好市多 (COST) 2012 Q1 法說會逐字稿

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

At this time I would like to welcome everyone to the first-quarter fiscal year 2012 operating results conference call.

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

After the speaker's remarks there will be a question-and-answer session.

(Operator Instructions).

Thank you.

Mr.

Richard Galanti, Chief Financial Officer, you may begin your conference, sir.

Thank you, Dawn, good morning to everyone.

This morning's press release reviews our first-quarter fiscal 2012 operating results for the 12 weeks ended on November 20.

Let me start by stating that the discussions we're 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 first-quarter operating results, for the quarter, as you saw, our reported EPS came in at $0.73 compared to last year's EPS reported at $0.71.

As was noted in this morning's release, there were two large one-time items totaling $0.07 a share that hit this year's Q1 results.

The first of these items was a settlement of an income tax audit ay Costco Mexico.

During the first quarter Costco Mexico recorded an after-tax charge to their income tax line which when expressed in US dollars was $24 million.

Since we consolidate Costco Mexico's operating results the full Costco Mexico P&L is included in our income statement, including the $24 million hit to our income taxes line.

The offset to this $24 million was a $12 million benefit to our income statement on the non-controlling interest line item near the bottom of the income statement.

This represents of course our joint venture partner's 50% share of this hit.

So in total the impact of Costco's net income as a 50% owner in Costco Mexico was $12 million or $0.03 per share after tax.

The $12 million number is a tax number, so it's after-tax, of course.

The second of the two one-time items was a $17 million or $0.04 per share charge to the SG&A line for our contributions to the Washington State I-1183 liquor initiative.

Washington state voters approved the initiative by a 59% to 41% vote.

The $17 million expense is not tax-deductible under US tax law so, again, it's a $0.04 a share hit to our EPS.

In terms of sales for the first quarter, as was reported in the press release, our 12-week reported comp sales figures for Q1 showed a 10% increase, 10% in the US and 11% internationally.

Excluding gas price inflation and the impact of FX the 10% reported US comp would be 6% and the 11% reported international comp in local currency would be at 10%.

And for the Company overall, excluding both of those, the 10% reported number would be a plus 7%.

Other topics of interest or review, our opening activities and plans, we opened four new locations during the first fiscal quarter of 2012 which ended November 20, one each in Pennsylvania, Texas, Wisconsin and Georgia.

For all of fiscal 2012 a current plan of 20 net new locations, 11 of which will be in the US, one each in Canada and the UK and seven in Asia, three in Korea and four in Japan.

This week we -- in fact of the four in Japan, this week we will open two of these new Japan units.

And with these openings we'll end the calendar year and this week with 598 locations around the world.

I'll also briefly talk about Costco.com, our membership trends and of course the recent increase we took in our US and Canada annual membership fees.

A little discussion further on, of course, gross margins and SG&A in the quarter and our stock repurchase activities during the quarter.

Very briefly again, sales for the 12 weeks were up 12.5%, $21.2 billion this year in the first quarter versus $18.8 billion a year earlier.

On a comp basis again, the 10% for the quarter excluding gas and FX was up 7%, comprising of a 6% U.S.

without gas and a 10% international expressed in local currencies.

The 10% reported comp was a combination of the average transaction increase of 6% for the quarter and an average frequency of increase of 4%.

Of course, the 6% includes FX and gas as well.

In terms of sales by geographic region, geographically Northwest has been pretty consistent for the past few fiscal quarters in the high single digit positive range.

California has been in the 9% to 11% positive range, in fact a shade higher towards the high end of that range in the most recent quarter.

Rest of the US, Northeast in the mid-single-digits, southeast around 10, and Midwest in the low double-digit comp increase.

Internationally in local currencies, again we were also doing fairly well, averaging in local currencies 12% in the fourth quarter, 11% -- I'm sorry, 12% in the fourth quarter of '11 this past summer, 10% in the first quarter we're reporting today, of course, and 11% in the recent November -- four-week November reporting month.

We are seeing the positive tailwinds of gas and FX subsiding a little during the quarter.

For example, during the quarter FX was a slight benefit to the comp.

In November it was a slight detriment implying that we've seen that cross over to where the dollar weakness relative to all the other foreign countries shows a slight strength.

And gas has come down a little bit from its higher level of inflation the first quarter as compared to just November.

In terms of merchandise categories, in the first quarter, which is essentially September, October and most of November, within food and sundries comps were in the high-single-digit positive with foods, candies, deli and refrigerated being relative standouts.

