好市多 (COST) 2009 Q3 法說會逐字稿

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

A this time I would like to welcome everyone to the Costco third quarter earnings conference call.

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

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

(Operator instructions) Thank you.

I would now like to turn the call over to Richard Galanti, CFO, please go ahead, sir.

Thank you.

Good morning to everyone.

This morning's press release reviewed our third quarter fiscal 2009 operating results for the 12 weeks ended May 10.

As with every conference call I'll 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 on 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 third quarter fiscal operating results for the quarter, as you saw this morning, earnings per share came in at $0.48 a share, down 28% from last year's third quarter of $0.67.

Current First Call consensus currently stood at $0.53 as we announced earnings this morning.

As outlined in this morning's release, this year's third quarter earnings results included impact of several items, nearly all of which negatively impacted our results for the quarter, and these include a pre-tax charge of $34.1 million, mostly noncash, related to litigation settlement covering our membership renewal policy.

That's about $0.05 a share.

From a couple of emails I got this morning there's a little bit of confusion of where that lands.

About $27 million of it hits the membership income line and about $7 million hits the SG&A line, the $7 million being the cost related to the plaintiff attorney's cost as well as mailing cost -- and production costs on our side.

The -- in addition, we mentioned in the press release, higher employees benefits costs.

About two-thirds consisting of higher healthcare usage and then other benefits as well.

In all about $0.03 a share negative impact.

What I mentioned for the last two quarters and I'll probably mention next quarter as well, ongoing FX headwinds, our foreign currency results when converted in US dollars hurt us again in the third quarter by a little over $25 million pre-tax or about $0.035 a share after tax.

That is assuming FX exchange rates were flat year-over-year, which they are not, of course, our foreign country operating results in Q3 would have been higher by this amount.

Assuming no major currency changes throughout the rest of the fiscal year, we would expect a continued hit to earnings of a little over $0.01 a month, or about $0.04 or $0.05 a share in the upcoming 16 week fiscal fourth quarter.

It could be a shade less than that at this point, and the last few weeks foreign currencies relative to the US dollar have rebounded a little bit, but again, that would just simply mean the $0.04 to $0.05 in my view might be $0.03 to $0.04 as a hit.

As you recall, there was significant strengthening relative to the US dollar, relative to the foreign currencies of several of the foreign countries in which we operate.

Back in mid-September to early November of last year.

Again, hopefully that -- once we get past that anniversary and hopefully see a little more stability in those exchange rates, that won't be an issue to discuss.

As you can see in our income statement our income tax rate was higher year-over-year inQ3, it came in at 38% this year in Q3, versus 36.6% last year in Q3.

This represented about $0.01 a share negative impact to our Q3 results.

There are a couple of discreet items I'll talk about later.

Nothing terribly exciting.

Other items hitting, if you will, Q3 P&L about a $4.5 million pre-tax charge to our investment accounts.

These are the remnants of the $1.1 billion we had in enhanced money market funds starting about a year and a half ago when some of the markets melted out there.

And liquidity got held up.

In addition, there's just under about a 5 -- very -- just under $5 million pre-tax charge to reserve for the closing and related cost of closing of two Costco home stores effective July 3.

Again, in Q3, we have a hit of about 4.9, right -- almost -- just under $5 million.

We expect to incur up to $2 million to $2.5 million pre-tax in Q4 when they actually close.

So another small hit in Q4.

LIFO was actually a little bit of a boost, about $0.01 per share pickup in the quarter or $6.5 million pretax.

And as I will discuss in a few minutes, the hits to gross margin we incurred in Q2 year over year abated nicely in Q3, I'm sure at least to many of you, and us.

In terms of sales for the 12-week quarter, reported total sales were off 4.8% or 5%.

Our 12-week reported comp sales figure showed a decrease of 7% around minus 7%.

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 basis, the minus 5% US sales decline in Q3, would have excluding gas deflation would have been flat at zero, and total Company comps reported at a minus 7% for the quarter, excluding both gas deflation and FX changes would have been a plus 2% for the Company overall.

Other topics this morning that I'll review.

Our opening activities and plans, after opening eight new locations in Q1, we opened no new locations in Q2, and then in Q3 we opened four net new locations in Q3.

Q3 openings included two new Costco business centers, one in Las Vegas and one in Hawthorne, California.

Three new Costco warehouses, one each in California, Hawaii, and Texas and a temporary closing of our 26-year old Redwood City, California Costco has been rebuilt and expanded and will reopen in the Fall.

Most likely in Q1 of fiscal 2010.

Since Q3 end on May 10, we've opened one new location in Dartmouth Nova Scotia, Canada.

With six additional openings planned before our August 30, '09-fiscal year end.

Included in the six are three in Asia, one each in Japan, Korea, and Taiwan.

A new business southern Southern California, another one, and our 32nd Mexico warehouse club.

A new one in Mexico.

In mid-August we expect to open our first location in Australia .

In Melbourne, Australia.

We now -- we currently operate 555 locations around the world including the 31 in Mexico.

Other topics, of course, this morning, ancillary business results, Costco online results, membership trends, a little discussion about margins and SG&A, balance sheet, which I'll briefly go through the numbers, but we'll be sending that out be available shortly in our big Q&A fax that we send out and a few comments about inflation and deflation.

On to the quarterly results.

Sales for this year's third quarter the 12 weeks ended May 10, were $15.5 billion, down just under 5% from last year's third quarter of $16.3 billion.

As I mentioned earlier on a reported comp basis, comps reported were down 7%.

The 7% third quarter reported comp was mostly comprised -- recall we start in the second week of February, and end in the -- at the 10th of May, but mostly comprised of the minus 3% that we reported in February, the minus 5% in March and the minus 8% in April, plus the first couple of weeks of May which we haven't reported yet.

Please recall the minus 3% in February, would have been a plus 5% without gas and FX.

The minus 5% reported in March would have been a plus 4% without those two items, and the minus 8% in April would have been flat.

A well, keep in mind that there was the Easter shift, so that the -- what I'll call the normalized plus 4% in March, had the benefit of we estimated 1% to 2% by the Easter swing, similarly the normalized flat in April had a minus 2% to 3% hit because of the swing of Easter.

So if you look at April and -- March and April, excluding FX and depreciation, and adjusting for the Easter shift, pretty similar numbers.

The minus 7% reported comp figure was negatively impacted by 4.3% due to the year over year strengthening in dollar.

As you noted in the press release, our international comps in local currency were actually up 8%, but once converted in to US dollars are reported at minus 12%.

Gasoline as I mentioned was the big impact, the minus 5% US comp would have been flat.

This impact may be a little bigger negative in Q4, as we anniversary peaking gasoline prices last summer, part of that will depend on what gasoline prices do between now -- unfortunately in the last several weeks they have been rising a little bit, if that continues in the summer, more, we might see the same kind of trend.

For the quarter, we always share with you what the comp number is in terms of -- if the product of the average transaction size, and the average frequency.

The minus 7% reported comp consists of an average transaction decrease of about 10.5%, and an average frequency increase of about 4.5% plus.

Again, though, the minus 10.5% includes FX which is a little over 4% of the quarterly comp number, and gasoline, which is a little over 4%.

So still down slightly after these adjustments.

Again, we continue to see some deflation is in consumables as well as of course, items like electronics.

In terms of cannibalization, not a big issue.

Maybe at some point we'll stop talking about it.

But it was about 35 basis points negative in the quarter.

Same impact as occurred in Q2.

In terms of sales by geographic region.

Overall Q3 was a tad weaker than Q2, taking out all of the noise, but not tremendously weaker.

Within the geographic regions, nothing surprising there as well.

California was the weakest.

