好市多 (COST) 2010 Q2 法說會逐字稿

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

At this time I would like to welcome everyone to the second-quarter and year-to-date results and February sales release 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).

I would now turn the conference over to Richard Galanti, CFO.

Mr.

Galanti, you may begin.

Thank you, Tina, and good morning to everyone.

This morning's press release reviews both our second-quarter fiscal-year 2010 operating results for the 12 weeks ended February 14th and our four-weeks sales results for the month of February, which ended this past Sunday, February 28th.

As with every call let me start by stating that the discussions we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and that these statements involve risks and uncertainties that may cause actual events.

results and/or performance to differ materially from those indicated by such statements.

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

To begin with our 12-week second-quarter operating results -- excuse me.

For the quarter reported EPS came in at $0.67, up 22% from last-year's second quarter of $0.55.

As noted in this morning's release, a $22 million pretax charge, or $0.03 a share was recorded in the quarter related it a change in the Company's employee benefits whereby certain unused time off will now be paid annually to the employee.

Excluding that nonrecurring charge, second quarter EPS would have been $0.70, or 27% increase over last- year's results.

As will be discussed in more detail in a moments, our second-quarter results and a comparison of these results with last-year's second quarter included several other items of note.

They include the following.

First, you recall that last year in Q2 we were took some very aggressive pricing markdowns on a variety of commodity items estimated around $0.04 a share; items like milk, cheese, butter, rotisserie chickens in order to drive sales.

No similar events occurred this year in Q2 so that helped the comparison year over year.

Second, we had a positive a year-over-year swing in our gasoline profits.

Last year in the second quarter we lost a little money, this year we made some money.

Third, LIFO.

LIFO is one that actually went the other way.

Last year in Q2 we had a $7 million LIFO credit, or about a $0.01 a year pickup, and despite recent levels of deflation there's no corresponding pickup this year in the second quarter, as our cumulative LIFO balance is in a net credit position and you can't go below zero.

Fourth, in the last several -- last couple years we've talked about FX headwinds, we're now talking about FX tailwinds.

Our foreign earnings results, when converted and reported in US dollars, helped us this year in the second quarter by a little over $20 million pretax, or $0.03 a share.

That is assuming FX exchange rates were flat year over year, this year's foreign operating results in Q2 would have been lower by that amount.

And lastly on the expense side, while we made -- we have made improvement from Q1 a variety of our employee-related benefits costs, notably healthcare costs and accruals for both workers' compensation expense and bonuses, were higher year over year in Q2.

Healthcare costs continue to be a challenge, but we are currently anniversarying when they began increasing in a big way last year in Q3.

If you recall, last year there were two issues.

One is there is ongoing healthcare cost inflation.

We -- kind of a double whammy for us over the last 12 to 15 months, have been that as we lowered the number of openings and existing employees weren't tur -- while the turnover's always been low it got even lower over the past year and a quarter with the economy as it is, that we saw the number of covered employees jump from the low 80s as a percent of our total workforce in America to the low 90s.

That certainly is anniversaried now, as well.

In terms of sales for the 12-week quarter, reported total sales were up 11.3% and our 12-weeks reported comp sales figure was up 9%.

For the quarter both total sales and comp sales were impacted by both gasoline price inflation and by the strengthening foreign currencies relative to the US dollar year over year.

On a comp basis -- this is for the quarter -- the 5% US sales increase in Q2 excluding gas inflation, would have been 2% and the reported 26% international comp sales increase figure, assuming flat year-over-year FX rates, would have been 10%; still a good number but not the 26%.

Total Company comps, as you saw, for the quarter we reported a 9% comp, excluding both gas inflation and FX changes, that would have been 3% for the Company.

And in terms of sales for the four-week month just ended, it's similar to the quarter.

Excluding gas inflation the 5% reported US comp would be 2%, excluding FX the 26% international figure would have been 10% and excluding both gas and FX, February's total Company reported comp of 9% would have been 4%.

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

After opening six new locations in Q1 we opened two new locations this year in Q2; one in Hayward, California and the relocation of our Warrenton, Oregon facility.

Since second quarter end two weeks ago we have not opened any new locations, but tomorrow morning we will open a new Costco in Los Angeles in Pacoima.

It'll be our 117th California locations and our plans for the remainder of the fiscal year to open up to eight more locations, probably seven or eight.

As wi -- also this morning I'll review with you our online results our membership trends, our membership trends, a little bit more discussion about margins and SG&A in the quarter.

I won't go through is balance sheets because you'll notice -- as you'll notice that was attached to the press release, I'm happy to report.

And give you a couple of other quick comments, including the recent appointment of Craig Jelinek to the title of President.

So let's start with the income statement here.

Again, on our quarterly results sales for there year's second quarter were up 11% from $16.5 billion last year up to $18.4 billion this fiscal quarter.

On a reported comp basis second-quarter comps were up 9%.

Now the 9% second-quarter comp figure was essentially comprises of a 9% in December, an 8% in January and a 9% in February -- recognize our quarter started the last week in November and ended in mid February.

And this 9%, 8%, 9%, if you will, for December, January and February, excluding the gas and FX, would have been 4%, 2% and 4%, so a pretty good showing, particularly for the most recent time of February.

The 9% reported comp figure was positively impacted by a little more than 3% due to the strength in the foreign currencies.

As I mentioned earlier, our international comp was reported at 26% was actually plus 10%.

The same thing with gas, the 5% reported in the US would have been plus 2% without gas inflation.

For the quarter our 9% reported comp figure is comprised of an average transaction increase of a little over 4% and an average frequency increase of a little over 4%.

I might add that the frequency trends during the past three months of December, January and February were 5%, 3.5% and about 4%, and this is now going over a year of seeing pretty good frequency numbers on top of pretty good frequency numbers a year ago.

February, of cour -- January and February, of course, was a little negatively impacted as a result of both the heavy rains in California and the unusual amounts of snow in the Northeast, Midwest and Southeast., and for February, of course, there was also the impact of the snows in the Northeast.

For February reporting month, much like the quarterly comps, again our 9% reported number.

Taking the gas and FX that was a plus 4%.

Within the 9% for the month of February, that is comprised of an average transaction increase of about 5% and, again, an average frequency increase of around 4%.

Again, that transaction increase of 5% is pretty much FX of 3% and gas benefit of 2% -- a little over 2%, so the net of those two average transactions increase was about flat.

Cannibalization pretty much consists of what little it's been of late, about a little over 0.5%.

In terms of sales comparisons by geographic region, for the quarter the Midwest and the Southeast were the strongest, followed by a pretty good showing in the Northwest.

California was actually a bit improved, also, and the weakest US region was the Northeast.

Of course they were impacted by a record-setting snow season.