We continue to see year-over-year inflation in many of the food-related areas, while again not increasing inflation over the last few months but as compared to a year ago.

Our hard-line sales show slightly positive comps overall with slightly negative comps in electronics offset by sales growth in tires, automotive and hardware -- sales strength, rather, in tires, automotive and hardware.

Within the mid- to high-single-digit soft line comps small electrics, jewelry and domestics were the positive standouts and media, of course, books, CDs and videos, continues to be one of the weaker departments.

And within fresh foods, it was up 11%.

All subcategories were pretty close to that number and showed strong results, again partly from inflation year over year.

Moving on to the other line items in the income statement, membership $416 million a year ago or 2.21% of sales, $447 million or 2.11% of sales this quarter, so up about -- a little under 8% in dollars or $31 million and down 10 basis points -- again reflecting the things I just mentioned earlier in terms of comps -- impacts of comps.

A continued good showing in terms of dollar of increase we think.

Strong renewal rates continue -- are 89% in the US and Canada and 85% worldwide.

And this continues to see an increase in the penetration of the executive membership program.

Our new member sign-ups in Q1 companywide were up 15% year over year.

This is largely due to the strong international openings this past year in Asia and Australia.

But even in the US there was a small increase in year-over-year membership sign-ups.

In terms of numbers of members at Q1 end, at fiscal year-end we had 25 million Gold Star members, that's 25.5 million 12 weeks later at the end of Q1.

Primary business [6.4 million] and [6.4 million], business add-ons [3.8 million] and [3.8 million].

All told 35.2 million households at year end, 35.7 million households at first-quarter end.

And including add-on cards -- spouse cards, 64.0 million, now up to 64.9 million.

At first-quarter end paid executive memberships totaled 12 million and were up about 270,000 from 12 weeks earlier.

So still getting about 23,000 a week increase during the past quarter.

Again, our executive member base is about a third of our member base and a little over two-thirds of our sales.

In terms of the number renewal rates, as I mentioned, they actually have strengthened slightly.

In the US and Canada we ended up at an 89.2% for the first quarter, up from an 89.1% at the end of the fiscal year.

So just tweaking up a little bit.

Total worldwide has tweaked down a little bit from an 85.7% down to an 85.4%, that's due in large part, many of these new openings, particularly in Asia and Australia, we're getting substantially higher than average sign ups and in first years you tend to have lower renewal rates to start with.

So again, that's a smaller piece of the pie, but nonetheless still at 85.4% for first-quarter end.

As you all know, we recently increased our annual membership fees in both the US and Canada essentially from $55 to $55 for primary memberships and from $100 to $110 for executive memberships.

This again is in the US and Canada.

These increases became effective as of November 1 for new members signing up in the warehouses and will become effective January 1 for renewals, it was back in late November/early December when we mail out the January renewals.

In all approximately 22 million members are impacted by this increase, approximately half of whom are executive members.

In terms of the timing of these increases hitting the income statement, remember that the membership fees are accounted for on a deferred basis.

For example, approximately 1/12 of the increase fee, that $5 or $10 increase from our January renewers will be booked in the first month that they pay it with an additional 1/12 being booked in each of the succeeding 11 months.

So increased fees from our February renewals will then be booked in essentially February through the following January and so on.

So no impact of course in Q1; very, very little impact in Q2; a small amount of impact in Q3; and more meaningful in Q4 and the first few quarters of fiscal '13.

The full impact of the increases is essentially a 23-month time line given the deferred nature of accounting for this.

For example, the last group of members to be billed these new increased fee levels will be next December of '12 and then of course that $5 or $10 increase will be booked to our income statement over the next -- over that month and the succeeding 11 months.

And with regard to executive membership, as you know, we raised the cap on the 2% reward from $500 per year to $750 per year based on eligible purchases.

Now going on to the gross margin line, the gross margins reported in the first quarter were down 35 basis points, 10.62% down from 10.97% a year ago.

As usual I'll ask you to make four columns and six line items, and the columns are a little different.

We basically have -- the first two columns are Q4 '11 results and the second two columns will be Q1 fiscal '12 results.

The first two columns for Q4 will be reported as reported and the second one without gas inflation, again, the dramatic amount of sales of gas and the fact there's been a big inflation, whether it's inflation or deflation it impacts the percentages of margins in SG&A so we try to share that with you.

