好市多 (COST) 2010 Q3 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the third quarter earnings 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).

Mr.

Richard Galanti, you may begin your conference.

Thank you, Christie.

Good morning to everyone.

This morning's press release reviews our third quarter fiscal 2010 operating results for the 12 weeks ended May 9.

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

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

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

To begin with our 12-week third quarter fiscal 2010 operating results, for the quarter our earnings per share came in at $0.68, up 42% from last year's reported third quarter earnings per share of $0.48.

As will be discussed in more detail in a moment, both this year's and last year's Q3 results and the comparison of these results included a couple items of note.

These were out lined in this morning's press release and include the following.

First, you will recall that last year in Q3 we took a pre-tax charge of $34 million related to a litigation settlement covering our membership renewal policy.

This charge hit the membership fee income line of our income statement last year in Q3 for $27 million and our SG&A line item for $7 million, negatively impacting last year's third quarter earnings by $0.05 a share.

This year in Q3, our SG&A line was reduced or benefited by a $14 million pre-tax reversal of part of a charge related to a Canadian tax liability that we had previously taken in the second quarter of fiscal 2007.

This had to do with stock option protection, the option issues, and protecting our employees in Canada who receive such options.

This is an SG&A impact, not an income tax impact.

Adding back the $0.05 to last year's third quarter, the EPS of $0.48, and subtracting the $0.02 EPS picked up I just described, year-over-year Q3 EPS would have gone from $0.53 last year to $0.66 this year for a 25% year-over-year increase.

As I will discuss, there are other items of note that impacted each of last year's and this year's fiscal third quarter results.

Some positive items, some negative; from income tax rates to LIFO and FX and closing costs, et cetera.

I will mention the FX issue right now; what I refer to as FX tail winds.

As you know, the US dollar this year as compared to last year, relative to several of the foreign countries and countries which we operate, had weakened so our foreign earning results when converted and reported in US dollars has helped us this year and has helped us in Q3 by a little over $28 million pre-tax, or $0.04 per share.

That is assuming FX exchange rates are flat year-over-year.

This year's foreign operating results in Q3 would have been lower by that amount.

In all, we look at our Q3 results as a continuation of positive trends that we saw in Q2.

In terms of sales for the 12-week quarter, reported total sales were up 12% and our 12-week reported comparable sales figure was up 10%.

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

On a comp sales basis, the plus 6% US sales increase in Q3 that is outlined in the press release, if you exclude gas inflation, that would have been a plus 3%.

Similarly, the reported plus 26% international comp figure, assuming flat year-over-year FX rates, would have instead been plus 8%.

In total Company comps, again we reported a plus 10% for the quarter, excluding both the gas inflation and excluding FX changes, would have been plus 4% for the Company during the fiscal quarter.

Other topics of interest, our opening activities and plans, we opened one new location in Q3 in Pacoima, California.

That is within the city limits of Los Angeles.

In Q4, which began on May 10, we plan to open six new locations.

The first of these six opened this morning in St.

John's, New Brunswick, Canada.

This is our 78th Canada warehouse location and brings our total warehouses worldwide to 568.

The five additional buildings we plan to open by fiscal year end include two additional ones in Canada, one in Queens, New York, an area called Rigo Park, one in Roseburg, Oregon, and our 22nd location in the UK, in Coventry which is about 95 miles northwest of London.

Also this morning, I will review with you our expansion plans for fiscal 2011 which are up, Costco online results, membership trends, certainly discussion a little bit more about margins and SG&A, and an update on our stock buyback activities and a couple of other items of interest.

In terms of the discussion of the quarter results, again sales for the quarter were $17.4 billion, up 12% from last year's Q3 of $15.5 billion.

Again, on a reported comp basis, it was at plus 10%.

And the plus 10% third quarter comp was comprised of a 9% in February, a 10% in March and an 11% in April.

And there were some seasonal -- some holiday changes, but essentially pretty close range there.

Again excluding gas and FX, the 9%, 10%, and 11% for February March, and April would have been a 4% and 3% and 4%.

The 10% reported comp was positively impacted by just under 4% due to the year-over-year strengthening of foreign currencies relative to the dollar.

As I mentioned, the local currency comp rate if you will for all of the foreign countries was a plus 8% when converted into US dollars because the FX was plus 26%.

As I mentioned gasoline had a big impact, about 3 percentage points.

That is the reported US comp 6% would have been a 3 without that.

Our average transactions increase was a little over 6% for the quarter, which of course includes gas inflation and FX.

And the average frequency increase was a little more than 3.5%.

In fact, the frequency trend during the past three calendar reporting months of February, March, and April, was 3.7%, a 3.5%, and a 3.7%, so pretty consistent.

I think most importantly these frequency figures are on top of a roughly 4-plus percent frequency increase during Q3 of '09 so pretty strong frequency continuing.

Recognizing people seem to be coming in more frequently, but are buying a little less each time, perhaps buying a little more on the food side as well.

For the quarter, in terms of sales comparisons by geographic region, for the quarter, the midwest, southeast and Texas were the strongest, followed by a good showing in the Northwest.

California actually had a trendwise over the last four quarters also had a good improvement track record, but at a lower level.

Internationally, in local currencies, we're doing quite well despite all the craziness around the world.

Canada in local currency is up close to 10% with Taiwan, Korea, averaging in the mid teens.

UK is closer to flat.

In terms of merchandise categories for the quarter, our soft lines was the strongest core category, followed by fresh foods, food sundries, with hard lines being the relative weakest one of those four.

Within food sundries, every sub category was positive in the quarter, ranging from 1% up to 12% up.

Tobacco was actually a little higher than the 12%, but that was an anomaly related to I believe an increase last year that tends to greatly vary sales levels based on the pending tax increase -- tobacco tax increase.

Within hard lines, the comp, the strongest sub categories were sporting goods, hardware, health and beauty aids, lawn and garden and tires.

The one of note that was a slight negative comp was what we call majors or electronics.

That's not inconsistent with what I think Bob Nelson has said on the monthly sales voice calls.

What we're seeing in TVs is there is not a lot of promotional activity out there, as the underlying components of the flat screens, notably the panels, as demand has increased in Asia from the Chinese consumers and what have you, that there is less need to -- for the manufacturers to provide incentives.

As you've seen in our VM mailers over the last several months, there not as much exciting activity in terms of promotional activity for TVs.

Within the soft lines comp, most every category was strong.

Generally every sub category but one was in the 9% to 22% comp range, with housewares, small electrics, domestics, media, home furnishing being stand outs.

And within fresh foods, all sub fresh food category, meat, bakery, produce, what have you, were all positive, each in the mid to high single digits and averaging in the high single digits.

Now moving down the line items in the income statement, I will start with membership fees.

And again, recall membership fees, first I want to take you out -- the component of that $34 million charge from last year, $27 million of which hit last year's Q3 membership fee income line.

I want to take that out in terms of comparison.

And then of course, I will show you without FX, since the -- with the relatively weaker US dollar, we show dollar increases greater in the foreign countries.

On a reported basis, for the quarter, we -- this year, we had $395 million, or 2.27%.

Reported last year was $329 million.

But again, I want to add in the $27 million, so the comparison to the $395 million will be $356 million, or 2.30%.

That's again without that membership litigation settlement in Q3 of last year.

On that basis, $395 million versus $356 million, dollars were up 11% and basis points were down 3 basis points.

And in dollars it was up $39 million.

Now, again, another complication is the gas inflation, which tends to screw up some of the percentage comparisons.

That minus 3 basis points number without gas inflation would have been plus 4 basis points.

Pretty good showing given the sales strength and relative membership strength.

Let's talk about FX.

Again, F X last year, the $356 million number would have been the starting point.