Internationally in local currencies doing quite well, as you saw from that plus 10%.

Despite economic turmoil everywhere Canada's up in the mid teens in local currency in the quarter and the rest of the country's averaging up in the high single-digit comps.

A little more color on February sales, as we are reporting these figures today, as well, instead of tomorrow.

In addition to the benefit from gas inflation and FX, we also benefited a little bit from the calendar shift to the Super Bowl.

As you recall from Bob Nelson's call in January, we estimated that the way the Super Bowl hit the calendar this year we estimated that January had been negatively impacted by 50 to 100-basis points; correspondingly, February would have been benefited from that.

We also went through and talked to our operators and looked how the weather, both in California, as well as the significant snows throughout parts of the country, and particularly in the Northeast, and the estimate there was that that was about 1% to 1.5%.

So probably the net of those two was a slight detriment to February, but it's a guess at that.

On a regional and country basis, the US regions with the strongest February results were the Midwest and Southeast, again followed by good showing in the Northwest.

Again California conditioned to improve a little bit relatively speaking there.

The weakest US region was Northeast, again greatly impacted by a record-setting snow season.

Internationally, Canada for the month was up in the high single digits in local currency and the rest of the countries averaging in the mid teen comps figures in February.

As reported in January overall, deflation in the food and sundries category appears to finally be abating such that year-over-year unit pricing decreases that had been running down 1% to 3% -- down minus 1% to minus 3% during recent months were essentially flat year over year in February.

Looking ahead, March sales, which is a five-week reporting month, will have 34 days -- selling days this year compared to 35 last year.

This has to do with the timing of the Easter holiday, which is one week earlier on the calendar relative to last year.

The March reporting period will end Sunday, April 4th, which is Easter, and will be reported that Thursday, April 8th.

In terms of merchandise categories for the quarter, within food and sundries average (inaudible) category was positive in Q2, ranging from plus 3% to plus 10%.

Within the hard lines comp the strongest categories were sporting goods, hardware, health and beauty aids and lawn and garden, and both office and majors being small positives.

Within the mid teen softlines comp, most every category was strong, ranging from a 5% to a 25%.

Some of the, what I'll call house-related smaller ticket items, like housewares, domestics and things like that were -- small electrics, domestics, home furnishings were standouts within the softlines category.

And fresh foods, much like food and sundries, was positive with all sub fresh food categories positive, as well, in the mid low-single to mid high-single digit range.

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

Reported membership fees were up 8.5%, or $30 million, to $385.8 million, which was 2.10%.

That's down six-basis points.

Excluding FX, since this includes the benefit of the strengthening foreign currencies when convert it into US dollars, the 8.5% dollar increase would have been 5%, or a $19 million increase on a flat FX.

I'd now also mentioned that the -- when we talk about both membership margin and SG&A, the gasoline inflation if you assume, again, flat gas prices, that minus six-basis point number, needless to say, the higher gas inflation makes the sales denominator in all these calculations higher making the actual numbers lower and that six-basis point negative would have been flat year over year, excluding gas inflation.

So we think a pretty good showing overall.

In terms of membership continued strong renewal rates, continued good penetration of the executive membership.

And despite only one net new opening this year in the quarter, our new membership signups in Q2 were actually the best they've been in a while, up 5% year over year in the fiscal quarter.

In terms of number of members at Q2 end, we had 20 -- a little over 22 million in Gold Star, about 5.8 million -- 5.7 to 5.8 million primary business, a little over 3.4 million add -on, a little over 31.1 million total primary, and just under 57 million, including spouse cards.

That, by the way, number is just under 60 million if you include Mexico, which, of course, we don't realize those numbers on our income statement.

At quarter end of February 14th, our paid Executive member base was $9.6 million, an increase of $340,000, or 4% in just the 12 weeks since Q1 end, so between new signups signing up as Executive member, as well as some pretty successful conversion programs out there, averaging $28,000 a week increase in the quarter, one of our higher results in the last few quarters.

In terms of membership renewal rates, again continuing strong at Q1 end and at Q2 end.

Business renewals were at 92% -- 92.0%, Gold Star at Q1 end was 86.0%.

It was actually 86.1% at Q2 end and all told 87.3% for the Company at Q1 end and tweaked up to 87.4%.

It's generally been running in the 87.2% to 87 .5% range quarter in and quarter out for the last couple of years on a quarterly basis.

Going down to the gross margin, gross margin the second quarter was higher year over year by 26-basis points from a -- it came in from a 10.42 last year to a 10.68.

Jot down the following numbers and we can go through it.

We'll have three column -- Q4 2009, Q1 2010, and Q2 2010 -- and the line items would be core merchandising, second line would be ancillary businesses, third line item would be 2% reward, fourth line item would be LIFO and last item would be total.

Going across core merchandising up 48-basis points in Q4 of 2009 -- that was on a year-over-year basis -- up 15 in Q1 2010, and up 15 in Q2 2010.

Ancillary, minus three in Q4 2009, minus 20 in Q1 2010 -- if you recall, the minus 20 it was a year ago in Q1 2009 when we had outsized gasoline profits -- and then in Q2 2010 a plus 16.

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

Again, a minus here indicating increased sales penetration to those Executive members.

LIFO plus 22 in Q4, minus one in Q1, and minus four in Q2.

And total was a plus 56 in Q4 2009, a minus nine in Q1 2010, and a plus 26 in Q2 2010.

Now with these numbers in front of us, as you can see our overall reported gross margin was higher year over year by the 26.

Now within this 26-basis point figure our core merchandising gross margin contributed 15-basis points in the total and ancillary gross -- business gross margins, principally gas, contributed 16-basis points.

These plus 15 and plus 16-basis point figures are actually a little more impressive, when you consider that the sales penetration of our higher-margin core business was down 2% in Q2 year over year, again related to the fact that gasoline inflation caused the gas sales to be a lot higher, and whereas the sales penetration of our ancillary businesses, again mostly gas sales, which is a lower-margin business, was up 2%.

The sales penetration of our core merchandising business being down, so while gross margins of our core merchandising business -- and recall, core merchandising business is in the high 80s as a percent of total sales -- is comprised of food and sundries, hard lines, soft lines and fresh foods, they were higher year over year in the quarter on a -- those departmental sales -- margins on those departmental sales year over year in Q2 the margins were higher by 54- basis points, but that translates into plus 15 when you account principally for the gasoline inflation.

The respective merchandise category gross margins, again that 54, represented ranges from 26 to 75-basis points, with the low end being.

I believe food and sundries, but you'll recall -- I'm sorry, the high end being food and sundries, but you'll recall that's because we had those aggressive pricing last year on a lot of commodity items.

