好市多 (COST) 2010 Q1 法說會逐字稿

Good morning, I'll be your conference operator today.

At this time I would like to welcome everyone to the first quarter operating results for fiscal 2010 conference call.

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

After the speaker's 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.

This morning's press release reviews our first quarter 2010 operating results for the 12 weeks ended November 22.

About 2.5 weeks ago.

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 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, as you know we reported earnings per share at $0.60 same as last year's reported first quarter earnings of $0.60.

Last year's first quarter included a few items of note.

The first the $28.4 million pre-tax charge SG&A related to the stock market fall last November and a mark-to-market hit if you will to the cash value of life insurance policies covering about 800 Costco management and employees.

A second small item $5.8 million pre-tax charge to interest income related to security impairment of our short-term cash investment.

Together these two charges total $34.2 million pre-tax or $0.05 per share hit to last year's first quarter earnings.

In last year's earnings release it was also pointed out that one, we had very, very strong gasoline profits and two the strength in the US dollar last fall relative to currency which at the time we turned FX headwinds resulted in earnings when converted into US dollars.

Effectively hit us last year in the first quarter by $0.03 a share.

In this year's first quarter results gasoline profits were actually pretty good but still about $0.04 a share lower than in the first quarter of fiscal '09 when the results were unprecedented as gas prices were dropping precipitously.

And with respect to last year's first quarter FX headwinds, we are now seeing of course, seeing strengthening of many of the foreign currencies relative to the US dollar such that this year in Q1 we benefited by about a $0.01 a share from what you can now call FX tailwinds.

The last item I'll point out is ongoing higher employee benefits cost.

Mainly the prior US healthcare costs.

I mentioned to all of you last December on our on fiscal '09 first quarter conference call that such cost hit first quarter results by an estimated $0.01 to $0.015 per share above what they had been running, mostly in the last month, month and a half of Q1 which is coincidentally when the stock was plummeting and we had a sense from our third party providers that part of the reason of increased utilization had to do with that.

I don't know that.

We also saw more higher than expected healthcare costs in Qs 3 and 4 of this past fiscal year and that trend continued in Q1.

It was still coming in a bit higher.

Probably an incremental $0.01 to $0.02 higher than expected.

On balance this year's $0.60 figure is just under last year's.

If you look at last year's $0.60, add back $0.05 for the unusual charges you get to $0.65.

If you look at this year's $0.60, we had no charge.

Gas was $0.04 less so that is $0.04 of the $0.05 where it is at least.

Then of course we had a $0.01 benefit from FX this year compared to last year's base case.

That $0.01 would essentially imply about $0.02 less year-over-year.

Which is about what we estimate on the healthcare side.

So those are the reasons not excuses but just the fact that that's where we saw.

In terms of sales for the first quarter, our 12 week reported comparable sales figure for Q1 showed a 3% increase plus 1% in the US and plus 13% internationally.

Excluding gas price changes and the impact of FX, the 1% reported US comp would actually be plus 2% for the fiscal first quarter and 13% international comp would be a plus 8%.

And the combination of those two, the 3% Company reported remain plus 3%.

The other topics of interest I'll review this morning are opening activities.

We opened a total of six new locations during the first quarter of fiscal 2010 which ended again, two and a half weeks ago.

On November 22.

All six openings were in the US including one in Phoenix, in the Paradise Valley mall, one in Redwood City, we actually had closed that unit a little under a year ago on the same premise with a little bit of extra land built a newer and bigger location.

One each in Colorado, Missouri and Ohio and of course our November 12, we saw many of you in Manhattan when we opened 116th Street and East River Drive in New York City.

For fiscal 2010, overall plan of 16 to 18 new locations.

13 or 14 which would be in US including the six I just mentioned as well as certainly one and maybe two relocations.

Since Q1 end on November 22, we've opened two new locations, one new warehouse in Hayward, California and one relocation in Warrenton, Oregon on the Coast.

We currently operate 566 locations around the world including the 32 in Mexico with our joint venture partner.

This morning I'll review our online results, membership trends, further discussion of margins and SG&A in the first quarter and our balance sheet information.

Again with sales, sales -- total sales were at 5.5% in the quarter to $16.9 billion up from $16.0 billion.

Comps plus 3% again, taking all the noise from gasoline price changes and FX issues, the US comp was a 2% plus without gas and the international and local currency was a plus 8%.

For the quarter, our reported 3% comp was a combination of an average transaction decrease of about 1.5% with FX and gas being about a wash to each other that year, but still we're still seeing deflation which I'll talk about in a minute and average frequency increased, continuing strong and a 5% increase in the quarter.

In terms of sales by geographic region, no big surprises in the US looking over the last couple of quarters, Q4 and Q1.

Probably the biggest and actual percentage points improvement had to be in California although it was also the weakest in Q4 and slightly positive in Q1.

Internationally again remains in terms of local currency the strongest, 7% in local currency in Canada our biggest international operation and a little over 8% in local currencies among the other international operations.

In terms of merchant, sales results by merchandise category, in the past few months potential we've reported September and October and November, those 13 weeks for reporting calendar within food sundries comps are in the low single digits with tobacco, candy and alcohol being relative stand outs.

Keep in mind that throughout food and sundries along with fresh foods is where we've been continuing to experience fairly hefty consumer price -- consumer products price deflation.

Also impacted of course by our increasing penetration of private label.

Our hard line sales showed positive mid single digit comps in majors, sporting goods and hardware.

Within soft lines comps which overall was in the low double digit range, apparel, housewares and jewelry were up in the low to mid single digits but may of the other departments like small appliances, domestic, media, furnishings, up 10 to 20% each, recognizing some of those strong improvements that are coming comparing against relatively weak numbers a year ago.

Fresh food is up low single digits.

Stand out continues to be unit sales increases both in meat and produce which we continue to strong unit increases.

The challenge again is deflation in fresh foods.