Southern California being a little weaker than northern California, you'll see similar things in parts of Florida and parts of Vegas and things like that where the real estate economy has hit us.

Relatively speaking our Northeast was the strongest region of our major regions in the US Canada, and other national fine, other international below doubles, positive.

So again, geographically, that's how we look.

In terms of merchandise categories for the quarter, within food and sundries which is in the low to mid-singles, adjusted -- taking out FX.

Tobacco continues to be in the mid-singles negative, otherwise mostly all -- and by the way, that is notwithstanding the fact of a $6 increase per carton or a $6 20% increase per carton on April 1, as a floor tax.

So while the sales price is up dramatically, usage, I would assume is down some.

Otherwise mostly all sub categories within food and sundries are in the low to mid-single digits, or low to mid-low single digits, this reflects some of the inflationary pressures across some of those consumable categories as well, I'll talk in a minute about that a little more.

Within the mid-to high negative hard line comps, again, same story as last quarter, the weaker sub categories, office, sporting goods and garden/patio and the negative sales impact from deflation of electronics.

Anecdotally like we saw in November and December and then January and February, as we saw in the third quarter as well, unit sales of televisions and unit sales of laptops were up in the 30% to 50% range.

Dollar sales are about flat, so tremendous deflationary pricing pressures and that but we have really, I think taken the opportunity in that area to really show great value and to drive sales.

Needless to sales if you have flat sales that are selling 30% to 50% more units cost you a little more to do so.

Within the soft lines comp, which again is in the mid-to high single digits negative.

Again, nothing tremendously different or thrilling from last quarter.

The one standout, exciting standout is small electrics, slightly positive, with media and jewelry being the weakest, both in the high teens, low 20s.

Fresh foods, light food and sundries slight positive, no thrilling standouts.

Actually the standout, if you will, in fresh foods is unit sales, which helps offset the deflationary pressures, both our meat department which is beef, poultry, and what have you and produce are enjoying unit sales up in the low double digits this past quarter year-over-year.

But the average price points of price per pound of meat and poultry and price of various items and produce are down a like amount.

Again a little bit of a challenge profitability wise, but still driving business and driving frequency and loyalty we believe.

Moving on to the various line items, below that on the income statement I'll start with membership fees.

There is a little confusion, based on ac couple of the emails I got this morning having to do with that $34 million.

$27 million of it related to the membership line, and about $7 million of it to the SG&A line.

We reported in the quarter, $328.4 million of membership fee income, or 2.12% compared to $350.9 million or 2.16% a year ago.

That would imply in dollars down 6% and in basis points down 4%, and, again, in dollars down $22 million.

Now there is two things that we need to adjust for.

One is the litigation settlement.

Again $27 million of that $34 million hit this year's Q3 membership line.

In addition, about 18% of our sales and roughly same amount of membership fee income comes from overseas where we have the FX impact.

If you adjust for both of those things the membership is $27 million, the FX is about $15 million, that the $328.4 million reported number, adjusting for those two items would be $371.3 million, or 2.40%, which would be up 6% in dollars, and up 24 basis points, or $20 million so a good showing in membership fees and as I'll show in a minute in terms of renewal rates as well.

Let me take a minute here and elaborate on the membership litigation.

The settlement related to a class action asserting that our membership renewal practices violated various provisions in California and New York common law and statutes, in New York and California common law and statutes.

Under our historic practice members who paid the renewal fees up to six months late generally had their 12 month membership renewal period commence at the time of the prior year's expiration rather than the time of the late payment.

The settlement provides members who renew their memberships late between March 1, 2001, and March 31, 2009, one to three months of free membership depending upon the length of their first late renewal in addition to the payment of attorneys' fees and costs.

Again, the accrued amount of the three months of free membership, if you will, we estimate at $27 million, and the $7 million was plaintiff, attorneys fees and processing and mailing costs to our members.

We did change our renewal policy in March of 2009.

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

Our new-member signups in Q3 were down 5% year-over-year in fiscal quarter.

Recall that they were down 7% in Q2 year over year.

We don't feel this is a big issue.

We still -- we still are feeling the impact of seven openings in Q2 last year, compared to no openings in Q2 this year.

Again, overall, fewer openings we believe are the biggest impact of that piece of negative.

In terms of number of members at Q3 end, at Q2 end we had 20.7 million at Gold Star we now have 20.9 million.

Primary business remains at 5.7 million, prime business add on remains at 3.4 million so total, which was at 29.8 million at Q2 end is now 30 million, and with spouse, 54.5 million at Q2 '09 end, is now 54.9 million.

At May 10, Q3 through quarter end our paid executive membership stood at 8.528 million which is a 325,000 member or 4% increase since second quarter end 12 weeks earlier.

That's about 27,000 new executive members or converted executive members increase in the quarter.

In terms of membership renewal rates, they continue quite strong, within 0.1% of our all-time high renewal rate coming in at 87.4% for the quarter.

The 92.1% on the business side and 86.1% on the Gold Star side.

Moving on to gross margin, gross margin was up in the quarter, compared to a year ago, 45 basis points from a 1054, to a 1099.

Again, we'll jot down some numbers and then talk through them.

The line items are merchandising core, second line item is ancillary.

Third line item, 2% reward.

Fourth line item, LIFO, and then a total, and I'll give you the last three quarters, Q1, Q2, and Q3, of '09.

Going across merchandising core, year-over-year in the first quarter was minus 13 basis points, in Q2, minus seven and in Q3 plus 42.

Ancillary, plus 46 in Q1.

Recall the gas movement there.

In Q2, minus 19.

And in Q3 plus eight.

2% reward, minus two, minus nine, and minus nine.

LIFO plus one, plus four, and plus four.

All told, in Q1 year over year we were up 32 basis points in gross margin.

In Q2 down 31 basis points, and in Q3 we reported up 45.

More importantly, let's start with our core merchandising gross margin which was up 42 basis points.

As was in the case in Q2, the plus 42 year-over-year is the result -- requires some explanation.

While still much better than our gross margin in Q2, our lower margin gas business, which represented 10% of our total sales in Q3 '08 only represented 6% of our sales in Q3 '09.

Thus, the sales penetration of our core merchandising business was up year-over-year as gas prices declined, and this -- and this aggregate higher sales penetration year-over-year caused margins to be up significantly more in our matrix.

Now, more importantly, our gross margins of our core merchandise business, and our core merchandise business we view as food and sundries, hard lines, soft lines and fresh foods, again that's a little under 80% of our total business they were actually higher by five basis points.

Recall that in -- this plus five basis points in Q3 year over year compares to our Q2 year-over-year gross margin delta in those core businesses of minus 57 basis points.

Of the four major departments, food and sundries, which is about half of our sales and hard lines which is a little under 20% of our sales were up year-over-year in Q3, soft lines and fresh foods were down slightly year over year in Q3.

Recognizing fresh foods, as I mentioned, with the higher units but lower prices really did pretty well given that but still a slight down year over year than the actual percentage.

So again, I think a relief to many out there, that -- given what we saw in Q2.

Gasoline profitability, by the way, year-over-year had very little impact on the quarter's P&L.

Q3 over Q3 gasoline operating results were within $2 million of each other.

Other gross margin comments, the impact from increasing executive member business continued in Q3 at minus nine basis points impact, implying about a 4%, 4.5% increase in sales penetration to these all important members, we believe this reflects increasing sales penetration to these numbers, which in this economy we believe is a positive.

LIFO, recall we had a small credit of $2.2 million in Q1, a credit of $7 million pre-tax in Q2, and as I mentioned a $6.5 million credit in Q3.

This reflects, the -- the deflationary trends that may continue into Q4.

But it's difficult to predict, particularly given the volatility of gas prices.