Lastly keep in mind, as we've discussed, that in terms of some aggressive on some commodity items, if you exclude the aggressive pricing markdowns, food and sundries gross margins were still up 13-basis points year over year on -- food and sundry margins based on -- divided by food and sundry sales.

The impact from increasing penetration of the Executive membership was one-basis point and LIFO, as I mentioned we had a $7 million LIFO credit last year versus zero this year, t hat would be a detriment to this year's margin on a year-over-year comparison of four-basis points.

Before we go into SG&A, again looking at these numbers, if you -- and the way I looked at it was is we started with that core of 15, the sales mix was -- of gas was 24, that would bring the 15 up to 39.

Then taking out the aggressive pricing was 17, because that's an unfair comparison since we did that last year, not this year, so you get something in the low 20s.

This is not an exact science, but I think the merchandising core of plus 15 is representative of what really happened in the quarter.

In terms of moving on to SG&A, SG&A percentage in Q2 over Q2 was higher or worse by nine-basis points, coming in at a 10.20 compared to a 10.11 last year.

The $22.5 million nonrecurring charge related to the change in employee benefits represented a detriment of 12-basis points, so really that minus nine you might look at as a plus three excluding that charge.

As a result, an improved result from Q1, nonetheless, and again, there's a little bit of further elaboration in SG&A, given the fact that SG&A benefited by 24-basis points because of the gas sales inflation.

So again, we'll write down some numbers and I'll try to give you an explanation here.

Again, four columns -- three columns; Q4 2009 and then Q1 fiscal 2010, and Q2 fiscal 2010.

The line items are operations, central, stock compensation, quarterly adjustments, total, and going across, operations minus 61 in Q4 2009 -- now minus being higher or worse -- Q1 2010, minus 16, and Q2 2010, zero.

Central minus eight, minus three and plus two, so again as a percent of sales central a little better year over year.

Stock compensation minus one, minus three and plus one.

Quarterly adjustments plus seven, plus 18, and minus 12 -- and again, the minus 12 is the item we mentioned the quarterly earnings release -- for a total of 63, minus four and minus nine.

Now, again, a little editorial here.

Operations, again the core operations was flat year over year in Q2, but again, it's about -- mostly about [salesmans] change, just like with gross margins percentages where increased gasoline sales penetration hurt us, it correspondingly helped us in SG&A by a little more than 20-basis points.

However, the combined negative impact of benefits cost, including healthcare, workers' come and bonuses, was a negative 24 and I'll go through that in a second.

So excluding those higher costs -- those are real costs, but excluding those the rest of the operations actually improved a little bit; payroll, and various other direct controllable expenses.

Our central expense again, was lower or better year over year by two-basis points.

As I mentioned, the stock compensation better by one-basis points.

Overall not a bad performance, but again the way I look at is we start with a minus nine for SG&A, we add back the 12 for the quar -- for the non-recurring quarterly adju -- charge to get to plus three.

The gas mix although, helped that by 20 -- a little over 20, 21 to 24, so you get something about a minus 20 in terms what it looks like.

Now, that's -- that roughly 20-basis point detriment is more than that in health, workers' comp and bonus.

Health we talked about, and as I mentioned, we're anniversarying some of the big increases from a year ago.

We are hopeful that that number on its own's going to come down because we have now transitioned to the higher percentage (inaudible) under the plan and I don't think that's going to go a lot higher now.

On workers comp that has as much to do with actuarial adjustments to the number at each quarter.

Last year I think it's just a little bit more of how the moons lined up this quarter versus a year ago.

A year ago -- he underlying , $2 million difference.

The bigger difference is, is last year in Q2 we had a benefit, a reduction in our accrual, and if you recall for workers' comp it's not just your incidents this year, it's the balance you have for previously-accrued expenses for any expenses that might have a two to six-year tail on it and, again, the actuaries come in and look for that.

So we had a pickup last year in that number and a detriment this year, or an increase in the accrual.

My guess -- and this is just a guess -- is that some of that relates to the fact, the same reason that healthcare costs are up over the last year, with everything that's going on in the economy and what have you.

The last piece of that, bonus accrual, in the last couple of years we haven't -- we start with a bonus accrual and by mid year we set our standards so we think they're achievable but not easy and in the last couple of years we haven't had it and have taken back a little in Q2.

In this case we're not because we are still hitting the numbers and that's good.

But on a -- we typically haven't talked about it for a couple of years because we haven't hit it.

Again, that is -- that's probably -- that was about six or seven-basis points to this detriment.

So all told, looking at all SG&A was higher year over year on a real basis given all these expenses.

I think some of them are going to start coming -- not being as big of a negative to us.

Hopefully we'll see positive sales, as well.

Next on the income statement is preopening expense.

Preopening last year in the quarter was seven -- a little over $7 million, this year $3.2 million, so it picked up of $4 million year over year, two-basis points better.

No real surprises her.

Last year's number, even though we didn't have any openings in Q2, there was quite a bit of preopening related to several post-Q2 openings notably, as well, as some of the ones internationally, which are higher numbers and preopening starts a sooner than life for some of those.

In terms of provision for impaired assets and closing costs, not a big deal either way.

Last year we had a charge of $1.2 million in the quarter, this year under $200,000.

So all told, operating income in Q2 was up 18% year over year from $399 million to $470 million, or an increase of $71 million.

Excluding the $22 million charge the $71 million would have been up $93 million.

Below the operating income line, reported interest expense was slightly higher year over year, with Q2 2010 coming in at $26 million, up about $800,000 from the $25.2 million in last-year's Q2, a small change.

That small change really relates to more to the change in capitalized interest year over year, which has the -- higher capitalized interest lowers the interest expense number.

The interest income year over year was up by $18 million and it's really the other, as I'll explain in a minute.

Last year in the quarter, interest income and other was up $11.6 million, this year in the quarter it was $29.8 million.

Interest income was actually lower by $3 million, a [reflecture] of lower short-term interest rates, while other income, which was up dramatically, and that's both principally a combination of earnings from Mexico, as well as profits from FX contracts used in our business.

A portion of those -- that profit in FX contracts historically had been up in operations in the margin and is now down below, so actually we hurt our reported margin this quarter.

It's not enough to talk about but that's where it'll appear in the future.

So overall pretax income was up 23% versus last-year's Q2 and up 29%, excluding the $22 million charge in the press release.

Tax rate, we benefited a little bit coming in at 35.6% versus 36.9% last year in Q2.

I believe it's a combination of a couple of discreet items that went our way, as well as increasing profitability of some of the foreign operations, which have a lower tax rate.

Now for a quick run down of other topics.

One I won't go over is the detail of the balance sheet, you have that in the press release.

Depreciation and amortization for the quarter was $185 million and $369 million year to date.

Balance sheet, as you'll see in the press release, continues to be strong.