The $395 million, assuming flat FX year-over-year, would have been $381 million which I think is probably the most appropriate comparison.

That would show that dollars were up $25 million, excluding FX or currency, or up 7%, the same reported minus 3 basis points, but excluding gas inflation would have been plus 4 basis points.

A lot to digest, but I think that is the best way to look at it.

In terms of membership, we have strong renewal rates and we continue to see improving, increasing penetration of the executive membership.

Really despite only two net new openings in the past six months in Q2 and Q3 combined, our new membership signups in Q3, were up 2% year-over-year in the fiscal quarter.

That is actual new signups.

In terms of member numbers in Q3 end, we had gold stars, 22.2 million and that compares to 22.0 million at the end of Q2.

Business primary, 5.75 million versus 5.7 million at the end of Q2 so slightly up there.

Business add-on, rounding down to 3.3 million from a 3.4 million a quarter ago.

Part of that is, is that as add-ons become executive members, if they're individuals they go in the gold star category.

Really the 22 million to the 22.2 million in gold star probably is a little lower than that 200,000 person increase and also which is part -- part of that is an offset to the reduction in add-ons.

All totaled, if you add up the numbers, is 31.1 million households at the end of Q2 and up to 31.3 million households at the end of Q3.

And if you include spouse cards, we went at the end of Q2, 56.9 million, up to 57.4 million.

Now, these numbers by the way do not include Mexico since we don't consolidate, including Mexico, 57.4 million would be 60.3 million.

At Q3 end on May 9, our paid executive member base was 9.9 million -- just a shade over 9.9 million, an increase of 292,000 or 3% in just the 12 week second quarter.

We added about 24,000 executive members per week during the 12-week third quarter.

Executive members now represent about one- third of our membership base and just about two-thirds of our sales.

In terms of membership renewal rates, they actually tweaked up a little bit in the quarter.

We went from a 92.0% on the business side, renewal rate at Q2 end, to a 92.1% and on the gold star side from an 86.0% at the end of Q2 to an 86.3% at the end of Q3.

All totaled, an 87.4% is now an 87.5%.

Those are figures by the way which have always been for US and Canada since some of the newer countries have a lot of new locations which tend to distort that.

We have always done it that way.

And now going down to the gross margin line, our gross margin in the third quarter was lower year-over-year by 11 basis points, from a 10.99 down to a 10.88 this year.

The two things I asked you to jot down of course are the two matrices for gross margin SG&A and we will start here with the gross margin.

The line items are merchandising core, ancillary businesses, 2% reward and LIFO, and then of course total.

And we will look at Q3, -- Q1, Q2, and Q3 for the fiscal year, and going across, merchandising core, plus 15 basis points in Q1, plus 15 in Q2, minus 10 in Q3.

Ancillary, minus 20, plus 16, and plus 6.

2% reward, minus 3, minus 1, minus 3.

LIFO, minus 1, minus 4, minus 4.

For a total in Q1 year-over-year, we were minus 9 basis points.

And in Q2, plus 26.

And in Q3, minus 11.

Now, again, the craziness here in terms of understanding percentages has to do with gas inflation -- or last year, we were explaining gas deflation.

Keep in mind, if you have gas inflation this year, your denominator in calculating any number over the reported sales number is going to tend to lower the percentages.

On the margin side, lower means it looks a little worse.

On the SG&A side, lower means it looks a little better and we will try to explain that to you here.

If you start with the overall number, 11 basis points, within this 11 basis points figure, our core merchandising gross margin as you showed -- as we showed in the matrix was down 10 basis points and ancillary gross margins, principally gas, contributed 6 basis points.

On a stand-alone basis, our gas gross margin was actually up close to 50 basis points.

But because it is a gross margin business that is 700 or 800 basis points lower gross margin than the rest of the Company, and the low to mid single digits, that that increased penetration at that lower amount, notwithstanding a pretty good year-over-year gross margin improvement in the gas business, contributed 6 basis points there.

Sales penetration of our higher margin core businesses was down 2 percentage points in Q3, representing 81% of our sales this year, versus 83% of our sales last year.

Whereas our sales penetration or ancillary business, again gasoline sales which is a much lower margin business was up 2 percentage points, this one was down -- the rest of the business was down 2 percentage points.

The sales penetration or our core merchandising business was down year-over-year.

As you see here, the minus -- hold on a second, I just lost the page -- the minus 10 basis points number.

If you look at just the core merchandise business margin versus the core merchandise business sales, and that is proven sundries, hard lines soft lines and fresh foods, which represents right around 80% of our total company, those realized gross margins in those realized businesses in Q3 were up 14 basis points year-over-year.

But again, the lower sales penetration caused it to be down on this chart.

The respective merchandise category gross margins were the strongest in hard lines, followed by soft lines, and then food and sundries.

Fresh food margins were actually down year-over-year, primarily to lower gross margins in meat.

In talking to Jeff Lyons, who is the senior VP in charge of fresh foods, meat has tended to be inflationary during the quarter, but still very competitive pricing out there, not only among the warehouse clubs but the major retail supermarket chains as well.

Prices have lagged a little bit in terms of covering that.

All in all, a good showing in the gross margin line, with nice increases in three of the four core subcategories and good increases in gas margins as well.

The impact from growing our executive member business, which results in higher 2% rewards, as you showed, jumped 3 basis points.

The implication there is that the sales penetration of rewardable off merchandise was up about 1.5 percentage points.

LIFO, last year, in all four quarters, we took LIFO credits.

I think totaling over $30 million pre-tax for the fiscal year '09.

This year, now that we're essentially -- you can't go below zero the way I can describe it and even though there has been slight deflationary trends this year, that is starting to switch but nonetheless, slight deflationary trends, you can't go below zero so there is no LIFO charge or credit in Q3, compared to a $6 million LIFO credit last year.

That was a 4 basis points detriment to this year, versus the comparison of last year.

This is one of those items that I mentioned early on, in terms of the pluses and minuses in looking at the Q3 year-over-year comparisons.

Now, after taking all of this gross margin information in, perhaps the easiest way to summarize Q3 over Q3 gross margin comparisons is that excluding gasoline sales year-over-year, Costco's gross margins would have been up in Q3 by 5 basis points and this is notwithstanding the minus 3 basis points variance year-over-year from the 2% reward and the minus 4 basis points variance from LIFO.

Moving on to SG&A, our SG&A percentages in Q3 over Q3 were lower, or better by 40 basis points, coming into the 10.29% of sales this year, compared to 10.69% last year.

Again, I will ask you to jot some numbers down and then try to as best I can explain it.

These line items would be operations, central, stock options, quarterly adjustments, total.

And then again looking at the three columns, it would be Q1, Q2, and Q3.

In operations, it is minus 16, going across, and minus means higher, or higher or bad.

And Q2 is zero.

And Q3 is plus 14.

Central, minus 3, plus 2, and plus 4.

Stock options, or stock [ or recompensation] now that we do our issues, minus 3, plus 1, and plus 5.

Quarterly adjustments, plus 18, minus 12 and plus 17.

Total, minus 4, minus 9, and plus 40.

Let me give you a little editorial here.

Looking at the first thing, operations was lower or better, core operations was lower or better year-over-year in Q3 by 14 basis points, but it is all about sales mix change.

Just like with gross margin percentages, where increased gasoline sales penetration hurt us, it correspondingly helped SG&A by about 22 basis points.

The plus 14, minus the 22, if you will is a minus 8.

So where is the minus 8 in the core operations?

It is mostly higher health care and other benefits related costs.

But as I will explain in a minute, there seems to be a little light at the end of that health care tunnel.

The rate of dollar increases in these benefits related areas increased year-over-year in Q3 at a rate of increase lower than has been the case in the last three fiscal quarters.

