好市多 (COST) 2009 Q2 法說會逐字稿

Good morning, my name is Chastity and I will be your conference operator today.

At this time, I would like to welcome everyone to the Costco Wholesale second quarter earnings and sales conference call.

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

After the speakers remarks, there will be a question and answer session.

(Operator Instructions) Mr.

Galanti, you may begin your conference.

Good morning to everyone.

This morning's press release reviews our second quarter fiscal 2009 operating results for 12 weeks ended this past February 15th, and our four weeks February sales results for the four weeks ended this past Sunday, March 1.

As with every call, let me start by stating that the discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

And that these statements involve risks and uncertainties that may cause actual events, results, and/or performance to differ materially from those indicated by such statements.

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

To begin with, our 12-week second quarter fiscal 2009 operating results for the quarter -- earnings per share came in at $0.55, down 26% from last year's Q2 EPS of $0.74.

This compares to current first call consensus of $0.59.

Which, needless to say, has come down over the past several weeks from the low to mid-70s to its current level of $0.59 as a result, I believe, mostly related to our February 4 announcement that Q2 earnings would be substantially below where first call was at that time.

As outlined in this morning's release, this year's second quarter earnings results were a result of several factors, virtually all of which negatively impacted results for the quarter.

These include several factors impacting gross margin, which I'll go through in a few minutes.

A negative swing in our year-over-year gas profits in Q2 by about $0.04 a share.

Fx headwinds, as I mentioned in the first quarter when the US dollar strengthened.

Our foreign earnings results when converted and reported in US dollars, this hurt us in the second quarter by about $27 million or about $0.04 a share.

Pretax, the $27 million.

That is assuming Fx exchange rates were flat year-over-year, our foreign operating results in Q2 would have been higher by this amount.

Additionally, while sales trends during the quarter showed some improvement in January and February as compared to December, the all-important month of December, with larger sales levels and increased penetration of bigger ticket nonfoods items, was the weakest of the three, four-week periods.

And these weaker sales, of course, were despite the aggressive pricing we did earlier in the fiscal quarter to drive sales.

We believe that that aggressive pricing roughly estimated somewhere in the $0.03 to $0.04 a share range.

Also, while our inventories came out of the holidays quite clean, we incurred higher seasonal markdowns year-over-year in Q2.

Roughly an estimated $0.03 a share.

LIFO was actually a $0.01 a share pickup in the quarter, about $7 million pretax.

I'm going to talk about that later.

Lastly, on the expense side, we actually did fairly well controlling expenses, given the sales weakness.

Although our costs for employee health care were up a little this quarter despite a small offset to that.

In terms of sales for the 12-week quarter, reported total sales came in at minus 1%.

And our 12-week reported comp sales figure was reported at a minus 3%.

For the quarter, both total sales and comp sales were significantly impacted by both gasoline price deflation and by the strengthening of the US dollar.

On a comp sales basis, the minus 1% comp sales decline that was reported, if you exclude gasoline deflation, would have been plus 4%.

So quite a big swing there because of the price of gas is so much lower.

And total company comps, again reported at minus 3% for the quarter, if you exclude both the gas deflation at our gas stations and exclude the Fx changes that we seen of recent on a local currency basis, if you will, that minus 3% reported would have been a plus 5% for the Company overall.

And in terms of sales for the 4-week month of February, it's similar to the quarter in terms of the impacts of these factors.

Excluding gasoline deflation, the 0% reported US comp would be plus 4%, and excluding gas and the impact of the Fx changes, February's total company reporting comp of minus 3% would have been at plus 5%.

Other topics of interest this morning - our opening activities and plans.

After opening 8 new locations in the first quarter, 7 net of one closing in Las Vegas, we opened a new Las Vegas location and then spent a few months converting that one into a new Costco business center which we just opened in the first few weeks of Q3 here.

So a net of 7 locations in the first quarter of this fiscal year.

Six Q2 end on February 15, we opened nothing in Q2.

But since Q2 end on February 15, we opened three new locations - new Costco warehouses in Lakewood, California and Honolulu, Hawaii.

And as I mentioned, a new business center in Las Vegas, that being our 7th Costco business center.

We now operate 553 locations around the World.

That includes the 31 in Mexico, the only ones which we don't consolidate the results into our numbers.

Also this morning, I'll review with your our online results, membership trends, additional discussions about margins in Q2 and trends.

Our balance sheet, of course.

And with that, I'll go down the income statement here.

In terms of our quarterly results, as I mentioned sales for the quarter, 12 weeks ending February 15, were $16.5 billion, down just under minus 1% from last year's Q2 of $16.6 billion.

On a reported comp basis, Q2 comps, as I mentioned, were down 3%.

The minus 3% reported comp figure for the quarter was comprised of minus 4% in December, minus 2% in January, and minus 3% in February.

The minus 3% comp was, of course, negatively impacted as I mentioned due to the strengthening US dollar which was about a little over 4 percentage points of impact on the Company.

Our international comps, as you saw in the press release, in local currency were actually up 8%.

But once converted into US dollars, given the dollar strength for the past several months, were reported at minus 11%, so a big swing there.

And gasoline deflation had, as I again mention, had a big impact, such that the minus 1% comp would have been a plus 4%.

In terms of the minus 3% comp for the quarter.

We always break that down into the -- of course, the comp is the product of average transaction size and average frequency.

The average transaction decreased compared to that -- to get to that minus 3% comp for the quarter, included an average transaction decrease of minus 7% for the quarter.

And it bounced around 6% to 8%, in each of the three months, a 7% in December, a minus 6% in January, and a minus 8% in February, pretty much a 7% average.

And the average frequency increase of almost plus 5% for the quarter.

I might add that the frequency trend during the past three months continued to improve.

As many of you know for the years that you followed us, our historical frequency trends tended to be generally in the 0% to 2% range.

A pretty small range there.

Over the summer we saw it improve somewhat, I think in part because of a lot of press we got on gasoline prices, as prices were spiking, and the value proposition, of course.

During the past three months, we saw December, January, February frequency being in the mid 3s, and December around 4% and January, and a little over 5% in February.

So while our members are buying a little less each visit, they are coming in more frequently, and as I think you will see in a moment, continue to be quite loyal in terms of renewal.

Included in the average transaction decrease of minus 7%, again, it gets convoluted because of the weak Fx and the gasoline deflation.

Fx being, again, a little over 4 percentage points of that negative to that minus 7%, and gas deflation being about minus 3%.

So as you can see, the average transaction ex- those two things are pretty darn close to 0.

In terms of cannibalization, not a big impact in Q2 or Q1.

As we've opened, as you know, in the low 20s in terms of number of units in the last couple of years.

For the February reporting month, much like the quarterly comps, are minus 3% reported comps were a combination of an average transaction decrease of minus 8%, which includes, of course, the Fx impact of a little over 4% and the gasoline deflation impact of around 3%.

I might add in terms of gas year-over-year, the average sales price per gallon in each of the second quarters down 41% year-over-year.

