from the line of Mark Wiltamuth with Morgan Stanley.

Hi, Richard.

Wanted to ask a little bit about your core merchandising margin that was down 13 [BIPS].

If you took the gas out of that, where do you think that would come out?

And I guess you made an overall comment saying the gas kind of offset the charge.

So should we imply that's like a $35 million number?

Gas is in the other number.

Gas is in our ancillary business.

That's why that number was so big.

Where it affects your core is when I said the 13 is -- just looking at core sales versus core margin, year-over-year it was down 2 basis points, but it appears it is down 13 because of the penetration switch.

Okay, and then if you look forward, if we actually get into cooling of inflation or maybe even deflation, is that good for you or bad for you, and on these prices where you did mention that things are down, are you giving it back to the consumer or are you pocketing some of that on margin?

Well, again, first and foremost, we're giving it back.

We still want to maintain a certain amount of dollars profit per unit, but much like when an item went -- I'm making this up, but let's say when we were making 10% on a $10 item and all of a sudden the item's now $12, we didn't necessarily make $1.20 now.

We made closer to $1 still because that's how we looked at it.

Similarly, going down, we still want to make a dollar, not less.

Okay, and thematically, do you think cooling of inflation or tip in to deflation is that good or bad?

I think it's bad.

Not big bad, but little bad.

I've always said that a little inflation is good because we do make a little -- again, we do make a little more.

Using my example of $1 versus $1.20 of gross margin, we make more than $1, but not all the way to $1.20, so a little inflation helps you a little bit.

Again, on a totally macro basis, a little inflation helps you because it makes the current (inaudible) look even better as we can drive that business, so we clearly make more money there versus some branded items.

So if we had a little inflation and had knowledge that that's how it was going to be for a couple of years, I think that would bode well for us and people out there.

Okay, and just, again, on the gas, do you think the year-over-year swing was something around $35 million or $40 million?

We're not saying.

Okay.

Okay.

Thank you very much.

Okay, thanks.

Thank you, everyone.

We'll be here.

This concludes today's conference call.

You may now disconnect.