Now moving on to SG&A, our SG&A percentages were higher year-over-year by 96 basis points, coming in at 10.69, compared to 9.73 a year ago.

Again, let's start by looking at a little matrix of numbers and then we'll go through them.

The five lines here would be operations, line two would be central, line three, stock compensation -- or equity compensation.

Line four quarterly adjustments.

And line five, total.

And again, we'll look at the three quarters, Q1, Q2, and Q3, and going across, operations would be minus 16 basis points in Q1, implying higher SG&A year-over-year, by 16 basis points, minus 34 in Q2, and minus 67 in Q3.

Central minus three, minus four, and minus 15.

Equity, zero, minus one, and minus five.

Quarterly adjustments minus 12, zero and minus nine.

For all told minus 31, minus 39 and minus 36 -- I'm sorry minus 96.

Wishful thinking.

Operations, again, going through the detail here.

Operations again shows higher by 67 year-over-year, again a very big factor here is deflationary gas sales levels.

Just like with gross margin percentages where it helped us it correspondingly hurts us.

We estimate -- we calculate that the reported SG&A, that minus 67 includes 34 basis points related to -- so a little more than half of that minus 67 is simply gas deflation.

I'll get to some other comments in a minute on that core.

Our central expense was higher year-over-year Q3 by 15 basis points.

About four basis points is gas mix.

Again the deflation, about three basis points or $5 million is site costs.

This, again, some of you will look at this as being good, and some of you you look at it as being a slight negative, but about $5 million of site costs in our SG&A number, because we have chosen not to do about five to six locations that we had on the books over the next couple of years, as the economy has softened and as we see, perhaps, some better opportunities with better available locations, including some in malls or in the parking lots of malls, we also looked over the next year or two and recognizing that we've walked away from a few that we can always do in a few years.

There's nobody rushing to do them in certain cities or certain extended cities for us.

So we did go through and I think there was actually six locations that we -- that we are deciding not to do, and any costs incurred in legal, permitting, negotiating, you name it, was -- we wrote those off, they are capitalized until the deal either dies or goes forward, and they of course capitalize if the deal went forward.

So again, about $5 million in -- inside the SG&A number.

That is something I didn't mention earlier.

Our stock compensation in dollars was almost flat year-over-year, up very slightly to about less than 1%, but because of lower sales dollars, it was a five basis point hit to the numbers.

Benefits, Q3 year over year, we mentioned qualitatively in the press release.

I'll let you decide how you want to book it or look at it.

Q3 year over year percentage was higher by 17 basis points, again, this is within the core.

This includes a sizable spike in healthcare utilization.

If you recall in Q -- I believe Q2, we saw back in November a big spike, we saw similar big spikes in two of the months in March and April.

I can't tell you how May is yet, but this has more to do for utilization per member.

So a higher batting average, if you will, of utilization by our employees and their spouses and dependants and kids.

About two-thirds of this spike -- this number relates to that spike, and the rest is divvied up among other various things.

We actually had a slight improvement in worker's comp to the tune of $2 million.

But still, the net of all of this together was a pretty sizable number, as I mentioned earlier a total of about $0.03.

Depreciation, dollars are up somewhat, but more importantly on lower sales depreciation hit us for seven basis points, which is usually at least five basis points more than we would normally see in a number like that in regular years.

Overall not a terrible SG&A dollar performance, but given the sales levels and given a couple of those unusual items it is what it is as we reported here.

Big question of course, going forward is sales trends.

We are going to continue to see the challenge with gas as it peaked last year in the middle of the summer, and we'll have to wait and see on healthcare utilization.

When we talk to our third-party providers, in general the perception is we are not the only ones suffering it.

In terms of more utilization with the stress out there.

However, recognizing nearly 90% of our employees are covered fully, and that certainly is probably a higher percentage than many other companies out there.

So wherever they're utilizing, in our case they are utilizing under our program, not someone else's.

In terms of -- next on the income statement line, preopening expense of about $850,000 from a year ago, or one basis point worse at $9.3 million versus $8.4 million.

We opened five units in Q3, versus four a year ago, no real surprises there.

In terms of provision for impaired assets and closing costs, in Q3 '08 we had a charge of $9.2 million for the quarter, in Q3 '09 we had charges of $6.6 million.

Just under $5 million of that was the Costco home, but, again, we had charges last year too, so that is pretty much a wash or a slight improvement to the Company for the quarter.

All told -- excuse me -- all told, operating income in Q3 was down 23% year-over-year from -- $465.6 million last year down to $359.1 million this year or a decrease of $106 million.

Of course hitting this year's Q3 operating results were many of the things I talked about earlier, the $34 million in membership litigation settlement, the roughly $0.03 on healthcare and benefits increases above and beyond what we consider normal increases year over year.

$0.03 to $0.04 in FX headwinds, offsetting a benefit of LIFO of about $0.01.

So just those items alone represents nearly three-fourths of this $106 million shortfall.

Not making excuses, just allowing you the detail to do the analysis.

Below the operating income line, reported expense was slightly higher year-over-year, Q3 was $25.2 million versus Q3 last year of $24 million, so about $1 million.

Actual interest expense was down about about $1 million, but offsetting that is the little less expansion, capitalized interest was actually lower and less reduction and interest expense.

Capitalized interest was actually lower year over year by about $2 million, interest income, $4.2 million this year, versus $23.9 million last year.

The $4.2 million of course includes that $4.5 million impairment on the enhanced money market fund, so still adjusted that $8.7 million compared to $29 million, allow us interest income.

Cash is fine, as you well know interest rates on safe stuff is very low.

A quarter to a third of what it was a year ago.

Also, almost -- so about two-thirds of that lower income figure was lower interest income, and about -- and the other -- a little less than the other third of it was our half of Mexico's earnings.

Mexico's earnings in pesos are fine, but the peso a year ago was a little over 10, and now stands at a little over 13 probably in the high 13s average for the quarter.

It has come back down from 14, 15 down to the low 13s in the last several weeks.

On to our tax rates.

Our Company tax rate this quarter came in at 38%.

A bit higher than both last year's Q3 rate of 36.6% and this year's first half tax rate of 36.9%.

Again, a handful of discreet tax items totaling about $5.5 million, this $5.5 million is after tax so it's a little over $0.01 a share.

The -- about half of that relates to transfer pricing between US and Canada, and the agreement that those two Federal taxing authorities have, where a little bit more income was brought down to US, which is taxed at a slightly higher US tax rate than Canadian tax rate.

The other roughly half of it is several little things, mostly a couple of states various audit adjustments that are ongoing.

Sometimes they go our way.

Sometimes they go the other way.

Quick rundown on the other usual topics, the balance sheet as of May 10, cash equivalents and short-term investments, $3.668 billion, inventory $5.277 billion, other current $1.142 billion, total current, $10.087 billion, net PP&E $10.498 billion, other assets $719 million, all in on the asset side $21.304 billion.

On the right hand side, short-term debt $92 million, accounts payable $5.370 billion, other current liabilities $3.797 billion, total current liabilities $9.259 billion.

Long term debt $2.145 billion with $2 billion of that being the $2 billion of debt we put on our books in February of '07.

Deferred and other $336 million, total liabilities $11.740 million, minority interest $91 million, stockholders equity $9.473 billion, total of that side of course $21.304 billion.

Some of you asked for, since we don't have the cash flow statement ready today, but we'll have that finalized for th 10-Q but some of you asked for the depreciation and amortization, for the quarter depreciation and amortization is $161 million, year to date through the third quarter $476 million.

The balance sheet, needless to say is strong.

Low debt to cap ratio.

Accounts payable, if you look at this on a reported basis, a year ago in the third quarter it was -- accounts payable over inventories was 108%.