Again as I mentioned, we had a great frequency in February of plus -- a little over 5%.

In terms of sales by geography, not a lot has changed.

California, which we had seen going back several months ago at the beginning of this economic downturn, during the summer we saw little bit of an increased spread in terms of as things were softening, it was softening a little more there, as the GAAP of California relative to the rest of the US for us, had come back a little bit closer to normal.

And even in California, again, if you look in terms of traffic or frequency comps in California, Q1 of California was a shade under 0% about minus .5%, and in Q2 around 3% positive.

So again, we are seeing that frequency is not the issue.

We're getting people in.

They are buying a lot more food and sundries and fewer bigger ticket items, of course.

Internationally, again, showing pretty good results in the quarter.

While international expressed in US dollars was in the minus teens, both for the quarter and the month of February, in local currencies they were in the high single and low double digits for the quarter, and in mid to high single digits in the month of February itself.

So again, internationally, despite economic turmoil in plenty of places around the world, we are seeing some very good results in local currency there.

In terms of categories, merchandise categories for the quarter, it's still the story of the haves and the have-nots.

Food and sundries and health and beauty aids and fresh foods continue to be positive.

Again generally, nonfoods, hard lines and soft lines overall, are in the have-not category, although there is a few shining lights within that.

Within food and sundries, for the quarter, tobacco continued to be a little bit negative.

That may reverse itself with an upcoming increase in price simply related to an upcoming Federal floor tax on tobacco of, I believe, $6.50 a carton in April.

Other than tobacco, though, all the other sub categories were up year-over-year with dry groceries and canned goods being the strongest in the low double digits, and other strength in the mid to high singles in frozen and refrigerated goods.

We've seen an increasing shift, I might add, within some of our private label.

As you know, for those who have followed us, we've seen private label sales penetration company-wide go from below 10% several years ago to the high teens over the last couple of years and continue to increase .5% to 1% a year it seems.

On the food and sundry side of our business, we've seen in the last six months about a 300 basis point spike in penetration.

And talking to Rose, our head of food and sundries, a lot of that has to do with -- his feeling is a lot of that has to do with the fact that this economy, despite many items that have great brand loyalty and are great quality, KS items, Kirkland signature items, continue to show increased unit penetration on that side.

Within the minus 2% hard lines comp, not a whole lot varies really.

Actually, not a bad number overall.

Strongest sub categories, tires and automotive, we also include health and beauty aids in our hard lines, so I view that more as the food and sundries and the like in terms of we talk about the haves and have-nots.

Again, we continue to see some unusual things within majors which was just below flat for the quarter and month.

TV unit sales, just in February, were up over 50%, dollars up just barely over 0%, in other words, big price point changes downward in those products.

We have been quite opportunistic in that area, as you know, over the last several months, and have provided great value to our members.

Other areas as we lead into the new spring season, that we see weakness and we expect to continue to see weakness are things like garden, barbecues and patios and the like.

Again, bigger ticket non-food items.

Within soft lines comps, again, negative not a whole lot thrilling.

Generally, everything is in the high singles negative to low 20s negative.

One standout is small electrics, surprisingly, which is a category within there.

That was slightly positive for the quarter and quite positive in the month.

Just anecdotally, looking at the items, things like coffee makers and food savers and toaster ovens are up 30% to 60% in many cases.

In some cases related to some of the mailers we are doing with the coupons.

Fresh foods, like food and sundries, is positive in the mid singles, bakery being a little more of a standout on the positive side than the other categories.

But nonetheless, all of it positive.

Moving down the income statement line, in Q2, in terms of dollars, membership fees up 4% or ten basis points, that was a $13 million increase to $355 million or 2.16% of sales.

That ten basis point increase is a little deceiving in the sense that while it is up as a percent of sales, again the gas deflation alone, if you just assumed flat gas prices year-over-year, I think a more correct way to look at that would be it would have been up 3 basis points.

Again, a good showing, given the economy, and we're certainly gratified by the ongoing improvement in these numbers.

In terms of membership, we continue to benefit from strong renewal rates and continued increasing penetration of the $100 a year executive membership.

Due to no new openings this year in the quarter compared to 7 new openings in last year's second quarter, while our new membership signups in Q2 were down a bit, about 7% year-over-year, much of that negative variance relates to last year's Q2 opening of 7 new locations, again compared to none this year.

In terms of members at Q2 end, we stood at 20.7 million Gold Star at the end of the quarter, compared to 20.5 million at the end of the first quarter and 20.2 million at the beginning of the fiscal year.

Primary business at 5.7, up from 5.6.

Grounded at Q1 and year end.

Business add-on continues at 3.4.

Recognizing what you see is partly is is as add-ons want to become Executive members, and in many cases they are being converted into the primary membership.

But all told, total member households 29.8 million at Q2 end.

Up from 29.6 at Q1 end, and 29.2 at the year end.

At February 15 Q2 end, our paid Executive members continues to grow, a little over 8.2 million, an increase of about 175,000 since Q1, after about 15,000 a week.

That level of increase is a little lower than in recent quarters, but again, I think that's good given no new openings in Q2 this year.

We also have seen a little bit of a pickup in when we sign up new members in terms of how many are signing up immediately as an executive member.

If you talk to our marketing department, they would suggest that a lot of that has to do with better marketing initiatives in place.

We've gotten a little better in doing that.

In terms of membership renewal rates, they continue strong, essentially at our all-time high.

At the end of Q1 '09 I had mentioned the business renewal rate was 91.9%.

For the end of Q2, that was 92.2%, so a little bit of improvement there.

On the Gold Star side 85.7% in the end of Q1, 86.1% at the end of Q2.

So we're still, I believe, at an 87%, but we're very close to 87.5, and we're certainly gratified in this economy that we see this level of member loyalty and renewal.

Gross margin, came down on a reported basis 31 basis points from a 10.73% last year to a 10.42%.

Again, we will jot down a few numbers here and walk you through them.

The line items would be core merchandising; second line item, ancillary businesses; third line item, 2% reward; fourth line item, LIFO; and the fifth line item would be other and then the total, of course.

In terms of trends, just looking at the last three quarters Q4 '08, Q1 '09 and Q2 '09, on the core, minus 19 basis points in Q4 '08 year-over-year, minus 13 basis points in Q1 as compared to its prior first quarter a year earlier, and in Q1, minus 7 basis points.

Ancillary, plus 6, minus 46 -- I'm sorry minus 6, plus 46, and minus 19 basis points.

2% reward, minus 2, minus 2 and minus 9.

LIFO - minus 14, plus 1, plus 4.

Other - minus 4, 0 and 0.

Which would give you a total in Q4 '08 we reported gross margins year-over-year down 45 basis points.

In Q1 up 32.

And in Q2 minus 31.

As you can see, our overall margin again was down 31 basis points.

But we will start with the core merchandise, the minus 7 basis points year-over-year core merchandise results, appears a little better than reality because the results in large part from lower sales penetration this quarter of the lowest margin gasoline business.