So again, in columns one and two will be reported and column two will be without gas.

And then for Q1 in '12 as well, reported and without gas.

The line items, first one is merchandising core.

The reported in Q4 '11 was minus 24 basis points year over year; Q4 '11 without gas plus 2; Q1 '12 minus 32 reported; Q1 '12 without gas minus 10; ancillary plus 6, plus 12, minus 2 and plus 2; 2% reward, 0 and minus 3 and then 1 and minus 3; LIFO minus 12 and minus 12 and there was no LIFO in Q1, 0 and 0; other minus 5 and minus 5 and 0 and 0.

So those all add up to in both quarters, quarters four and quarter one, the reported margin year over year was down 35 basis points.

In Q4 without gas that minus 35 without gas is a minus 6.

And in Q1 the minus 35 is a minus 11.

Now let me explain a little of this to you now.

Our core merchandise gross margin for Q1, again, reported minus 32; again the lower margin gas business represented about 8.5% of our sales in Q1 last year and about 10.5% of sales in Q1 this year.

So a little over 200 basis points increase in sales penetration on a margin business that is significantly lower as well.

So not only is it lower margin but more importantly the piece that we're taking out here is the year-over-year inflation in gas which distorts the denominator in the calculations.

So this alone resulted in a 24 basis point -- minus 24 basis points impact to our overall company gross margin.

While gross margins in our core merchandise business, that's food and sundries, hard lines, soft lines and fresh foods, still was lower year over year by 10 basis points it's the lower aggregate sales penetration by inflation that caused it to be down so much in the reported.

Food and sundries and fresh foods were slightly lower year over year while non-foods, hard lines and soft lines, which is a smaller percentage of the total, was positive.

I know many of you will ask why is core gross margin net of gas impact down year over year 10 basis points and what does that mean.

There are two factors I want to mention here.

First, we did choose to be a little more aggressive in pricing going into the fall and Christmas holiday season.

We all see what's going on in the economy; we've been aggressive on inventory levels and we wanted to drive our top-line sales.

We believe we have done that.

This had an impact on the comparison of gross margins year over year in Q1, but it's no secret that this is what we do and that we feel it was appropriate to do that over the last few months.

The second factor that impacted the year-over-year comparison of Q1 gross margins can be seen in our interest income and other line, which showed a dramatic increase in Q1 year over year.

I'll go into more detail in a minute about that.

But approximately $8 million of the year-over-year variance, in fact $9 million of income this year end of Q1 versus $1 million of income last year, this was due to FX gains related to the purchase of foreign currencies -- in our foreign operations, by the way -- related to the purchase of foreign currencies at a rate more favorable than the rate used to record the foreign merchandise payables.

For example, Canada buying merchandise that is payable in US dollars, they will buy either contracts or convert some of it into US dollars.

GAAP accounting requires that these FX results be included as a component of interest income and other even though from our perspective it is related to buying and selling of merchandise.

In fact, internally we credit this to the buyer's margins and then take it out of the margin for GAAP reporting purposes.

The same thing happened to slightly lesser extent in Q4.

Prior to that, we haven't seen the kind of volatility in this.

Usually, it's been a couple million positive, a few million negative.

But we wanted to point that out because it's certainly part of the reason that we saw, both this quarter and the last quarter, the underlying core margin, x gas being a little bit further down.

So for Q1 overall, we were aggressive on pricing.

And again, $9 million or 4 basis points was down below the line in income statement under those FX items I mentioned.And lastly, with respect to gross margins, we booked no LIFO in either Q1 '11 or Q1 '12.

So far this year through the end of Q1 '12, just for the first 12 weeks, our LIFO index as for our U.S.

inventories is ever so slightly deflationary, not enough to warrant even booking that small amount as a positive.

Now moving on to SG&A.

Our reported SG&A percentages Q1 over Q1 were lower or better by 18 basis points coming in at a 10.13% this year compared to 10.31% last year.

Again, we'll have the same four columns for SG&A -- Q4 reported, Q4 without gas and Q1 reported and Q1 without gas inflation.

The line items, the first one is operations, Q1 reported -- Q4 reported, just to give you some perspective -- Q4 reported was plus 44 basis points so lower or better by 44; without inflation plus 20; in Q1 plus 28 reported and plus 9 without inflation; central minus 2 and minus 5; and for Q1 plus 4 and plus 2; equity compensation plus 2 and plus 2; and then for Q1 minus 6 and minus 7.

