好市多 (COST) 2011 Q2 法說會逐字稿

Good morning, my name is Debbie 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 operating results for fiscal year 2011 and February sales results 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, Chief Financial Officer, please go ahead.

Thank you, Debbie.

Good morning to everybody.

This morning's press release reviews our second quarter of fiscal 2011 operating results for the 12 weeks ended February 13 and, of course, our four-week February sales which ended Sunday, February 27.

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 second quarter of fiscal 2011.

For the quarter our earnings per share came in at $0.79, up 18% from last year's second-quarter earnings per share of $0.67.

As was noted in the press release, in last year's second quarter we had a $22 million or $0.03 a share charge that was recorded related to a change in the Company's employee benefits.

Excluding this charge, Q2 EPS last year would have been $0.70 and the 18% EPS increase would have been 13% on a more normalized basis.

In looking at the year-over-year Q2 earnings comparison there are just a few other items I will quickly note here.

As was the case in Q1 year-over-year, with rising gas prices our gasoline operations were still profitable in Q2 this year, but less so than in Q2 last year to the tune of about $0.02 a share.

So that hurt us a little bit year-over-year.

As was previously disclosed, we are taking a 4.9% pretax accrual in the second quarter to pay pending court approvals from attorneys' fees in a derivative suit.

LIFO, it's back.

After at least nine fiscal quarters with no LIFO charges, in fact back in 2009 all four quarters had LIFO credits, we recorded in Q2 here a $6 million pretax LIFO charge.

And based on the way things are looking, we would expect more in the coming fiscal quarters.

Lastly, currencies.

Foreign FX; many of the foreign currencies in the countries in which we operate have strengthened relative to the dollar year-over-year as compared to the US dollar such that when we consolidate the profits from these foreign operations by converting such profits into US dollars this helped Q2 by approximately $0.02 a share.

If you take those four items that I just mentioned -- gasoline profitability, the $4.9 million accrual for legal fees, LIFO of $6 million, and the FX benefit -- added together these four items collectively hit this year's Q2 EPS by approximately $0.02 a share.

One other item of quick note, as I had mentioned it last quarter's conference call, effective the start of this fiscal year back in September we began consolidating the results of our Mexico operations -- our Mexico joint venture.

Historically, before this fiscal year, these operations were treated on the equity method, investment method, thus, we only reported our 50% share of the joint venture's net income within the non-operating interest income and other line item in our income statement.

Since the beginning of this fiscal year we now fully consolidate the Mexico venture.

In effect, it adds 2% to 3% to top-line sales, assets, and liabilities.

100% of the venture's financial statements are included in our P&L and balance sheet and cash flow.

And then the 50% portion held by our joint venture partner is then backed out at the bottom of our income statement to offset it such that there is no effect to our bottom line or our earnings per share.

It does, however, impact the discussion of the percentages of gross margin and SG&A and the like and earnings basis points.

And I will point that out as I discuss our results in the next few minutes.

In terms of sales for the second quarter, reported total sales were up 11.4% and our 12-week reported comparable sales figure was up 7%.

For the quarter, as has been the case for several quarters now, both total sales and comp sales were impacted by gasoline price inflation and by the strengthening foreign currencies relative to the US dollar year-over-year.

On a comp basis the reported 5% US sales increase, if you exclude gas inflation, would have been 3%.

The reported 12% international comp figure, assuming flat year-over-year FX rates, would have been plus 8% resulting in the total company comps, which again were reported as plus 7% excluding gas inflation and excluding FX, would have been plus 4% for the Company.

In terms of the four-week month of February which we are also reporting this morning, it's directionally similar to the quarter.

Again, excluding gas inflation.

The 6% reported US comp would be plus 4% and the 14% reported international comp would be plus 7% in local currency so that such that excluding both gas inflation and FX, February's four-week reported comp number of 8% would be plus 5%.

And again, for the month of February this, what I will call the normalized plus 5%, compares to a normalized plus 4% for the entire second quarter.

Other topics of interest that I will review this morning, our opening activities and plans.

After opening eight new locations in Q1 we opened two new locations in Q2, one net.

One is a new location in a suburb of Minneapolis in Burnsville, Minnesota, and our second location in Vancouver, Washington, which is just north of the Oregon/Washington border north of Portland.

We also closed a unit in the quarter in San Marcos, California.

This unit is being torn down and rebuilt on the same site.

It will open again later this summer before the fiscal year-end.

Since Q2 end on February 13 we have not opened any new locations but will open a third unit in Tucson, Arizona, in mid-April and plans are for 14 buildings to open by fiscal -- additional 14 buildings to open by fiscal year-end including the relocation of that San Marcos -- the reopening of the San Marcos site.

All told that would put our fiscal year 2011 opening schedule at 24 net new units.

That would include 14 in the US, three in Canada, five in Asia -- all of which are planned for our fourth quarter which starts in early May -- and two in Australia, which would be our second and third units in Australia.

Also this morning, I will briefly review our dot-com results and our membership trends and again talk about margins and SG&A in the quarter, mention what we bought in terms of stock repurchase, and a couple of other miscellaneous items.

Okay, so on to the discussion of our quarterly results.

Sales for the quarter, as I mentioned, were $20.4 billion, up 11.4% from $18.4 billion a year earlier.

Again, our reported comp was 7% which, of course, is benefited by the inflation and the FX.

For the quarter the 7% reported comp included -- resulted from the combination of an average transaction increase of plus 3% and an average frequency increase of about 3.5%.

The frequency trend, by the way, during the past three calendar reporting months for December, January, and February was basically 3.5%, 4.5%, and 4%, a little under 4%.

We are now going on to two-plus years with year-over-year frequency increases in the 3% to 5% range on the year-over-year monthly basis.

And that is after, as many of you know, after years of frequency figures in the really 0% to 2% range.

For the February reporting month, much like the quarterly comps, our 8% reported comp figure was a combination of an average transaction increase of 4.2%.

Again that includes the FX benefit and the gas benefit -- it would have been somewhere between 0.5% and 1% net of those two -- and an average frequency increase of 4%.

In terms of sales comparisons by geographic region, for the quarter the Midwest, the LA, and the San Diego regions were the strongest followed by good showings in the Bay Area and the Southeast.

The weakest US region was Northeast.

Of course that was impacted by the ongoing inclement weather.

Internationally, in local currencies, UK has been the weakest as it has continued to be about flat, with Canada and Taiwan in the mid-singles, and all the other countries in the double-digit comp range in local currency.

For February we have continued again to experience weather in different parts of the country.

During February there were impacts in Midwest, Texas, Northwest, and Canada.

We estimate that detriment to what we would have -- in terms of lost sales somewhere in the 0.5% to 1% range.

On a regional and country basis for the month of February, US regions with the strong results were the Midwest and all three California regions -- Bay Area, Los Angeles, and San Diego.