Our gas business, whereas it represented 8% of sales in Q2 of' 08 last year, this year represented 5% of Q2 '09 sales, and again, with the price per gallon down 41%.

That's certainly evident.

So that's the sales penetration of our core merchandise business that was up year-over-year.

So our gross margins of this core business, which is food and sundries, hard lines soft lines and fresh foods, were reported in this matrix to be down 7 basis points, it was actually on like sales, those departments margin divided by those department sales, it was actually down 57 basis points.

Our largest merchandise department, food and sundries down year-over-year by nearly 70, in large part due to some of the aggressive pricing that we mentioned in both the February 4 and today's press release about aggressive pricing on select commodity items.

One last comment on sales and margins results, deflation of basic products, we have seen it.

We saw it a little bit in Q1 and certainly into Q2.

Sales -- we are seeing that in our sales, despite the fact that sales have been reported pretty well, we are seeing the deflation, and margin dollars are being impacted by that as well.

So that's part of the issue in Q2.

Examples of recent price declines across the board on commodity items- milk and eggs in the minus 10% to 15% range.

Items like trash bags in the minus 25% to 35% range.

Nuts, minus 5% range.

So again, a lot of commodity prices coming down.

We expect to continue to see that for a little bit.

In terms of the outlook going forward.

Overall, again we will have to see each quarter.

But keep in mind we will work foremost to drive top line sales, which may sometimes require some sacrifice of gross margin.

I think we saw some of that in late November in Q1 and early December in Q2, as I described a little bit to some of you, kind of the perfect storm, driving -- consistent on driving sales, as well taking advantage of the underlying price declines we knew would come in some of the product as commodity prices were falling, and getting out there in front of that to be evermore competitive.

We would hope that some of the increased frequency is a product of that.

The impact from the increasing Executive membership, that was a little unusual in Q2.

In the last several quarters it had been impact on margin of minus 2 or 3 basis points which would imply an increase in sales penetration to Executive members of 1 or 2 percentage points, given they get a 2% reward.

What the minus 9 implies is it's a little over 4% sales penetration.

We believe this is a good thing and that reflects increasing sales penetration to our most loyal members.

LIFO, as you recall, was small credit or income in Q1 of $2.2 million pretax, and about $7 million credit tot Q2.

This reflects, again the same deflationary trends that should continue into Q3 and possibly on.

We will have to see.

We should point out that moderate LIFO benefit reported in Q1 and Q2, exclude the effect of gas deflation that's occurred since the beginning of the year.

Because we just are not confident that gas prices will stay this low and certainly don't know when they will turn.

If gas prices continue to be as low as compared to prior year, we might realize some additional positive LIFO adjustments in the upcoming two quarters.

One offset we are aware of, as I mentioned, this $6.50 a carton floor tax on tobacco - a carton of tobacco in the US.

That, of course, will increase the cost of tobacco, and in many ways that may be very much an offset to any LIFO-type credits we get on gas.

Again, it is LIFO, not cash, but nonetheless something that will impact the reported EPS.

Moving down to SG&A.

Our SG&A percentage Q2 over Q2 is higher by 39 basis points, coming in at 10.11 compared to 9.72% as a percent of sales last year in the quarter.

Again quickly, to jot down a few numbers, the line items are operations; second line item is central; third, equity, which is stock options and RSU's; fourth is quarterly adjustments; and fifth would be total.

Again, looking at three columns Q4 '08, Q1' 09 and Q2 '09.

Going across, operations was plus 21 in Q4 '08, meaning it was lower by 21 basis points.

Plus is good.

Q1 '09 minus 16, and Q2 '09 minus 34.

Central, plus 3, minus 3 and minus 4.

Equity related charges, minus 3 , 0 and minus one.

Quarterly adjustments, minus 6, minus 12 and 0.

That's for a total of a plus 15 in Q4 '08 year-over-year.

Minus 31 in Q1 '09 and minus 39 in Q2 '09.

A little editorial on these numbers.

Again, it shows operations was higher SG&A by 34 basis points.

But again, this is mostly related to sales levels, and just like gross margin percentage where it helped us, it correspondingly impacts negatively reported SG&A, into minus 34.

About 21 basis points of the 34 basis points relates to the sales deflation -- the gasoline deflation.

Central expense was higher year-over-year in Q2 by 4 basis points, as you can see in this chart.

Again, the same story as it relates to sales.

I will tell you that while we haven't had any layoffs at central or regional offices which total about 8,000 people of our 140,000, we have instituted a hiring freeze about 2 months ago.

And that remains in effect for the time being.

We do at the warehouses, of course, after every seasonal Christmas, have seasonal -- what we call seasonal layoffs.

In some cases we dug a little deeper there,but I believe in the most extreme examples the people that were laid off were part-timers that had tenure of less than six months with the Company and will be the first to be hired back should they want to be hired back.

And usually that takes a few months.

Overall, we're very pleased with the fact that our sales have remained in the positive direction these last few months and we were able to withstand the fate of many of the companies out there as it relates to hiring and layoffs.

Stock compensation expense, not a big deal there.

I think the actual expense has come down a shade because of the lower stock price, but up a little bit as a percent of sales, simply because of the lower sales results.

Benefits -- overall our benefits in Q2 -- our benefits percentage was higher by 9 basis points.

Again, dollars increased about 4 percent on health care but just below flat sales.

Again, the more we can get sales driving and labor up with roughly the same type of health care costs, that will be good.

Overall, not a bad SG&A performance, given the sales levels and the gasoline deflation.

Next, on the income statement.

Preopening expense - last year $9.7 million or 6 basis points; this year $7.3 million or 4 basis points.

So $2.4 million lower and 2 basis points better.

Of course, last year we had 7 openings, this year none.

But again, it's the timing of openings .

We incur preopening expense, in some cases several months before the actual opening, and in addition, we had some openings just after the quarter as well.

No real surprises in those numbers.

In terms of provision for impaired assets and closing costs, in Q2 '08 last year, we actually had income on this line of $2.9 million, basically $0.5 million dollars of impaired expense and closing cost expense, more than offset by a $3.4 million pretax gain on our property sale.

All totaled, operating income Q2 '09 was down 21% year-over-year.

From $504 million last year to $399 million this year, or a decrease of $105 million.

Below the operating income line, reported interest expense was slightly higher year-over-year, Q2 coming in at $25 million.

Up $1.5 million from $23.5 million in last year's Q2.

These amounts mainly reflect the interest expense on our $2 billion debt offering we did in February of '07.

The reason that the net interest expense is actually down or improved by $2 million has mostly to do with the offset to interest expense which is part of this line item known as capitalized interest, that was actually lower year-over-year by $1.6 million.

Interest income and other was lower year-over-year by $33 million in the quarter.

Coming in at $7.8 million this year compared to $40.6 million last year in Q2.