We have seen a little let up in deflation in the last month in the meat side of the business, produce continues to be somewhat in the 10% plus deflationary area.

In the second quarter which we are now two and a half weeks into we are so far enjoying positive impact of sales from year-over-year gasoline prices as well barring any future dramatic shifts in currencies which of course, we certainly cannot predict versus the US dollars.

The negative impact to sales earnings that we experienced since last fall are now reversed to sales and earnings.

Again we don't know what will happen in the future with gasoline prices or with FX ratios relative to the dollar.

Moving down the income statement line items, membership fees were $377.4 million, up 2.23%.

One basis points lower than a year ago in the quarter.

Up 5% in dollars or was $19 million.

Again since we talked about it last year, the positive FX, that $18.7 million would have been about 14% or $14 million up without the benefit of FX.

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

New membership sign ups in the first quarter Company-wide were almost exactly flat year-over-year.

Actually an improvement from recent prior fiscal quarters when new sign ups were down 5% year-over-year in the third quarter of last year and down 3% in the fourth quarter of last fiscal year.

Overall fewer openings do impact new sign ups where we offset a little of that weakness is in the strong new sign ups in places like Australia and Asia where in the last couple of months of fiscal -- late summer we opened one each in each of those four countries Australia, Japan, Taiwan and Korea.

In terms of number of members at Q1 end there was, 21.9 Gold Star members.

Up from 21.4 million at year end.

5.75 million primary business up from 5.7.

Business add ons remained at 3.4 million.

So all told 31.1 million households at Q1 end, up from 30.6 million at fiscal year end August 30.

With spouse and partner cards, 56.4 million at the end of the first quarter, up from 56.0 million at fiscal year end.

As of November 22, paid executive members were just shy of 9.3 million an increase of 341,000 in just the past 12 weeks.

That represents about 28,000 a week increase.

We did introduce the executive member program in the UK in Q4 so now that we operate that in the US and Canada and in the UK.

The UK accounted for about 25,000 of those 341,000 so even without the UK, the weekly number of increased executive members was a little over 26,000 per week in the quarter.

In terms of renewal rates, they've continued strong essentially the same rate renewal that there was at fiscal year end.

92% in business 86% in Gold Star and 87.3% Company -- that would be US and Canada.

Going over to the gross margin line.

Our gross margin in the first quarter was lower by nine basis points a 1088 versus a 1097 last year.

As we always do we'll talk about a few numbers.

The line items of these numbers are merchandise core second line item ancillary businesses, third line item 2% reward, fourth line item LIFO and then total.

Looking at three columns all of fiscal '09, Q4 '09 and Q1 of fiscal 2010.

Going across core merchandising and for all of '09 we were up year-over-year 18 basis points.

In Q4 '09 up 48 and in Q1 up 15, ancillary businesses in fiscal '09 it was up seven, in Q4 down three, and in Q1 down 20.

2% reward minus six, minus nine and minus three.

Of course the minus there reflects the increasing penetration of the 2% reward program.

LIFO in all of last year was plus nine basis points in Q4 plus 22 when we took the big credit at the end of the year and in Q1 minus one.

There was no LIFO charge or credit in Q1 this year versus a small credit last year.

And all told all of '09 28 basis points up, Q4 56 up and Q1 fiscal 2010 nine basis points down.

As you can see, while our gross margin was lower by nine basis points our core was up 15.

Our lower margin gas business represented 9% of sales a year ago in Q1 and 8% this year in Q1 reflecting a little bit of gasoline reflection there.

The sales penetration of our higher margin core merchandise business was up year-over-year about 15.

Now, the actual four major departments here, food and sundries, fresh foods, hard lines and soft lines which this comprises a little over 80% of our business, looking at just those sales and those margins were up 11 basis points.

Again the 15 reflects the fact that those were a little bit higher mix this year than last year.

But nonetheless up.

Of the four major departments, food and sundries, hard lines and fresh foods were up year-over-year in Q1 with soft lines coming in a little lower year-over-year.

In terms of factors and impacting gross margin going forward, gasoline, of course gasoline margins last year in Q2 were substantially lower than first quarter which was again an unprecedented positive last year in Q1.

We'll see where it comes up this year.

We will have that kind of comparison.

In addition, as you know in last year's second earnings report we took a significant number of markdowns during the four weeks of December trying to drive sales as commodity prices were quite deflationary but many of the procurement costs just hadn't been deflected yet but we chose to take a little over $30 million of markdowns that weren't protected.

This is not currently happening this year.

Moving to SG&A, our SG&A percentage Q1 over Q1 was higher by four basis points coming in at 10.50% this year compared to 10.46% last year.

Again last year jot down the following line items.

A little over three column charge here.

Operations, central, the third would be stock compensation, RSUs, quarterly adjustments and total.

Again, the three columns would be all of '09, Q4 '09, and Q1 fiscal 2010.

For all, going across operations for all of '09 it was minus 47 points being higher year-over-year by 47.

Operations minus 61, and for Q4 rather, and Q1 minus 16.

Central, minus seven, minus eight and minus three.

Stock compensation minus one, minus one and minus three.

Quarterly adjustments minus three, plus seven in Q4, and plus 18 in Q1.

That of course relates to the $28 million mark-to-market charge that we talked about earlier last year that hit us versus nothing this year.

All total 58 basis points higher in '09 overall, 63 basis points higher in Q4 and four basis points higher in Q1.

Overall inventory on all these numbers, while SG&A operations, while SG&A operations was higher by 16 basis points year-over-year in Q1, a big component of that, about 10 basis points of the 16 was gas mix change in the quarter.

Our central expense was higher year-over-year in Q1 by three basis points which is actually an improving trend from the fourth quarter when it was minus seven.

Central payroll by the way in the first quarter year-over-year was actually lower by one basis points that of course offset what I mentioned earlier the higher healthcare cost.

Our stock compensation expense was slightly higher.

Benefits, we talked about this in Q1 year-over-year the percentage of benefits dollars had increased by 17%.