Quarterly adjustments, which is minus 10 and minus 10 for Q4 reported in without gas; and in Q1 it's minus 8 and minus 8.

That minus 8 is the $17 million I-1183 charge to SG&A.

All told reported plus 34 or lower by 34 basis points year over year in Q4 '11 as compared to the prior Q4.

Without gas inflation the 34 would really be plus 7.

The reported was -- for this quarter again was 18 basis points better or lower versus, again adjusting for gas inflation, minus 4.

Now again, the core operations plus 28 without the big gallon gas -- price per gallon gas inflation would have been only plus 9.

And by the way, the 9 basis points in core payrolls were a little more I believe than all of that -- or a big part of that.

And we've certainly been working on driving more efficiency in the warehouse.

Our central expense was lower year over year in Q1 by 4, again adjusting for inflation better by 2.

Our compensation expense, I mentioned that already, it's -- year over year the delta there has to do with, one, there's a substantially -- the grants in last year are substantially higher than the ones going out of the equation from five years ago.

And finally, as I mentioned, the $17 million of expenses for I-1183 hurt SG&A by 8 basis points -- reported SG&A.

Overall SG&A percentage improved a little in the fiscal quarter and we will continue to focus on the things that I've talked about in the past about driving efficiencies in the warehouse.

I think in these times it's made it a little easier to do that, but not on the backs of our employees' wages or health benefits.

In terms of factors that will impact our outlook in the future, it's things that we all know about -- sales trends of course are paramount, healthcare and gasoline sales and deflation/deflation which we'll take out for you.

Certainly as we expand overseas, particularly in Asia and Mexico and Australia which have lower SG&A, that increasing sales penetration -- to the extent we continue our plans to open more units overseas should help that a little bit.

Next on the income statement is preopening expense, $12 million last year in the quarter, $10 million this year, so $2 million lower and a basis point better.

Last year we had eight openings in the first quarter, this year only four.

But this year's $10 million number included a little over $3 million for the two Japan openings that are opening tomorrow and Saturday.

So in the first couple of weeks -- the first three weeks of Q2, but the preopening -- much of that preopening is in Q1.

In terms of provision for impaired assets and closing costs, we had a charge last year of $4 million, this year we had a credit of $1 million due to a small gain on the disposition of a piece of property.

So a $5 million year-over-year swing for the quarter.

All total reported operating expenses in Q1 came in at $525 million last year, up $18 million to $543 million this year.

This year's $543 million figure includes, of course, the $17 million I-1183 initiative charge and does not include, because it's below the line, that $9 million I mentioned and I discussed that's in the interest and income and other line in terms of how we manage our business internally relates to our buyers and their buying of merchandise.

These amounts mainly reflect the -- hold on, I forgot a line here.

Below the operating income line reported interest expense was about the same in both quarters -- both first quarters, Q1 '12 coming in at $27 million compared to $26 million a year earlier in the quarter.

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

As I mentioned previously, we anticipate paying off $900 million of this $2 billion of debt in mid-March of 2012, so a few months from now.

On an annual basis beginning with the debt pay down the anticipated annual pre-tax interest expense savings to Costco, given that we're paying about 5.4% debt and foregoing interest income of sub 50 basis points on our current cash investment, it's around $44 million pre-tax per year, but again that will start in mid-March.

Now turning to interest income and other.

As you noticed, there was a big increase in this number year over year.

In Q1 last year it was $6 million, in Q1 this year it was $37 million.

Again, try to give you a little bit of light on that.

It has to do with the FX things I mentioned as well as Costco Mexico (inaudible) that.

Actual interest income for the quarter came in at $10.5 million versus $7 million a year earlier, so better by about $3.5 million.

The other component of interest income and other amounted to $23 million this year in the aggregate versus a loss of $4 million last year or better by $27 million year over year.

$15 million of that positive -- of that $27 million variance relates primarily to a gain on US dollars held at our Mexico joint venture.

Again, because of the strengthening of the dollar relative to the peso and the fact that historically we, Costco Mexico, have kept -- the goal was to keep about half of our excess cash down there in dollars recognizing the volatility in the currency and recognizing that they buy many goods that are sourced to the US.

With the strength of the US dollar -- yes, so that $15 million variance, basically Costco Mexico, again we consolidate those numbers, had $12 million of income just related to the fact that they held US dollars compared a year ago in the quarter when they had a $3 million loss for the same reason.