Recall that San Diego region includes also not just the San Diego market but Colorado and Arizona.

The weakest US regions were the Northeast and the Northwest.

Again, both impacted by strange weather.

Internationally in local countries -- in local currencies we are doing fine.

In Canada up high single digits, and Korea and Japan in the teens.

One quick comment on weather and its impact on our sales.

I recently read an Internet article about our comments on weather.

While a negative impact to year-over-year sales increases, it's not really an issue because we had similar reasons a year earlier in discussing sales.

Now we understand that.

We were just trying to share with you what our operators look at in terms of what we feel we lost whenever you have the kind of weather we have had.

Some of those sales are not recoverable and we give our best guess -- our operators give us their best guess of what they lost, which then Jim discounts a little bit and that is what we give you.

Inflation in fresh foods continues in the low to mid single digits range and in food and sundries in the low single digit range similar to January.

Looking ahead to March, March is a five-week sales reporting month.

We will have a full 35 selling days this year compared to 34 days last year; that is due to the timing of Easter which is three weeks later on the calendar this year versus last year.

Last year Easter fell on April 4, which this year it falls on the 24th.

The March reporting period will end Sunday, April 3, and we will report on the April 7.

In terms of merchandise categories by quarter, in terms of sales -- I am sorry for February, within food and sundries all subcategories were positive ranging from plus 3% to plus 12% for the month with essentially a flat hardlines comp sales increase.

The strongest subcategories within hardlines for the month of February were automotive, sporting goods, and office.

Majors, which is electronics overall, were negative.

That is the offset to the other areas.

The big dollar negatives were in computers and other miscellaneous electronics, like audio and what have you, which overall were weaker, both in terms of average selling price and units.

The one positive note within that negative majors is TVs.

While the average sales price per television is down, the TV unit sales in February were up 9% which resulted in about flat dollar sales in TVs.

So you can figure out what the average sales price decline was, but nonetheless we had a good unit sales increase in TVs.

Within the high single digit comps soft lines, housewares, home furnishing, small appliances, and jewelry showed the strongest results.

And within fresh foods all right around 10% plus or minus a couple of percentage points.

All four sub-fresh food categories -- meat, bakery, deli, and produce -- in the high single to low double digit range in each of those sub categories.

Moving on to the line items in the income statement, we will start with membership fees.

We reported $426 million or 2.08% in Q2 of 2011; that is up 10 percentage points in dollars or up about $40 million from last year, about 2 basis points less.

Again, I could go through all the explanations of gas inflation that impacts it, but nonetheless in dollars it was up 10% or $40 million.

If you take FX out it was up 9%, that is still a good showing.

In terms of membership, we continued to enjoy strong renewal rates and continued decreasing penetration of the executive member.

We had one -- as I mentioned, we had two openings in Q2, but actually -- and then one closing with that San Marcos but two openings.

Our new membership sign-ups in the quarter were still up slightly year-over-year in the fiscal quarter, net new sign-ups overall.

In terms of number of members at Q2 end, at the end of the first quarter we had 23.5 million Gold Star members.

It's now 23.9 million.

Primary business 6.2 million at the end of the first quarter, 6.3 million at the end of the second quarter.

Business add-on 3.6 million and 3.9 million, and total households would be 33.3 million and 34.1 million.

And if you include all cardholders, some households of course have two cards, 61.2 million at Q1 end and 62.0 million at Q2 end.

These figures, of course, include Mexico now that we consolidate but both Q1 and Q2 have apples-to-apples comparison there.

At Q2 end on February 13 our paid Executive members were just shy of 11 million, 10,974,000.

That is an increase of 200,000 -- 210,000 or about 17,000 a week, 17,500 a week during the last 12-week quarter.

In terms of renewal rates, they have actually continued pretty strong.

At the end of the year our US and Canada renewal rate was 87.7%, which is the number we have always reported.

At Q1 end it was 88.2% and at Q2 end it was 88.8%.

Certainly part of that, I believe, is the continuing increasing sales -- membership penetration of the higher renewal rates that we engender from the Executive membership base.

We see the same trends on a worldwide basis in many of the new markets where you have units that are a lot younger you start off typically in the 70% range and trend up towards our company average.

Overall worldwide we are around 86%.

Going down the gross margin line, gross margin in the second quarter was higher year-over-year by 15 basis points.

This is where you get out your pen and we will jot down a fewer numbers.

We have three columns -- fiscal 2010, Q1 2011, and Q2 2011.

We have several line items -- core merchandising is line one, ancillary businesses line two, 2% reward line three, LIFO line four, other -- well, actually there is no other these quarters -- total.

And then I have added two lines, Mexico impact and then the last line below Mexico impact would be without Mexico.

Again, because we were consolidating Mexico starting this fiscal year to give you the true reflection of the basis point changes we show you with and without that.

So going across these line items, the core merchandise for all of 2010 it was up 6 basis points, so plus 6 basis points.

In Q1 2011 up 19 basis points and Q2 2011 up 24 basis points.

That is again on a year-over-year basis of how the margin improved.

Within ancillary businesses its contribution to the total change plus 3 in all of fiscal 2010, minus 9 in Q1 2011, and minus 5 in Q2 2011.

2% reward, which simply reflects the increasing sales penetration so a higher reward being paid back to our members; minus 2 basis points in 2010 and then minus 1 in each of Q1 and Q2 2011.

LIFO was a charge of minus 5 -- rather, not a charge, but a year-over-year comparison of minus 5 in fiscal 2010, zero in Q1 2011, and minus 3 basis points in Q2 2011.

For a total reported year-over-year change in margins of plus 2 basis points for all of fiscal 2010, plus 9 for Q1 2011, and plus 15 for Q2 2011.

As I mentioned, the consolidation of Mexico benefited both of these numbers in Q1 and Q2.

So in terms of Mexico impact, no number in the first column, Q1 plus 3 basis points, in Q2 plus 6.

So without Mexico it would be plus 6 for Q1 overall and plus 9 basis points in Q2.

So with that chart in front of you, as you can see, our overall reported gross margin was higher by 15% and that is what we reported.

Within this plus 15% our core merchandise contributed 24% and ancillary business gross margins, principally gas, hit or reduced our Q2 gross margin by 5%.

In fact, the gas gross margin component was minus 6% or more than all of that minus 5% with the other ancillary businesses and that -- and on a net basis contributing 1 basis point.

In Q2 the gas sales penetration was higher year over year by just under 1.5 percentage points.

As you know, it's a much lower gross margin business to start with and, in fact, within the gas business margin was reduced year over year with the rising gas prices.

That is what we see.

Our lower margin gas business represented 7.2% of last year's second-quarter sales compared to 8.5% of this year's second-quarter sales.

Again, it's a sales penetration of our core merchandise was lower year over year that tends to temper.