I also mention that -- while that was the -- the plus number went to a minus number, one of the positives was a payroll comparison which we're seeing some payroll leverage in Q3 over Q3.

Payroll percentages showed improvement of 10 basis points year-over-year in Q3; pretty good given the relatively low underlying label -- the levels of sales growth.

Now, in terms of health care costs, in fiscal '09, US health care costs in dollars jumped 26% in Q3 '09, versus Q3 '08, and 27% in Q4 '09 versus Q4 '08.

If you recall, that's when we started talking about what I call the double whammy.

One, there is health care inflation.

And two, with the reduction in new openings or warehouses, which is where you have a lot of new hires, particularly new part-time hires that take up to six months to become benefits eligible, as we open fewer warehouses, that meant that the mix of employees became more eligible instead of having these new part-timers.

Similarly, existing employees are not leaving their jobs.

Our turnover rate overall which in good times, good economy, economic times a couple of years ago tended to be in the 20% range and is now in the 10% range.

Again, we've seen a double whammy which seems to be now anniversarying that we have more -- higher percentage of our base of our employees in the US being covered with health care.

Again, in looking at Q3 and Q4 last year, as compared to their respective quarters the prior year, we saw US health care costs go up 26% and 27%.

In the first half of this year, Q1 and Q2 combined, the increases were about 20%.

And in Q3, the quarter that I'm talking about right now, as we have anniversaried at least the big increase in percentage of employees who are benefits eligible, our Q3 year-over-year increase in health care costs was up a little over 11%.

Hopefully, that trend will continue.

Our central expense was lower or better year-over-year in Q3 by 4 basis points.

Again, a chunk of that is the gas inflation.

Stock compensation expense was 5 basis points better.

The latter, a slightly lower dollar figure on strong total reported sales figures.

Finally, the quarterly adjustment line of 17 basis points in SG&A consists of last year's -- that component of the $34 million that hit SG&A line, about $7 million of that $34 million, and this year's $14 million dollars credit for the partial recovery for the Canadian charge taken in '07.

Again, that Canadian charge was -- it was Canadian taxes to our employees that we protected those employees that received those options up there.

That hit the SG&A line, not the income tax line.

And there were 4 basis points of miscellaneous items hitting Q3 last year, but more on a one-time basis.

Overall, I think probably in the last couple of years, one of our better SG&A performances given the current sales levels, and the slowing rate of growth but escalating -- still escalating costs of health care.

We continue to work hard and we're focused on SG&A, and that's the primary focus of Jim and Craig.

Next on the income statement line, preopening expense, $9 million last year in Q3, and $3 million this year in Q3, so $6 million or 4 basis points better.

Last year Q3, we had five openings and this year in Q3, we had one opening.

Also last year in Q3 we had quite a bit of preopening.

About half of it expended in Q3, related to several upcoming openings and international.

No real surprises here.

It will fluctuate.

Of course preopening expenses will start to increase as our opening plans for Q4 and fiscal 2011 start to increase.

In terms of provision for impaired assets and closing costs line.

In Q3 '09, last year we had a charge of $7 million for the quarter, compared to charges of $3 million this year.

Last year, $7 million charge included a $5 million reserve to cover the closing costs and asset impairments related to the then planned closing of our two Costco home units which actually took place on July 3rd last year.

All totaled, operating income in Q3 versus operating income in Q3 a year ago was up 36% year-over-year.

And of course, excluding the items noted in the press release, that operating income increase year-over-year would have been up 21%.

Below the operating income line, reported interest expense was slightly higher year-over-year in Q3, and Q3 coming in at $27 million, versus $25 million in last year.

That is actually a little under $1.5 million increase.

It is due to rounding, the $27 million and the $25 million.

These amounts mainly reflect the interest expense on our $2 million debt offering we did in February 2007, with the amount of capitalized interest in the quarter being virtually the entire reason for the year-over-year $1 million difference.

Interest income was higher year-over-year by $4 million.

It came in at $10 million, versus $6 million a year ago.

Interest income was higher -- that $4 million delta, interest income was actually higher year-over-year by $1 million.

Rates have not gone up dramatically needless to say, but the amount of cash has.

With most of the rest representing higher year-over-year Q3 earnings from our half interest in our Costco Mexico.

Overall, pretax earnings were up 39% in Q3 from $340 million last year to $474 million this year.

Of course, excluding the items outlined in this morning's press release, that being the $34 million charge taken in Q3 last year, and the $14 million benefit, benefiting this year's Q3, pre-tax income would have been up 23%, from $374 million last year to $460 million this year.

Our company tax rate came in at 34.5% this year versus 37.75% last year.

Last year's tax rate had a couple of discrete items that added slightly to the rate whereas this year, we had a couple of items that benefited, or lowered the effective rate slightly.

Again, there is the multitude of state, various state and government-related tax audits, and that will always fluctuate a little bit from that roughly 36.5%, 37% underlying number.

For a quick rundown of other topics, I won't be going over the balance sheet as it is included in this morning's press release.

You have that already.

I will mention depreciation and amortization.

For Q3, it was $180 million and year to date for the first three quarters was $549 million.

In terms of the balance sheet, needless to say, quite strong, low debt to cap ratio.

Accounts payable in terms of us being able to show dramatic improvements and not having to front a lot of our inventories, on a reported basis, last year in Q3 -- at Q3 end, our accounts payable as a percentage of inventories was 102%.

This year, in Q3, reported was 108%.

That includes other payables in addition to merchandise payables, like construction payables.

If you look at just merchandise payable to accounts payable, last year in Q3, it was 85% this year in Q3, it was 90.

Again, an improvement there and a reflection of some finely -- some small amount of sales strength, and very little increase -- effective increase in the inventory levels.

Average inventory per warehouse was up $277,000 per warehouse from $10.089 million to $10.366 million or up 3%.

And actually the $277,000 figure would only be up $90,000 if you exclude the year-over-year FX impact of $187,000, so no inventory concerns.

If anything, we saw some examples like seasonal patio furniture the last several weeks, we've been scrambling as we sold through that pretty well early in the seasonal season.

In terms of CapEx, in Q3 '09, we spent $226 million.

In Q3 2010, we spent $139 million so a little less, as you might expect.

Year to date, we've spent all of $644 million.

I would estimate that our FY 2010 CapEx would be somewhat lower than last year's figure, probably $950 million to $1 billion.

In terms of that -- of course will increase and I will talk about expansion in a minute.

Costco online, as you know in '09, Costco online was down about 4% or 5%.

For the third quarter and the third quarter year to date, sales were up 5% in the quarter and 7% year to date.

E-commerce profits were up 7% in the quarter and 14% year to date.

Our average ticket has come down a little, as you might expect, with the fact that we have a very high average ticket because of the items that we sell.

But site traffic continues to grow and was up 9% in the quarter year-over-year.

Like the four-walled warehouses, on e-commerce, big chunk of the business is electronics.

Again, there hasn't been a lot of promotional excitement or lower price excitement on the flat screen side with increased worldwide demand of flat screens.

That seems to be coming to a near end.

And the sense that I got from our GM in charge of electronics who just yesterday came back from Asia, talking to the electronics manufacturers that supplies and hopefully pricing will ease up as we start into the -- near the end of the summer.

In terms of expansion, I mentioned we opened one new in the quarter.

We plan six for Q4.

That would give us a net total of 15 openings, one of which was a relocation so 14 net openings in 2010.

In 2011, the current construction schedule shows 26 locations, including two relocations so 24 net.

Now, I will mention before I go into fiscal 2011, I will mention that the Q3 end, our total square footage, some of you have asked for that, stood at 76,190,000 square feet of retail space.

In terms of expansion plans for 2011, currently there are 24 net new projects active on the current construction list.

Nine of these are planned for months 11 and 12 of that year.