It's still over 100 but it's 102%, that includes, of course, construction payables and other payables, not just merchandise payables, on a apples to apples merchandise payables standpoint, last year it was 88%, and this year it is 85%.

We'd expect it to be down a little bit while inventories are down slightly in terms of real dollars, but the fact is that slower sales or a little lower turn as well.

Average inventory per warehouse, last year at Q3 end stood at $10.506 million, this year at Q3 end stands at $10.089 million so down about $417,000 or 4%.

FX is three quarters of that, about $80,000 of that $400,000 is lower inventories in local currency dollars.

So no real inventory concerns.

One comment I made on Q2 call was that in addition to the aggressive pricing that impacted gross margin in Q2 negatively, we also had higher-than-normal, if you will, seasonal markdowns, particularly at Christmas to the tune of we estimate of about $0.03 a share in Q2.

When asked about Q3s outlook on the Q2 call I indicated, of course, the aggressive pricing we felt would abate and of course, as you saw in our core merchandise gross margin it did nicely.

In addition, my best guess at the time was that if it was a $0.03 hit for seasonal markdowns, notwithstanding some weakness in things like patio furniture, we did a good job of cutting back inventories and canceling some orders, and so that talking to our non-food merchant, not only in Q3 did we have nominal changes year-over-year in markdown dollars, but he doesn't see any -- in terms of -- lawn and garden doesn't see any big hits in Q4 as well above normal.

In terms of CapEx in Q3 we spent $226 million, to year to date that stands right just under $900 million.

I would estimate that for all of fiscal '09 it will be lower than last year's figure of course.

Probably in the $1.2 billion to $1.3 billion range.

Compared to last year -- fiscal '08 of $1.6 billion.

Mentioned our dividend, earlier in May we increased our quarterly dividend from $0.16 a share to $0.18.

An annual amount of $0.72 a share.

This annualized $0.72 a share dividend represents a cost to the Company of about $310 million to $315 million annually, and at today's stock price represents about a 1.5% dividend yield.

Costco.com, and Costco.CA, up in Canada, still very profitable business, the challenge, of course, with the economy and particularly with the fact that our dot-coms are typically big ticket nonfoods item.

Principally average ticket in the high $300s down from the low $400s a year ago.

That certainly is impacting it somewhat, but still quite profitable.

In Q1 sales were up slightly, with September being more than all of that increase before all (expletive) broke lose out there in the economy.

In Q2 sales were down slightly, mid single digits, again a reflection of the sizable penetration of big ticket discretionary item.

In Q3, down very slightly.

In the low single digits, so a relative improvement from Q2, nonetheless quite profitable.

Next -- I'll discuss expansion.

As you recall, in Q1 we opened eight new which included the temporary closing of Las Vegas I believe where we reopened that later in the fiscal year as a Costco business center.

So a net of seven in Q1.

Nothing in Q2.

In Q3 we opened five and closed -- and relocated -- and closed one.

Again, we'll reopen that in Q1, that's the Hawthorne, California -- the Redwood City location.

So net of four.

In Q4 we will open a total of six, although we'll be closing for good the two Costco homes in early July, so a net of four, plus one in Mexico this fiscal year, so, again, new openings, 20, less four, two of which were temporary closings, and two of which were the Costco Home closings.

For a net of 16 this year which includes the one in Mexico.

So all told 16 net on the beginning base of 543 is about 3% unit growth and about 3.5 square footage growth recognizing we open bigger units and do some relo's -- some remodels to add square footage to a handful of units as well.

.

Total square footage stood at 74.3 million square feet.

Lastly in terms of stock repurchases.

We purchased a very small amount in the quarter.

When the stock fell below $40, early in the quarter we started to dip our toe back in the water.

Recognized back in September we had halted it.

Had more to do with liquidity concerns back then given that there was lockups in the money market funds and the enhanced money market funds, and cash was king, and there was no rush to do anything other than make sure that we have adequate cash.

We were just getting our feet wet when -- a matter of a week, the stock jumped another $5 to $10 back to the high $40s, and, again, long term, we view ourselves as relative buyers of the stock, but don't feel the pressure when asked, that we have to go do something tomorrow.

Lastly, while no guidance for this year, this year is what it is, I mean, I don't think there is -- hopefully some of the comments I gave to you today, enhanced -- improved some of the confusion we have like on where the hits in membership settlement, things like that and hopefully some of those other items, you recognize are related either to the economy or some anomalies as well, like the spike in closing costs and what have you.

Hopefully you will take away from this call the following, food and sundry sales are certainly driving retail business right now and certainly helping us, non-fuel sales there stilt is softness.

There is still overall deflationary pressures that are with us right now.

I cannot tell you when that will abate but it will I just don't know when, Gross margins, again, came back nicely.

Underlying gross margins came back nicely in Q3 as compared to Q2.

Expenses, again, I think in dollars, taking out a couple of the things I mentioned were pretty well controlled, but certainly a challenge with what is going on right now with sales and certainly with the spikes in healthcare.

Frequency is still at a high level for us.

Membership renewal rates are great.

Loyalty is great.

Membership dollars are fine.

We are picking up some high-end vendors, which long term is a positive, we think.

Come fall, of course, September, October, November, we'll anniversary both the high gas prices which was late August and into September, and also the beginning of that dramatic US dollar strengthening, relative to several of our foreign currencies.

In terms of real estate, again, these are not earth-shattering things that are going to change our Company's bottom line tomorrow, but whereas we have eliminated or postponed units that we can have the opportunity to do later in our corporate life, and we are seeing some more exciting opportunities out there.

In many cases of some lower costs.

Again, it's not going to be a one-year thing, we think this is over the next three or five years that will benefit us, not dramatically but somewhat.

And financially we're quite strong.

So we think that, again, bottom line it's been a challenging year and challenging quarter, and we don't see any big changes in Q4 as it relates to the challenges of the economy, but we are well positioned going forward.

With that supplemental information ill be posted on the Costco investor relations site later this morning, and I'll turn it back for Q&A.

(Operator instructions) We'll pause for just a moment to compile the Q&A roster.

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

If I look at your reported comp down 7% in the quarter backing into the first 8 days of May I arrive at -- roughly at a down 10% comp which suggests a core comp of roughly flat or maybe even negative.

Which I don't think is the case.

I'm just wondering if you can flush that out.

I know there's some rounding going on there, but could you give us a little bit of color on May -- May sales?

There's not a whole big change.

Again, I think as -- as -- the trend during Q -- taking out Easter, taking out FX inflation the trend in Q -- like in April was a shade weaker than in March -- I don't think we saw any big improvement from April.

So not a lot.

A little bit of a change.

I mean there is some rounding in there, but maybe a shade further negative.

Not negative, negative but--?

Right.

But not earth shattering.

And then for the upcoming -- looking back at the last fourth quarter, if I recall the four key parts of your business were up about 20 basis points on gross profit.

Can you give us a sense for what you are thinking this up-coming fourth quarter will be?

I know you just said that the core businesses were up about 5 basis points, gas was 42 for the 47 but what do you think for this upcoming fourth quarter?

Should we think a little bit better than 5?

I wouldn't predict at this point, since we're not giving predictions.

Clearly at the end of the Q2 conference call, again, the big issue was, is, wow, there is this aggressive pricing and seasonal markdowns, both which could continue to impact Q3 and Q4.

I'm pleased with what we saw in Q3.

Again, the feeling in Q4 at least as it relates to lawn and garden, many merchants feel that markdowns are fine.

So that won't be an issue in Q4.

Again, it's hard to predict what Q4 brings in overall core but I'm more comfortable with Q3 than I was in Q2.

Okay.

And just last question on CapEx, it looks like you lowered it about $300 million from the last call.