With the strength of the US dollar year over year compared to the peso our Mexico operations benefited from an FX gain on our US dollar denominated cash, again GAAP accounting is how you take care of it.

Because we owned 50% of the venture half of that gain was deducted as part of the non-controlling interest line down below such that the total benefit from us was approximately $7.5 million pre-tax.

Much of the remaining year-over-year benefit of the approximately $12 million of that $27 million I talked about related to our buyers managing the cost of foreign currency denominated -- foreign currency inventory purchases in for [four] operations previously disclosed.

And to a lesser extent the required mark to market accounting for our [foreign] exchange.

As I discussed earlier, buyers consider what they have done to manage foreign exchange rates and pricing merchandise and associated gross margins.

Again, I think you'll see in the last two fiscal quarters, and why I'm pointing it out now is it's how we run our business.

We've never seen big changes in it in terms of the level of volatility as we have in the last couple of periods.

Overall pre-tax income was up 10% versus last year's Q1 from $504 million last year to $553 million this year.

And excluding I-1183 pre-tax income would have been $570 million or up 13% year over year.

Our tax rate, it came in again as reported, 40.8%, certainly higher than last year's 34.2%.

Excluding the two items mentioned in the press release our effective Q1 tax rate was 35.3%, still about a point higher, percentage point higher than last year when we had a one-time benefit of a discrete item that made it up about 1% higher than -- it was 1% lower than it would have been.

Now for a quick rundown of other topics.

Depreciation and amortization, $205 million in the quarter.

The balance sheet I don't have to tell you is strong.

Accounts payable -- on a reported basis accounts payable as a percent of inventories last year was 105%, this year it was 99%.

But more importantly, merchandise -- not a lot of that has to do with construction payables.

More importantly, merchandise inventories as a percent of inventory -- merchandise accounts payable as a percent of inventory was 91% last year and 92%, up a shade this year.

Average inventory per warehouse was up 8% from $11.8 million last year at Q1 end to $12.8 million this year, up $966,000.

Now recognizing we don't know exactly what the exact inflationary number there is, but we're using the various LIFO indices and what we see coming through the front end.

If you assume 3% to 5% and inflation -- or 3% to 4% inflation, even at 3% inflation that would be about -- a little under half of that $960,000 increase.

Much of the balance -- of these increases are spread across many departments.

Of course that's related to that inflation.

Perhaps a little more inventory as well in the likes of jewelry and electronics.

I might add, though, in talking to our head merchant yesterday, asking about any issues related to year-end and seasonal markdowns and he felt that we were quite clean going into the end of season here.

In terms of CapEx, our first-quarter '12 CapEx with $343 million.

For the year we expect it to be $1.5 billion or a shade under.

This compares to CapEx last year of $1.3 million (sic).

Some of the higher annual year-over-year estimated CapEx is due to both the higher penetration and number of units planned overseas particularly in Asia and a little bit more ramp-up hopefully going near the end of this fiscal year, going into fiscal 2013.

Dividends, as you know in the spring we raised our dividend from [respectively] $0.84 -- $0.82 a share to $0.96 a share on an annual basis.

On an annualized basis this dividend -- a $0.96 per share annual dividend represents a cost the Company of about $420 million.

Costco.com in first quarter, sales were up 9%.

And in terms of expansion, I mentioned we're going to open 20 units this year, four in Q1, two in Q2 which are the two Japan openings this quarter, four -- a net of three in Q3, four plus one relo.

In the fourth quarter we have 11 planned and so far we're on track to do those.

Inevitably one or two of those may slip into the next fiscal year, but we'll see how that goes.

In fiscal '11, assuming we do 20 net new units, that will be 3.5% square footage growth.

In fiscal '12 -- and in fiscal '11 it was 3.5%.

Assuming we open 20 this year on a base of 592, that would be also about 3.5% square footage growth.

And again, as I mentioned, the 20 would include 11 in the US, one each in Canada and the UK, three in Korea and four in Japan.

Some of you asked for square footage.

At Q1 end our total square footage was 84,982,000 square feet.

In terms of common stock repurchases, during the quarter we purchased an additional 2.1 million shares for a total of $173 million.

All told since inception back in the mid-'80s -- mid '05 we purchased 110 million shares for just under $6.2 billion.

Our supplemental information packet which includes some additional stats will be posted on the Costco investor relations site later this morning.