Just under two-thirds of the lower income figure was lower interest income due to significantly lower interest rates being realized on our investments and a little bit of that lower -- most of it is just year-over-year market changes and interest rates.

A little bit of it is changes in composition of our cash related investments to safer capital-backed type securities like government money market funds.

Another big chunk of this delta was the reporting of our half of Mexico's earnings, the equity method on this line.

Given that the peso has gone from roughly 10 pesos to the dollar several months ago to about 15 pesos to the dollar today.

So again, when we report US dollars on this line, that has an impact there as well.

Overall pretax earnings were down 27%.

From $521.5 million last year, to $381.9 million this year.

Tax rates were pretty much the same year-over-year, 37.2% last year -- this year, and 37.1% last year.

So no real change year-over-year.

Quick rundown of the balance sheet, $3.282 billion cash and equivalents.

Inventories of $4.995 billion.

Other current of $1.414 billion.

Total current of $9.691 billion.

Net fixed assets of $10.354 billion.

Other assets of $692 million.

Total assets of $20.737 billion.

On the right side short-term debt of $173 million.

Accounts payable exactly at $5 billion.

Other current $3.825 billion.

Total current liabilities $8.998 billion.

Longterm debt of $2.198 billion.

Deferred and other of $332 million.

For total liabilities of $11.528 billion.

Minority interest of $88 million.

Stock holders equity of $9.121 billion.

For total of $20.737 billion.

Some of you ask each time for a depreciation and amortization which, of course, will appear ultimately on our cash flow statements when we issue the 10-Q.

For the quarter, depreciation and amortization was $160.9 million.

Year to date, $315.7 million.

In terms of our balance sheet, a strong balance sheet, debt to capital 21%.

In terms of accounts payable ratio, if you just take the numbers, the accounts payable divided by inventories -- inventories divided by accounts payable -- I'm sorry, accounts payable divided by inventories.

This year was at 100%, down ever so slightly from 102% a year ago.

That includes quite a bit of construction payables for our new openings, so if you take and look at just merchandise payables, a year ago was 84%, this year, 83%.

In terms of average inventories per warehouse, last year in Q2 it was $10.45 million.

This year it was $9.625 million, so an 8% reduction or $825,000.

Now againFx is part of that, about $475,000, over half of that $825,000 reduction is the strong US dollar.

So when we convert foreign inventories into US dollar inventories -- foreign currency inventories into US dollar inventories, we see that show low there.

But even taking that out, we had about a $350,000 year-over-year decrease.

It's spread among many departments.

The largest chunk is in majors.

Some of that, again, we believe is simply price deflation on many of those items.

So cost deflation as well.

No inventory concerns.

We feel we did a good job taking the markdowns early and reducing commitments on certain seasonal items.

We continue to see that as we get into the post-Christmas season, spring season here.

Things like patio furniture and barbecue grills we've, like many retailers out there, who are conservative and have the ability to cancel little bit along the way.

So hopefully we'll be able manage our markdowns there.

We'll have to see.

In terms of CapEx, in Q2 we spent $339 million.

Last year in the quarter, Q2 this year, we spent $289 million.

Based on where we think we will come out for the year of 21 net new units, one in Mexico, we'll be probably right around the$1.5 billion range.

A shade lower than our original plans for the year but, nonetheless, pretty substantial amount.

I get a lot of questions about real estate, what is going on with prices and availability.

Availability is going up but prices coming down.

But I need to say they never come down as quick as you want them to.

We are talking with property owners and developers who previously would not even talk to us.

In some cases, short-term where deals haven't been started yet, to the extent the developer has gotten into some financial trouble and the banks have taken over a couple of the projects we had ongoing, we may even delay it a few months where things are sorting out.

I think long-term, this economic downturn and what it's doing to the commercial real estate market is probably net positive for us over the next three to five years in terms of giving us more availability of better sites at perhaps and, hopefully, a little better price.

In terms of Costco online, both Costco.

com and Costco.ca in Canada, avery profitable business, last year did $1.7 billion.

It too, as you would expect, has been impacted this year by the economy and certainly, given the nature of our focus, many of our items are big ticket discretionary items, like electronics, like home furnishings, like jewelry and the like.

In Q1 sales were up slightly but recall, September for us was pretty strong.

It's in October and November when our sales started to come down a little bit.

In Q2 sales were down slightly in the mid single digits.

Again, I believe a reflection of penetration of these bigger ticket discretionary items.

We've seen our average ticket on Costco.

com go from the low $400 range to the high $300 range.

Our ecommerce, as I mentioned,the business is very profitable, but sales have been below plan, as you might expect.

That being said, it's a good business for us and we'll continue to capitalize and grow it going forward.

In terms of expansion, as I mentioned in Q1 we opened 8 new locations and closed one.

That was really the closing of our original Las Vegas location which we have since in early Q3 here re-opened as a Costco business center.

So a net of 7 openings in Q1, no openings in Q2, we plan 5 new openings in Q3 and 8 new openings in Q4 which would give us 21 openings less the one relo, so 20 net openings.

In addition, one in Mexico, so 21 for our company.

If you look at the 21 on our starting base of 543 at the beginning of the year, it's about 4% unit growth and perhaps a little over 4%, 4.5% square footage growth.

At Q2 end our total square footage for those of you who keep those stats, 73.7 million square feet.

Lastly, in terms of stock repurchases, as you know that we began repurchasing stock back in June of '05.

We purchased through this past September, just under 89 million shares for about $4.8 billion.

We still have repurchase authorization under our Board authorized programs of about $2 billion.

We currently are not in the market and we have not been, as I mentioned, since last early fall.

We are prepared to be in the market as conditions warrant and we will let you know when we are.

As mentioned in the February 4 press release and conference call, given the volatility and uncertainty we are not providing guidance for the quarter and the year, but hopefully can give you some insight into how we've done in the quarter and what we see going forward.

Lastly, I'll mention that we have supplemental information including balance sheet and quarterly LIFO charges and opening schedules, in our q-and-a we put on our investor relations site later this morning.

With that, let me turn it back for questions and answers to Chastity, and I'll be happy to

(Operator Instructions) your first question comes from the line of Charles Grom with J.P.

Morgan.

Good morning, everybody.

When you look at the second quarter, the 57 basis points of core margin erosion, I know you are not going to give us back half EPS view, but in terms of modeling purposes do you think that's a good proxy or do you think it could be a little bit better.

I think you walked through all the components except the 19 basis points of ancillary margin compression in the quarter, could you just kind of flush that out for us?

I would hope that the minus 57 were better, recognizing it includes seasonal markdowns which were higher than planned, but for a good reason to do.

It included that "aggressive pricing" which as I -- I don't know if I mentioned on this call but when we did that, as you recall, we did a little bit of it at the end of Q1 as well in November.

What we did is comps were starting to weaken.

We felt very strongly we wanted to drive sales in the right directions.

We saw commodity prices starting to come down, and knew it was matter of weeks, not months, where many of the underlying procurement costs would come down.

And we did what we're good at.