A little bit lower rate of increase than the past two quarters.

About a third to a half of this increase is due as I mentioned last quarter to the greatly reduced employee turn over and therefore a smaller percentage of employee base are yet to be benefits eligible.

A little over a year ago the percentage of US employees that are benefits eligible was in the low to mid 80s.

Today is in the high 80s to low 90s.

We don't see a lot of relief right now although the rate of increase, or dollars in Q1 was a little bit lower than in Qs 3 and 4.

I mentioned the quarterly adjustments the positive 18 was simply a fact that there was no unusual charges this year whereas in Q1 last year we had that $28.4 million pre-tax charge for life insurance.

Overall not a bad SG&A report given sales levels, level of gasoline deflation and increased benefit costs.

In terms of preopening expense, last year it was $12.8 million.

This year $10.8 million.

So $2 million better.

Two basis points lower.

No big surprises.

Last year we had eight openings in the quarter.

This year we had six as I mentioned earlier.

In terms of provision for impaired assets at closing costs, last year we had a charge of $6.8 million in the quarter.

This year we had a charge of $2 million.

So an improvement of $4.8 million year-over-year positive swing.

All told operating income in Q1 was up 1.6% from $420.9 million up $7 million to $427.7 million this year.

Below the operating income line, interest expense was about the same in both quarters with Q1 of this year coming in at $24.1 million.

Actually a shade lower than the $24.6 million last year.

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

Interest income and other was lower year-over-year by $3 million.

$18.2 million this year in the first quarter versus $21.2 million a year ago.

Actual interest income was up $400,000.

The other big change was about half of Mexico's earnings since we don't consolidate Mexico half of the earnings of that operations go into that line.

Our half of those earnings were lower year-over-year due principally to the weak peso.

There was about $3 million less of income and pesos for the Mexico operations were up in Q1.

Overall pretax income was up 1% this year in the quarter, $421.8 million this year versus $417.5 million last year.

Our tax rate not a big difference, a shade lower.

This year the tax rate came at 36.1%.

Again, slightly lower than the 36.4% the year earlier.

A quick run down on the balance sheet.

Cash and equivalents and short-term investments $4.189 billion.

Inventories.

$6.223 billion, other current $1.215 billion.

All current assets $11.627 billion.

Fixed assets, PP&E $11.115 billion.

Other assets $736 million.

And total assets $23.478 million.

On the right side short-term debt $81 million.

Accounts payable $6.318 billion.

Other current liabilities $3.886 billion.

Total current liabilities $10.285 billion.

Long-term debt, $2.292 billion.

Deferred and other $470 million.

All liabilities $13.047 billion.

Minority interest $86 million.

Stockholder's equity $10.345 billion.

Again total side of the right, $23.478 billion.

We'll have a cash flow later, not today but depreciation and amortization so you can put that in your model, for the first quarter it was up to $184 million.

Balance sheet, again, quite strong.

Debt to cap 19%.

Plenty of financial strength there.

Accounts payable, per the balance sheet accounts payables as a percent of inventories last year, was 99%.

It was a three percentage points higher this year to 102%.

That includes all construction payables and other payables.

Looking just at merchandise payables to merchandise inventories that we improved five percentage points from 83% a year ago to 88%.

Average inventory per warehouse up about 2% and we built up for Christmas both years but a little higher than during the year as well but quarter, first quarter over first quarter basis it was $245,000 averaging $11.676 million versus $11.431 million a year ago.

The main reasons, strong FX represented actually more than $245,000, it represented $372,000, within the core merchandising areas, the notable three departments, toys were down about $160,000.

A big chunk of that has to do with the less big ticket electronic toys relative to a year ago less quantity.

Jewelry was down about $115,000 and majors which is electronics was up $138,000, very prominent in our locations.

In terms of CapEx in Q1 we spent $307 million.

For the year we expect it to be around $1.3 billion maybe a shade higher if we get a few warehouses open.

We are working on some.

We are not sure when they'll close.

In terms of expansion overall, as I mentioned in the first quarter, we opened six new units.

No relos.

That debt maturity I mentioned was not considered a relo because we actually closed to that a year ago.

It went out of the number last year and put it in this year.

In Q2, we expect to open two new units and one of which is a relo so a net of one.

In Q3 one new one no relos.

So a net of one.

In Q4, eight new no relos, a net of eight.

All told for the year would be 17 less one relo for a total of 16.

As I mentioned we'd expect somewhere in the 16 to 18 range this year.

At fiscal '09 we added about 3% to our square footage and ended with 543 locations in operations.

In fiscal '10 assuming the 16 here, another 3% square footage increase and be at 559.

As of Q1 end our total scare footage in operations stood at 75.815 million, again some of you have asked for that.

So that's the number there.

Two final items before I turn it back over to Brandi.

Later this morning you'll see the supplemental information packet online which includes some useless stats and our detailed balance sheet.

That will be posted on the Costco investor relations site later this morning.

One other quick thing.

This year we adopted a new accounting pronouncement related to the accounting and disclosure for noncontrolling interests formally referred to as minority interests.

As a result of this adoption on our financial statements, is to separately list on the face of our P&L the amount of earnings attributable to noncontrolling interest below the net income to arrive at a new subtotal referred to as net income attributable to Costco.

This amount was previously included in the interest income and other line.

Additionally on the balance sheet minority interest which was formally outside of equity is now included in the equity section listed as noncontrolling interest.

Again I think this is just a small accounting announcement but we did and so for your questioning, that's it.

With that I'll open it up for Q&A and turn it over back to Brandi.

(Operator Instructions) Your first question comes from Charles Grom with JPMorgan.

Just on the gross profit, the core was up 11 basis points I think you said and in the fourth quarter it was up 6.

I wonder if you can give us some color by category.

As I recall in Q4, two of the four subdepartments were up and two were down slightly, still net positive where we had three of the four this year in the first quarter.

There's really nothing that discernible there.