That 24% actually is tempered in the fact that on a like basis, if you look at the four core merchandising areas which are about 80% of our business, which is food and sundries, hardlines, softlines, and fresh foods, just those sales divided -- those gross margin dollars for those four main departments divided by the sales for those four main departments were higher year over year in Q2 by actually, by 36 basis points.

But with the lower sales penetration the net impact on the chart there is plus 24.

Basically, within those four categories food and sundries, hardlines, and softlines were all up nicely.

Fresh foods was down ever so slightly, less than 10 basis points down year over year.

Primarily down due to the commodities price inflation and the fact that we tend to hold pricing as long as we can, particularly on key small business items like 15-packs of muffins and some of the items at the food court as well, then the bakery and the deli.

Overall, Q2 margins were just fine.

The impact, as I mentioned, from Executive membership was 1 basis point, which on a back-of-the-envelope basis implies about a 2% increase in the sales penetration of those rewardable sales dollars.

And LIFO, as I mentioned, is back and we took a charge of $6 million or 3 basis points in Q2.

Again there is no way to predict what will happen other than my crystal ball tells me that certainly it will be a LIFO charge in Q3 and most likely Q4 at this point.

Mexico again has the positive impact that we just mentioned.

Moving to reported SG&A.

Our SG&A percentages Q2-over-Q2 were lower or better by 24 basis points coming in at 9.96% as a percent of sales this year compared to 10.20% last year.

And last year's Q2, as we mentioned in the press release, we had the $22 million charge related to the change in employee benefits.

That was a detriment last year in Q2 on a year-over-year basis by 12 basis points, so really when we report a 24 basis point increase it's really an improvement of 12 basis points net of that.

Again, like margin we will jot down a few numbers.

The same three columns -- all of fiscal 2010, Q1 2011, and Q2 2011.

The line items will be core operations, central, stock or equity, quarterly adjustment, total.

And then again two new line items -- Mexico impact and then the total without Mexico.

Going on across and plus numbers here means lower SG&A and plus is positive.

Operations in fiscal 2010 was plus 2 basis points year over year, in Q1 2011 plus 17 basis points, in Q2 2011 plus 13 basis points so better by 13.

Central plus 1, plus 1, and minus 2.

Equity zero, plus 1, and plus 1.

Quarterly adjustments plus 7, zero, and plus 12.

That plus 12, by the way, is that employee benefits comment, the $22 million amount.

Total would be plus 10, plus 19, and plus 24.

Now Mexico in Q1 2011 there is no numbers in the fiscal 2010 column.

In Q1 2011 it was plus 7 and then Q2 2011 plus 11, so excluding Mexico it would be plus 12 and plus 13.

In terms of a little editorial on SG&A, we did have the negative impact of the $4.9 million legal fee related to the derivative settlement.

That is a couple of basis points.

There is about a 5 basis point negative impact from benefits costs, including healthcare and workers' comp.

On a positive note, our payroll percentages year over year benefited SG&A by 14 basis points.

Total payroll dollars for the whole company increased 7.3% in Q2 compared to an 11.4% total sales increase.

Both of those numbers include higher increases because of FX, but again it's on -- both numbers do so, it's a like comparison.

Again, small changes in central and equity; nothing big to talk about there.

Overall, we feel pretty good performance in SG&A given the continued escalating costs in healthcare and additional small legal expense.

In terms of the preopening expense, a little over $3 million in Q2 and a little over $4 million in Q2 this year versus a little over $3 million last year.

Both numbers were calculated out to 2 basis points.

No big issue in both quarters and two openings.

In terms of provision for impaired assets and closing costs, last year we had a very minimal charge of just under $200,000 for the quarter.

This year just under $2 million.

So all told, operating income in Q2 was up 27% from $470 million last year to $597 million this year.

Again, if you exclude that $22 million charge that hurt last year's number the $127 million increase in this line item would be $105 million.

Below the operating income line reported interest expense was slightly higher year over year with Q2 coming in at $27 million versus $26 million a year earlier.

These amounts almost entirely reflect the interest expense on the $2 billion debt offering in February of 2007.

If you recall, in February 2007 that $900 million was five-year money which will become due and payable in March of 2012.

That will be a nice change given that we are earning a lot less on our excess cash right now and we will be paying that off by essentially writing a check; $900 million of that $2 billion in March of 2012.

In terms of interest income and other, which again, like Q1, was much lower year over year, it was lower by $26 million; just under $4 million versus a little under $30 million last year in the quarter.

The big change there, of course, is again Mexico.

Actual interest income was higher year over year by about $4 million.

That is a reduction of higher cash balances, certainly not because interest rates have risen a lot, but also the consolidation of Mexico's investment income into our financial statements.

However, the biggest component of this $26-plus million year-over-year change was the earnings from Mexico, which are now consolidated, and to a lesser extent profit on FX contracts used in our business.

Overall, pretax income was up 21% from $474 million last year to $573 million this year.

Again, excluding the $22 million charge, pretax earnings were up 16%.

Our company tax rate is pretty similar year over year in the second quarter.

It came in at 35.5% this year versus 35.6% last year in the quarter.

We generally have seen that trend down a little bit.

The effective rate in the US, which includes federal and state, is higher than that.

In some of the foreign currency countries, which have lower federal income tax rates, given our increasing profitability overseas, we have seen that number over the last few years trend down a little bit.

No big changes or issues on the tax rate.

A quick rundown of other things.

We will include in the -- you will have online what we call the Q&A, which talks about quarterly LIFO charges, summaries of openings, calculations of earnings per share, and also the full balance sheet so we won't go over the balance sheet here.

What is not on there is what some of you asked for is depreciation and amortization.

For Q2 depreciation and amortization was $195 million and year to date $386 million.

We have a strong balance sheet, as many of you know; lots of cash.

Net cash even net of the $2 billion of debt; strong debt-to-cap ratios.

Accounts payable, if you look at on a reported basis a year ago, accounts payable as a percent of inventories was 104% at the end of the second quarter.

At the end of this year's second quarter it was 97%.

If you take out all the non-merchandise payables, notably and most importantly, construction payables, it was flat year over year at 87%.

Inventory per warehouse, $10 million, right at $10 million last year at Q2 end and about $10.5 million at Q end this year so up about $500,000 or 5% per warehouse.

FX is about $170,000 of that $500,000 so it's really, on a flat currency basis, $330,000.

And of that $330,000 about a little over a third of it, about $130,000, is electronics.

No inventory concerns to speak of.

We feel we did a good job of taking markdowns through the holidays and our inventory is in good shape.

In fact, our physical inventory -- our physical inventories, which we take at midyear and year end, our midyear numbers continues the trend of improving ever so slightly the basis points of inventory shrink.

In terms of CapEx, I think Q2 we spent $234 million, so year to date $540 million.

As I mentioned earlier, we have got a lot of openings planned for the last four months of the fiscal year starting in May.

And for all of 2011 we would expect CapEx to still be in the $1.5 billion range.