But they are active real projects.

My guess is that the figure for 2011 will ultimately be around 20 to 22, including seven or eight outside North America as we ramped up some of our Asian expansion.

Lastly I want to talk about our stock repurchases which we began after buying nearly $5 billion of stock between July of '05 and into the late summer of '08, before the market went to heck and the concerns about liquidity in general became a major concern.

We purchased -- so again, we purchased quite a bit back then.

During the week of February 8, which was the last week of our fiscal second quarter, we got back into the market, buying about 250,000 shares that week, or about 50,000 a day.

During the 12 weeks of Q3, we purchased 1.925 million shares.

Now there were two or three weeks, --several weeks where we were in blackout where we did not buy any.

On the days that we did buy, we bought about 60,000 shares a day as compared to 50,000 a day during that the last week of Q2.

During the first couple of weeks of Q4, we have averaged 100,000 shares a day.

And principally a reflection of what I have stated in the past, we've got an analysis that we update on a periodic basis.

Generally speaking, we're not trying to be perfect in deciding when to buy, but as the stock shows more weakness in the market, not related to us but in general, we buy a little more, and when it shows strength, we buy a little less.

Overall we have been a net buyer.

With that, again, there is supplemental information that will be posted on the Costco investors relations site right away, within the next hour.

You already have the balance sheet.

The other stuff in there relates to the quarterly LIFO items, the actual calculation of EPS, to show you the little components of it to do your fully diluted calculations and the like.

With that, I will turn it back over to Christie for Q&A.

(Operator Instructions).

Your first question comes from Robbie Ohmes with Banc of America.

Good morning.

A couple of quick questions.

Great quarter, guys.

One question was, I was hoping you could talk a little bit more about the executive membership program and I think you said it is one-third now.

Where do you foresee that potentially going?

If you dreamed the dream, where do you think executive membership could get for you guys?

And then just the second question, unrelated is -- I might have missed it, but can you just discuss what the current expectation is for food inflation for you guys over the next six months?

Thanks.

In terms of the executive membership, and the assumption is that we're not going to just do executive membership and I'm not implying anything by that.

There have been no discussions.

At one what point do we say, hey we're only going to offer an executive membership?

That has not been discussed.

But my personal biggest surprise has been the ongoing increase in penetration, even in the most mature country, the US, where we've done it for, gosh, eight or so years now.

And the good news there is that the incremental increased penetration has very little, if any, adverse selection.

If you think about it, who is the first member to sign up for this seven eight years ago?

It was the owner of a restaurant or a convenience store, that is already buying $25,000 or more of membership rewardable merchandise.

And so for doing nothing other than paying an extra $50 or so, they get a check at the end of the year for $500.

Needless to say, all of those people have done this for a long time.

Today, if I had to profile the member who is opting to convert or opting to sign up as an executive member, it is somebody that is likely annual purchases are more towards the breakeven of this program, in other words $50 extra divided by 2%, they have to buy $2,500 a year in rewardable merchandise.

And those are the people that on an affinity basis, looking at an affinity program, are incented to buy more.

Even though these are smaller rates of increase, I'm surprised they're continuing at the levels they are and I think that is good news.

Keep in mind, also, in the last -- we've had US for the longest period, and Canada has been probably gosh, three or four years now.

And the UK and Mexico, although Mexico we don't consolidate so they're not in these number, in the UK we just started this recently, about six months ago, not a big number yet, but again, the UK is -- we just opened -- we're just getting ready to open our 22nd unit so 22 units out of 500-plus.

I think that it will continue.

The other piece of that is, is that if you go back a couple years ago, for every 100 new members signing up, we tended to get 10 or 12 to actually sign up originally as an executive member.

Today, that number is in the low to mid-20s.

And I think that is partly because we do a better job at the counter, if you will, when somebody is coming in to sign up, explaining the virtues of it.

All of those things bode well.

These people shop more frequently.

They buy more.

Those that convert, once they convert, they buy at an increasing rate, as compared to the control group and so all that is pretty good.

In terms of food inflation, in polling buyers in all merchandise categories, a couple of weeks ago, the general view is that over the next six months there is inflation, but not a lot.

And I think that their view was somewhat influenced by rising oil prices and rising gas -- freight costs and manufacturing costs, and that has subsided in the last couple of weeks.

But if you ask them today, they're still going to say a little bit of inflation.

And fresh foods, whether it is meat, produce, there is all kinds of anomalies that impact inflation and deflation, not just the economy.

But overall I would say, you know, sub 1% or 2%.

And then that is tempered a little bit at Costco because of the deflationary trends related to increasing penetration of private label.

Very modest inflation.

Great.

Thank you very much.

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

Good morning.

Two main areas of questions.

First, on the multi-vendor mailings, what has been the net impact to sales and also margin year to year?

I understand in April there might have been less couponing which hurt the comps and I think you were going to try to pick some action here in May.

I'm also curious whether that has helped the business this month.

By the way, the ASH is more of a timing issue.

I think on a fiscal year over fiscal year basis, it is -- maybe 31 versus 33 weeks, or 33 versus 35.

It is a couple of extra weeks.

As related to April, in Bob's comments, on the monthly call, that had to do more with timing of a given mailer, where one started earlier last year.

We benefited a little -- hurt a little one month and benefited a little the other month.

The big issue with it is if you go back a year ago or a year and a half ago, there was always three or four or five items that were $1,000 TV's or $1200 TV's with $300 off, or $900 for $200 off, as well as a little less of an issue, but the same thing on PC's, or laptops.

Again, right now, there is very little of that.

I don't have the exact dollar numbers.

There has probably been a slight less on a per-week basis, a dollar amount of sales from the MBMs.

But also people are pushing more -- people are pushing more basic household goods, where again, when we talked about on a monthly basis, some of the nonfoods categories that have been in the low to high teens comps, some of those are influenced by some of the items you see there.

There is lots of $30 to $80 items in the MDMs, whether it is -- I don't have that one in front of me, but things for the home, but not the $1,000 items.

And so that is part of the impact there.

The view is that that will start to lighten up near the end of the summer in terms of being able to offer some promotionals, but there is no guarantee.

My other question is on the gas operations.

What actually was the year-to-year EPS benefit to you in the fiscal third quarter?

And then we founded the gas price advantage for Costco seems to have widened versus competitors maybe $0.03, $0.05 per gallon over the last six months.

I'm sorry what was the latter part of that question?

It is a question about has your gas margin -- sorry, your gas price per gallon -- and it looks like it has widened versus the competition over the last six months.

If we're correct on that, has that resulted in better comp gallons?

And then with the big drop in oil, can you remind us how it is impacting the business?

You turn the inventory faster, would you be seeing a bigger benefit to the bottom line?

Or would you be putting that into more aggressive pricing?

Sorry, I know there are a bunch of questions there.

In general, gas is one of those things that -- it is like a teenager, you love them, but it drives you crazy sometimes.

In the quarter and year-over-year, there is a small benefit, less than a couple of cents, maybe a couple of cents at most, $0.01 to $0.02, I think it rounds to $0.02.

But usually we don't talk about that other than when there is a big delta.

And in terms of the gap of $0.03 to $0.05, are you suggesting that we -- that our prices compared to our competitors, that gap has spread?

The gap has widened, as we looked at it, Richard.

I don't see -- well, I don't see that.

And it may be more regional.

But all I can tell you is that we comp shop our gasoline in some locations two or three times a day, versus the direct competitors of Sam's or some of the discount stores or supermarkets.

And at least once a day in all locations.

We feel we're very competitive.

We're all -- I assume we're all making more money this week versus two or three weeks ago, as gas prices came down.

That is good for us.

We entered Q4 positively.

Although we made a decent chunk of money in gas last year in Q4.