Overall I think the trend in the core business has generally been up for the last several quarters.

Okay.

And then you alluded to it on your prepared remarks regarding the cycling of items, the seasonal markdowns, the aggressive pricing.

How should we think about gross profit margins and SG&A over the next couple of quarters?

I know you don't want to give guidance but can you hold our hands on how we should think about those two items?

A lot of it depends on sales, underlining sales.

Overall Q1 was good.

November was a little shakier than September and October.

November overall was pretty good.

Clearly the biggest item is the fact that we took $35 million of commodity price markdowns on milk, cheese, butter, chickens, that wasn't covered and we haven't seen any of that to date.

I'm not suggesting tomorrow either but again so far so good there.

The fact that we lost a little money in gas last year and so far we haven't this year, but again tomorrow is another day there too.

But those are at least directionally positive for us.

If Jim were sitting here I think he would say margins aren't our problem or challenge although we feel we've been able to do a little of both here to be able to be competitive and to improve margins slightly.

Last question on deflation you spoke to still seeing it in produce, meats letting up a little bit, can you talk about dairy and then also maybe the center part of the store, Kroger talked about their grocery deflation getting worse.

Are you guys seeing that or did you see that earlier in the year?

We probably talked about it earlier than the supermarket change did.

They probably were starting to incur it as well.

We probably have been pushing a little harder private label which does two things.

One is you replace, even though the gross margin dollars are generally pretty good there, the average private label penetration is down 20, 25% versus the price we sell the branded goods.

Once that drives business the brands come back and lower prices a little bit too.

Again this is not statistically perfect, but last quarter I know we took, a couple of months ago we took a look at the top 20 like items in each sub department, which is probably half of our sales in terms of dollars and it was in the 5 to 6% range on pricing.

Now I don't know if that means it's 4 or 5, but certainly not 1 or 2.

Has it gotten worse?

I don't think it has gotten worse.

We are still cycling through this major year of big deflation.

I think once we get into January, February, hopefully that cycle will be broken a little bit and it won't be ongoing.

I will tell you that talking to Tim Rose, who is head of the 50% of our business which is food and sundries in the US, his view is, is when asked, I've been asked by many of you about the competition with the supermarkets because of all the pricing.

His view is is look, any lower prices is not a positive but we really don't see, feel a lot of impact from the supermarkets.

Most customers, most members are shopping both places.

They will pick up some sale items there but from a competitive standpoint he doesn't feel that our pricing has been impacted by what the supermarkets are doing.

Thanks for the color.

Your next question comes from Mark Wiltamuth with Morgan Stanley.

Good morning, Richard.

I wanted to dig more on the private label.

You had a slide on that on your analyst day and up at the Harlem store opening.

You talked about getting the private label to go from 22% to 37%.

What is a realistic time frame to get to that number and what are you thinking about for private label penetration category wise in the year ahead?

Well, I think when Jim showed that slide and there was a couple of follow-up questions on it I think he acknowledged that that was a slide that was done about a year, a year and a half ago and looking out I think three to six years at the time.

So now four years from now, I believe that was correct, the implication would be would go from the low 20s to the mid 30s.

I think he said those are our goals, those are stretched goals that we are shooting for.

The timing is probably longer, and I think when pressed, he obliged.

Who knows how long.

It's certainly more than four years.

I think trend wise, we will keep, private label works for us, so does branded goods by the way.

We want to be able to sell both and will keep going in that direction.

Anything notable in the year ahead?

Which categories are going to be emphasized in the year ahead as you are doing more private label?

All of the above.

On the food and sundry side, there's probably a little less on the nonfood side.

You see it, you certainly see growth in apparel in the private label.

We've seen growth in private label and in some of the holiday items, a lot of the trim-at-home and things like that.

Again we've already done luggage.

More of it is on the traditional supermarket side I would say.

And longer term do you think this is one of your primary margin levers or is it more secondary?

I would say it's up there with other initiatives.

It's certainly a chunk of it.

Okay.

Thank you very much.

Your next question comes from the line of Robbie Ohmes with Bank of America.

Thank you very much.

Just a couple of quick questions.

First Richard, I was hoping, I see that Coke is going back into your stores.

Was there anything you learned for that brief moment in time it was out of there, if you can share with us what cycled up when that was pulled out?

Was it your private label, was it other national brands and are there other brands like Coke that we can see similar situation with?

And then the second question is the slowdown in your traffic growth in November.

Is there anything anecdotal you can speak to and whether there's been a rebound from that in December at all?

Thanks.

The Coke thing I think, I don't think we've announced anything, but it is correct.

Effective this coming Monday Coke will be back on our shelves.

Look our sign that we had in store everywhere basically said it all, it says until we can provide our members with these products at competitive prices and provide our members with value, we are not prepared to sell it, and we are now going to sell it.

So that is really all I can say at this point.

We have a long time relationship with Coca Cola and they are a great brand and we are happy to have them on our shelves.

I don't think, I know everybody wants to know more, but that's all you are getting.

On the transaction traffic side, when I looked at September and October and November, traffic was huge in September.

It was like what 6.5, 4.5 and 3.5 basically Bob?

Traffic almost 4?

In November?

All those are great numbers guys.

I can't say anything about December so far until January, but again we -- everybody, given September and October was pretty darn good relative to where it has been.

Everybody wanted a little more in November, so did we.

We felt all three months including November were pretty good and going into Christmas we feel pretty good.

Terrific.

Thanks a lot, Richard.

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

Hi.

Good morning.

Building on the traffic question, what do you think is the normalized run rate for traffic and given the exceptionally strong volume growth you had in fiscal '09, do you think we should expect it to be somewhat lower in fiscal '10?

Yes.

If you look at ten years of monthly comps up until when gas prices really started going through the roof in the spring of '08, it was never below minus 1 in a given month or above 2 and generally between 0 and 1.5.

And never was it above 2 other than a timing difference - of July 4.