Is that a function of just lower costs to manufacture the sites -- or, I'm sorry, build the sites?

As well as a lower store count?

I'm just wondering if you are reducing CapEx elsewhere?

It is more the lower store count.

There is -- when you talk to the -- to Jeff Rodman and Paul Malton and the real estate guys, they are seeing, 20 to 25 -- 15 to 25% reductions in projects that were ongoing, but hadn't been signed yet, both in land values as well as construction costs.

Most of the construction cost decline is on -- we're building more and more steel buildings, and as I understand, the price of steel is down 75% -- 65 to 70% from a year ago.

From $1200 a ton down to $400 a ton or something like that.

And of course, labor has -- the actual physical cost of constructing, the labor costs have come down, but not nearly like that, very little, in fact.

But some -- but all in, 20, 25%.

I think a bigger issue is, the roughly $5 million of -- of site-location costs, which is SG&A, that's not site-closing costs, that was site-location costs, that is again, about a half dozen projects where we just halted on them.

In part -- I'm sure we'll end up doing some of them, but we're able to negotiate better numbers, and then again, I guess in you model, (inaudible) my guess a little less rounding.

It could have come down 200 depending on what your estimates were.

But again, it's not going to jump next year to $1.8 billion.

My guess -- and we haven't put our numbers together for next year, but it probably gets back to that 1.5 billion, 1.6 billion and goes from there.

There are a few more opportunities, but we also reduced a few opportunities this current year.

Thanks, Richard.

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

Ms.

Weinswig your line is open.

Thank you.

Good morning, Richard.

Your frequency is that it has been quite strong, do you believe that you're getting more of your customers grocery spend?

And what percent of their wallet do you believe that you have currently, and what do you think the opportunity is there?

On the latter part, I don't know what percentage of their wallet, I would like to think all, but -- on the frequency, clearly when you look at the comps on -- even anecdotally on things like rotisserie chickens, take-out pizzas, the Food Court even, those things are way up.

Even within some of the anecdotal stories I hear on things like housewares like toaster ovens and food savers and the Magic Bullet, that thing that mixes stuff at high revolutions, I mean, all of those types of home stuff for food preparation is increasing, and -- so, yes, I do think, and clearly the frequency helps offset some of he reduced transaction.

Some of that reduced transaction is not just TV sets that are lower priced, but people coming in more frequently to spend a little less.

What is your outlook for deflation in food and separately non-food, and is there an opportunity to hold price and pass this along in the form of higher quality?

That's our mantra.

An example just a month and a half ago, two budget meetings ago, was taking our tuna.

We introduced, as I understand over the last 30 years, the normal tuna sized can has gone from the low 7 ounces, to the low 5 ounces, and we basically went back to a 7.1-ounce can called a retro can, I guess, on KS, and then with two of the manufacturers whose branded items we sell, two of the three tuna suppliers, we said basically build us a 7.1-ounce can so our customer can see what -- how compares our price to theirs, and our poundage of -- our units and our poundages is up in the 20 to 30% range.

That's anecdotal and it's one item.

I can look at other things like price decreases on things like all of the food wrapping and tinfoil and they're down in the 7 to 10% range prices.

Paper towels down just a couple of percent.

This is over -- year-over-year, all of your plastic spoons and cutlery.

All again, along with paper plates and things, down 6 to7%.

Water, branded water down 7%.

Partly because ours is a much better value, and just like we have seen increased penetration of the branded -- of the private label items across all of these consumables, same as water.

So, various -- and -- and by the way, if you recall in Q2's call, I mentioned that -- whereas normally we might see a half to three-quarter percent increase in sales penetration year-over-year in private label.

Within many of the -- what I'll call the supermarket items, whether it's food wrap or paper plates or liquid detergent or fabric softener, we saw a 300 basis point increase in penetration of those items relative to the brands.

And needless to say, 10 and 15% increases in US sales at the core to KS, and like decreases in units of the brands.

At the same time three months ago, we started seeing articles as you did in the Journal, and other newspapers, talking about some of the big consumer branded companies didn't -- weren't passing all of these savings back yet, they were still having higher prices and companies like us saying oh, yes?

Well, we are starting to see some of those reductions.

And again, that's the right thing to do and good for the customer.

It creates a little bit of a challenge.

But again, you can't have deflation on top of deflation on top of deflation.

We're in the year that we're having it.

Hopefully as we anniversary it will it start to flatten out if not get a little better.

Then last question, how should we think about unit or square footage growth for 2010?

What are the greatest opportunities from a geography perspective?

And how do the business centers fit in to all of this?

Well, let's see, if we started with 543, at the beginning of the last year and add 16, so we'll start the year at 559 and throwing out a number here, if it was 23 on 559, that would be 4% unit growth.

So somewhere between 3.5 and 5% unit growth.

Or say, 3.5 and 4.5 unit growth and 4 to 5% square footage growth.

In of the business centers, we're opening more of them.

They work.

It enhances the value to that all-important business member.

But we're not going crazy.

Forever it seemed like we had 2 or 3.

Now we have 7 a year -- we'll probably add two or three a year for the next two or three years, but it could be more than that.

But it's not like we're going to go from 7 to 20 to 40 in the next two years.

So they are profitable.

We find things there that we then roll out to all locations.

I think the most important thing is it seemed like it was 10 or 12 years where they just were a little profitable and not terribly exciting, and again, I think partly, Phil and his people, one of or VPs, and the guys that runs it, took it over a few years back, and I think we have done some great things in that area.

Thanks for the color and good luck.

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

Good morning.

Richard if you take our your membership fees and look at just your retail margins, they are down to about 0.2% which is near a historic low.

Philosophically would you want to defend your retail margin and keep it from going negative, or would you be more focused on keeping the sales and traffic numbers up?

We're going to keep the sales and traffic numbers up, but we -- yes, we have always -- and I have -- this is the 100th time in the last 20 years that this question comes up, and of course, as there is weakness -- recognizing there is some overall weakness right now, so even your 0.2 should be higher next year without the recession and without the membership litigation hitting the healthcare spike and some other things.

But that notwithstanding, we view our business as a gross profit number, which includes our merchandise gross margin plus our membership fees.

That number approaches 13, we would like our expense numbers to approach 10 not 11 as they are right now, but if it went slightly negative it's the same story.

We're pushing for total profitability.

We're not trying to break even.

We would very much like to make over 1% on the operation net of membership fees.

That's not in the cards right now.

But, again, it's -- your -- the question -- I don't mind the question, but it is being asked when -- and my hopeful view is is we're at the low point of this process and as we get past this fiscal year, and -- and cycle through gas deflation, and cycle through FX, and cycle through, hopefully, and continue to maintain some margin improvement hopefully, and cycle through FX, all of those things will -- you'll see that go the other way hopefully, but, my guess is only a little better than yours at this point.

When.

Do you have any sizable buckets of cost that you can still go after if things stay weak or get weaker?

They're not sizable but something I mentioned probably to a half a dozen of you as you have called over the last 12 weeks, for years I've always said there's no silver bullets and we run a pretty good shop.

Well, you know what, when we look at the numbers -- if you looked at the underlying payroll, which payroll and benefits is 70% of SG&A, and payroll is 70% of that number, of that 7%, payroll dollars weren't up that much, and -- and we have been -- we have done a pretty good job of controlling payroll.

What we have found is, notwithstanding those silver bullets, when it got a little tougher, we're finding little bits and pieces of money.

Not a lot, but -- are there any big buckets?

No.

But we'll see where we go from here.

There are a few things that we're looking at but I'm not going to talk about them now and I'm not -- there's nothing giant.

It's not like when we changed the healthcare.

We are not looking to change healthcare to pass on more to the employee right now.