And what I have learned is, is even though we're 2 one-half weeks into Q4, I can't extrapolate for 16 weeks.

As soon as you bring out the party frills, something happens and gas prices go up, and oil prices go up, and the profitability is tempered some.

But we're starting off well.

That's helpful.

The other small question in there was the change in the comp gallon trend.

Has there been any?

Gallons are up.

I don't think there has been -- if anything, last year, the trend was flat a little bit and it is improving a little bit this year.

Great.

Thanks.

When we saw a big comp gallon change was in '08 when prices went through the roof and people were talking $4 a gallon gas during the spring and summer of '08.

That's when we -- and I'm sure some other warehouse clubs, but virtually in every market in the country, whether it was Missoula, Montana or Los Angeles, when the local TV consumer advocate was on the nightly news, talking about where is the cheapest place to buy gas, we benefited greatly from that and we saw gallon comp goes up dramatically as people were trying to save money.

That is not as big of an issue now, but we're still seeing some.

As prices fell dramatically, again it was flattish and now it is up a little.

Next question?

It comes from the line of Charles Grom of JPMorgan.

Good morning, Richard.

I just wanted to go into the gross profit and make sure I understood -- heard you correctly.

The total is down 11.

If you look within core, you're down 10.

But I believe you said the core -- within the core, was up 14.

Is that correct?

You're within the four -- 80% of the businesses was up 14?

Yes.

That is correct.

You think about it, and these are not exact number, I'm just doing this on the back of the envelope here.

If you assume that the core, relative to gas, is 800 basis points delta, and have you -- it might be even a little more than that, if you have 800 basis points and a little over 2 percentage points of reduced sales penetration of that higher margin stuff, the core, 2.25 or 2.5 percentage points -- about 2, 3, penetration difference, times 800 or 900 is 20 basis points.

That 14 compares to the plus five a year ago, right?

Yes.

That is a plus 19 versus a down 3 last quarter so I'm just trying to get a sense for what changed within the quarter that led to such a big improvement.

Was the markup great?

Was it IMU?

Was it lower markdowns?

I think it is a little bit of everything.

It is higher penetration of fresh foods.

It is slightly lower what we call D&D.

It is an improvement in our sales returns reserve a little bit which impacts the margins through the salvage estimates.

It really is a lot of little things.

It is not like we sat around the table 12 weeks ago and said, how can we improve margins more?

There is generally a trend that margins are not the issue, that we can show some improvement and still be competitive.

Bob Nelson is sitting here saying, well you and I did.

Yes, but we're not the merchants.

The fact is it is a lot of little things.

Fair enough.

And then my second question, just moving down the P&L, interesting comment in the second quarter was $30 million, this quarter I believe it was $10 million.

Your cash balance increased.

I'm just trying to connect the dots.

Is that just lower other income coming from the JV from Mexico that led to the --

I'm sorry, interest income was $10 million versus $6 million.

Last quarter was $6 million?

I'm sorry, last quarter --

I'm looking at sequentially.

Okay.

Hold on.

I've got my cheat sheets here.

Bear with me a second.

Bear with me a second.

Okay.

Interest income -- the interest income was actually --

It was down $20 million sequentially.

It is a pretty big dropoff.

Hold on.

We're looking at it.

I don't -- there is nothing -- I need to find out what it is.

I just don't have it in front of me.

I'm happy to call you and --

All right.

I will circle back with you offline.

My last question is if you look at cash and short-term investments per share, you're sitting at I think an all-time time high of $12.

It sounds like you're starting to buy back stock, but are there any other plans to utilize cash in any other way, get a little more aggressive with the buyback or sitting with a lot of cash?

My comments a minute ago implied that we are more aggressive.

We are more aggressive in the latter part of Q3 than the beginning of Q3.

We are more aggressive in the first two weeks of Q4 than all of Q3 or the latter part of Q3.

Yes, more aggressive there.

In addition, my guess is, is $900 million of the $2 billion debt was five-year money that comes due in March of 2012 which is now only less than two years away.

We will write a check of that, so that is $900 million that we will spend.

And CapEx should ramp up nicely in 2011 and 2012 compared to the roughly a little over $1 billion in '08 and '09.

Those are the three areas that I would see more.

Okay.

Great.

Thanks a lot.

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

Good morning.

Richard, if you look at the average of the monthly comps you've been announcing for the US business, that 3% ex-gas number that you posted this morning for the quarter, that implies that the stub of the first nine days of May may be up.

Could you maybe comment on that a little bit?

I'm sorry.

Somebody was chatting here.

Could you repeat the question?

The average of the three monthly numbers that you've released already, comes in below the 3% comp that you reported today for the US business excluding gas.

I'm wondering if that implies that the first nine days of May is trending above what you did on those April numbers?

There is a little bit of an anomaly, because our quarter is like February 10th or so.

February, March, April, so we didn't give out anything for May, so he is saying the implication is it is a little better.

I would have to look at the numbers.

I don't think there is any major change either way.

Okay.

And then also if you give us a little update on what is going on competitively out there, Wal-mart is getting more aggressive on roll-backs.

We're starting to see that roll into the beverage area a little bit.

Are you feeling any impact from that?

Or can you see it at all in your stores?

We have not seen it, but it is top of mind discussion every day around here and the merchants are out there looking.

Recognizing we're less impacted by what Wal-mart is doing versus what Sam's is doing.

And Sam's has always been very competitive, as have we.

They are taking certain items down dramatically.

There are certain items, I won't say which ones, that we have taken down to cost, a very small number, by the way.

And we will do what we have to do.

But overall, that has not really been a big impact to us.

I think it is a much bigger impact to supermarkets and general merchandise retailers.

Okay.

And on the quarter here, part of the margin performance you posted was much better SG&A control.

In fact, you said this is one of your best SG&A controls -- quarters in some time.

Is there anything you can point to specifically that you're doing that we could -- give us some comfort that that trend will continue or is that just lapping some of those health care problems?

The health care is lapping, but all of the health care and related benefits costs were still a detriment, but a much lower detriment Q3 over Q3, as compared to Q2 over Q2, or Q1 over Q1.

I think payroll is the biggest one.

I think in the last year, we've reduced the average SKU count, which means we still have the same square footage so we're just mapping up and more efficient in what we are selling.

We have gone back -- and I think I've used the comment that for many years, I would always say, there is not a lot of silver bullets because we're pretty efficient.

But in tough times, one gets more efficient.

Everybody out there I think is working a little harder.

Even the little things we're doing, whether it was changing out the color copiers to being -- you have to opt into color, I have used that example.

There are lots of little things.

There is no big giant changes out there in the warehouse, other than a focus -- a renewed focus on expenses.

Okay.

Thank you very much.

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

Thanks.

Richard, if we could just continue on that line of the expense control, it looks as if that 10 basis points of payroll leverage is quite good.

Could you remind us what happened with the negotiations of the contracts, what that implies in terms of leverage opportunity going forward?

Every three years, which the three-year periods are -- most recently is March of 2010, we re-write our employee agreement.

It is not a contract.

It is actually an employee agreement that we sent to them, on the 60 locations out of 500-plus that are union.

That is a contract, but it is very similar to what you see in the employee agreement for the nonunion employees.

And the question, if you go back a year ago, that with the economy bad, what happens to top of scale, which is about a little over half of our hourly employees are at top of scale, what type of increases are they going to get each year.

Basically, very little change from prior years.

If you look back at the last two or three year employee agreements, so 2007 and 2010, 2004 to 2007 and so on, once they are top of scale, they rise pretty quickly from where they start here, over the first for our five years to get to top of scale, with big increases each year.

Once they hit top of scale, historically it has been somewhere around a 2.5% increase.