All of a sudden it was in the 2.5s and 3s and the last several months it been in the 3s to 5.5.

So I don't think we can assume that on a 4 -- let's say a 4 average over the last 12 months we can keep doing 4s on top of 4s given that for 10 years we were doing 1s on top of 1s.

But I also would hope that it's still a positive number, not a negative number, meaning that we kept this frequency level and people that have gotten used to shopping with us more frequently, arguably for food, arguably this economy has helped enhance that frequency, I think we would hope that it would at least have a plus sign in front of it.

We can't sustain 4s and 5s.

Richard, as we think about leverage point on expenses for comps to the extent that deflation moderates, at some point I know it's tough to call that exactly, but should we think about some moderation in the leverage points for which expenses could be favorable versus sales?

Clearly, I know I've said it before and I just read it somewhere else yesterday.

Little inflation would be nice from a bottom line standpoint here.

Not a lot of inflation but a little, again as it subsides, it helps us.

Or hurts us less in the case of if it's still deflationary.

My last question.

Looking at the November sales relative to the 12 weeks, it looks like the 13th week grew quite a bit faster than the beginning of fiscal second quarter.

Was anything unusual around the timing or your Thanksgiving -- post Thanksgiving experience because it looked like it picked up quite a bit for you.

I think it does work out that way.

So good analysis.

There's nothing unusual in that.

Okay.

Thanks.

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

A couple of questions.

First with the obviously the low end store growth here.

Can you just give us a rough idea what you think the membership growth dollars should look like and excluding FX, of local currency membership growth dollars in the next couple of quarters?

Secondly, if you can give us a little bit of color on the new store productivity particularly in the newest stores Harlem and I think also the mall based store in Arizona that would be helpful.

I can't give you direct guidance on membership dollars, the drivers of course are increasing conversion and penetration of executive membership which we do every quarter and we just did give out those numbers.

The fact that we are still adding net of the UK, which is brand new, just in the US and Canada we are adding 25,000, 26,000 either conversions or new sign ups a week is pretty darn good in that regard, that helps.

There are no current plans to raise the base membership.

As you know, historically we have done that every five or so years and we did it almost four years ago.

So it's still a while off before considering that.

But again certainly, in terms of the slowdown of openings, one of the things we talked about I think it was at the New York opening, while we opened 15 or 16 in '09, a net of 16 or 17 this year, 16 to 18 that we would expect, we were hoping and planning for that number to be in the low 20s in 2011 and 2012 but the high 20s on that.

But our efforts are to push that number upward in terms of openings.

That doesn't impact the next two quarters of course but that is where that is.

What was the second question?

The second question was around new store productivity.

I'm just curious how your earlier results on the Harlem store and then any additional color on the mall based store in Arizona?

We're not going to give you specific numbers but the malls overall have done well.

We opened a year and a half ago in Houston, the Galleria which has been open for us or in Cumberland in Atlanta, north Atlanta which has been very good.

I think so far the results have been fine.

I can't give you specific numbers.

New York is doing as we expected.

I know that doesn't help you a lot.

I can tell you signups are good.

We are getting very strong weekend traffic as expected because people actually go out and do stuff rather than on the way home from work, saying, hey, let's go to Costco like they do in the suburbs and we are building that small business business.

So we are pleased with where we are.

It's not like a Tokyo or a Taiwan opening which is mass hysteria of positive but so far so good.

Given that that store is a bit smaller and the results are as you expected, would you consider opening up smaller stores and markets where real estate is a little bit tougher to get, maybe the size of store that you'd want but would you think about duplicating that elsewhere?

Well, never say never.

Manhattan is unique.

I can tell you that several years ago there was a great location in a very fluent part of Atlanta that was a six or seven acre site, not a 10 or 12 acre site and it required two floors of parking and at the end of the day, as much as we want to do it because there was really nothing in that area, the discipline of saying no was due to the fact that when you've got double decker anything, it's more expensive.

And we should not allow ourselves to go down that road unless, it's the last thing that we can possibly do.

I think will there be more in the future?

Yes.

This by the way recognizing in Manhattan you don't sell a lot of patio furniture and 50-pound bags of dog food.

So some of the bulk was taken out of it, bulk items, clearly it's smaller, but in addition we are fortunate that given this is a five story retail structure, we have the ground floor.

On the ground floor there is basically two things, us and the receiving docks for the entire facility.

The entire five floors of retail.

So we have great receiving without freight elevators, without escalator ramps, visit two floors of retail.

So there is some, for a city like -- relatively speaking, it's great relative to what we thought we could ever do in Manhattan.

Could there be some more?

Yes.

I don't think we're going to be rushing to do a lot.

No.

If there are two more sites in Manhattan, and other parts would we do it?

I think we would do it in a second.

The late month (inaudible) that you saw in the November business, is that continuing into December?

We can't comment.

Thanks.

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

Thank you.

Richard, you talked about you're not really being impacted by the supermarkets in terms of pricing but given the sense of what you are seeing in the competitive environment out there, we've obviously heard a lot of chatter about Wal-Mart getting more aggressive, give us some thoughts especially as you're heading into that easy margin comparison into Q2.

Well, again I don't want to belittle the supermarkets or Wal-Mart, the industry of the super markets and Wal-Mart are both great retailers.

Let's not forget the fact that our average markup is 11% and supermarkets average markup is in the mid 20s and Wal-Mart depending on the format, not Sams but the Wal-Mart stores are probably somewhere from the high teens to the low 20s depending on the format in the departments, so at the end of the day it's hard to beat our pricing overall.

We recognize that people still shop at a Wal-Mart or Target every week.

We recognize that everybody still shops at a supermarket a couple times a week.

But we are getting more of that dollar than we've ever gotten before given our frequency and given the people that people are looking first and foremost.

In terms of pricing, I don't want to be arrogant about it, but I can't predict what the future will hold but we've held our own pretty well in quote, unquote, very tough times, and as I mentioned earlier this conversation about the supermarkets, we don't believe that they've impacted us a lot on our pricing.