One of the ratios we always look at is what we call our AP ratio, which is simply accounts payable divided by inventory.

On a reported balance sheet basis it's up four percentage points from 100 a year ago to 104%, meaning that more than all of the inventories are being funded with receivables.

If you take out -- and some of those receivables are construction receivables, so in fairness it's still up 4% from 83% a year ago to 87%, so -- I'm sorry, I said receivables, payables, I mean.

87% of our inventories were funded with trade payables as of Q2 and up from 83% a year ago.

And, again, I think that's simply a reflection of slightly-higher sales and, of course, slightly higher turns.

Our average inventory per warehouse was -- at Q2 end was $10.046 million, or up $421,000, or 4% from a year ago.

If you take out FX that up $421,000 is up only $128,000 per location.

No inventory concerns, we came out of Christmas clean and felt pretty good about getting through that with getting rid of seasonal items in a good fashion.

In terms of CapEx, in Q2 2009 it was a shade under $300 million, and compared -- and then Q2 2010 it was a shade under $200 million, year to date it's a little under $500 million.

I'd estimate our fiscal-year 2010 CapEx will be slow slightly lower than last year's figure, probably in the 1.0 billion to $1.2 billion range, but probably closer to $1.0 billion given the fact a couple of things have been delayed.

The next topic Costco online, both Costco.com and Costco.ca in Canada continues to be profitable and growing.

For Q2 and Q2 year to date sales and profit of these operations were up over last year and while our average ticket has still come down a little bit, recall our average ticket is in the high -- mid to high $300s, it had been in the low $400s before the economy got hammered, and in Q2 year over year our traffic was up 8%.

In terms of expansion, as I mentioned -- as we mentioned previously, in Q1, we opened six new locations, with no relo, so a net of six.

In Q2, we opened two, including a relocation, so a net of one.

We'll open tomorrow in Pacoima, California, and that will be it for Q3, and then Q4, up to eight.

With bad luck it could be five.

With likely possibilities it's probably six or seven, and we're pushing for eight.

They all will be under construction, it's a matter of did something fall from August into September.

So our best guess at this point is 17 new, less the relo, it would be 16 net, and maybe 15, we'll -- 14, but we'll see.

In fiscal 2010, assuming the 16, that would be 3% unit growth and bout 3.5% square-footage growth, and a number that some of you like know, at Q2 end total square footage stood at 76 million and 32,000 square feet.

Lastly, just making a brief comment about stock repurchases.

As you know we began buying back in June of 2005 and pretty much ceased in September of 2008, as the economy and ultimately the market was getting hammered, and we bought -- we had spent a total of about $4.8 billion during that time.

We bought a little bit in the middle of calendar of 2009 and I mean a little bit, I think one or two days worth of purchases.

We did, during the week of February 8th, got back into the market, purchasing in aggregate over the five business days of 250,000 shares that week.

And then we've since -- since that week we've not bought during -- leading up to the earnings release and we'll look to see what we want to do after that, but we did buy a little in that week of February 8th.

The last comment I'll make before I turn to back over to Tina is, as you know, a few weeks ago we made an announcement that Craig Jelinek was named President and Chief Operating Officer effective at the time of the press release in early February.

Craig has been around Costco and, frankly, around many of the people that started Costco since the very late 60s, as he told me.

Craig's 57, he started at Fedmart in 1969, spent 12 years at Fedmart and then three years in the late '70s through the early '80s -- in the late 1981 to '84 at Lucky stores and joined Costco shortly thereafter in 1984, originally, I believe, as a warehouse manager, and has been in Costco for the past 26 years.

He's been -- for most that have time through 2004 he was in operations.

Most recently, at that time in 2004, as one of the EVPs and COOs of oper -- Executive VPs of operations and basically in charge of about a third of North America operations.

At that time, in 2004, he and Doug Schutt -- Doug at the time had been in charge of nonfoods merchandising -- basically switched jobs and for the last six years Craig has been in charge of merchandising until this recent announcement in early February.

Doug, who's in his early 50s -- I think 51 -- started his career pre Price Club on the sales side with WIlson's sporting goods, selling to Price Club and joined them before the merger in 1993 with Costco, and at the time of the merger, Doug became head of nonfoods merchandising for the combined Company.

So most of his career had been spent in merchandising up until 2004, at which time Jim had asked Doug and Craig to basically switch jobs a week from that Monday, which they have done, so Doug will take over as head of all merchandising.

Replacing Doug is a gentleman named John McKay, who was one of the two Senior VPs of operations reporting up to when he was running this northern division.

That's basically it on that.

As we said in the press release also that Jim plans to be around for at least a few more years, and so don't get too excited about not seeing him here.

With that, I'll just mention that the typical supplemental information packet will be posted on the Costco investor relations site later this morning, and with that I'll turn it over to Tina for any questions.

Thank

(Operator Instructions).

Your first question comes from the line of Deborah Weinswig with Citigroup.

Good morning.

Richard, you addressed it briefly, but can you walk us through your share repurchase expectations or how we should think about that going forward?

Well, it's kind of like earnings guidance, we're not going to give specific guidance.

I think history has shown for nearly three and a half years on a pretty much regular basis we bought stock.

When we stopped it was as much the decline in the economy and concerns about what was going to happen, but probably more importantly, the whole issue of liquidity when various types of money market funds, including a little over $1 billion of the ones we were invested in, were locked up for three to six months and that was a little scary.

I think certainly we feel comfortable long term about our business.

I don't see us trying to pick a price or pick an event in time where where we're going to -- I wouldn't expect to see us announce that we did some big, accelerated repurchase.

Historically what we did when we were buying, when the stock was moving up a little we bought a little less that day and when it was moving down we bought a little more, but generally feeling that the underlying value going forward is appropriate.

Again, I don't want to be cute about it but I think what we've said in the past is that we will probably be a buyer of our stock over the long term.

You probably won't talk about it again until next quarterly earnings release, but I think the indication that we started a process here is viewed that we are buying -- not buying at this point.

But again, since that week we haven't bought and, again, I'm not really poised to say what we're going to do in the future other than historically we've shown that we do.

Okay.

And then as you are aware, I'm sure, BJ's reported earnings this morning and they talked about an increasingly competitive environment, can you maybe just discuss what you're seeing from a competitive standpoint?

Well, I think there's -- when you talk about competition there's two things that we're always asked about.

One is all the supermarket chains over the last many months have talked about much more promotional and increased competitive market, on top of the fact that there had been deflation in a lot of those categories that supermarkets are selling during those many months.

Our position hasn't really changed.

While certainly the food buyers look at the weekly ads on ground beef and soda pop and the likes, but those are items that are probably lower-than-average margin items to begin with for us, we really don't feel a great impact from that.