We try to drive sales and ate some of that margin.

So given that you never know what is going to happen tomorrow in terms of sales, I think, as I mentioned, we are prepared to sacrifice margin if comps are going in the wrong direction.

At least for the last couple of months they've been going in the right direction.

Based on that, I would hope that it's a little better than that.

Again, we will have to wait and see each quarter.

In terms of the ancillary business margin down 19%, that's basically gas.

That could be up or down.

Our underlying margins in the ancillary business is photo, one hour photo is probably the weakest as people, even though we are getting a lot of business and a lot of specialty printing with the books and all the things you can do online and the come pick up at Costco for the most part, people are storing more things on their computer and not printing out lots of copies until they want to print out what they want.

So that's a business -- that's a challenge in the industry.

Pharmacy is, despite its challenges with $4 prescriptions and Medicare, Medicare part D and everything else going on out there, we seem to be doing pretty well in pharmacy.

Food court is strong.

We cycle -- it was a year ago I think we were anecdotally talking about holding prices despite huge increases in things like cheese.

I think one of the national pizza chains actually had a cheese surcharge, price surcharge, for a period of time back then.

That has reversed itself with procurement cost, and within the food court we see strength in take-home items like full cooked pizza which is quite strong right now.

Again, I think the fact that people are eating out less and eating more at home.

Okay.

And moving on the P&L historically, I think you said roughly a 4 to 5 hurdle rate with your traffic up north of 5% and food becoming a bigger piece of the mix, is it costing more for you guys to generate each sales dollar or, in other words, less dollars falling to the bottom line for every sales dollar you generate.

I think you have a couple of things going on right now that does.

I look at our health care costs which, again, in real dollars are up 4%.

Notwithstanding no layoffs.

To the extent we cut hours back of a few people, we are still paying for 100% of their health care, if even if they are working 70% or 80% or 90% of the hours they used to work.

So that has an impact there, short-term, hopefully short-term.

Also, some of deflationary nature.

Anecdotally, we sold 60%-- almost 60% more television units for a 2% increase in price.

Our margins -- our percentage is fine, but we are seeing more labor involved in getting those dollar sales.

And then you look at deflationary pressures on -- I looked at one, and again, it's a more extreme example, but something like garbage bags which in the last couple of months the price point come down over 30 %.

Units are up five or ten which is good, which means dollars are down less than 30%, we are not making all that margin back.

So as you certainly know, we are also looking at how to drive bigger sizes of items we continue to do that to help offset that.

Those are the things I think make it little less predictive of, say, if I give you comp -- underlying comp -- if you give me underlying comp I can give you what the SG&A is going to go up or down.

We feel pretty good about controlling our expenses.

Recognizing that we are getting a little benefit, also, from some of the packaging changes, which in part is the greening of manufacturing, but some of the square boxes I talked about instead of round containers, better, more tight packaging on paper products with new technologies by the manufacturers, all those things lower freight, lower handling expense.

So on a very small basis it's helping your margin and your SG&A or offsetting some of the other things that are hurting them.

Thanks.

Thank you.

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

Good morning.

I appreciate the comments on the garbage bags, et cetera.

But if you look at the products where you proactively went lower on margin, how is the price elasticity on some of those categories?

Honestly, we don't look at it and then determine we won't do it again because we only got a 5% bump in units when we thought we might have gotten a10%.

What we try to do and I look at it more as when we run our business, when we saw the underlying US comp go from a 5 in September to a 2 -- this is without gas -- 5 in September to a 2 in October to a 1 in November, we are saying, hey, we are going to -- and knowing that there are several commodity items that were going to come down in price in the weeks to come, let's be proactive and take them down fast.

If it costs us $10 million or $20 million or $30 million, we are going to do it.

That's us guys.

So we are less concerned -- we know -- we believe it helped.

We see our frequency up when our brethren out there are not seeing these types of numbers and we are going to do that from time to time as we see fit.

I think Jim talked has about in the past, we are for profit company, and we are trying to go in that direction.

We feel we are being better served and our shareholders will be better served as we come out of this economy, maybe in a couple of years from now, maybe a year from now, because of the things we are doing right now.

Have you looked at how you effected those discounts, was it done with couponing or was it done in-store signage, how did you show that to the consumer.

Mostly just lowering the price.

We are not big at putting out bright yellow signs saying we are lowering price.

We don't do that.

But on the kind of commodity items that we're talking about - milk, cheese, butter, chicken, our customer gets it.

The couponing, like the multi-vendor mailers that we do, generally those are negotiated with manufacturers where a lot of those costs, other than perhaps some private label items which are both the manufacturer and us, those are the types of things that will that we negotiate and the vendor pays for a lot of that.

But just the lowering prices is where we do it.

They get it.

Sales are I mean -- I hate to use the chicken example again.

But on an item we are selling a million a week of -- that chicken, a million units a week, we went down from $5.99 back to $4.99 about 8 or ten weeks in advance of the underlying cost to us coming down.

Our margins in chicken from 3 months ago, they went down by half and they've nearly doubled going into the next month, back to a healthy margin.

Again, I'm sure somebody can show us that if we had not lowered it, we might have made this month a little extra dollars, but when you see the type of frequency and member loyalty we have, and the underlying sales growth, we think that's the right thing to do.

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

Thank you, Richard.

Just following up on the margin, just share your outlook in terms of deflation and procurement costs and it sounds like, much like we saw this past quarter, we should expect ongoing investment in price.

Is that fair?

I think -- I hate to use the word, but I do.

It's a little bit of a perfect storm as you look back in November.

Again, we are looking at comps going from 5 to 3 to 2 to 1.

We're looking at commodity costs starting to really come down a lot.

Knowing it's a matter of weeks, not many months, before the costs to us are going to come down.

And that's a little different than now where, yes, there is continued price deflation and we'll take that, but we don't necessarily have to always take it 8 weeks in advance.

Particularly when we see comps going in the right direction here.

I think that's a little bit different painted picture there.

So you got ahead of it, I guess, last quarter and now perhaps --

Ahead of it, maybe there's still a little of it.

But not as much back in late November, December.

Keep in mind, we are not the only ones out there pressuring manufacturers.

So on the one hand you read in the paper that some large, very great consumer products companies are talking about increased prices sticking.

I think you could think there is more than just Costco out there saying, oh, yeah.

And we are out there every day, and Jim and Craig are putting the pressure on the buyers to go out and get it.

We have a unique position in the sense, also, that we don't have to carry three brands.

We can choose between brands that are going to be more aggressive that help us help our member.

So it doesn't happen overnight.

We respect the fact that for years there was probably some pent-up demand for some price increases as the retailers could push back hard during those periods of small inflation.

But there is some big inflation that -- last year, and every time when it was explained to us it was because resin prices went up this and electricity costs went up that.

And feed prices and grain prices went up x, y, z.

We know what those prices are now and we are going back for it.

I think you will see both.

Again, the manufacturers will have to choose what they want to do also.