In terms of Costco.com both here and in Canada, sales are up a little over 10%.

It continues to be a profitable business.

Our average ticket has come down a little, but the site traffic continues to grow and was up a little more than this total sales increase.

In terms of expansion, as you know in each of fiscal 2009 and 2010 we opened about 15 units; I think it was 13 in 2009 net and 16 in fiscal 2010.

This year, as I mentioned, we plan to do 24 which includes eight in Q1 and net of one in Q2.

It was two less the relo or the closing in San Marcos.

In Q3 one with no relos, Q4 14, so all told we would have 24 net new increases on a starting base of 572.

So about 4% unit growth which would translate to about 4.5% square footage growth, given some expansion of existing locations, adding some square feet here and there, as well as opening on average units that are on average a little higher than the existing company average.

As of Q2 end square footage stood at 84 million and 84,000 square feet.

In terms of stock repurchases, since the beginning of our program back in December of 2005 and through the end of fiscal 2010 back in August we have repurchased just under 100 million shares at an average price -- or about $5.37 billion, an average price of about $54.37 a share.

And in Q1 we purchased -- those 12 weeks we purchased $150 million worth at an average price of a little under $62.

And in Q2 $94 million worth of stock at $71.73 per share.

We are generally buyers every day, including each of the past 11 or so business trading days since Q2 end, and no big change in those expectations going forward in terms of being out there.

That is about it.

As I mentioned, supplemental information will be posted on the Investor Relations site later this morning.

Lastly, our Q3 scheduled earnings release date will be on Wednesday, May 25.

That is a little bit out there.

And with that I will turn it back over to Debbie for Q&A.

(Operator Instructions) Charles Grom, JPMorgan.

Thanks, good morning, Richard.

Can you just dig into a little bit the fresh food margins being down?

Is that because you guys haven't been willing to pass on the price increases?

And then I guess looking ahead, do you expect to see similar pressure over the next couple of quarters, because obviously those costs are going to continue to rise here?

Yes, I mean it is us more than anything.

When you look at -- I'm making these exact numbers up, but if you look at a 15-pack of muffins or something that we sell a heck of a lot of those to restaurants and businesses and convenience stores and then sell them in (inaudible).

And I don't know the price of the top of my head right now, but if it was at $5.49 or $4.99 or whatever the X was, you tend to hold off and realize a lower margin for several weeks or a few months and then finally bring it up to that next level of $0.30 or $0.50 extra, and you get back to your regular margin in that stuff.

That is not a competitive issue other than we want to protect the prices to the members that are buying these items.

We feel that overall our margins have been quite good and we continue to do that kind of stuff.

We really don't see any major competitive issues in our fresh foods.

Okay, fair enough.

And then you said gas pricing hurt by, I think you said, $0.02 in the second quarter.

Can you give us a little bit of sense, given how quickly gas prices have been moving up here in the past three weeks since your quarter end, how the profitability has looked for you guys?

Well, it impacts it.

It's not as extreme as it used to be.

Years ago you lost a bunch in those weeks and you made some amount in most of the other weeks.

You tend to make a little more in those other weeks and you lose less or make a little in those weeks.

It's tempered relative to where it used to be.

The big issue here was the comparison year over year.

We had huge profit gains, profits in Qs 1 and 2 last year and I think the -- like this $0.02 delta we talked about here in Q2, I think it was a little over $0.03 in Q1 on a year-over-year basis.

So again it's going to move around.

Gas is still a profitable business, a very low margin business, a business that, as I have mentioned before, requires some stomach lining occasionally.

But nonetheless, we are getting good frequency; I think that is part of the frequency issue as well.

But certainly when prices spike for a week or two here you see some relatively flat numbers.

Whether it's plus a little bit of profit or minus a little bit of loss, it's not a real big issue.

Looking last year, Q3 was not as impactful, was not as profitable as Qs 1 and 2 in gas.

Okay.

And you called out for February California continuing to be strong.

Is it at the Company average in the US or is it ahead now?

I think it's about the same.

It's in line, yes.

It's in line?

Okay.

And then last, it looks like you bought back about $100 million worth of stock here in the quarter.

What do you -- is there any change in the Company's cash priorities?

You are really starting to build a pretty big balance, I think close to $12 per share.

Just wondering at some point do you accelerate that or do you step up the dividend or what?

Well, every spring historically over the last six years we have.

I can't tell you what we will do this time, but we generally haven't done anything giant special.

We just increase it methodically historically.

And, again, we will look at what we do come this spring.

CapEx certainly has been ramped up to you, although so has cash flow.

So it's a high-quality problem.

One of the issues -- I think in a roundabout way what you are asking is you bought less in Q2 than you bought in Q1 while your cash is going further going north.

Part of that has to do that we tend to historically have bought through blackout periods with 10b51s.

You have to put those in place before you know anything material about what you are going to report, whether it's monthly sales, which is a week and a half before, let's say a week and a half or so before, or in the case of a quarterly earnings number, four or five weeks before.

Again, I think the high-quality problem has been we put a matrix in place, if you will, with how much we are going to buy at different stock prices out there and put some reasonable numbers above what the existing stock price is.

During those four weeks the stock price then climbs quite a bit and so part of it is simply a fact that when you lock in a matrix four or five weeks ago based on where the stock price was then.

Again, I think it will ebb and flow.

I think the message here and the message that I have gotten talking with the Board and Jim and Jeff, of course, is that we are certainly continuing to be comfortable buying stock back.

You are not going to find us wanting to make some big announcement that because it went down $3 we bought a lot extra today.

We are going to buy more each day when it goes down a little and still buy when it goes up a little.

But then we get caught in these four- or five-week 10b51s when the stock jumps a lot so that mitigates the amount that we bought as well.

But overall we are still a buyer out there and we will see where it goes.

Okay, great.

Thanks.

Mark Wiltamuth, Morgan Stanley.

I just want to follow up a little bit on that California question.

If California is kind of in line with the Company average how much more room of recovery does it have?

Or another way to ask that is how much stronger was California versus the average back before the downturn?

Well, California was always a little weaker and I'm pulling these numbers from the air here.

But if you looked at what was -- if the total US comp in good times a few years ago was, I am making it up, but a 6, California was a 4.

Now part of that was we had more cannibalization in California relative to the rest of the US at that time as well.

That was a little bit of it.

Then when the economy got hammered California went down further.

So again using my nomenclature here, if the spread of California comp versus the rest of the US comp a few years ago was at 200 basis points delta, there were times at the trough of the economy a couple of years ago where that gap was 4, 4.5 percentage points.

So California got hurt harder.

It's now back in terms of actual comp dollars, so part of it you might say the gap is closer to zero now than even 2.

Part of that is because it was weaker a year and two years ago.

Again, trend-wise it's encouraging.

We hope it has got some more room; we will see.