So before I turn it back to Dawn for Q&A, hopefully I've explained a few of the nuances of this quarter's income statement.

Of course the two items I mentioned in this morning's press release, as well as the $9 million in the interest income and other line that relates to the buyers purchasing and selling of merchandise and in fact essentially half -- on a pre-tax basis half of that $12 million of income from holding US dollars in Mexico.

So a little bit unusual in a few of these things, but nonetheless hopefully we've given you some transparency in particularly that big interest income and other line.

With that I'll turn back to Dawn for questions and answers.

(Operator Instructions).

Deborah Weinswig, Citigroup.

Can you talk a little bit about inflation, the core categories that you're seeing it in what's your outlook for the rest of the year?

Well, certainly fresh foods.

Again, I hear anecdotal items all the time, including last week's budget meeting from our fresh foods people.

They give examples of anywhere from 5% to 8% on many meat, pork and poultry items.

In produce you see it all over the board because it's not only the economy, it's demand from overseas as well as crops -- what happened with the weather.

And across nonfood categories, while we did see actually I think in November on the call we mentioned that in electronics and TVs, first time in as many months as I can remember we actually saw the average selling price per TV go up a little bit versus down.

A lot of that has to do with the fact that the TVs yet again are getting better, crisper and cheaper.

So people are upgrading and perhaps spending more per TV, but getting a larger television with more clarity or whatever it is these days.

But across many categories -- of course jewelry has continued to be inflationary.

Now again, the thing I want to differentiate between is as we talked about inflation, it's year over year.

In the last three months we actually again have seen less than a 20 basis point delta in the LIFO index year over year.

As I look -- again these are just some samples and these are inflationary items in just the last three months.

Again, these are anecdotal.

But if I looked across things like blueberries are 60% up.

I assume the blueberry crop wasn't very good this year.

Grapes were up 20%, prawns are up 12%.

I'm just looking down the list here.

Other types of blueberries are up only 12%.

And then I looked on the deflationary line -- yes, peanut butter is quite a bit up.

On the deflationary side gas is actually slightly down in the month, although -- I'm sorry, in the month -- not compared to a year ago, compared to the beginning of this fiscal year.

Various electronics items might be down on an exact item 10% to 25%, but again the average selling price on some items has gone up, as I mentioned.

Butter is down 10% to 15%.

So again, it's a mixed bag.

When you ask -- when I ask the buyers -- if I asked them two or three months ago aside from there's been a little bit of lessening of continued inflation as compared to the previous month, when do you see prices coming down a little bit?

And kind of the pat answer from three to six months -- from two or three months ago about looking forward six months was in three to six months.

If you asked them today or last week it's in three to six months.

So I don't think we know completely with that regard, but the feeling is that prices have perhaps flattened out a little bit more of late, but still inflationary compared to a year ago.

Okay, thanks.

And then in terms of basis points how much of your gross margin deterioration should we think of as price and investments?

And should we think of that as a one quarter investment?

And also on the same topic we saw Sam's last quarter with a 28 basis point gross margin decline which is the first time I think in at least 12 quarters and they're talking about price investments as a new strategy.

So just wondering thing if there's a more aggressive pricing stance in the club industry overall?

Well, there's 100 different reasons, honestly, including different countries, including the ancillary businesses, some of which work on significantly more margins because we look at as a margin of the item on the selling floor which includes direct labor and supplies in the optometry and the pharmacy and things of that sort.

I can tell you Sam's is ever competitive and I think they would say the same about us.

We do not view this as really competitive related, it's more us related frankly.

In terms of will it sustain itself?

We'll see.

I'm not trying to be cute about it, but it's by no means all of the reason of whatever somebody thought it was going to be and what it was.

But it's certainly a component of it.

Okay.

And then last question, as you open more clubs outside the US, how does that change your return on invested capital outlook.

Well, if it goes like we hope it goes it will be a positive.

But that's -- tomorrow could be another day.

We'll see.

As we've shared with you, one of the reasons that we have increased the proportion in locations overseas is because we're doing well.

We've had great returns so far in Asia and three of our best openings ever were in Australia.

And so we're excited about that.

But what moves the needle of coarse short-term is the existing results on the -- whatever -- 500 plus out of our 600 units that are in the US and Canada.

But the simple answer is, yes.

Okay, great and best of luck the rest of this holiday season, Richard.

Robby Ohmes, Bank of America.