We think there is an opportunity for the manufacturers to help our members as well here.

And then shifting to private label, big spike up in that penetration, that 300 basis point spike, help us understand there the margin opportunity.

Have you been as aggressive on private label?

One would assume given that penetration, how helpful has that been in terms of offsetting margin.

Does that represent as healthy of a margin as we once saw.

Certainly, the private label margins tend to be better.

This is not the extreme example of replacing some branded sales where it was a commodity football item out there that was always selling at 5% to 8%.

And we've replaced it with a $0.75 price point in a 20%, 25% lower price at twice the margin percent, so at more margin dollars per unit.

Some of it is more that I think while it will continue to help margins as it plays out over the next year, what we have seen in just the last few months, really, for the first time is why is it more than just a gradual increase in penetration.

It's that -- our feeling is it's somebody looking at a $20 price point on a branded sundry item and saying, hey, I can save $6 or $7 or I can save $4 or $5 on a -- $3 or $4 on a $15 item.

Th brand loyalty changes a little bit.

I think part of it is also the quality.

Once they try it, they like it.

That is there are items -- there are items out there right now where the brand hasn't come down, so that $3 and $4 on a $20 item might be $6 or $7.

These are finite examples.

But I don't it's just the low-hanging fruit any more.

So yes, there is a net margin percentage pick up.

There is a pick up in dollars, but not huge.

But that's okay.

I guess my question is the differential in terms of margin or private label versus national brands, has that narrowed.

I think it's only narrowed in a sense that the original low-hanging fruit was taking the ultimate hugely brand loyal items that everybody discounts out there, diapers, paper towels, you name it, that it's 8% to 10% margins, or even 5% in some cases, where we can replace it with a 12% to 15% margin.

Okay.

My last question, it seems as if the sharper prices are striking a chord, you are seeing incredible traffic.

But the fact is the model is less equipped to handle smaller tickets and greater frequencies would seem to pressure the cost structure, and understand you are looking to add members in the eventual upturn, but could you be doing something to, perhaps, mitigate the pressures on the clothesline as traffic continues to move higher and tickets come down?

Well, we still -- it's the old saying - each buyer has 20 priorities that are number one.

One of them is on food sundries items and increased package sizes.

We are constantly doing that, we're constantly going from a 6-pack of canned goods to an 8-pack where we can.

I think we found our limits in many water and soda items,the darn thing is - we've gotten up to 30 counts of water and power drinks and what have you, we've had to increase plastic so it doesn't break when you pick it up and we don't want you to hurt your back either.

I saw examples in the last budget meeting where we're looking for bigger sizes of our own KS tuna, in the numbers of cans and size of the can.

That's how you combat a little of it.

But I wouldn't say that's number one on the list.

We are driving our business right now.

Again, whether this economy in its current state lasts three, six or nine months, or two to three years, it's probably somewhere in the middle, we will incur part of those costs while it happens right now.

There is not a lot magic bullets.

I think some of the greening stuff that I mentioned, we are seeing freight improvements, not only freight rates but pallet throughput because we get more items on a pallet.

Thank you.

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

The questions I have, first, on the increased penetration of the Executive membership spending, did this reflect accelerate growth in spending by Executive members or a slow down in spending by nonexecutive members?

I think a little bit both.

The fact is is they tend to be a more affluent and certainly a more loyal group.

I think part of it is the fact that ,as I mentioned, that we are more successful today converting people to an Executive member than we were a year ago.

By the way, gas is part of that, too.

Even though gas as a percent of sales is down a little, gas doesn't -- it's not disproportionate to the business member.

Just some questions on the gas business overall, so gas profits were down but prices really didn't move much.

Has your thinking changed around the profitability or the approach to the gas business?

Not at all, gas is going to probably be volatile as long as we are around.

Every time it goes up, it becomes the topic d'jour at night on television.

And we have seen that enhance our value and frequency.

Despite, again, the requirement for a thicker stomach lining in terms of reporting gas profits, on any rolling 12-month period it's been profitable.

And as I joked, it was embarrassingly high profitable in Q1.

Slightly not profitable in Q2.

That's the nature of that beast.

But if we could have a gas station in every location we would.

We are constrained, of course, because of the size of the parking lots and traffic mitigation issues and the like.

We are constantly in every existing location that doesn't have one, where we can, we want to put one.

On the gas, can you talk a little bit about gallons trending and when you look at the overall traffic number for the business, where do you think all the share gains are coming from within retail?

For us?

Yes.

Well, I assume gallons are coming from, again, I think -- this is my own feeling, not something else as we -- but I think for the same reason you are seeing people willing now to save and $3 and $4 on a $20 item, which they, despite brand loyalty versus KS, the same reason.

There is a few more people probably going out of their way to save a few bucks at the gas pump.

And it's reinforced every time somebody on the news talks about gas.

I want to get back to the larger sizes, too.

That stuff is always a better value.

Again, everything right now is reinforced out there, that average family that's eating one or two fewer times in restaurants every week, the fact that our pizza sale -- our whole pizza sales are up in the food court dramatically.

The fact that penetration on $15 to $20 price points are up.

People are willing to save $3 and $4.

All that stuff is, in my view, the common reaction to what is going on out there.

So I think we will continue to drive towards what we call sensible upgrades of sizes, some customers sometimes argue that we've exceeded that sensibility but we keep trying.

One last question for you, Richard,is when you look over the next several months with discussions with the buyers, do you think the deflationary trends will be greater than what you have experienced over the last three months or four months?

Over the next six months, with discussions that you have with a lot of the suppliers and vendors, do you think deflationary pressures will be greater than they were over the last three or four months?

I hope so, that is probably the focus right now of our buyers on those items.

Prices of the underlying raw material cost and electricity costs to make it, and we want it.

We want to give it to our member and we want to be first.

Thank you very much.

Thank you.

Your next question comes from Dave Binder with Jefferies.

They got the Binder part right, they got the first name wrong, but that's all right.

It's Dan Binder.

Couple of questions for you, first on the -- if we just go back to the 57 basis points of gross margin erosion, it sounds like the inventory is in pretty good control, so the markdowns presumably won't continue, as you pointed out.

But if we were to look at sort of the piece that was attributable to more aggressive pricing.

I think in your preannouncement call, you had said that rough and tough -- I think you said you sort of back -- 75% back up to the way of -- back to normal on the items where you did cut prices.

And I'm just curious, how do the margins look today on those items that you cut prices on versus what they look like prior.

Well, they're going to be less negative or hopefully going towards better.

And the 75% were in the items that we did.

We are still -- there still may be a little more in the future.

There is nothing driving that goal now.

If you look back when that trend line over September through November was south in terms of underlying comp, there is a, if you will, a call to action to do a little more of that.

I think -- I would hope you will see it a little better.

We will find out in late May or early June when we announce Q3.

The improvement in the renewal rates was pretty significant.

I think you have probably like 15% more members renewing during that November to January period than any other time during the year.