We don't generally price to that.

Within the big box stores, both the direct competitors, and BJ's, as well as the indirect ones like Target and Wal-Mart and to some extent Home Depot and Lowes, and even the office product super stores, we have not seen any increase in the bar of competition.

Okay.

And then can you maybe discuss the initial performance of spring seasonal since holiday was, obviously, quite strong?

Well, again, I think if you look at February's -- the components of February's comps on the soft line side, particularly, we had some numbers that are very strong.

Recognized part of that is it was very weak a week ago, but it seemed like starting in September on some of these categories we finally saw some fives and eights and tens and threes.

And on the positive side I think this past month that's the first time we've seen more than a couple of those sub department in the high teens to mid 20s.

I think apparel was more in the mid singles, but it's more of those small electric, housewares, domestic that what I'm calling mid-priced stuff for the home that is selling pretty darn well.

Now, maybe a little of that has to do -- if you look in our coupon booklets we recognize there's a limit of how many big ticket items are going to sell over the tough economy over the last year and you have seen probably a little bit more marketing effort -- or merchandising effort toward some of those items.

So, I think more it has to do with just what's going on in the industry and a little bit has to do with what we've done.

Okay, and then the last question.

We actually had the pleasure of visiting your Danville club out in California [which you say] had the highest membership renewal rates in the country, and you also mentioned that member signups were strong in the quarter.

Can you talk about what you're seeing there specifically and is there anything that you're doing differently to drive it up?

The run rates are pretty constant.

Again, they've been in that mid 87.3, 87.4 range for a while now.

THe -- on the signups, in talking to Paul Latham yesterday, who's the VP of marketing, it's a lot of just blocking and tackling.

What I find, frankly, is what we call our marketing people in the warehouse, which are combination of that membership renewal desk and -- the membership desk, as well as the refund desk, some months or weeks they're doing -- they're focusing on Executive memberships, some times they'r going out and talking to small business and medium-sized businesses about new member initiatives, and so my guess is that a little bit has to do with the fact of where did we place our bets this quarter.

But overall I've got to believe a little of it is just the press that clubs are getting in general and that we get as it relates to this is a good place to save.

There's nothing magic that we're doing other than blocking and tackling.

Do you find that the -- as a follow up to that do you find that new member signups have been disproportionately Executive members or it's been -- is it pretty representative of what you -- what the base already looks like?

It's -- well it's disproportionate, but not majority.

If you go back a couple of years ago, for every new member that signed up, whether it was at a new warehouse in the US or an existing warehouse, our success rate of getting them to initially sign up as an Executive member was something in the low tens, ten to 12, I believe, and in the last year I believe it's gone up to the low 20s.

And if you, again, talk to Paul and his people a lot of it has to do with what I'll call [dah].

They're doing more stuff in the warehouse at the desk and getting our message down a little bit better.

Recognizing that we have just regular hourly employees out there, we don't have trained marketing people, but I think we've done a little better jarv -- job of communicating to our member why they should.

Okay, great.

Thanks so much and buckle up.

Thank you.

Next question comes from the line of Charles Grom with JPMorgan.

Good morning, Richard.

Just don't recall -- ever recall so much concerns about earnings guidance for you guys in the past, but I was wondering relative to your initial expectations, how did the quarter wind up coming in.

Was it a better in line or did you miss what you thought you'd originally set out to do?

Hold on, I'm looking at our in-house counsel.

No, I -- if you look at our original budget for the beginning of the year, and keep in mind this is last August, I think we were pretty darn close to where we thought we were going to be.

Okay.

And we're satisfied with the number.

Okay, fair enough.

And then on the margins, the 54 BIPs, can you walk through those -- the four key categories just by category for us, how it actually broke out?

Yes, they're all -- again, I already mentioned the food and sundries, which, again, it is the biggest but then you take out the -- hold on a second.

If you look at -- yes, food and sundries was above 50, hard lines was around a quarter, soft lines was around three quarters of a percent and fresh foods was about 50.

You add all those up prorated, weighted average based on sales and you get to that mid-50 number.

And just to follow up the gas mix to get down to the 15 is the plug so it's 39-basis points, is that right?

Just gave a lot of numbers.

I was trying to make sure I got it right.

Or was it 24?

No, the 24 is the gas mix.

There's another things.

There's the ancillary -- there's the other ancillary business margins, there's the hit, which was a lot of basis points from Executive membership.

There's the hit year-over-year comparison of LIFO, which was four.

So there's a few other things, as well.

Okay.

And then I know you don't want to talk about the next couple of quarters, but can you give us a little bit of sense for what you're thinking on gross profited and SG&A, just given that every basis point tends to move needle a lot?

I'd love it but I can't.

I'm not trying to be coy, we -- again I think that the trend, at least for the last few months has been promising.

The fact there's less deflation on the food and sundries side, virtually about flat, no inflation, no deflation for the first time in a while in February.

We still have deflation on the electronics side and the like.

The fact that the dollar is weaker help our -- I think -- and again I'm not a predictor of currency rates,but if they stayed where they are now we're still being helped by that each quarter.

We don't have the freebie of the big aggressive pricing we did last year versus now.

I think we lost a little in gas last year in the quarter and then made in Q3 -- in Q4 last year, so again, that's going to be a help and then a challenge.

Depending on what happens, it's so hard to predict what gas profits are week to week.

But I think at the end of the day, cautiously optimistic, but we'll have to wait and see.

Okay, and then my last question is regards to Sam's closing their ten stores.

Have you guys done an analysis of what you think that can do to your profitability as they close those stores?

Yes, I think those ten locations, I think seven or eight of them were directly near Costco locations -- I believe it's eight -- and I believe those eight impacted 12 Costco's.

In some cases -- in a few cases there's one on both sides of that Sam's.

The big effect is margin and that effect, as you might guess with Jim at the helm here, is not going to change immediately overnight.

But historically, when we look at what I'll call competitive locations in the US versus noncompetitive, you could see as much as one to two percentage points of gross margin difference, which is all -- kind of falls down to the bottom line, so it can be meaningful in those locations.

We don't expect a big sales pickup.

As you might expect, the ones they're closing aren't their best units, they're the lowest volume -- the presume -- based on our analysis of them they're the lowest volume units.

We'll get a little pickup in sales, a gradual pickup and probably not the whole amount in margin because that's not what we do.

But, as someone said once, it's like chicken soup, it can't hurt and it probably helps you a little bit over the next 18 months, as did the six closures in Canada that Sam's did helped us for 12 to 18 months.

And my guess at the end of that we get 75% of what you and I might get.

Okay.

Okay, thanks very much.

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

Good morning.