We have had a hiring freeze at central now for about four, five months, you have always been more efficient in the warehouse because it is more seasonal than hourly, and you can fluctuate those numbers a little bit.

Notwithstanding that, with the closing of the two Costco Homes, between the 180 employees, about 90 each in those two locations and 22 employees here, that's about 200 people, we have no layoffs.

Now, we could have, but we're going to incur a little extra employment, the Northwest warehouses in Puget Sound are taking on about 80 employees, and at central we're going to take on 15 or 20 employees.

And that's the right thing to do, and that's nominal compared to the whole picture.

Okay.

Thank you very much.

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

Good morning, Richard.

Couple questions.

First, you did (inaudible) on the buyback, I was wondering what it is going to take for you to resume guidance from the business perspective?

What are you looking for?

In terms of guidance -- are you talking guidance on buyback or guidance on guidance?

Well, you feel comfortable to step in on the stock at a certain point, I'm just wondering what it will take for you to get more comfortable to predict -- give us a little bit of a range, or resume your guidance, quarterly or annually, et cetera, or whatever going forward?

I guess I will preserve that for -- when we talk at the end of Q4 in early October.

There's frankly a bias among -- among the Board that, less guidance is better, the question then becomes as you just mentioned, should there at least be annual guidance.

I don't want to suggest yes or no yet, because I am involved in those discussions, but I'll wait to discuss it again, later this summer.

All right.

I apologize for not being more clear, but we don't want volatility.

We -- we all -- not just Costco have gotten a little bit of a free pass this year, with the craziness in the economy, and it's easier not to guide right now, but I personally have a bias towards trying to at least provide some guidance.

But we'll wait and see.

On the cost side when you look at the $0.03 to $0.04 hit from healthcare costs incremental this quarter, how long do you think that is going to continue?

How should we think about that going forward?

Well, I don't know.

T-minus 3, and a little under $0.01 of it was other miscellaneous accruals and things that were just some catchup, nothing earth shattering, several little things, but on the $0.02 that I'll call the healthcare spike, I don't know, it happened back in October, November, and then it abated, and, again, we kind of -- and our third-party provider kind of broad brush stroke said that it was related to the stock market, everybody freaking out and people had more accidents, people had more claims.

Some would argue that it's also related to the fact that people who fear being laid off want to get everything in that they can before they get laid off .

Now, I would argue that that should be less of a concern at Costco out there so far but there's those fears out there.

I don't know haw many -- again, we saw it in March for the first time since, I think November, and then we saw it in April again.

We don't have any indication yet for May.

Those are numbers that come in at the end of the month.

If I was a betting person, I would say you will see it in May, but perhaps not as large as March and April, but if it's 8 million or $9 million a month it's real dough, it's a $0.01 plus a month, but I don't think it is $0.01 plus a month for the next six months.

I think it will ebb and flow a little

Okay.

One last question, when you look at California, and we have heard of a number of companies talk a little bit more constructively about what they are seeing in California.

Why do you think your business hasn't gotten much better in California?

Well, I can only say I know within the club business, we are the highest -- we believe we're the highest penetrated -- not only nonfood items, but - big ticket items and we're all getting hurt.

We all know, I say this somewhat fluously we all know very affluent people that are choosing, they can afford it but are are still choosing not to buy a new car, not to buy a new patio set, not to buy $1,000-plus items, and that's certainly part of our business.

And you live and die by that a little.

Again, I'm thankful -- in any one of those categories, our negative comp is a lot better than traditional retails in those categories.

That is partly because we got them at least coming in the door and we're offsetting some of it with food.

But, again, in my view, the fact that our unit sales -- our pounds of meat and poultry, and our units of cantaloupes and grapes are up 10%.

That's not going away when the economy gets better, and it's not going away when the average price per pound or per dollar go up a little bit.

So, I think those things bode well for us, but once we anniversary or once the economy improves a little.

Okay.

Thank you very much, Richard.

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

Two questions for you.

First on the 5% decline in new member signups due to fewer store openings in Q2, I guess, has had a residual affect on Q3.

What would you anticipate that to be in Q4?

Should we start to see that membership growth rate in local currencies come back up to more like a 7%, 8% level?

5% is only about 30,000 people.

So it's -- it's -- I'm just looking at my -- my calendar here.

What is going to really help Q4 and the comparison year-over-year, is the fact that we have got three in Asia.

Asia is nuts when it comes to member signups.

If you divide our total Company by -- total number of members divided by total number of warehouses, I think the number of members per warehouse for our whole Company, whose average warehouse does $140 million or whatever and whose average age is in the mid to high teens -- mid teens, the average members per warehouse is in the low 50s, 53,000, 54,000 -- on opening day, we count all signups that have come in during the 8 to 10 weeks that we have the table set out with the flags and the tents outside to sign up people, typically in Korea, Taiwan, and Japan, we may sign up 40,000 to 55,000 members as of opening day, and it goes only up from there, so having Japan, Korea and Taiwan, each have an opening in second week in July so that's about halfway through the quarter, I haven't calculated leverage but if I'm a betting person we'll see it up year over year a little bit or flat but certainly not down 5.

I'll bet it will be up a little.

So in local currency should our membership growth get back to that 7% level or so in Q4?

Yes.

It is already at 6 in Q3 in local currency without the membership hit from that settlement.

So, yes, the answer -- I would say probably yes.

Okay.

And then on dot-com, you talked about, I guess that business being a little less bad in Q3.

Given the nature of the products you are selling there, and the fact that the comps actually got a little bit worse in Q3 for the rest of the business, I'm just trying to reconcile that, you think there's early signs there that the consumer is -- we're starting to see a bottoming on the discretionary purchases?

Are you seeing that anywhere else in the business outside of California?

These are purely anecdotal, first of all, the comp in dot-com in Q2 was in the mid-singles negative, and the comp in dot-com in Q3 was in the very low singles, so there was a relative improvement.

Just a week -- I think a week ago, I was talking to Jim when he was traveling, and he was starting to see some light on the lawn and garden stuff, and these are markets where we saw -- markets where the season had already occurred.

In other words the Phoenixes, and the Southern Californias, it's not like in the Midwest where it was a late spring and where we saw pickup finally when the sun came out last week.

So, again, those are anecdotal positives, and then I know on dot-com, we have also offered some -- some additional medium-priced items.

We're not switching out of high-prized items, but we're giving the customer a little alternative.

Which is easier to do on dot.com and something we're not prepared this early to do in store yet.

Two final things.

Are you expecting any -- should we be expecting any other nonrecurring type items in Q4?

And then, I know you're not providing specific guidance but if we look at the First Call consensus at $0.77, any thoughts in terms of whether that's in totally left field?

Or any comments on that at all?

Well, let me say, there is no comments on the second part of your question.

Nice try, though.

And on the first part of the question, what was it again?

Just in terms of nonrecurring items, I'm just curious, in Q4, should we be anticipating any nonrecurring items as we build our models?

That I hope not, I did mention the 2 million to $.5 million of Costco home closing costs which is a rounding error, relatively speaking.

My guess is the $1.5 billion market funds we had in December of '07, we're now down to about $40 million at book, having written off about $16 million over the last year and a half, including the $4 million this quarter.

My guess is there will still be little remnants of $1 million, and $2 million a quarter for a couple quarters, but, again, there's no, that's just -- I'm shooting from the hip.

It's not based on any analysis, it is based on the fact that these things just keep bleeding a little bit, but we're through the pain on that, but it is more of a thorn.

Okay.

Other than that at this point, no.

Okay.

Great.

Thanks.

Your next question comes from the line of Mark Miller with William Blair.

First mechanical question, you quantified the impact on SG&A on higher gas penetration -- excuse me, lower gas penetration.