How much do you think the lower prices may have helped to boost those renewal rates above what we typically see?

Well, if Jim were here, all of it.

I think it's all of the above.

The fact that we've always seen the Executive member be more loyal.

To use the 87 number, execs are in the low 90s.

So that 25% or 28% of our membership base, by definition, is the one that they see the value, they are willing to pay twice as much.

By us being more successful at converting new members or signing up new members as Executive member, to start with, by our success in figuring out how to keep talking to the same ones that have said no in the past without upsetting them that we're asking them again, but we've done, I think, a better job of that.

So that helps as well.

I'm hoping that some of the press out there, not the Wall Street press but News press, recognize that what we are doing in some of the price reductions, unlike a lot of people -- retailers out there, we are helping the consumer out there, too.

We are doing it so we can drive business, but we're being aggressive on that.

And hopefully that drives sales when our members know we not only treat our employees right, but we're bringing down prices.

I'm not sure if you mentioned it earlier, when you adjust for the currency impact, was your membership dollars closer to 8%?

That's kind of what we were coming up with, just wanted to double check.

They were up -- yes, I mean if it had been flat currencies, it would have been higher by about 4 percentage points.

Okay, so close to 8.

Then in terms of the new store productivity on the stores you opened in Q1, how are you feeling about those thus far.

In terms of what you're seeing.

They are fine.

I might add that the two new warehouses that we opened in the last few weeks, arguably in very successful markets for us,Los Angeles and Honolulu, we're not only pleased with the sales levels, but with the-- in our view of the net new business we're getting.

Now, they're only a couple of weeks old, two weeks old.

But we are getting off to good starts in those.

Then lastly, I know you are not providing guidance but street is at like $0.60 on Q3.

Based on everything we heard today, it sounds like that's probably too high.

I don't know if you can give us any color in terms of your thoughts about that.

My Securities counsel is across the table from me and he is pulling a quiver out of his pack.

No, we are not doing that.

Okay.

Thanks.

Thank you.

Your next question comes from the line of Daniel Hofkin with William Blair.

Good morning, Richard.

Question I guess if we were to kind of look at operating income trend and the growth in membership fee income, if you were to strip out just the membership fee income you would have sort of operating profits down something on the order of [70%] year-over-year.

Obviously that is allocating no expenses whatsoever to membership fees.

I'm just wondering what's the right way to look at that, how much of your overhead do you think ought to be allocated against membership fee income if we wanted to look at those two sort of the merchandising --

I would do very little.

Yes, there is an ongoing expense of running the membership return desk and mailing out 29 million or whatever lower number because of some of them are auto renewal.

But the fact of the matter at the end of the day, we have always looked at membership fee as part of our total gross profit margin.

If we are at roughly -- if member fees in the second quarter were 2.16, and gross margin was at 10.42%, that's a 12.6, in good times, approaching a 13.

That 13 is roughly an 11 and a 2, or that 12.5 is a roughly a 10.5 and a 2.

No matter how we get it, that's our model.

I know it's nice to be able to strip it out.

Needless to say, we wouldn't be getting them unless we did what we did in the warehouse.

No, you have a fair point.

And that's the basis of the question, not wanting to overweight or underweight the allocation there, just in terms of how you look at internally.

And I guess another question would be, I think you indicated in the prerelease call that gallonage was even stronger in January, gas gallonage on a comp basis.

Has that continued into February?

We will see.

Gallonage has been positive, and there is no indication that it's going to switch.

i think what you are alluding to is the fact that on the way up in prices, when gas was hitting $3.50 plus, not only was the price per gallon up, but the gallonage itself was up better than normal.

And the fear, of course, was well, now that nobody cares any more about the price of gas as much as they did when it was approaching $4, are people going to then come less frequently because they don't see it on the news every night.

To our pleasant surprise, that did not occur.

But I think probably gets back to the point I made on some of the switch in private label.

People are going further to save $2 or $3.

Again, everybody is on the value train here.

And then final question on the -- at the very beginning when you quantified sort of the sources of the profit difference, was that all compared to last year's second quarter, or was that compared to what you might have expected a few months ago?

Well again, if you look at what first call for Q2 was, as we began our fiscal year, I think it was about the same as last year.

Plus or minus a penny or two.

It's really kind of both relative to what expectations were, first of all, and arguably perhaps, we were providing a little more guidance six, eight months ago.

So roughly that $0.74 number last year I'm pretty sure was pretty darn close to what the expectation was in Q2 this year.

At the beginning of the year, of course, it's come down.

And so in that regard, either way you look at it, it's the same.

When you look at it, if you took last year's number versus this year's number, that $0.19 change times about $7 million is $130 million pretax.

If you look at gas and the Fx, each of those was in the mid-20s, so that's about 50 of the 130, so everything else is the other 80.

A shade of it might be expenses but the vast majority is all the things we talked about that impacted margins.

Thank you.

Your next question comes from the line of Deborah Weinswig with Citi.

With regard to some of your prepared comments on aggressive pricing , I think you said there is a $0.03 to $0.04 hit.

Was the majority of that, the reductions on pricing, on

No, that was all really consumables.

Chicken, milk, cheese, butter.

Garbage bags, things like that.

That was entirely good stuff in terms of sales.

We wanted to be aggressive and the customer knows those prices, and if we can show it, they will see it.

And as we think about kind of moving forward through the rest of '09, its sounds like the levels -- it's sounds like you're not being as aggressive, but how should we think about kind of relative to what we saw in the quarter?

I think we are going to be as aggressive in terms of our mind set.

Again, I think given that November was like the third or four month in a row of downward trending underlying comps, prices started to fall, underlying commodity prices, and so we knew it was a matter of weeks not months.

We are not perfect but we are not being aggressive just to damn the torpedoes here.

We are going to still try to grow our bottom line as well .

There may be weeks or months when we want to be as aggressive.

I think the general view out there should be that it will be not as aggressive, but we are going to st ill be aggressive relative to our competitors and we're going to do what is necessary.

I think we all have our fingers crossed for you guys that we won't need to be that aggressive.

And we are trying to -- we have a tough job.

We're trying to lower prices and

What are you doing in terms of communicating the more aggressive pricing to your customers, or is it mainly that they are in the store and they recognize that the prices are lower.

We would ask each of you to call your friends.

In truth, we don't do a lot.

Again, we don't have big bright yellow signs saying it.

We don't needlessly advertise sales.

Our view is that the customer gets it.

In our view, they are more value conscious today than ever before.

I think we see that again in the fact that gas frequency has continued despite the price point that's come down 40 plus percent.

We see that with the people willing to save $2 and $3 and $4 on a $15 or $20 branded versus Kirkland signature item moreso than they have ever before.

That's what we think drives our business.

I can guarantee you though, that somebody out there on the call from one of news agencies, it will become a -- not as big as we'd like, but they will get the word out, too, that we are doing what is right for our customer.

With regards to the categories that you are seeing deflation in, are you seeing an increase in volume there as well?