The -- as the G&A hits become smaller negatives and also I know you've done some work on sustainability, which might be helping on the cost side, what do you think that does to the underlying comp sales leverage point?

Mark, it's a guess.

I remember a few -- guesses is based on some things that everybody's doing, including us, and trying to be a little tougher on ourselves, and excluding healthcare, that maybe the breaking point had gone from a 4.5 guesstimate to a 3.5.

Who knows, but we'll have to see.

I'd probably stick to that.

We haven't done any type of regression analysis on it of late.

Can you talk about when you started the new employee wage contract and should we think about that being a factor going forward?

I guess I'm thinking with deflation maybe that's potentially better terms?

Yes.

It's effective March 2010 for the upcoming three years.

We -- he big item typically is what happens -- there's three new columns, if you will, for hourly progression.

It really doesn't impact new employees until they hit top of scale.

About 55% of our US hourly employees are top of scale, and there's not a big difference between what they're going to get each year going forward for the next three years, versus what they had gotten in the past three years.

We looked and discussed it around and around at a couple of different offsite meetings and at the end of the day, there is not a big change.

The view is, is that this is the time -- particularly the first year of it is the time our employees need it the most and as you would expect, that's what we did.

Again, I think that the challenges of some of the comps that we had over the last year-and-a-half have started to abate.

Both economy, not that it's getting better tomorrow but we've certainly seen in benefit, and the whole issue of deflation and inflation, so the feeling is we'll be able to take care of that.

So not a big change in terms of any major savings there, other than savings with sales growth.

Okay.

And my other question is, can you give us your updated thoughts on potential membership fee increase and I'm sure you are going to be looking at renewals, which look healthy, but if you could maybe talk about the main things we should be watching to see when the fee might be coming up?

Thanks.

Well, there's no plans yet.

History has shown that about every five or so years we've done it on the base fee from 25 incrementally $5 each time up to 50 now.

One of the issues is near over 35% of our US operation is California, in California the statute says that membership fees are not sales taxable as long as the fee is de minimus.

De minimus is currently defined at $50.

In their statutes they calibrate it every fifth year and that calibration calculation, subject to change -- the state of California can do anything to change to the current law -- but the current way it works would be as in January of 2011 that number would be reset based on the prior de minimus amount plus the California CPI over the next five-year period ending in January of 2011.

Now in January of 2006, when it was calibrated from $45 up to $50 we did not the next day go out and raise it.

I believe we didn't raise it until May or June of that year.

my guess, we've never shown a shyness to increasing the fee as we feel that we've got more than that $5 increase in value to our members.

That's our conviction And I don't -- I guess the good news is that the economy went a tailspin a year-and-a-quarter ago.

I'm kind of glad that this calibration didn't occur then because I don't think anybody had an appetite, even if we felt confident we could.

I can't say when it'll be.

Will we raise it again?

My guess would be yes.

Would it assume that there's this calibration change in California.

My sense would be yes.

Will be in January right after that?

My assumption would be no.

Will it be sometime over the next year.?

That's a probability but, again, there's -- we've not discussed it, and nor have we discussed what we would do with the $100 Executive membership number.

In the past two $5 increases from $40 to $45 and $45 to $50, we've chosen to leave the $100 alone and I think that's why you see this -- that is one of the reasons you see this strong, continuing conversion and increased penetration of those members, because that breakeven has gotten smaller each time when the delta was $60, then $55, and now $50.

But I think, again, we would look at that, as well.

And again, I'm not trying to be coy.

History has shown that we do and at some point we probably will.

When -- we've been asked, I know, and they have all been asked as often, what's the impact of one of our competitors it'll be a big year difference with them and we really -- not to be arrogant about it but we've really never looked at that difference.

In the face of a higher delta between our fee and our competitors we've done it in the past successfully and I don't see that as a big concern.

Okay, that's helpful.

Thanks.

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

Thank you.

Richard, maybe just stepping, you clearly had a lot of headwinds last year that seem to be turning into tailwinds, whether FX, deflation, gas and maybe share your thoughts in terms of the slope of these lifts, where they were and how steep you thought they were at the start of the year, where you think they are now?

Clearly they're all positives but share in terms of the degrees of positive.

Well, from eight degrees to 40 degrees, just kidding.

I would guess -- an offsetting slope need clearly is healthcare and, again, I'm hopeful that part that have increase, which had to do with just increased penetration of number of employees covered, has peeked and is not going to impact additionally.

I guess so much of it depends on what is going to be the rate of underlying real comp sales growth, ex-FX and ex-gasoline inflation and deflation.

The trend over the last four or five months has been good.

The fact that in February we essentially saw no inflation or deflation compared to some deflation in the prior months on the food and sundries side is a positive.

I think if Jim were here he would say margins aren't an issue.

We've shown the ability to improve margins and I think we'll continue to be able to do that in a controlled way.

If Jim were here I would say in a very controlled way.

On the expense side, frankly, I think we've done a decent job on payroll and on central, and on everything but the big -- the second biggest nut and that's healthcare.

The bonus thing, it's really a mid-year deal because -- I'm not concerned about that.

Hopefully we'll always accrue that every year and it'll be a flat comparison year over year, but I don't -- this is the quarter that it hit us.

And the same thing, I think the workers' comp was a little bit of an increase and a bigger piece, which was just the luck of the actuarial draw of being a bring back in Q2 last year and a positive this year.

Frankly, any bring backs last year the quarter as so crappie we didn't talk about a lot of little things.

Okay, that's helpful.

Just drilling down then on the deflation, as you said Jim says margins aren't the issue.

It sounds like deflation abating and as you described it a pretty rational, competitive environment.

I think we all know philosophically you guys are the first to lower, is the flip also true that you're the last to raise?

Absolutely.

Last to raise sometimes is three days or a week and we're not going -- if a price -- if a cost of an item is going up and it's a high=volume item, toilet paper or whatever -- well, first of all, it's really the commodities because even on things like paper goods, big volume, or water, we run into six and 12 and 24-month deals with these vendors and they've locked in certain pricing, too, to be able to commit to us.

So some of it is going to happen over time.

But you really get down to a lot of commodities and fresh foods, which changes daily and weekly, we're not going -- if the price of something goes up, we reflect it pretty quickly.

Quickly might be two weeks instead of one week later.

Thank you.

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

Hi, good morning.

Just a question on the SG&A again, not to beat a dead horse.

If we look at first quarter, you really did have a big FX hit there and your SG&A growth was probably just -- I think was just under 8%, recognizing that in any given quarter there may be some one-off items as there may have been in this quarter.

It sounds like you're not expecting much in terms of one-off items in the next couple of quarters, so does that mean the SG&A dollar growth should look more similar to Q1, [that's including FX]?

I think -- and again, last year wasn't the greatest year.