How about sales per warehouse, is that metric back to normal?

I don't have that in front of me.

My guess if you take out gas it's probably still a little lower.

Gas is an unfair benefit here.

But keep in mind, you had a couple of -- I would bet it's close or on its way there given where we have seen comps in the last few months.

Okay.

And then on inflation for food, have you seen manufacturers providing some promotional support as the increases have been rolling in?

Yes, but the biggest promotional support that you see is typically they announce an increase and then they allow you to buy in at the old price two weeks, four weeks, six weeks at the old price.

Of course, we take advantage of every one of those.

I would assume many retailers do.

We probably then hold the price longer than anybody else, as well, because of that.

So that is the kind of thing you are seeing.

I think there has been some pushback by the retailers, not just us, as I would imagine, but at the same token some of it's coming through.

You can't -- when you see underlying commodity costs go up, you see the improved penetration, a little bit extra penetration in private label.

It's funny, when you look at the -- when our merchants show us in the budget meetings that this commodity went up 28% and this one went up 42%, but then the average price point went up 2% to 6% on an item.

Partly it's the raw materials, partly it's pressure we can put and come to bear on manufacturers.

Part of it's the pressure and competitiveness of private label, but ultimately some of it has to come through.

Again, I would expect to see more, not less, in the last -- in the next couple of quarters, at least based on what the buyers tell us.

Okay.

Lastly, could you tell us what your gallonage of exposure is on diesel with that price spiking?

I don't think we have diesel, do we?

Well, or I guess gas on your transportation?

I am sorry.

In terms of transportation, I am speaking from a couple of years ago so add 15% in terms of how we are bigger; 15% or so in total.

What I will call the freight surcharge that runs through our depot operations -- and we have estimated back a couple of years ago that every percentage point of that was about $18 million of freight costs in the system, both inbound freight to us from vendors as well as outbound freight from depots to warehouses.

My guess, just rounding to $20 million, most of that is passed on.

It's passed on when the buyers are buying it increases their costs on which they marked up.

I would think that the freight is less of a lagging issue than when a manufacturer raises the price of the item we try to hold it a little longer.

So it's an impact but it's a modest trend impact.

I don't think that is a big issue here.

If anything, we have shown our -- those numbers, by the way, are in our margin numbers as part of the cost of goods and we have shown that our margins have been pretty good this last year -- this last quarter year over year when I can guarantee you the freight costs within those merchandise sales have gone up in the last 12 weeks year over year.

Okay, thank you very much.

Mark Miller, William Blair.

Good morning, Richard.

I have got a couple of questions on the average ticket.

Can you, first of all, give us the comp sales leverage point for expenses we might see in the back half of the year?

And then how much might that leverage point come down if we see further strengthening in the average ticket as a proportion of the total comp increase, so that versus the first quarter improved for you?

We didn't see that much of an improvement in the G&A trend, though.

I guess there was some noise there and outside of that payroll did improve a little bit.

It's hard to guesstimate what the actual point of leverage is.

I can tell you that we -- the operators feel confident that in the last couple of years we, like everybody out there, got a little better.

So whatever that threshold was it's a lower number and I think that is why we have seen things like the payroll percentage improve like they have.

With healthcare it's always something.

Some of these increases don't even relate to some of the new changes are coming over the next couple of years and so that is a challenge.

Now the fact -- to the extent that a sales increase includes inflation on like items, clearly that is the good stuff in terms of leveraging SG&A.

Again, it will help -- I am sorry I can't quantify it anymore but I think that it's going at least in the right direction.

Okay.

My other question on the average ticket, while it's going up in the stores you said down a little bit in e-commerce.

Why do you think that might be different?

And is that a function of members not buying as many of the higher price point items on the website or is it due to changes your merchants are making?

The biggest -- the single biggest reason is the average price point of an item going through the front-end check out is, what, $10 or $12.

The average item online is just under, somewhere in the $375 to $400 range I am guessing.

So part of it, I think, is as the economy got worse we know it -- I remember it falling in 2009 versus 2008 from like $425 down to $390 or $380.

Couple that with deflation in big-ticket electronics items; I think that is more than anything the economy and deflationary type items that permeate that site.

Okay, thanks.

Adrianne Shapira, Goldman Sachs.

Thank you.

Richard, just to follow up, keep on the inflation topic, as you are holding prices flat on food in the face of rising commodity costs any sense of what competitors are doing?

Again, this is from what I hear at the budget meetings from Tim Rose and others.

We tend to be the strictest, not to imply that everybody else is not.

Our sense is that some retailers try to get margin when they can.

We try to hold it a little bit when we can.

And given that we have had some relatively strong margin improvements in other areas, which includes different components.

As we changed our electronics returns policy two years ago, we are still seeing some modest increases in improvement in what we call D&D, damaged and destroyed, which is a cost of sales to total gross margin.

Our shrink numbers got a little better, just under a basis point better.

Well, a basis point is $8 million so $5 million or $6 million this year implied by that.

So all those little things help too.

It has more to do and it has less to do with this traditional supermarket items like tinfoil and paper goods and cereals.

Those things we tend to move along.

I am talking more about items within the bakery where you don't want to change prices every week.

And so historically what we have always done is if you pick an item that forever it seemed it was at $5.99.

Ultimately, you are going to take it to $6.49.

Well, you are not going to take it from $5.99 to $6.09 to $6.19 sequentially, but once you get there you are fine.

If it takes five weeks or 12 weeks or whatever that is fine.

Same thing in the food court, which is not part of fresh foods, but with rising prices in cheese and things like that that is impacting the profitability of pizza.

Not a big deal to the Company overall but all those things impact margins a little bit.

We certainly have had strength in our overall margin and feel very comfortable doing that, and feel very comfortable that all the metrics are going in the right direction in terms of frequency and a little improvement in G&A and the like.

Yes, understood.

In these budget meetings when you are hearing from the buyers, any sense of how they see the direction of inflationary pressures?

And following on that given that you have had success on controlling what you can on shrink and payroll, is there a tipping point, is there a point at which in the face of these inflationary pressures it is hard to hold prices?

At what point does it get a little bit tougher to kind of hold off the pricing?

Mind you, we are not holding prices on every item in a location.

That is -- it's kind of like in a budget meeting when a buyer gets up and talks about sales of this small subcategory or this item was up 30%.

Well, your department was up 4% so what was down?

And so we hear about that cotton has doubled in price and tin has gone up so tinfoil is up.

There are items, like tinfoil I believe, and I don't know if it has happened yet, but there are price increases coming from all the manufacturers in the high single digits.

Well, we are not going to sustain that.

I mean you have got to pass a good chunk of that on.

But when I highlight something like bakery and front-end, we are not going to change the cost of a slice of pizza until we really have to.

We can well afford in that small sub-department to do so.

So it's kind of like when you hear that the average price increase out there in the Consumer Price Index was 1.5% or 2%.