The question -- just two questions, I guess the first is can you talk about the categories where you were most aggressive on pricing in this quarter?

Maybe a little more detail there.

And then maybe also on the inventory investment that you're talking about that was made, same thing, maybe the same categories.

Maybe speak to us about where the inventory investment was as well.

Thanks.

In terms of where we're sharp, we're always going to be sharpest on items that are those high visibility consumer items, whether it's milk or ground beef and steaks or Advil or Tide -- those key competitive items were $0.50 or $1 makes a big difference in somebody's eyes because it's a wow.

As well, given the season, it was across many items in non-foods.

Again, if we could take -- and I'm not going to give you a specific example, but if we can take an item -- and I'm making this up -- but retails for $179 or $189 and we're normally $139 and we can go to whether it's -- we go to $119 that's huge.

Because the savings versus traditional retail is that much greater.

And many times it works and sometimes it doesn't, in terms of driving sales.

But overall, each buyer in each department looked at different things that they felt would be high-end backed items.

Again, I don't want to offer emphasize this whole aspect because it's different -- we were talking about this yesterday.

It's different than late 2008 when we said, hey, the economy is in crisis and this is all new to us, and the market was down 30% or 40% and people are -- as house values are going down.

And we wanted to do something to drive sales specifically on a handful -- in a big way on a handful of very high-volume items.

This is more across the board and a general feeling.

But there are plenty of ways for us to get margin, and it's a balancing act.

And we felt we did what was right for our customer and for our business in terms of continuing to drive sales.

When we looked across categories, again if I look at the 966,000 per warehouse, just dividing the increase in inventory divided by number of warehouses at quarter end; again, you've got to figure roughly half of it is inflationary.

But there is no sub department that is more -- and let's say there's about 25 sub departments, 27 sub departments, there is no sub department that even has three digits in it.

So it really is across the board.

Certainly the biggest ones on the list would be, as you would expect, as I mentioned, jewelry and electrics.

So just to clarify, is this really a holiday strategy or should we expect you to be maybe a little more aggressive in price over the next year or so as you're rolling through the membership fee increase?

I think yes, yes, yes and no, no, no.

I mean it's -- again, I wanted to try to explain why some of the margin is down a little bit.

We don't view -- it's something that we look at every day and every week.

Certainly, as Jim and now Craig has said and says constantly, we are first and foremost a top-line company to drive sales.

And we think we are investing in the future.

I don't know if it's another quarter or half a quarter or two years.

We'll let you know each quarter.

And I'm not trying to be coy, but as you know, we don't give specific direction.

Got it, thanks.

Adrianne Shapira, Goldman Sachs.

Richard, can you talk (technical difficulty)?

Operator, can you hear me?

Yes, sir.

I think our line disconnected.

We'll take the next question.

Okay, and try to get her back on.

Thank you.

Yes, sir.

My question was about -- talk a little bit about the categories as we're heading into the holiday season.

Maybe give us a sense of what's working, what's not.

Talk about the consumer electronics, how that's faring.

And then specifically on soft lines, it seems that the category had been stronger the last few quarters, up low-double the last few quarters, up high-singles and now mid-singles.

Maybe give us some color in terms of what trends you're seeing in soft lines?

Thanks.

Okay, let me just pull my notes out here real quick.

In terms of what's working and what's not working it's really -- I've got to tell you over the last six and eight months it seems like it's been the same things.

Certainly food is strong, fresh food is strong.

Certainly jewelry is strong in part because of inflation, significant inflation in some of those items.

Across many of the non-foods mid-ticket items we've seen relative strength but not on the -- we mentioned a couple of those each month whether it's housewares or small electrics and things like that.

Within electronics, if I look at the last couple of months and quarters, again it was slightly -- I believe in November -- in November electronics was slightly up year-over-year as a percent and for the quarter I think it was slightly down.

So the trend during the last three months was up a little bit.

And of course a lot of that has to do with TVs which we mentioned I think in the call was up in the high- to mid-single-digits in dollars in the past month.

And so it continually amazes me, I think in the four weeks of September we sold just a shade under 300,000 televisions, which is a mind-boggling number.

So it really is across the board.

Now within the other one you mentioned, soft lines, let me just look real quick.

Jewelry and apparel, but in terms of any trading down -- I know men's and women's apparel tend to fluctuate up and down based on what we're getting in.

And I don't have other details on that in front of me here.

In November -- I'm just looking here.