Roughly number at top of scale is $20 you assume and $0.50 an hour would be a 2.5% increase.

We went into discussing things, but generall speaking, we thought this was an important time to continue that when employees are in need.

There is not a lot of benefit to their bottom line from saying, hey, we can only do half as much, because we chose to do as much.

I think we're really going to see a benefit on the labor side, as we have great employee relations.

I think we've seen some of the improvement in payroll percent, is that people get it -- our people get it, and they are working harder and smarter.

I think also if we get a little leverage from sales, that will help.

Where I think the opportunity is going to be is some actions that we can take on the health care side.

That's a big nut.

It is growing.

Forgetting about the increased number of people eligible, because of the slowing warehouses, that will improve as we ramp up warehouses a little bit, but more importantly, making our employees better consumers.

We're not going to do take-aways, but we, like a lot of companies, are looking at a lot of things, like -- I will give you a simple example.

In the greater Puget Sound, let's say there's 20 places, hospitals, medical clinics, where you get a standard MRI, mammogram, or colonoscopy.

Those are three major items.

The contract in negotiated large company here rates range, it could be a four-fold delta between the cheapest and the most expensive in the community.

Now, we're not going to just say you can only go to the cheapest, but it has been structured so they can go anywhere.

And there's got to be some rationale there that something that costs $1,000 in one hospital and eight miles away in another well known hospital costs $2800.

We're not doing anything that other companies are not doing, but we're looking at all of those types of things and we think we can save money, and to help control that a little more.

Okay.

Just to be clear on the employment agreements, no change.

It had been -- we had been calling it out as perhaps a BB, not a silver bullet, but an opportunity.

But it sounds as if no change there.

Correct.

Okay.

Got it.

And then just talking about on the -- you had mentioned on the earlier question, a small number of items you priced at cost.

Can you just perhaps dig into that a little bit?

I know not that long ago, a year ago, you guys got a jump on being quite aggressive and we saw -- traffic picked up, but we also saw the impact on margins.

Could you give us a sense, as you talk about Wal-mart as top of mind and top of center around the discussion around there as it relates to the roll-backs, what would be the tipping point in terms of getting more aggressive, like we saw last year?

First of all, last year, which we were talking about is essentially December of '08, when commodity prices had fallen precipitously, but the underlying commodities from vendors were lagging four to eight weeks.

And we chose to -- given that comps were heading towards zero, and we chose to basically take upon our ourselves about $30 million to $35 million in commodity markdowns on a limited number of items.

But in the aggregate, $30 million to $35 million.

And it was just chickens, milk, cheese, butter, to drive traffic, and we saw an improvement in frequency.

That was the perfect storm as I described it back then because we knew it was a matter of weeks, not months or years, where the underlying procurement cost to us would come down and fall in place, but that hurt us because we didn't get price protection on that.

I don't see any current scenario that dictates that.

Again, Wal-mart is amazing at what they can do and what they're doing right now.

But a lot of that is Wal-mart versus supermarkets, not Sam's versus Costco.

I think we and Sam's and BJ's, but we and Sam's in this regard, are fiercely competitive, have always been.

I think we both know that if one of us gets aggressive, the other one is going to be equally aggressive.

Arguably, we've got Jim, and we're aggressive.

And I don't see that as a current issue.

Things could change tomorrow, but we're going to hold our stand here.

But there is nothing in today's tea leaves that tell me differently.

Okay.

And the items that are down to cost in terms of -- could you be a little bit more specific in terms of categories, where they are?

There is one -- I heard one example yesterday in a meeting, and it wasn't a meeting on Wal-mart, it was a meeting on a lot of things.

There was one item in health and beauty aids where they're selling it below cost and we have take continue down to cost.

It is one little item and I don't want to say what it is.

But it is meaningless to the Company.

Other than, I'm sure there are some other things out there.

But we are -- let's face it, we and Sam's are fierce competitors and respect one another.

And we both also have pressure to make money.

And I think that we will hold our own here.

Okay.

And then just lastly, on California, an update there, the trends that you're seeing?

Again, at a lower base, but the quarterly sequential over the last four quarters have been good, including Q3.

Great.

Thank you.

Any more questions?

Yes, sir.

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

Hi, guys.

Just a couple.

Quickly, Richard, the third quarter buyback, how much money did you spend to buy those shares back?

I have it right here.

$114.6 million.

Okay.

Thank you.

And then the G&A growth I think you said it was $180 million and the growth was 5% year-over-year.

That was a big stepdown.

And I think in the second quarter, G&A was up 15% year-over-year.

Is that correct?

And if so, is it just a slowdown in the club?

And it seems like a pretty street dropoff.

Is that what we should be thinking going forward?

I think it is more than anything timing of openings.

I asked the same question this morning when I said, sequentially it looked like it was a little less of an increase in Q3.

It is just timing of a few things.

Nothing dramatic there.

Once we ramp up expansion -- I think part of it is also is we had committed a little more over the last year to IT which has three and five-year write-downs.

Nothing earth-shattering there.

And just lastly, on private label, can you give us a sense what the penetration was in the third quarter versus last year?

Penetration year-over-year is up about one -- a little over 1.5 percentage points.

About 1 percentage point -- maybe 1.25.

Great.

Thanks very much.

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

Good morning, Richard.

Two questions for you.

One, you talked about a lower SKU count in the store.

What is the current number that you guys are operating with?

SKU count, 3750.

And is there a plan to change that or take that any lower from where you are today?

I think we are comfortably low right now.

Keep in mind, probably four years ago when the stated goal internally was 4000, it was inching towards 4200.

When Jim in every monthly budget meetings would say, guys, would you like me to do it -- would you like to do it or like me to do it and it would take about half an hour.

And then the feeling is, the top 200 items or 5% of the items represent near 40% of the sales and you can imagine what the bottom 200 and let's max out and do more aggregate volume.

I think we feel comfortable where we are right now.

And then are there any new brands or different categories that you're excited about, things that you're selling now or you're looking to get that you can talk about?

I think in terms of -- there is certainly -- and I'm sorry, I just don't have -- I missed that one, so I don't have that list in front of me.

I know there is more brands in apparel and more availability of some apparel.

There's -- in terms of the KS, I think between now and the end of the year and into next year, look for some more branded private label and lots of supermarket consumables, canned goods and things like that.

And I think last six months you've seen things like KS macaroni and cheese and the like, so both dry and canned foods.

Electronics I think again is -- 3D will happen.

I'm not sure everybody will jump on it the first day, but it will be there.

LED, back lit, there are some things there that are exciting on that side.

But I'm stretching here.

All right.

And so Richard, when you look overall at the trends, some of the things you're naming, but discretionary versus nondiscretionary, where do you think we are from a consumer perspective today?

I think the biggest change from now versus a year and a half ago was the fact that as TVs -- flat screens went from $2000 to $1500 to $1200 to $800 to $700 in demand, units were up huge.

And finally, I think that is satiated a little bit, their appetite as well with increasing demand worldwide, like in China and India, what have you is what I've being told.

For the first time in a long time, the last few months, the underlying cost of the panels, the OEM cost of panels was up dramatically, so there is not a lot of promotional money to do any of the multivendor mailers and things like that.

Not only do you have price deflation in some of those categories over the last couple of year, you have a little less demand than you have historically.

That being said, I think we -- what is a positive for us?

We went into this season for patio furniture, which we sell between January and March, a couple of months before the season starts, and want to be out a couple of months before the season ends.

We have been scrambling for probably by mid March, we were scrambling for extra inventory, because we -- while we were a little conservative committing this year, not a lot of conservative, but a little conservative, we sold through it very well.

Whereas people -- my favorite article that I read about all of this was called, Frugality Fatigued.

People were frugal last year.

Some of them are a little tired of being frugal and they're buying things for the home.