You are thinking, wait a minute, gas went up 28% and my healthcare costs have gone up, whatever, high teens and all these other things.

So overall, ultimately, you have got to pass on cost increases but we want to hold them longer, and particularly on those business items like the 15-packs of muffins.

Great.

I will ask the membership fee hike increase.

We understand you are doing well with controlling what you can and maybe you don't need the fee hike, but perhaps give us and update in light of the fact that frequency is strong and ticket is improving and all the metrics are heading in the right direction.

That would seem to suggest that perhaps the backdrop is ripe for a fee hike.

All the reasons that you would list on a page of why we should or shouldn't do it, you get comfort by the fact that you said the renewal rates and frequency and all that stuff, the customer loyalty, all that stuff is fine.

We haven't made any decision yet.

We will at some point discuss it and you all will be the next to know.

The last time we did it was I think May or June of 2006 so five years hence would be May or June of this year.

I think I shared with someone -- you guys on the last call or maybe the previous call that back in the middle of 2009 at the height of the terrible economy, the trough of the economy when everybody was still feeling very poor from their 401(k) plans and their house values and their job layoffs, all things being equal, we had very good frequency and loyalty then.

That was a time that we would think about doing it, wouldn't we and the view was generally no.

There is no rush to do it; we will do it when we want to do it.

And I think I added to that that if you are looking at the next three- or four-year model is it likely at some point, yes, but I can't tell you when.

So we really don't have any indication of that at this time.

Thanks, best of luck.

Bob Drbul, Barclays Capital.

Hi, Richard.

The question that I have, just a couple things.

Could you just give us a feel for where you think your consumer is and your ability to pass through some of the inflation?

And I guess more on any general economic thoughts in terms of where we are right now?

Well, we have been asked about the 2% payroll tax benefit that everybody gets.

It's kind of like when there was the $300 tax gift from a few years, several years ago to the $600 one.

Generally upscale retailers and Costco tended not to feel the benefit of that as much as the lower, medium-end discounters, and the dollar type stores.

The same thing here.

We really don't see that as a big impetus for us.

Again, as it relates to our abilities, I think we have the -- the good news is we are our most competitive -- we are own toughest competitor.

We recognize you have got to pass on increases, but we are in a pretty good position to be able to delay that for short periods in some instances.

This is by no means the example of late 2008 when we took an extra $30 million or so of markdowns on half a dozen or a dozen key items to try to drive business a little.

Business is a fine.

Some of these increases are being passed through and ultimately you have got to pass them through.

Great.

Can you maybe --?

In terms of the economy, again, I guess I will say the same thing that -- again none of us here are economists and we read and listen to the same news that you guys listen to.

It doesn't seem like anything is causing it to get better fast.

It doesn't feel like there is another big shoe that is going to drop other than the current thorn is oil prices and what does that do and how does that impact it.

But again, we are adding jobs as we open units.

I think I read recently that Target was adding a bunch of jobs, and so there is some jobs coming but nothing huge.

And this housing concern is still an issue.

We feel confident in our numbers, in our frequency, and in our comps, unit comps and everything else in the face of not terribly exciting expectations about the economy.

And speaking of Target entering Canada, can you maybe just talk about the environment in Canada and how your clubs are doing up there with the 80 that you have?

Well, it has been great.

In local currency for a couple years now we have been running comps in the mid to high single digits compounded for the two years.

Their economy is strong.

It's a -- a big chunk of their economy, I believe, is natural resources which have gone up.

They did not have any or very nearly any fallout from what happened in the finance and banking in the subprime issue.

Funny thing, they didn't allow that kind of stuff and so it's a pretty good economy up there.

It's -- so our numbers up there have been quite good.

It's very competitive up there.

Wal-Mart is huge up there over the last seven or eight years.

There is some strong retail competitors like Loblaws and others up there.

And so Target, I would think, will do well up there.

We would like them all to close and just be us, but that is not going to happen.

But we are doing fine up there.

Great.

And then my last question, Richard, are there any new items that you are really excited about as you look to this calendar year?

Gosh, you caught me off guard on that one.

I am just trying to think off the top of my head.

No, it's more of the same.

If I think in a category specific, apparel has been pretty exciting in terms of vendors that are -- not necessarily new people selling to us, but really major increases and some nice increases in everything from outerwear to shorts and pants to shirts to bathing suits as we start entering that category, so -- to kids clothes and baby clothes.

I am trying to think what else.

There is the -- there is a lot of electronic stuff coming out to compete with some of the products that are already out there, like the iPad.

And there is -- 3D is not the most exciting thing but I am not telling you anything that you don't know.

But TVs are -- again, unit sales on TVs overall are pretty good.

PCs, there has been a little hiccup I think in the last several weeks with this new chip coming out that delayed some of the new laptops and PCs that people were waiting for.

It's not big to our company but a little thing there.

I can't think of anything specific other than more of the same.

Fresh foods, it never ceases to amaze me when the buyers get up in the budget meetings, whether it's new bakery items to drive what was a sluggish sale and then it's a good sale.

We are very strong in the meat and protein department, so overall I think we are doing well in that stuff.

I can't tell you this one late, great item.

Great.

Thanks Richard, very much.

Deborah Weinswig, Citigroup.

To continue on with the international comments, can you provide additional color on your performance outside the US, especially as it's representing a greater percentage of your square footage growth going forward?

And also, in light of that, how should we think about the margin contribution of those clubs?

First of all, every quarter you get to see in the Q the segment reporting analysis.

We have kind of implied that we probably -- outside of -- we show US as a separate column and Canada as a separate column and then other international.

Within other international Mexico has actually done quite well despite the economy down there.

UK has been the toughest one in terms of their economy and our comp sales over there.

Asia, the three countries in which we are in in Asia continue to do quite well.

Australia is great but it's all at one unit.

We will have two more in this calendar year, this summer hopefully and maybe one will fall into early fall.

But I think this summer.

So overall, I would say margins reflect the strength or the weakness.

So we are going to drive sales in the UK, we will work on -- we are a little tougher margins.

In Asia they are a little stronger, but there is other metrics that impact the profitability in these countries.

On average benefits expense as a percent of sales is lower everywhere other than the US.

Labor costs, while relative to local labor costs in those countries, we still pay the best wages for hourly out there.

It's a much lower percentage of certain of those countries and a somewhat lower percentage in other countries than the US.

In some cases there is a little more occupancy, like in Asia, but we are driving big sales dollars in Asia too so that helps.

There is lots of little things overall.

I think the margins outside of the US and the pretax return on sales you will see in those columns is higher than the US.

Great.

Then it has really been now two really impressive quarters in the core merchandise margins.

Should we think of this as an inflection point of impressive performance against tough comparisons and can you provide some additional details?

I hope it's not an inflection point.

We will see.

I mean an inflection point on the positive.