Can you do the same in terms of how much that benefited the gross margin?

Can I, Bob?

Yes, hold on, I'm looking.

Bob Nelson is sitting here and he's looking for it, it's in the mid-20s.

Okay.

And I was hoping you could elaborate on the higher penetration of sales from the executive members.

Add some context around how that's been changing sequentially and sort of what is happening with the non-executive members?

So that spending is softer, I'm wondering, what is it about their spending?

Are they tending to be more discretionary, treasure hunt shoppers, or how do you observe the trends in those two groups?

Well, first of all, the executive members is the higher-end customer, the one that spends a little more.

So it's a little bit self fulfilling here.

In talking to our membership marketing people, clearly in the last two quarters, operationally, is -- our view is we have done a much better job in warehouse of getting you to convert, or when you first come into sign up, getting you to signup as a executive member versus a Gold Star member.

Last numbers I heard two months ago in the budget meeting where market people were talking about it is a year or two years ago, when we would have 100 new people come in to signup at the warehouse there, we might get 10 or 12 to sign upas an executive member, today it is nearly double that, it is in the very low 20s.

We are better at selling them on it, recognizing we don't do a lot of selling.

I also recall the anecdotal story of back when there were 8 or 9 warehouse operations out there, companies, and one of these recant companies called Costco, which started in about late '83, probably in '85 or '86, we were set to open our first location in California, I believe in the Bay area.

And at the time, Price Company maybe had three locations in the Bay area, and a half dozen in L.A.

and a half a dozen in San Diego, and at that time, the entire industry because this is when Price Company originally was a pioneer, wholesale members payed $25, and Gold Star payers members pay nothing, but paid a 5% upcharge.

To Price Company's credit, when somebody finally was going to go into somebody else's market, in this case us going into their market, they eliminated the free Gold Star member, and 5% upcharge, and just said everybody pays $25, it's now $50, of course, but everybody pays $25 and there is no surcharge.

And what they did is they eliminated a lot of low-end members that didn't value the membership, and kept all of the ones that did, and the same thing happens here.

We're better at also -- while they are standing in line, we ask them occasionally to see their membership card, we hit it with a handheld RF gun, and it immediately tells us that based on their prior 12 months of purchases if the had been an executive member, it would have more than paid the $50.

If they do it and they find out it's not we're happy to give it back to them.

And so again, I think we're getting better in the field of doing it.

I don't think it tells you a lot beyond that.

The lesser member who doesn't value it is moving on or staying at the low end.

My last question is can you update us on the comp sales leverage point for expenses?

And to be able to get leverage on labor, do you need to have that average ticket go up?

I'm curious about the labor hours.

Do they tend to be tied to frequency?

So traffic is strong but you need to staff to that.

Kind of what is your thinking on the leverage point overall?

Yes, all of the above, the fact is we're selling 15% more TVs and 5% more dollars it's costing us more and we get the same margin percentage but it's costing us more than 5% in labor dollars.

One area where we have done a really good job is in fresh foods.

Particularly in the manufacturing parts of fresh foods, fresh meats and in bakery, because unit sales are up -- you have two things, because unit sales are up, you are a little more efficient so you don't lose it all.

It costs you a little bit more labor but not as much, and in the case of things like produce, given that unit sales are up your spoilage is down.

So your labor may be up, but it is being offset on the gross margin line by a little less spoilage.

And the comp point sales leverage line, Richard?

I have given up on guesstimating.

I still think it is in the 4 range, but it is a guess.

Okay.

Thanks.

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

Thank you.

Richard, core comps have decelerated to that 2, 3% over the last few months and the last time we saws comps soften to that rage.

In the Fall you took aggressive pricing actions to drive better sales.

I'm just wondering if you could give us a sense what is that tipping point?

As you mentioned, philosophically it is to drive traffic and sales, so it would seem like we're back at that level.

Well, other than if you recall the comments I made about the perfect storm.

The other component of that perfect storm was, is there was huge deflation in core commodity items, less than a couple of months before the underlying procurement cost.

So yes, we were eating into our margin to do it, but we knew there was a finite end to it.

So we're not totally crazy here.

I don't view it as healthy right now.

I can't predict what tomorrow brings but at this juncture what you saw in Q3 is continuing in terms of our MO.

Okay.

And what are you seeing out there in terms of the competitive landscape?

Are you seeing other people be similarly rational?

No.

Sam's is still pretty tough.

As they would say we're still pretty tough.

As -- and again, you who follow BJs have more insight than I do other than reading a couple of the research reports on it.

But as you know they recently announce, they upped their estimates for the year, and they talked about 100 basis points or higher for higher gross margin, which leads us to believe that they're keeping more, as prices are coming down, they are keeping more of it.

That's their prerogative, that's not what we're going to do but it does give us a little bit of a window, recognizing that window is not as big of a relation to us than the Sam's window, but it gives us a little bit of a window there.

Supermarkets, we think are keeping a little of it, but not as much, probably as some others.

Okay.

And then just on the core comps, the softening that we have seen over the last few months.

Just qualitatively, is it deflation hitting food harder, or is it worsening declines in the non-food?

What is driving the recent weakness?

I think it's the former, in the last couple of months, because we finally saw some deflation, and the comment because we finally softened deflation, and the comment I made about some of the large consumer product manufacturers who just a couple of months ago were talking about we're not seeing -- we're not having our prices come back down so we're making more.

If I looked down this list, just in the last month, in the last four weeks, we have seen items like -- effective May 18, a price decline of 6 to 10% on some liquid soap items.

I'm not going to name the name, but you guys can figure it out.

We have seen 6 to 7% -- 7% in March and another 6% on June 1, on all of the plastic spoons and forks and 7% on water back in -- our branded water, a couple of different brands back on April 13.

So, we are seeing seeing -- branded companies cannot keep their prices up unless they want to lose market share, and we have shared with you some of the deltas of our KS brand versus the national brand where ours is up 10 and 15 percentage points in units and theirs is down like amount.

Ultimately they got to change their pricing.

I think there's relatively speaking a little more of that.

Just then the final question to combat that ongoing fab deflation, help us understand what you are doing on the non-food side to drive better trends there?

It would seem with such strong traffic we should see better conversion.

You obviously have members in there shopping for the food.

Why then aren't we seeing them convert to non-food already.

Perhaps give us your thoughts on merchandising issues.

Obviously big ticket is a part of that.

Is the big ticket perhaps being rethought and maybe not as big ticket as we saw a year ago in an effort to drive those nonfood sales?

Two things.

One is -- you look at two big ticket, big dollar items, PCs, Laptops, which is more Laptops than desktops today, PCs and TVs, I don't know if we can do any better than 40 or 50% unit increase, but 40% lower price points, means, flat or up slightly dollar increase.

So you have that trend.

It won't go down 40% a year, again I think it's been a perfect storm for that stuff.

There's not only been standard deflation every year but also the weakness and the excess inventory out there.

And we benefited from that, or got hurt less from that.

I lost my train of thought.

On merchandising in general, I asked the question of our lawn and garden buyers a few weeks back, because it is in June and July where we commit for the upcoming January through April season, and clearly, I've used the example to many of you in the last few months, that we have got a $3,000 patio set out there for $1299, but this great value, beautiful, it's actually good looking stuff but it's just not selling.

Well, again fortunately we cut back, we canceled about $55 million of orders which was about a little over a quarter of our commitment.

And so the good news is we're not going to have markdowns.

The bad news is we have 25% less sales.

So the question is, is for next season, if we think the economy, maybe it can get a little better, but it is stilt going to take some time, and it's not going to be better yet, that do we come in with a $999?

And the answer is both.

We're going to try come, but we're not going to eliminate the $1299.