So really no change in the competitive landscape this holiday season?

Those are your words.

I'm not trying to say yes or no.

Okay.

Just talking about the categories.

Obviously we are seeing some encouraging nonfood trends versus food.

Give us a sense of what you're learning in the basket, where the interest is and what you've done in terms of the mix to perhaps improve that nonfood trend.

We've seen actually TV unit sales actually start to come down pretty dramatically, plus 30 last month it was only up 15%.

So give us a sense you are obviously seeing some recovery in the nonfood, but where is it coming from and have you done anything in the mix in terms of pricing to spur that?

We've done nothing with regard to pricing.

Again there's no new sale items or new lower price items on stuff.

Part of it has to do with the fact that we are starting to compare against the weakness from a year ago.

Part of it is the fact that people are staying home a little more.

Categories like housewares and domestics and things like that, I think apparel is a combination of what I just said as well as the availability of goods.

There's still a lot of great availability there.

And continuing better brands and what have you.

If anything, a lot of the focus, I think that our nonfoods buyers are just relieved that it finally turned after suffering something that they had suffered forever.

Maybe something with a negative product.

Bob was saying here it really is all categories across the board.

And then on the electronics side, I think we are doing okay given the fact that there was even 15 or 18 in the last month or two.

That's on top of 40s and 50s a year ago.

Clearly we can't sustain that, but fortunately as the unit growth comes down, so has the level of deflation in those categories.

Again electronics is helped by the fact that people -- our camera business is quite strong deflationary but unit sales still making a positive and PCs with the notebooks and everything else.

Deflation is strong but unit sales are stronger.

Frankly, I think it really is all of the above, and the continued improvement in our fresh foods area.

Every day we feel better about our fresh foods selection and growth and how it separate us from the rest.

I think people brag about our stuff because of the quality, the size and the price.

Okay.

And then your point about some of the opportunistic buys, any change there?

Everyone seems to have been focused on leaner inventory.

Is that still as flush as we saw or is it getting tougher to find those buys?

In terms of the direction throughout this time, even a few months ago as we are getting ready for the Christmas and the fall seasons, the message from Jim to the buyers was be aggressive.

We are in a unique position that when we make a mistake it means we got six or eight weeks of inventory instead of three of four and the stuff we sell aren't -- you got to be a little more careful on gift baskets because there is a short window before Christmas on those, but you can afford to be aggressive relative to our complementary retailers.

In terms of -- there is less, a year ago there was some really unique things out there because some of the really high end apparel and related goods and electronics, remember we were selling the two pack of TVs at ridiculous prices relative to what they've been a week before, that had to do with the fact there was inventory backed up as traditional retailers were canceling and there is not much of that because the manufacturers have planned better this year knowing what the economy was doing.

Great.

Thank you.

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

Hi, Richard.

The question that I have is on the electronics business a little bit.

Can you talk a little bit about demand and pricing and sort of how the lower price points or the lower screens are doing versus the larger ones and how you see that playing out?

The second question that I have is when you look around at the business from the perspective of the gasoline business, how competitive has that been or what are your expectations around that?

Because the supermarkets also have talked a little bit more about their gas pricing and the challenges there.

I think the trend overall in gas is still volatile and still requires reclining.

The bad weeks are not as bad and the good weeks are better than they used to be.

Overall it has become a little bit more profitable business and I'm only speaking of the last 15 months or whatever.

But I can remember when we had not a lot fewer stations, but fewer stations two and three years ago, a bad week you could lose 3 million or more.

Today it seems like a real bad week is in the low 2s.

Again, it's anecdotal but at least it's directionally -- it's still volatile, if you look at last year, again in Q1 we had great profitability.

Q2 and 3 we lost money, not a lot, and Q4 we made a decent amount.

So overall we did fine for the year our best year ever, but it was certainly volatile and as I mentioned earlier on this call, Q1 is starting out, Q1 did actually pretty good but comparing against ridiculous from a year ago.

And Q2 we lost money last year two weeks into we are making a little but nothing -- you never know what can happen tomorrow.

The other part of that question?

Electronics.

Yes.

Our sweet spot actually is still the bigger TVs.

There's lots of 40 to 55-inches in the $800 to $1,600 range, and on the TV side, our chart, our graph would be skewed to the right with price points going up to the right.

On the net book side, they are doing fine.

We still sell more of the full line laptops and desk tops recognizing a really good full line laptop now is $600 to $800.

Our challenge is to keep putting more into it so we can drive the price point up a little and still be a great value.

Thanks, Richard.

Your next question comes from the line of Colin McGranahan with Bernstein.

I wanted to focus on SG&A dollars.

If I back out the $28 million charge from last year, and I don't know if my math is any good or not but try to adjust it for currency, it looks like the SG&A dollar growth year-over-year was about 6.5% adjusted for currency, a little bit faster than in the fourth quarter but the sales improved a little bit.

But you managed to leverage payroll.

Can you just give us any more color on anything you were able to do to kind of keep the SG&A dollars in check during the quarter and how to think about that growth rate going forward?

For those of you who have none us a long time, used to always say that there aren't a lot of silver bullets, we're pretty efficient.

I think in the last year we've gotten better.

Everybody is looking everywhere else.

Every sub supervisor is looking to see where they can save a little bit.

It's hard, but I think -- we've taken our -- we've tested this in some regions.

We've taken our ratio of full time to part-time to warehouse from 50/50 to maybe 55/45 recognizing if you have more full timers you have a few less full time equivalents.

You have the same payroll dollars perhaps but a few less people on benefits because everybody is still eligible but just a few less full time equivalents.

That is not everywhere and it does work but I'm trying to think what else.

How about healthcare going forward?

You're now beginning to anniversary some of those higher cost.

It looks like maybe the employment situation could be bottoming just from a year over year change in employment.

How do you think about that going forward in terms of the impact of healthcare costs on SG&A dollars?