We feel very confident that we are still the most competitive pricing out there and we have still been able to show some margin improvement.

But it's a tough business and as we get a little too strong we are reminded by the powers that be here that we have got to make sure that we are fiercely competitive.

But we have done that over time.

I have seen that in departments, I have seen that in countries where things were really strong.

We bring it back a little bit and continue to drive sales and ultimately long-term profitability.

So I think we are -- I think Jim summed it up recently at a budget meeting.

He says we don't have a lot of issues with margin right now and we don't see that being an issue in the future, the near future.

Beyond that we will see.

Okay.

And then one last question.

Can you just comment on what you are seeing out of your small business customer?

Actually, it's -- I don't have the exact data in front of me.

When we look at the small business sales penetration, and you got to take gasoline out of there because gasoline is generally a consumer item even if it's for the small business, it got hit a little bit in 2009.

It came back not all the way in 2010 and my guess is it's continuing to come back a little bit.

Maybe not being where it was before late 2008.

But when you look at things like restaurant business, the restaurants that got hit the hardest were the business restaurants, the high-end steakhouses, not the neighborhood -- not as much the neighborhood restaurant or the diner.

Those that did get hit a little bit can come back a little.

So that is a very vague answer because I don't have the exact statistics at the tip of my tongue here.

But, generally speaking, that is the trend we have seen I know over the last couple of years.

Great, thanks so much.

Appreciate all the insights.

Chuck Cerankosky, North Coast Research.

Good morning, Richard.

I was wondering if we could go back to the promotions question again from the packaged goods companies.

How are they looking at contributing to your coupon mailers as prices begin to go up faster?

I think it's really a separate issue.

I can tell you that we have got more demand to be in those than we have spaces.

It works well; they like it and we like it.

So, again, that is another way for them to give us some competitive monies.

It's a vehicle for them to provide some discounts, but again we are pretty full in that stuff already in terms of the vendors liking it.

Would it be -- you talk about space.

Is it something you could expand as part of the marketing approach to the members as inflation picks up?

I assume so, but again I am shooting from the hip here.

As you know, we have expanded it in terms of numbers of days or weeks there are various coupons out there.

We have expanded the offerings a little bit over time as well.

Clearly, as prices go up there is an opportunity to drive more business of a given item.

So again conceptually, yes, I am just am not -- I guess I am not -- I don't have the numbers specific to that to tell you what different suppliers are doing.

All right, thank you.

Neil Currie, UBS.

Good morning to you.

I just wanted to go through the gross margin table again that you gave us, because just allied to what Deb was asking, it looks to me that if you take out Mexico that in the first quarter there was still quite a nice increase in core operating gross margin.

Then the second quarter once you take out quarterly adjustment in Mexico the core merchandise margin was pretty flat.

Is that the right way to look at it?

I am sorry, say that again.

I was just turning to that page.

So if you look at the Q1, total gross margin was up 19 bps and if you exclude Mexico it was up 12 bps.

Right.

And so the core margins still have nice, useful at least 10 bps growth there.

If you look at Q2, if you exclude Mexico it was up 13 but the quarterly adjustment was 12 of that, so it would indicate that the core merchandise margin was pretty flat.

The quarterly adjustment is an SG&A item, not a margin item.

Sorry, I am looking at the wrong page.

Okay, so if I was to look at the first and second quarter then and look at the strength in the core merchandise margin, what is going on there?

Because obviously it seemed a difficult environment in which to raise margins given the fact that costs are going up?

Is there a mix shift going on?

There may be a little bit of that.

Frankly, I stand by my comment earlier that we are our own toughest competitor historically.

Part of it is the comments, which I actually didn't talk about today, is the whole area of sustainability.

As we take packaging and freight costs out of items sometimes they are a small enough amount that you are not lowering a price point on something, but you are -- the example I gave a couple of years ago I remember was just on the plastic container that grapes -- that we sell the four pounds of grapes in.

We reduced the height of that container by 3 or 4 cm and allowed you to get an entire additional line, if you will, slip sheet, layer of those cell units on a pallet.

Just the actual cost of the like number of plastic containers was like $300,000 of savings.

Every budget meeting the buyers, whether it's going from a round to a square container for peanuts -- just on our cashews, there is another example I remember from last year I shared.

Just on the one item of cashews, that three or four pound container of (inaudible) cashews, by going from a round to a square container we reduced the -- on like-unit volume the throughput of pallets in our US system by 32,000 pallets and however many couple of thousand truckloads.

A lot of those freight costs don't necessarily lower the price by $0.08 a unit or something.

We don't lower the price on something like that necessarily.

So I think the fact that we improved each year, even in the last five years probably on average a half to a basis point of shrink.

The fact that we have had a little bit as a percentage of sales slightly lower returns in part because of the change in the electronics policy a few years ago.

All those things help as well, not just pricing.

Okay.

So it's basically -- it's not that you are raising prices and that is what is improving your margins.

It's more that your cost of goods sold is seeing benefits here, there, and everywhere, and that is a reflecting in your -- in a slightly improved cost of goods sold?

Sales penetration of private label.

I am not going to sit here and say that it hasn't happened, but I got to tell you that is the last thing that a buyer looks at because they know they are going to be looked at.

So in the past, though, you have generally tended to pass through a lot of the savings through to shoppers and it seems that you are getting some savings building up and building up here.

Could we expect you to maybe perhaps reinvest in the future?

As Jim is saying, margins are looking good here.

You are happy just to take the margin as we see it now?

Well, I can't tell you what is going to happen next week much less next quarter other than we feel pretty comfortable about how we are doing right now.

We certainly have a confidence level in our renewal rates in our frequency that until it changes we will feel comfortable about it.

We feel very comfortable that competitively there is some tough competitors out there, but we are the toughest.

I say that feeling very honest about that from what I hear.

The buyers know that they can't get too aggressive on things.

Again, we still take key items down.

We used to talk about the hotdog and soda for $1.50.

Then we added the rotisserie chicken to that cadre of items and then we added the 35 count, I think, of the half liter of water that the (inaudible) has gone from $4.39 to $3.55 now.

Maybe it's a little higher now with freight, but that was a couple of months ago.

So we are -- I kind of look at us as having our cake and eating it too.

We are able to have some decent margins and still feel very comfortable; the priority is still going to be to be the toughest competitor.

Keep in mind, again, when you look at the fall of 2008 when everything hit we had and we specifically talked -- I specifically talked about the $30-or-so million of extra markdowns.

That is because comps for the first time in close to ever were approaching zero and we wanted to reverse that trend.

That is not the case right now.

Again, overall, we feel that things are going in the right direction.

Again, I can't sit here and tell you it will continue how it has been, but I can tell you that we currently feel pretty good about how things are going.

If I may ask a second question, clearly you have been very successful for a number of decades, particularly with the shopper that started off with you as family shoppers and they have grown with you.

You still have a lot of appeal among the boomer generation.