Yes, but again it's not always proportionate with the same steepness of slope.

Again, what I have in front of me is just some charts from the last budget meeting a week ago from some of the buyers.

There is examples of where a branded -- these are nonfood sundry type items, whereas the branded item in the last 20 weeks is flat or down 5% units, and the Kirkland signature item is up 10% to 30%.

So we therefore stamp it, must be because -- this is not a new item, it's an existing item.

That's been around.

And all of the sudden that big delta.

Not on every item.

Needless to say, certain items are more brand loyal than others.

And certain items, there is no private label.

Yet, as Jim would say.

Last question, I don't think you used exact penetration, but the percentage of sales that Executive members represent.

And then are you seeing the same increase in traffic by that customer or is it greater?

I don't know the traffic question.

I know that just the simple math of the impact on basis points to margin 2%, 2 basis point impact year-over-year negative to margin.

That's a 1% increase in penetration.

In Q2 it was nine basis points.

So that's about a 4.5%.

I don't want to be -- sound arrogant about it, but the Kirkland Signature has become a brand.

When we see in leading consumer comparison magazines where they are testing 12 SKUs of this like item across 12 different brands, we are usually one of two or three out there that are private label brands that are right up there -- that are at the top of the list in terms of quality and value and price.

And so in many cases our brand is becoming a brand.

Thanks so much, I really appreciate it and best of luck.

Your next question comes from the line of Sandra Barker with Montag and Caldwell.

I had a question about items where there is deflation and the price is going down, will your degree of price pass through to the customer, be what you would consider sort of normal?

Or will it be more aggressive than you maybe might have been doing during your margin enhancement.

First of all, our normal is aggressive.

And recognize, arguably we are always going to try to maintain some dollars.

But again, when a selling price on an item out there for Costco is at $15, and I'm making the number up here, but let's say the cost was $13.50 and we made $1.50 on it, so we made about 12%.

When the underlying price went from $13.50 to $9, like a garbage bag in the last few months, we might try to make $14 or $15 as the case may b,e but still that's not going to cover the 30%, 35% reduction in price point.

So we will lose those margin dollars on that.

But that's normal for us.

Conversely, we are still trying to find those items where we can make a little more.

Second question has to do with just inventories of discretionary merchandise, are you being ever more tight on the way you're planning that?

I mean, how do you look at that?

If that continues to be weak are you continuing to control that more and more tightly?

The answer is both.

I think things like electronics, the fact that nobody else out there -- nobody else out there is selling 50% increase in units.

They are all experiencing 30% and 40% decreases in average selling price.

We have the ability to do that.

In fact, in the case like TVs, there is almost a limit to how much we can do because, I mean, how many more TVs can we sell to our members right now.

Clearly, going into the spring season here, which for us starts the day after Christmas, way back in June, July when we are making commitments to barbecue manufacturers, grill manufacturers and patio furniture manufacturers, and pool accessories, we are, again this is anecdotal, it's not across all items, but I think gives you a direction.

If in a normal year we'd be buying 8% or 10%more units, we might be buying 10% or 20% fewer units at the extreme, maybe5% to 10% in some cases.

In addition, we are able to negotiate also increased cancellation capacity.

So if we are bringing in 20 containers of an item that by certain date, by date certain we can cancel some of those, based on their manufacturing schedule.

So there have been some instances already.

I'm not going to name which items, where we may have planned units down 10%, but we also -- we have already canceled a few orders such that unit sales will be down 30%.

There is others that are just fine, by the way, so I don't want to imply that all categories.

But that's the nature of the beast right now.

It's a hell of a lot easier for us when we can focus on one item and do that.

Clearly, our focus is driving nonfood sales for all the reasons.

That was our focus, we are turning the food and sundries a lot faster.

We have a lot of capacity to turn those other areas physically, and so the focus is on nonfood.

So if we can get somebody to buy another $100 or $200 or $500 item, that's a lot better than getting them to buy 50 more $20 items or $10 items.

Lastly, you didn't talk about anything particular in terms of availability of new brands or what that environment is like or also getting special treasure hunt type deals?

It's good.

That's probably the one thing I didn't ask the buyers about in terms of giving some examples.

But you see some -- not just in apparel but in luggage and vacuum cleaners, I'm just thinking aloud here -- some well known name brands out there.

Electronics.

And again, a lot of that is going to stick after the economy.

So that's a net positive.

But again, if you look at apparel, despite increased brand availability, apparel is down slightly ,which is a heck of a lot better than traditional apparel.

It hasn't made it plus ten, it's just made it a lot less -- a lot better than minus 20 or 30.

Sure, thank you.

Why don't we take two more questions.

Your next question comes from the line of Teresa Donahue with Neuberger Berman.

A follow up on the discretionary question, do you have any sense at this point to where the mix may bottom in terms of when the comparisons start to become easier on the discretionary categories, when we may get some mix relief on margins.

Say it again, Terry, I'm sorry, I didn't follow.

Discretionary the mix shift --

Started in December.

But it was exacerbated, I think if you look at the Dow Jones industrial average.

It really hit into October and into November.

Thanks.

Thank you your next question comes from the line of Michael Eckstein with Credit Suisse.

Good afternoon Richard, that's East Coast time, of course.

Can you talk about where you are in sort of penetration of private label?

And how you're using it?

Are you using it strictly for price points.

Is there any margin opportunity in that as it gains traction and recognition?

Thank you very much.

On the latter, yes, there is always -- we will have a higher number on it any way.

We allow a higher number internally, we still have some initiatives available.

In many cases, we get near the highest end, as compared to branded which, again, can range from five to -- even though the cap on branded is 14 and private label is 15, I would say compared to each of those categories capacity of 14 and 15, we can get a lot closer to 15.

We are using it to -- certainly using it to drive business and making sure that we are -- ultimately it's when we create that loyalty with that item as you all know, we have it for life.

As long as we continue to show the quality, in that 20 or at least 20 or, in many cases, more percent value.

So I think that -- what the -- on the one hand in some categories like apparel, this downturn in economy helped us with availability and certain nonfood categories.

On the food and sundry side, and health and beauty aids and the like, we're getting help for a different reason on private label versus branded, the fact that people are not just looking to save $100 on something, they are looking to save $2 and $3 on something.

What was the penetration like?

I'm sorry, penetration is I want to say somewhere between 18 and 19 total company on the food and sundry side.

Which is about 15% of our sales.

It's about 22%.

So it would be in the probably mid teens on the nonfood side, recognizing nonfoods.

Most electronics, it's all brands.

Has that grown over the last 6 to 12 months significantly because people traded down?

The biggest growth we've seen on is on the food and sundries private label, in the -- since year to date, so the last 24 weeks.

We have seen -- in a normal over the last ten years you might see a half a point to a point increase in penetration.

We've seen over 300 basis points penetration.

That's a lot.

Thank you very much.

Thank you everyone, we will end the call and Bob and Jeff and I are here.

Thank you for listening.

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