And whether it is door mats or house wares or coffee machines or live goods, plants, that's stuff that has been strong.

Great.

Thank you.

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

I know that you guys can appreciate the difficulty for us in forecasting gas's net impact on your gross margins.

You cited some changes in penetration, but pretty good gross margins on gas itself now.

Do you think that gas will have a more or a less of an impact on Company-wide gross margins in Q4?

What is the trend right now?

I think that -- Bob is saying here -- I was going to say, I think it will be a slight, a lesser negative.

You're still going to have year-over-year inflation in gas.

And so that penetration on lower margin, you will have better margins probably year-over-year, but not as great as I mentioned here in Q3.

A year ago in Q3, we lost a little money.

This year, we made a little money.

Last year in Q4, we made more than a little, not a huge amount, but more than a little.

We're entering this quarter pretty good.

Let's assume we do a little better than last year bottom-line wise, or therefore, gas gross margin wise, still the increasing penetration dwarfs it.

Got it.

Great.

Thank you.

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

A few questions, actually that still haven't been asked.

If you talk about what you're seeing in terms of spending by small business members?

Our sales penetration, all I can tell you is that the sales penetration has been fine.

There has not been any dramatic change.

I think one of the issues for us has been over the last year when we saw -- everybody talked about restaurant business is down.

Restaurant -- first of all, the restaurant business was more down for the bigger restaurants, the bigger higher-end restaurants which is not necessarily our customer.

In the case where the restaurant business was down, who benefited?

Supermarkets and warehouse clubs.

I think we had some offset there.

And you said were you impressed with higher traffic on top of difficult comparisons.

Can you talk about what the basket looked like?

When I go out there, it is a lot of foods and assundries.

There's fewer TVs in the basket, and not a lot fewer, but fewer.

Again, I think we have become -- I think if there is a silver lining to this horrible economy over the last year and a half is that the warehouse clubs and us in particular, the extreme value proposition, one of our signature categories in our view is fresh foods.

People are shopping with us more frequently than they used to.

Some of that is restaurant business.

In my view, some of that is supermarket business that people are getting more of their stuff at Costco.

They are shopping more frequently, but the overall ticket is less?

Yes.

Okay.

And then can you talk about international performance?

As I mentioned, UK's comps were close to flat.

Everybody else, the local currencies is quite strong.

Canada is the one that is most impressive from the standpoint, in my view, from the standpoint that it is 70 or 80 units, and it is as old, almost as old as our whole Company operation, and so relatively mature, and it is showing 10% comps in local currency.

How should we think about international margins?

Positively.

Okay.

And then lastly, I just wanted to confirm that the target rate for private label is still 37%.

I think it is.

But that -- when your children go to college, I think directionally, yes, but it is going to take some time.

Okay.

And clearly, as I get into the remainder of the calendar year, we will be able to talk more about some of the things like some canned goods and some other items, recognizing we tried a mayonnaise two or three years ago and a peanut butter and we underwhelmed you.

Not everything works, but most things do work.

There is -- not a whole lot of [saccharo sact] in terms of branded goods.

We want to offer both.

We want to show our member the quality we can offer.

Clearly, if we can get them to be loyal to the KS brand, that's great long term and we're pretty much determined to try everything.

The last one to throw out there, based on the average household income of your members, have you been surprised at the uptake in EBT as a form of tender?

No, I think it is positive.

It is still small, a very small percentage.

I think it rounds to 1%.

But I think we looked at ourselves in the mirror and said, we probably were a little bit -- a little arrogant not -- for a long time we didn't do it for whatever reason.

Even though technology-wise, it got a lot simpler and it did not have any real impact to the front end, in terms of slowing up the lines.

Our view that it really isn't our member, well the reality is it is everybody's member.

If it can help, and it is not very costly to do, which is the case, then it is a positive.

It is a slight net positive.

Thanks so much and best of luck.

The next question comes from Colin McGranahan with Bernstein.

Good morning, Richard.

Thanks for taking the question.

Just quick follow-up on two topics that have been discussed already.

On SG&A, you gave us the cadence of the growth rate of health care.

I know some of the things you're looking at in terms of making your employees better consumers, those are long-tailed.

Do you think that the 11% growth right now is more of a steady state growth rate for some period of time?

Or should that continue to inch down as the compares maybe get a little easier still?

I think that on the one hand, there are things -- first of all, the long tail is not completely long.

This is not like smoking cessation programs or weight loss programs or exercise more and eat better so you will have less heart attacks 10 years from now.

This is -- some of these changes can be made in the next year and each one can be a few million bucks.

It is not giant, but they will all help.

I was going to say one other thing.

The offset to that is changing health care legislation and not just the new plan.

One example, next year, and this is -- I don't think this is even part of the what's referred to as the Obama health care plan, is that currently, dependents of employees who are under 22 -- under 18 or under 22 if they're in college, can be on their parent's health care plan.

There is a cost to that, to the employer.

The new law is -- I think it goes in effect January -- either January 1 or September 1, based on the fiscal year but I think it is January 1.

The new law is up to 26, and you don't have to be in college.

If we look at our current employee base in the US of 95,000 or so people, existing employees who had dependents in the plan, but based on their age, they left our plan, either at 18 if they weren't going to college, or 22 if they were going to college, we have about 13,000 or 14,000 people out there that have left our plan of current employees.

Now, not all of those are going to jump on our plan.

If they're working themselves, and many of them are, if they're eligible for their own plan, they can't go on our plan.

But let's assume half of them do.

That's 7000 and they're young and they're healthy.

But even if the average cost was only $2000, there is $14 million a year.

There are things to mitigate some of the savings.

But nonetheless, I think that -- I can't guess.

I would expect the growth rate in dollars in Q4, given that we had a high increase last year in Q4, is around the same or a little better.

And hopefully it gets a little better, but it is still going to be at best in the high single digits going forward over the next couple of years.

That's really helpful.

And final follow-up, through the quarter and really focusing on the US business, the average ticket didn't really improve maybe as much as we might have expected it to.

I know you have talked about more frequent trips still happening, but any other thoughts on that?

I think as the discretionary categories are showing a little bit of life that maybe that average ticket trend should be getting better faster.

Keep in mind, they are coming in more.

They're buying a little less each time.

And also, they're buying more food and assundries and less $1000 TV's.

That goes a long way to changing that average ticket a little bit.

And I think we're probably half to a little more than half -- or half to a little less than half of the way through on a year cycle on that, in terms of the pressure of less TV's.

Just if you go back a year or two or three years ago, one $1000 television in our NBM, in two or three weeks we could sell 20,000 or 30,000 units or $20 million or $30 million of one item.

There are none of those right now.

Those are things that impact.

Is it offset by coffee makers and toaster ovens and exercise equipment and a lot of other things?

Yes, we're doing a pretty good job of fighting and tackling.

My view is a simple one is we got them coming in more frequently and it is not like they're buying it somewhere else.

When they start buying it, they are buying it at us.

Okay.

Great.

Thank you.

Your next question comes from the line of Neil Currie with UBS.

Thanks.

Richard, I wondered if you could follow-up on that question earlier on average ticket.

You mentioned consumer electronics and selling less TVs.

I think we've spoken in the past and you've talked about how there has been more of a shortage of big TVs, and that's led to -- not to pricing potentially, but lower sales.

I was just wondering if you could give us any view on how that is going to change over the next six months or so, whether you see more TV models coming into the system.

Whether we should start to expect TV sales to start going up again?

The big issue over the last four to eight -- four to 10 week, let's say, has been less promotional opportunity for us at NBM's, and arguably less -- offset a little bit by less deflationary trends in there.

Again, our VP of majors and electronics literally just got back yesterday from a week in Asia, meeting with all of the manufacturers.