I don't know that I have all of the right answers or any of the right answers yet.

One of things we're talking about is again one of the things is moving slightly the ratio of full time to part-time, recognizing as you do that it's harder to manage the business because part-timers allow you more flexibility.

What was his question again?

I'm sorry.

Somebody was asking me something.

I was thinking about the increased dollars dedicated to healthcare.

I understand you're trying to--?

We are doing proactive things that for long term help but don't help this quarter or next quarter.

What we are not going to do is charge the employee a lot more.

They are paying a little more because the cost is going up, but they are not -- they are not taking the brunt of it.

There was one other thing I was going to mention on the healthcare.

It escapes my mind.

I apologize.

I'll think about it as we go along here.

Thanks, Richard.

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

Baird.

A couple of questions here.

First on private label, can you remind us what the penetration was for fiscal 2009 in total and then what it was in the first quarter?

It's up about 2 percentage points year-over-year.

I would say it's approaching 20 or right at.

I need to get a better look at it but I think it's up to 20 up from maybe 18 a year ago.

The food and sundry side is disproportionate.

It's probably up 300 plus basis points on that side.

That is the first quarter or for fiscal '09?

I am I thinking of year-over-year.

Getting back to the previous question about healthcare, there are two other things.

One of the things that hit us hard in the last year that has added insult to injury here in dollars is the increased percentage of our employees that are eligible because we haven't opened as many units and because people aren't leaving.

Again for years we were in the very low 80s in terms of those eligible because your new hires generally are part-time hourly.

They take on average six and a half months to become eligible.

Having opened a fewer number of units and having existing -- our annual turn over has gone from a very attractive low 20% number to 12% in the past year.

As economy gets better, it is not going to jump back up to the low 80s in the case of -- from the low 90s in terms of eligibility.

My guess is over the next three or four years we will get incremental improvement in that number.

That will help you a little better, it will help offset some of the increases.

The other thing is that in these tough times over the last year, we've done -- this is anecdotal, but in discussing this with our third party administrators, like the Aetna's of the world it's not just at Costco.

What is just at Costco I think is that we have a very generous plan where the employees pay a small piece, so we're getting hit with a little bit more of the burden but what has happened over the last year is there's increased frequency in utilization.

The stress on people's lives at least on the surface it would appear that people are doing more.

It's not that we're -- we are still devoting as many dollars to working safety in the warehouse.

People are just doing more things.

I am not talking about workers' comp in general.

Whether it's stress, accidents, you name it.

So that too I think as the economy gets a little better, anecdotally it should improve a little.

We are being very proactive and these are longer term issues like all companies out there on things like weight loss, smoking cessation, how do you incent your employees to do that without being punitive.

What we don't want to do is say if you smoke it's this much more but at least what about if you try?

Try to do a cessation plan.

You don't have to succeed, but you got to try.

These are the types of things that we are doing and looking at.

These are more long term than the next quarter or two.

Okay.

Sticking with the healthcare thing then, you said earlier in the call that it was $0.01 to $0.02 higher than expected.

I recall on your prior call you said you expected the hit to be $0.03.

Was the hit $0.04 to $0.05 or was the hit just $0.01 to $0.02 so a little bit better than what you thought it would be.

What did I say earlier?

On the fourth quarter call you said that the healthcare hit was going to be about $0.03 a share.

Honestly I would have to look through the notes.

I don't think it's $0.04 to $0.05, but I want to see how I used that $0.03.

I'm not trying to dance around it.

I don't believe it's $0.04 to $0.05.

No problem.

Then on the trend to California that is getting better, can you break that down between kind of the core business, because I'm sure some of that is gas getting less negative.

If you strip out gas, how has the California market been performing 1Q versus 4Q?

Still better.

Is it positive?

It was ever so slightly positive.

Excluding gas?

Hold on a second.

Ever so slightly negative.

And then lastly -- thanks for that.

And then lastly the depreciation number you gave, I think that was about 19% higher than last year.

It has been growing more than 11%.

Any reason why depreciation accelerated?

Probably the biggest single thing is we -- historically we had used outside disaster -- for our IT we had used outside disaster recovery sites and we finally took the plunge about six months ago, eight months ago, a little over that maybe nine months ago.

And eastern Washington rather than in Sterling Forest, New York or Boulder, Colorado, is in eastern Washington we basically expanded close to $30 million on computer equipment and that facility over there that is a dedicated facility for many companies, that's a disaster recovery center where we have our caged in areas and we are also relatively new over there but unlike the banks that have mimicked the IT system all over the country and the world, we historically have been here and used third party disaster recovery.

Most of that equipment has a five year life, I believe.

A little may even have three year but lets say on average four to be safe here.

So that alone is a chunk of it.

Okay.

The other thing that we have really pushed in the last couple of years which I think we are seeing a little bit of increase and you'll still see it is remodel activity.

One of the things that we are notable for historically is all the places look pretty good, and have the latest and greatest we are taking the offense on driving business.

We are spending a lot of money on fresh foods and refrigeration and frozen foods.

Those are profitable departments and penetration is up and we are devoting lots of money to thing like that.

Great.

Thanks so much.

Your next question comes from the line of Laura Champine with Cowen Group.

Good morning, Richard.

Can I get a clarification on an answer that you gave to another caller?

When you said the comp is unlikely to stay up in the 4% plus range but you are hoping to have a positive sign, it seems like you might get to 4% plus just on currency and gas having a better impact.

Were you talking about the total cost or were you just talking about the merchandise comp?

What I was talking about is the traffic frequency, the frequency.

So the comp was the product of average ticket and average frequency and we've been enjoying for ten years the frequency component, the shopping frequency.

For every hundred shops, the existing members to this year they would do 101 or 101.5 next year.

So frequency was up 1, 1.5%.

Since gas spiked in the spring or early summer of '08, we started seeing the frequency improve like never before.