How do you feel that your appeal is going with some of the younger shoppers now who are starting to form families who are perhaps thinking about where they should buy some of their consumables in bulk?

And with more options like the Internet, how do you think your appeal is to these younger shoppers, the Generation Y shoppers?

(multiple speakers)

Well, we want each of them to have three children.

No, look, at the end of the day we ask ourselves this question too.

We are not going to be everything to everybody.

To the extent that trend has occurred in the last three or four years, it has occurred in spite of -- in spite of that our frequency is up and our comps are a little better than others in general for such a big retailer as ourselves.

We are cognizant of that, but we keep coming and trying to come out with the right merchandise at the right price, and we change it.

There is no item that has a lock on its space and we are constantly bringing things in an out.

Organic would be an example of areas which are growing nicely.

Some things work, by the way, in that area and some things don't.

And some things we are just waiting for more supply because we could exceed the entire US production of certain given organic items.

Now as it relates to Internet, are we always a little behind everybody else?

Yes.

I think we have saved ourselves from stubbing our toes occasionally and some would argue that the opposite that we are not looking as hard and fast.

I can assure you we are looking, but we want to stay true to the things that we do.

We think that, frankly, there is abilities to drive more we traffic into the warehouse by using some of those same tools.

We recognize we have got one of the largest manual social networks.

You say the word Costco and people around you start talking about it.

So we are looking at some things but I don't want to suggest that there is a lot of things coming tomorrow afternoon.

I guess this is a question that will be better addressed if and when we see some reduction in some of the things I just mentioned.

But we have some people looking at that all the time, but we also don't want to veer from what we have seen be successful.

Okay, thanks very much.

Why don't we take two more questions?

Greg Melich, ISI Group.

Thanks, Richard.

I have two questions; one hopefully a bigger picture on inflation and then on inventory.

On the inflation side I think you mentioned that food was up mid-single digits and sundries up low single digits.

If you just think about the mix of your sales would you say that probably impacted comps for the Company about 150 bps in the quarter if you were to compare it to the US comp of 3%?

No.

First of all, I think the food number was the fresh foods number, not the food and sundries.

Got it.

So if we were to think about general food, fresh food coming together compared to that 3% US comp number, ex gas?

I can't exactly calculate it.

I can think of some of the offsets to what your premise is and that would be things like the average price point on televisions down close to 10% on a much bigger ticket item.

If you look at it that way, was their inflation in that 3% number overall, at least a little bit?

Or do you think that some of the pressure --?

Absolutely.

My guess is there is some inflation.

Now the other thing that -- again I am just shooting from the hip here any increase -- we might have inflation on a KS item but we also have increased unit sales penetration of KS items which are typically are 20%-plus lower price points.

So if I just took every physical item that went through the front-end my guess is it has a plus sign in front of it but it's closer to zero than one.

And that is a guess.

Okay, fair enough.

Then on the inventory side you mention that it was $330,000 on a true like-for-like basis up per club and most of it was electronics.

Is that -- can you just fill us in on what actual products that was, which parts of electronics?

And did that sell-through in February, is that sort of a historic number?

A little bit has to do with a year ago there were some shortages in some of the flat panels.

We have more SKU selection in TVs than we had a year ago.

It probably helped the unit sales of TVs, by the way.

A little of it is if you talk about the pendulum swinging in terms of goal of SKU selection, I remember three or four years ago and the US is an example in the SKU selection, the SKU goals on average warehouse was probably somewhere around 4,000, 4,050.

You turn around and it got up to about 4,200 and then we brought it down to about 4,000 again.

Actually, before the economy got hammered a couple years ago, on a conscious way we said let's bring it down to 3,850, 3,900.

There has got to be -- if the top 200 items or top roughly 5% of the items are in the mid to high 30% of sales that tells you what the bottom 200 items are.

And so it's a little bit of an art form but I think that we probably have moved it -- as it got a little too high towards 4,200 it probably got a little too low towards 3,800, 3,850.

It has come back a little.

And if I look at it -- again I think I mentioned about $130,000 of that $330,000 was electronics.

The rest of it if you look down about seven or eight sub-departments it was $20,000 to $40,000 each.

Got it.

And that would be indicative of the SKUs, maybe adding back 50 or 100 of those SKUs?

Yes, again there has been no indication, even on seasonal stuff, that we have got any big problems out there.

In fact, there has been confidence in the last couple budget meetings about it, whether it was patio furniture or getting through outerwear last fall or getting into some of the spring and summer apparel items now.

And then could you just maybe just touch on the decision to take the Apple products out of the store?

No, there is really not a whole lot to say.

Basically the two of us couldn't figure out how to make both of us happy and we are both out there still selling merchandise but just different merchandise.

Okay, great.

Thanks a lot.

Okay, one last question.

Robbie Ohmes, Bank of America.

Richard, a quick one.

Just can you just remind us on the international outlook and sort of thinking the next three years plus where are you most excited and where are your people most aggressively trying to get real estate sites?

And weave into that I think you have added one more store in Australia than we were expecting today, just an update would be terrific on that outlook.

Thanks.

Well, as I have said in the last couple of quarters, the three existing countries in Asia where we are -- Japan, Korea, and Taiwan -- between those three probably over a five-year period we are adding on average of one or two to the total of three countries a year.

We are going to open five in the fourth quarter, which is also I think six for the year in total.

So we have stepped it up there.

Australia, again, so far so good but it's one unit.

I am pretty confident that a year from now we will say so far so good, but it's only three units.

But we will continue to look there.

The only other areas -- the fact that I think we are opening three units in Canada this year implies that we still think that we are not saturated in a country that has 80-plus units.

It wasn't that long ago that we felt that as we had 50 going to 60 we said at some point here we are going to fill the country, and we are happily finding that is not the case.

Mike Sinegal, who -- don't hold it against him that his dad is Jim -- but Mike has been here for 24, 25 years -- 25 years since college.

He opened and ran Japan for us.

He did spend a couple of early years with Carrefour when Carrefour owned 10% or 20% of Costco years earlier.

He speaks -- in addition to English and fluent Japanese, he speaks fluent Spanish and French.

And so he is over there in Europe.

There is no promises, but my guess is in the next two or three years you will see us announce, if not open, a unit or two in a couple of countries over there.

But our MO I think will continue there as well.

It takes us a while to open a few units and make sure we like what we see and we understand all the issues with distribution and labor hiring and everything else.

And so, again, it will be additive and increasing penetration, if you will.

But even in this year with, what, 24 net new units I think I mentioned 17 of them -- 14 in the US and three in Canada -- are in very predictable, very comparable countries.

Got it.

Seven out of 24 was more than we did the year before and more than we did the year before that.

Great.

Thanks a lot, Richard.

Thank you, everyone.

Bob and Jeff are here as well and appreciate your time.

This concludes today's conference call.

You may now disconnect.