In Q3 last year we had -- we also had a bonus bring back, I'm hopeful this year we won't, so that'll be a slight negative.

I don't think it'll be as big of a negative as this year.

I don't think -- again, if you look at the luck of the actuarial draw on -- more to the tune of historical prior-year stuff that's occurring here, my guess is that's not likely to happen.

It could, but I'm not guessing that's going to happen.

The healthcare, it's going to not be as big of an increase, but it's not going to be wonderful either.

Every month when we see the statistics in terms of number of incidents, or number of high-cost incidents, just when you're starting to feel a little better one month the next month it's a little higher.

But again, it was last year in the second half of the year when healthcare costs were up in the low to mid-20s and so -- versus when it had been up in the ten to 12 range before that -- or ten to 15, so I'm thinking -- and I know we're not seeing the big increase in employees covered, that we've anniversaried now, so yes.

The answer is, is it better, yes.

Is it wonderful, no.

Okay.

Then in the electronics business -- separate topic -- I think in one or two calls ago you were thinking that deflation in electronics might start to ease.

We heard from Wal-Mart recently that they thought it was easing a bit.

Just in terms of your outlook at this point, can you update on what you're thinking for TVs and electronics broadly from a deflation standpoint and how you think that may impact you this year?

Or the remainder of the year?

Actually, yes.

I was looking -- and I'll talk while I look.

Is that?

Yes, here it is.

In the month of February TV sales -- TV unit sales were down very slightly and dollar sales were down a little more than that, so it's still a little deflation but less than 5% deflation.

What we're seeing on the TV side, a little of that was shortages.

All of a sudden there's a pickup in world demand in Chi -- I think last month was the first month ever that more TVs were sold in China than in America ever.

And between Europe -- the flat-screen demand in Europe and China, our head merchant in electronics, Tim Farmer, at the budget meeting last week was talking about the fact that -- I forget what size it was, but the underlying cost of the panel itself in the US gets something like $125 and in Europe and China is getting $200, so there's some big differences and so more stuff is going that way.

So we actually had a couple of supplier shortages that have, I believe, are in process of fixing themselves.

Last year the other thing was -- and this is when I talked earlier about the couponing, it was about a year ago that we saw -- we were very strong in some of the multi-vendor mailers over the last year.

The success of some of those items have come down as, A, everybody has televisions, and B, the price points have come down and what has been successful is -- look at the MVMs.

Getting people in the door is basic items.

So I think in terms of -- we think that there's still plenty of demand in unit sales.

We think that the price points are pretty much flattened out but we're still comparing against the craziness of that -- near the tailend that have year, year-and-a-half period where we were seeing 30%, 40% and 50% unit increases.

Right, got you.

On the couponing booklets, as you look out over the next quarter to -- whether it's for TVs or just broadly that the coupon books you send out -- are they from a promotional standpoint or product discount savings, is it a similar posture as a year ago?

The posture on our MVMs going forward is similar to you're going to -- I think -- the maturation is to get more nonfood and bigger ticket items in there and bigger ticket means going from medium to a little bit bigger than medium but not all giant like it was during the gravy days.

Great.

Thank you.

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

Hi, good morning, Richard.

Basically had two questions for you.

The first one is, can you just give us an update on the private-label penetration, and I guess the lateral piece of that is any reads that you feel into the consumer that you guys are seeing?

And then the second question I was wondering is, if you could give us any early learnings or perspective from the Manhattan store and how that's going?

What was the first question?

You said Manhattan -- oh, private label.

I think the trends continue.

We're approaching 20%, I'm not sure if we are at 20 yet.

We are at 20% yet now, so it's growing.

The big delta year over year in sales penetration that we saw is continuing.

Not as dramatic as it was six to nine months ago, but still increasing penetration.

We have several items on the food and sundry side that will be coming out this fall, which I can't talk about yet.

Again, nothing earth shattering, which is going to take the 20% number to 25%, but it's all additive and all -- basically, there's not a whole lot out there that's sacrosanct that we want to sell both the best brands and the best (inaudible) alternatives.

On Manhattan, at the end of the day we're doing fine.

We're probably doing 80% to 90% of what we originally thought sales was.

What we finding is is that during the week we get a lot of local neighborhood traffic.

What you don't find is people on their way home from work saying, hey, let's go drive over to Costco on their way home from work.

They don't do that.

We see upper east side and even upper west side traffic on weekends.

We get a lot of grief for the parking lot because it costs $4 -- it's not our parking lot, by the way -- but it is what it is.

But overall, I think we got a little press locally in Manhattan because of the layoffs that happened after Christmas and we always have seasonal layoffs afterwards.

In addition, having opened this on November 11th we probably -- we over expected, and then came in a little under and so the layoffs were a little bit bigger than normal, but nothing that's -- nothing that was as newsworthy as it appeared in the local newspaper here.

We want to get as many people back to work and as quickly as possible, but it's continuing to grow.

We're seeing the bodega, the small business improve.

Again I think it's going to be a great location and it's -- I think we got a lot of questions about it because of the local news of 160 layoffs or whatever.

Thanks.

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

Hi, this is [Joe Parkula] in for Mark.

Just one more time -- I'm sorry -- on the SG&A line, so if you look at year-over-year growth, excluding the $22 million charge, it's about 11%, what would that be without FX impact?

About 8%.

About 8%, okay.

And going forward that could moderate a bit as you lap the health, or is that incorrect?

Sorry.

Well, if -- yes it could and we're hopeful that it will and we'll let you know.

Okay.

And then just on the $22 million charge you took this quarter, was that a cumulative charge for the entire year, or will you continue to accrue this?

And then also --

It's a cumulative charge that will grow as the Company grows.

So this is rough numbers, but if the company was 10% bigger in people incrementally over that two-year period, there'd be another $2 million or $3 million charge to hit to the P&L but not a $20 million charge.

That was a cumulative charge.

Right.

And so -- and that was just a new decision that you decided to start paying for unused vacation?

Yes.

What was the decision behind the timing of it.

Is it just you feel better about your business?

The timing had more to do with the fact we already dealt -- did it this way in certain states based on certain state laws and we thought it was the right thing to do.

And it's tied into the March 10 new employee agreement.

We got a lot of questions on it from employees.

As we go through a -- really a one-year process leading up to the new employee agreement you get all kinds of requests from open-toe shoes and wearing shorts to how different holidays are handled and we were getting questions on it and we looked at it and said you know what, we're -- what happens is you get employees that have moved and in one state they got it and in another state they didn't, and it was just the right thing to do.

All right, thank you.

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

I'm back to gross margin and this may be an odd way of thinking about it, but if the core gross margins are up, I think you said 54-basis points, in the prior year core margins were down 57-basis points because of obviously the markdowns and the sharp pricing.