The view is, is that availability will be greatly enhanced by mid to late summer.

That the capacity is up.

And so there is a feeling going into the seasonal parts of September through Christmas, there will be a little bit more promotional opportunities.

And I hate to use the word promotional, but let's face it, when you have something that has been declining on its own $200 or $300 a year, and on top of that, a couple hundred, $300, three-week, $300 off in an NBM Mailer, that drives business.

Again, there is not a lot of that excitement in the NBM mailer related to those bigger ticket items right now.

You think in the first quarter of this year also we should start seeing them come back in the NBM mailers --

Four months from now, in early October when we talk about Q4, we will talk about -- it is still an impact in Q4, but near the tail end of Q4 and into the first month of Q1 of September, we start to see a change.

That would be my hope.

Okay.

Why is the UK so flat against other international markets?

Is it just economy-based or is there something else going on?

In the UK, we operate under a slightly less format.

When you walk in, it is a membership warehouse club.

It looks like a warehouse club, and it smells like a warehouse club and it walks and talks like a warehouse club.

The one difference there is in order for us to make economic sense, we locate our facilities in what are called commercial trade areas, not retail areas which are still expensive, but not as expensive and are more available.

Because of that, each -- and I forget if it is cities, states, provinces, but each locale has a minimum required of business to the trade.

We do not market nearly as strongly to nontrade members or nonbusiness members, so we have less of a consumer piece over there.

That always has impacted us a little bit over there.

Basically what you are saying the business community there is not recovering --

That's my guess.

And you don't look into the consumer recovery --

Our view is our pricing is more favorable over there relative because there are not other warehouse clubs over there and discounting is not as dramatic.

But again, the economy -- I'm not an economist, and I don't have the numbers in front of me for the UK, but my guess is it is a little bit of a small business recovery, but also the fact of how we have to market.

Thanks.

And just finally, any thoughts on the west coast?

Any changes you're seeing to California economy in particular?

Again, I think that sequentially, we're seeing it pick up nicely.

It is still at a lower rate than some of the other parts of the country.

But I think we're all looking for tidbits every week, or every day, when you hear something about finally there is a reduction in the foreclosures.

But the fact is, again, I think the frugality fatigue helps a little bit, but we are seeing a little pickup.

There is at least not the concern that the sky is falling.

Okay.

Thank you.

Why don't we take two more questions.

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

Good morning.

Question on membership growth going forward.

You've had a nice little acceleration off of lower levels in prior quarters.

How would you expect that to play out in local currency over the next couple of quarters?

Still at that 7% level?

Or does that start to get a little bit better, do you think?

Could you repeat the question?

It broke up.

The question was regarding membership growth.

It has shown some nice improvement in local currency in the last couple quarters and I was just curious about what your thoughts were over the next couple of quarters.

Does it maintain this 7% rate or so?

Or do you think it can improve off that level?

I would hope it can accelerate somewhat because we've gone from opening one unit in each of the last two quarters to six in Q4, and God willing, around five or six a quarter in all of the quarters next year.

Recognizing whatever -- so that would be -- should be an improvement, an acceleration.

Recognizing any acceleration in terms of the P&L, we record membership fee income on a deferred basis.

We get an incremental new member tomorrow at $50, it is basically $4 a month extra incrementally into the next 12 months.

And so that will temper that rate of acceleration.

Okay.

And then through the earnings season, we have heard retailers talk about some softness or choppiness related to weather in May.

Obviously we've had a lot of turmoil in the markets over the last few weeks and I realize comps are next week.

But I'm curious, are you seeing choppiness or any increased volatility in your business, over recent weeks as this has unfolded?

The only choppiness that we see relates to how a holiday falls, like Memorial Day fell a week off, so it helps you one week, hurts you the next week, or vice versa, and the timing of an NBM mailer, where if -- I'm making this up.

But let's say, last year it was weeks one through three of the month and this week, it is weeks two through four.

And week one this year, since you had an NBM last year, but not this year, you see sales down.

And in week four, it catches back up.

Okay.

And just some housekeeping items.

I don't know if you mentioned earlier, but do you have an expected tax rate for the full year?

And I was just curious where you think pre-opening and net interest will fall out for the full year also?

Pre-opening should start to escalate some.

I'm sorry, I don't have that in front of me.

Let me look at last year, but it should escalate from where it has been with more openings.

And interest income -- by the way, getting back to I think it was Chuck Grom's question on Q2, interest income.

The big delta in Q2 -- interest income, I looked at my notes from Q2 while we were on the call here, and interest income actually was only up a few million dollars year-over-year in the quarter.

And the big difference sequentially that Chuck, you had mentioned, was related to first of all, Q2 has Christmas, and Mexico -- our half of Mexico earnings are dramatically higher then.

In addition, as I mentioned -- I did mention in the Q2 conference call, we did pick up some incremental dollars on FX contracts.

Usually that is something that is no more than plus or minus a couple million dollars and I never talk about it.

We happen to have in Q2 a benefit of probably a penny, $7 million or $8 million, and so that was an anomaly in Q2 that is more of an anomaly whether it was a plus or minus in Q2.

It was nonetheless an anomaly.

And the other big chunk was just quarterly profits in Q2, and that is dramatically different in Q3.

Looking to Q4, I don't see a big change.

Again, it doesn't matter how much cash you have, there isn't a whole lot of money.

And given that we know that we are going to pay off -- we're going to pay off $900 million in March 2012.

In the last few month, we have taken about $900 million and extended it out up to just under two years, and are making an extra 80, 90 basis points.

900, times 80 basis points is $7 million a year.

Maybe annualized you will get a couple million a quarter from that, but that's not earth-shattering.

And then the tax rate for the full year?

I think our tax rate -- I start every quarter with a tax rate assumption of around 37%, or high 36's.

And usually it is between -- again, the percentage in Q3 which was 34.4%, part of that is is Q3 is a lower profit quarter.

When you've got a $3 million or $5 million benefit or hit in a quarter on a lower percentage, that changes the percentage more, on a lower base.

Okay.

Great.

Thanks.

Your final question comes from the line of Chuck Cerankosky with Northcoast Research.

Good morning, everyone.

Richard, my question has been answered so why don't you give this to somebody else.

Your final question will be from [Damion Wataski] with Gabelli and Company.

Good morning, Richard.

Just going back to your comments on regional strength, any sense of what percentage you would attribute or just what -- is it the region improving?

Or is it that you're just taking share in those regions?

I think in the midwest and Texas, a little of it has to do with we're newer there.

I almost can't say newer anymore because we've been in those regions for 10 or so years, but we're not there for 25 years.

I think Texas, again, we've been there for 10 or so years and our competitors have been there for 25 years.

I think we're just showing some nice improvement there.

In Florida, or southeast which is Florida, Georgia, the Carolinas, I think it is half and half.

I think some of it we're taking market share because we've done a pretty good job and some of it we have some newer units.

And then you haven't -- I haven't seen northeast mentioned in a few quarters here, I think now as a regional strength regional strength, and isn't it just because it didn't fall as far and has less room to improve or what is happening in the northeast?

That is correct.

But in addition, the northeast, I forget which quarter or which months it was, but they had hard weather patterns.

There were a couple -- and I hate to use that as an excuse, but I know there were a couple of months there, a few months ago, which really impacted it.

Okay.

And then just lastly, are you finding it harder now to find -- to buy in better deals?

And if so, what categories in particular?

The only one that I've heard about is the electronic -- the TVs.

Again, there is not as many deals out there, because of the worldwide increase in demand.

And again, that seems to be finally abating a little bit over the next couple of months.

Other than that, there's plenty of deals out there.

Okay.

Thank you.

Thank you, everyone.

Have a good day.

This concludes today's conference call.

You may now disconnect.