We hesitate to bring down price points, but we're also logical thinkers here that we have to try a couple of things, and we're trying some of that right now.

And I'm sure that as we go into, my example of June and July we'll be bringing in a combination of things.

As we head into the holiday season any thoughts in terms of ticket year-over-year?

What we could expect ticket to come down on some of those items?

I think for holiday sales, we already getting hit for tickets, in other words, we took big markdowns on gift baskets and stuff.

My guess is in terms of realized, including the markdowns, realized pricing will be okay this season for gift baskets.

I -- I guess I'm a little less concerned, a little more optimistic on pricing than others, than you guys.

I think we have already seen some hurt.

Again, we're not going to have another 40% decline in the average price point of a TV year-over-year on top of this 40.

It is going to be down 15 or something, but not down 40, so, again, I -- and -- and again, think once we anniversary it is it not another hit on top of that hit so Adrianne, at the end of the day, I don't know completely.

I know that, clearly, like in housewares, frankly, the fact that we are selling more coffee machines, and more toaster ovens, and more food savers, hasn't really changed the average price point in housewares.

We're just -- it's helping offset the fact that not everyone is buying a new serving platter.

Thank you.

Your next question comes from the line of Andy Wagstaff with Touchstone Investments.

Thanks for taking my question.

I saw this press release yesterday where you guys are doing this test in two New York City locations on accepting foot stamps, and I guess BJs already does so but I wanted to try and get my arms around this, given the fact that obviously we're talking about a membership environment where members are paying you $50 a year.

Outside of this, can you just kind of help frame the idea behind this, and why do you -- I guess are these customers that would have already been on food stamps and paying $50?

Or is it such that these customers have in the last six months become unemployed and have gone on food stamps and they were prior customers from years past when they would not have actually received them?

Clearly there are more people on food stamps today than there were a year ago.

We historically have chosen not to accept food stamps because there are challenges of accepting them.

You have to make sure that they're only for eligible items.

In other words, tobacco you can't buy, paper towels you can't buy I don't know what all of the rules are today.

I know literally 35 years ago, my dad's supermarket in Atlanta, there was that issue that you have to make sure the customer is not buying.

Clearly today with the automation and electronic registers, you can flag items to make sure it hold up the front end.

If a family is coming through with a buggy load of merchandise, some of which can be bought on food stamps, some of which can't you have got to separate them and transact it that way, so it's a slowdown to a very efficient front end.

Right.

That's why historically we have chosen not to accept food stamps.

Right.

And I was just struggling really to understand why people would pay you the membership fee of $50 if they're on food stamps, but I guess there some that do.

The other question I have for you is -- and I'm a big fan of the coffee that you guys sell there, and actually it's one of the off-brand labels, just some sense about maybe buying patterns in the coffee area with respect to your brands and the San Francisco French Roast which is the one I'm partial to and the pricing there seems reasonable, are you noticing buying patterns of people in the coffee area that are actually choosing to go with either plain label, the Kirkland brand or one of the others as opposed to the Starbucks, and some of the primary labels you guys carry?

One last response to your previous question, I think people in terms of food stamps, they are still coming to shop at Costco because the prices are great relative to other traditional retailers.

And part of the issue of us deciding to test it and accept it is we have had a lot of pressure, including political pressure in the city and state of New York.

And we're -- we don't have our head in the sand, we're going to see what happens here.

Yes, yes, yes, just test it out.

I hear you.

But it could be a positive.

When I was a kid you had to accept them, they were a little book that's a 5, 10 and $20 food stamps.

Today it is a card, you can program the registers for a flag just like you program each item as taxable or non sales taxable so my guess is some of the inefficiencies are gone, but we'll have to see.

Getting back to your item, I don't know specifically about coffee.

If you want to email me I can find out a little bit more color.

I can tell you across all -- what I'll call supermarket items, whether it's paper towels or cans of corn, or batteries that -- or fabric softener or laundry detergent, across the board we're seeing a switch from branded to private label.

Why?

Because even though ours is the best price on that branded item relative to traditional retailers, it's still -- on a $15 or $20 sale price, if that customer can save $3 or $4, it is no longer an affordable luxury.

They're making the switch because they want to save $3 or $4 on that item.

Period, end of story.

Okay.

But our quality, it's a no-brainer long term for us because once we got them we got them because it's a great quality KS.

Okay.

Thank you.

Your next question comes from the line of Wayne Hood with BMO Capital Markets.

My questions were answered, Richard.

I just wanted to have one additional question that we didn't have to call you afterwards.

What are you seeing with your coupon redemption rates versus a year ago?

are they higher?

And if they are higher how are the discussions with the manufacturers going?

Because that puts pressure on them given a higher redemption rate and their discussions with you about cost.

And then the other question I had was on renewal rates which you discussed a little bit, but I was curious about the renewal rate of the executive member in clubs that were two years older -- or older.

Those are my two questions.

Thanks.

Coupon redemptions are up.

Bigger issue, there is less concern among the lower price point consumer product items.

Relative to the big ticket items where the manufacture of a laser printer, fax machine or the manufacturer of a TV or manufacture of a GPS item, where, they are comfortable giving us that discount on 10,000 units but not on 25,000 units.

The problem is is those are the items that we're not selling as much as we used to.

And the consumer product companies love it.

So yes we are seeing increased redemption.

Our goal is to keep trying to put more things in there that are bigger ticket to get those items selling again too.

But just like bigger ticket items are weaker out there bigger ticket items in here are weaker relative to what they had done historically.

Second question, I'm sorry, again.

Just on your executive membership renewal rates on clubs that are a year or more older?

You talked to it broadly speaking but I'm more interested in the ones that are a year or more older?

Yes, we see the -- the trends have been pretty consistent, based on your tenure of being a member, Gold Star, or Executive, we see the longer you have been here, the more likely you are to renew the next year.

In a first year when we open a new market you might have 100 people sign up and then 70 then renew.

Then the next year you've got a new 100, 70 of those renew but then 78% of the 70 from year two renewed, and over time it gets up to that average of 87.

On the executive member, we haven't seen any improvement or deterioration in a converted member who converted and then a couple of years later goes back to the regular membership.

That happens, but we haven't seen any any deterioration in that rate.

Thanks, Richard.

Your next question comes from the line of Chuck Cerancosky with North Coast Research.

Good morning, Richard.

I want to take a look at your sales mix, say in Canada, and some of your non-US locations, realizing you only have 75 or 80 units in Canada, any significant difference between food and non-foods in Canada versus the US?

Not in Canada specifically versus the US but just like in the northeast we have a higher food and health and beauty aids penetration relative to the rest of the country.

We see that similarly in Montreal as an example.

And similarly in Asia we see a much bigger penetration of food and health and beauty aids.

I think part of it is the great value proposition on those item items.

Particularly on things like health and beauty aids and analgesics and things where -- and vitamins.

The price points on those items and traditional retailers in Asia, before we got there, were crazy.

And food, again, we were told certain things wouldn't sell over there like our oversized muffins and our pizza.

The penetration is going nuts in those items.

Many of those locations are our highest penetration of those items.

How is gasoline doing as a traffic draw apart from the price drop?

Or maybe as the prices drop?

As prices drop it's a little less positive but still positive.

It is more related to the fact that, when prices are spiking at $4, you could turn on any channel of news at 6:00 or 11:00 at night, and the consumer advocate, says where is the cheapest place to buy gas.

Because that is not top of mind each night on the news now you see I think a little less positive from it.

All right.

Thank you very much.

I'm going to take two more questions.

At this time there are no further questions.

Perfect.

Thank you, everyone.

Good day.

This conclude's today's Costco third quarter earnings conference call.

You may now disconnect.