So you didn't quite get back all the margin you lost last year versus in the first quarter I think the core margins were up 11, the prior year they were down two, so you had a net positive.

If I go back a few quarter's you've been seeing that core piece of the merchandise margin growing and up and adjusting for the easy compare last years maybe was just down slightly.

I would have thought with mix and some of the better soft line category numbers the mix would have been a little more positive.

Is there anything else going on there that maybe those core merchandise margins aren't up as much as they thought they should have been?

Well, there's a couple of things.

First of all, last year you had -- whereas this year gas helped -- helped your margins -- hurt your margins.

Last year it helped your margins.

Last year is when you had huge deflation in gas.

Yes, I've got that in, so we had 50-basis points of positive benefit on gas but you still had 57-basis points of core ex-gas right?

Yes, but you're --

No?

I have to look at this (inaudible), but I believe believe that 57 includes the benefit that we actually got last year because of the deflation in gas.

Well, we're just -- we'll have for look.

When we looked at the numbers, we felt that it was still a positive, but let us look at it and happy to share -- to discuss it.

There's no secrets here.

Well, the other way you can look at that is obviously the subcategories and you went through by each of the sub categories, did you feel like you got back all of the lost markdown pressure from last year at the subcategory level?

Yes, because virtually all of that -- well, virtually all of the aggressive pricing that I talked about was commodity related in the food and sundry side and that number, without that roughly $30 million of markdowns was still a plus 13 on like sales.

Okay.

Then just bringing the horse out to kick him once more in SG&A, have you disclosed or could you disclose what percentage of the SG&A is healthcare, so that if we adjust the growth rate for that as you're anniversarying it we could see what the ex-currency growth rate on SG&A might do?

I don't have it in front of me.

It's -- but if you think about last year in 2009 it was roughly $700 million --

Okay.

-- plus healthcare costs.

For the full year?

For the full year on sales of $70 billion.

Okay, that's good data then we can do a little math on it.

And then just finally on the FX contracts, is that just currency swaps and you're saying it had been in the operations line of SG&A?

Was that ever particularly material?

It actually is in the margin line.

It has to do -- as an example, let's use Canada as an example.

Canada buys some of their goods in the US with US dollars and during the -- and then there's payment terms on those that could be ten days, seven days or it could be 60 days.

Based on their weighted average of daily expectations of US dollars out, they convert some of their Canadian sales receipts into US dollars.

Or -- and all it is, is when you mark that to market, at the end of a month or end of a fiscal period.

We tend to err -- subject to giant changes in currencies we tend, historically to err to our benefit a little bit and so there's always a few million pickup, frankly.

Historically that's been in margin and now, because of some accountant smarter than me, the new rules are it's down in interest income and other.

And it's -- I'm sure there is some FASB or APB or some other acronym out there that's making you do it this way, but rather than reclassify stuff from prior years it is what it is.I t's a handful of millions, not a heck of a lot,

Got you.

So some periods of rapid currency moves like we saw here, you typically had a benefit?

Yes.

Core strengthening?

Yes, we've had -- we tend to mitigate the impact when it's the four-week fiscal period that happens to be at quarter end.

We can be a little more assertive in the two months leading up to it knowing the bills will be paid and we won't have these contracts in place at the quarter end.

Got it.

Thank you.

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

Thanks.

Hey, Richard, if we look to the core average ticket, excluding gas and FX, it was down about 1.5% in the second quarter, but you said it was flat, I think, in February.

As we look to the back half of the year, is that something that we expect -- should expect to be positive year over year?

It depends.

The trend is good and we're hopeful, but your guess is as good as mine.

I think clearly from a merchandising standpoint, we're aggressive.

We're out there, the buyers are buying and they're told to be aggressive on getting stuff and be aggressive on -- don't be meek on bringing in bigger-ticket items.

But our motto allows us to be more aggressive, arguably.

And so yes, hopefully yes, but you never know until it's there.

Peter, I'm hopeful that with some of this price deflation abating that that will help, as well.

The FX and the gas are going to be what it will be, but for it to improve a little bit, barring the same traffic levels, we're going to have to see a little bit of the improvement there in the core comp for that to happen.

Thanks, Bob, for that.

Shifting over to the membership income, that 5%, excluding FX ,growth rate that you saw in the second quarter, any reason why that isn't sustainable over the back half of the year?

Should be.

Well, other than it's our first time in a while and when you talk to the marketing guys -- yes, the membership revenue increase.

Again I think the answer is it should be, but it's always something.

Okay, fair enough.

Lastly, Richard, can you talk about the trends you are seeing in California, excluding the gas business, if you take out the gas business, what's been going on in California?

It's actually, doing pretty good -- hold on a second.

The trend in California -- again, if I looked at the last three or four months it's been gradually improving.

Is it positive excluding gas or still slightly negative?

I believe it's positive, but I"ll let you know.

Hold on.

Slightly positive in February.

All right, good.

Thanks so much.

Why don't we take two more questions.

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

Good morning, guys.

Just quickly, what was the -- why did you make the change that cost us 12-basis points in SG&A in the quarter, the change in benefits?

What was the driver of that?

The driver was that in about 30% of our employees in the US in certain states, it was something that upon termination they will get paid up to three days, some fraction of three days , and for the other 70% they weren't, and we were getting questions on it.

We'd always done it that way, but as each state changed some rules we just thought it was the right thing to

Got it, thank you.

With the employee agreement and so it was a good time to tie it in.

Your next question comes from the line of Sandra Barker with Montage & Caldwell.

Hi, Richard.

Most of my questions have been asked, but I guess I'll ask about real estate, just what you're seeing in terms of opportunities there and how you think about the pipeline of opportunities going forward?

There's more opportunities.

We're now getting back into it.

There's this -- again, it was about a year ago when we halted anything that wasn't signed to renegotiate.

I know we're talking -- continue to talk to the shopping center operators, as well as banks in the case of some foreclosed properties.

We are ramping up some of our international a little bit and we think there's -- our success in Asia, as an example, and Australia recognizing we have one unit for a few months there, but ramping up doesn't mean we're going to go from one in Australia to ten in two years.

It means that instead of doing three in three years total we'll do hopefully five or six.

And so we've -- I would say active.

The hope is that -- we did a net of 16 last year and something around that number this year -- this fiscal year that that number would get back in the low 20s and 2011 and 2012 and in the high 20s in 2013 and 2014.

We've been wrong before but we are -- we do have a lot of irons if the fire there.

We've got two coming in your state.

Hello?

Yes (inaudible).

Anything else?

Tina?

At this time there are no further questions.

Okay, well thank you, everyone.

Have a good day.

Thank you.

This concludes today's conference, you may now disconnect.