I think it improved even more with the economy and with our people shopping more often to keep more cash in their wallet.

With the penetration of food and sundries.

Certainly unit penetration people are shopping for that versus bigger ticket discretionary items.

So what I was saying was is that frequency in the last year has started in the 3 range and headed toward 5 plus.

Clearly we are not going to see it go 5 on top -- 4 on top of 4 on top of 4 on an annual basis.

I would be happy if we maintained it and we are able to keep growing back to the old days when it was 1.

Got it.

Thank you.

I am going to take two more questions and call it a morning here.

Go ahead.

Your next question comes from Deborah Weinswig with Citi.

I guess we are going to call it an afternoon.

On the fourth quarter call Richard, you talked about for holiday you brought in some seasonal items a little early, I think into mid August rather than early September?

Did that change the cadence of sales, did that give you early return, what did that allow you to do different holiday '09 versus holiday '08 if it did?

Well, less markdowns.

I think it gets back to what Jim talked about as being aggressive and if you have great merchandise at great prices let's get them in there earlier and people see it here first and buy it here first.

And we have the luxury in our model to do that.

I view it as it was again more being, taking the offense and also giving us more time if we did need to sell through to sell through without markdowns.

And then at the analyst event you held in New York you elaborated on your central fill initiative.

Can you provide some additional details in terms of what that has allowed you to do in terms of improving your pharmacy operation and are there additional plans to open more central fill facilities?

Well, yes, what we talked about was, A, there's a shortage of pharmacists in the country because everybody has pharmacies.

Not just pharmacies, the Walgreens and the CVSs of the world but the supermarket chains, the Targets and Wal-Marts and the Sams and the Costcos.

So in that regard, there's a shortage.

The average cost to fill, the central fill can do high volumes very automated for the most popular prescription drugs, and we can cut by almost two-thirds the all in cost of filling a prescription.

We are not the only ones doing it but given our volumes it's kind of like we take most advantage of our cross-talk operation versus traditional distribution centers and the retail industry, we take more advantage in fillings here because of the volume.

We have a couple of these places doing upwards of 15,000 prescriptions a day with three or four pharmacists and the number of pharmacy techs supporting it.

It's a highly automated system.

So will we do more?

I'm sure we will.

I think what it has enabled us to do is to maintain our very strong profitability in that business over the last few years particularly in the markets where we have these three on the West Coast while everything in that business is tougher.

The 100 pills for $10 and Medicare Part D which I use one of my relatives as an example who takes several different prescriptions of more expensive state-of-the-art drugs and the annual cost at Costco before Medicare Part D was about $6,300.

Overnight it went to the low 4s, 4200, $4,300.

That came out of the retailer's gross margins.

So I think with those, notwithstanding all that, this has helped us maintain a good profitability in that industry which is an ongoing, changes daily.

I heard a lot of questions on this call about deflation et cetera, but what are you seeing with regard to list prices from your vendors?

Is input costs coming down?

And then I thought you had some very interesting insights with regard to your approach to private label and how that is changing your vendor relationship.

How might that also might be changing some of your list prices?

When you say list prices, you mean on branded goods?

Correct.

It's a circular thing.

One plays on the other.

The fact is, people always ask are our buyers better than some other retailer?

What makes our buyers better in some regards or good in some regards is the fact that we have to manage fewer things.

We are managing 2 skews, not 30.

We are putting all our buying power into 2 skews not 30, which allows our buyers to get more in depth and understanding of very component or production cost.

I think sometimes we drive vendors crazy with that.

But it has helped us and has given us in our view an advantage out there.

And not taking anything away from any other retail buyers and other companies, but we spend a lot more time focusing on the cost, the component cost from direct labor, electricity, packaging where are you getting your resin from, you name it, and all that goes into helping us do a good job.

As Jim has said a number of times, we want to be both a seller of great private label goods which does a lot of good things for us and the customer, great value and prices to the member, allows us to protect our margin and enhance loyalty because the only place you can get our product is here, but it also allows us to be more competitive.

Time and again over the years as we've introduced the Signature items that very strong, very brand loyal brand item has had to come down in price from already great prices to regain some of the lost market share.

So ultimately it's -- what our mission is is to provide our members with the greatest products and quality at the lowest prices.

So we think there's plenty of opportunity.

We also -- as you've heard us say, there's a lot of great branded manufacturers out there.

Everybody can say it makes them better too but it does.

We all know who some of the best brand, suppliers our there are in terms of innovation and as they lose an item or a portion of a sale of on item, they are coming out the next day with something, that's a third level up or ultra thing or improve that or completely new items.

So that makes it better for all of us.

Okay.

And then I think, if my memory serves me right, you rolled out EBT to the New York City area.

I just want to confirm you are going to rule it out to the rest of the change.

Can you provide any color around what you see in the New York area as a result?

It is down everywhere in the US.

The only place it may not be, there was a time delay in the state of New Jersey and had to do with some regulations of how you do it.

It's more a timing issue and not an issue of not doing it.

I could be wrong that it may already be in there but I know it wasn't in the first few weeks after we announced it.

Look, it's a slight net positive.

It's still a very small percentage, but we have gotten a lot of positive responses from, we have also gotten some new members.

You have got to believe on a macro basis there were some members that preferred to shop at Costco, but chose not to for one reason.

They are on food stamps and we did not accept them.

So from that perspective we are gaining incremental new business, and at the end of the day some of our reasons for not doing it historically had gone away.

Is it still a small percentage?

Yes.

But is it slow at the front end a lot, no.

It used to when you had to separate the basket into food stampable and nonfood stampable, do two separate transactions, paper value coupons, not electronic debit cards effectively and so we probably waited a little too long, but it's a good thing we did it.

What was the date that it was rolled out?

It was over several weeks.

I want to say a month, two to one months ago.

So very recent.

Thanks so much and best of luck to the rest of the holiday season.

At this time there are no further questions.

Thank you, everyone.

This concludes today's conference.

You may now disconnect.