Again the ones we mentioned were hardware -- I'm sorry, in soft lines.

Small appliances was strong, women's apparel was double digits, men's apparel was mid-single, no real -- nothing that stands out there, Adrianne.

Okay, thanks, Richard.

And then my other question, as it relates to the pricing environment, it sounds as if this is more proactive than reactive in terms of your decision to be a bit more aggressive.

But can you give us a sense of what's out there on the competitive landscape?

Clearly now BJ's private, what you're seeing out of them, Walmart has obviously been very vocal of kind of winning back the holidays and going after the weekend and the entire season pretty aggressively.

So if you could just give us a sense, characterize what you're seeing out there, how intense, how aggressive and maybe in response to your aggressiveness as well?

Thanks.

Well, I would agree with your comment of proactive as compared to reactive.

Who is our toughest competitor?

Clearly Jim and Craig, but outside of Jim and Craig it's -- Sam's is our most direct competitor, more so than BJ's in terms of intensity.

Although BJ's has gotten stronger than they had been.

But I think I mentioned as long as a year ago there seemed to be a period of time for a couple years where we less and less (inaudible) price shopped them a lot, we are now over the last year.

So BJ's gotten a little tougher.

But we feel very strongly that again we're being proactive in this and there's not this, oh, no, there's something new happening out there.

But Sam's has always been tough and we are pretty tough ourselves.

So I'm not trying to sound arrogant about it, but again we aren't seeing a lot.

Outside of that, certainly we recognize that in some categories like media, the Internet is changing that landscape.

And you've seen that in our warehouses; over the last year we've reduced a little bit of square footage of things like CDs and DVDs and to a lesser extent books because there are still plenty of people that want to buy physical books.

And we've done other things.

In the one hour photo there's a lot of very cool things that we do with prints on canvas and photo books and things like that that is actually driving that business with a plus sign in front of it.

But in terms of competition, for those of you who have known us for a lot of years it's the same things.

When our numbers are good we scrutinize them more, we have -- you've seen our strengths in some of our overseas items and our overseas locations like Asia, like Mexico and like Canada -- which is of course segmented out and shows a higher margin -- we want to make sure that we're competitive, not just because there's a competitor across the street but because we want to be strong up there.

So we were cognizant of the economy and our strength and we want to make sure that that's going to continue.

And then just on the buyback, could you give us any sense of the appetite there?

Obviously we know you could do more if you opted to, but give us any sense of pace and appetite going forward.

Well, I think if you look at last year I think we did about 6 something, $640 million -- I don't have it in front of me.

And I think in the fourth quarter it was annualized closer to $1 billion, $950 million let's say.

If you take the 12 weeks that we spend when we spent $173 million, that is roughly about $750 million.

So that's a little bit down in the annualized figure in Q4.

But as we've told everybody, we are an ongoing buyer as long as we feel that the outlook continues, and we do, not just for us but for the crazy world that we live in.

So we have been essentially a daily buyer.

We tend to do that in a matrix format that if the stock is going up we're buying a little less a day, if it's going down we're buying a little more, recognizing we don't -- we can't predict exactly.

And certainly there was a lot of strength during the quarter, so there were days when we were buying on an annualized basis.

If you just do simple math, if you're buying 25,000 shares a day that's about $500 million a year.

If you buy 50,000 a day that's about $1 billion a year.

And when people have talked about what do I put in my model for the next five years?

And says, A, we don't know.

But certainly that $1 billion number a year is a starting point.

And is it a little less than that?

It could be.

Could it be a little more?

Sure.

Great, best of luck.

Chuck Cerankosky, Northcoast Research.

The money you spent to get prop 1183 passed, can you give us some analysis what you expect to get back from that or boost in liquor sales in Washington I guess starting from zero when it takes affect middle of next year?

Well, first of all the $17 million, I think the total was about $19 million just about -- a little under $2 million was booked in Q4, small enough that we didn't even talk about it.

But of that money it's probably twice more than we wanted to spend to start with, what we thought we would spend.

But as we go forth once you're into it you do it.

Generally speaking, in states where we sell spirits it's about 2% of sales.

And I don't have the exact amount of sales, but it will be a decent return on even that larger investment.

But keep in mind we did it more because of the principle that our mission is to sell merchandise to our members at the lowest price.

And you can see even with higher taxes afforded on the spirits in the state of Washington, we believe that our member is going to be able to buy spirits at a lower price and that's what we do for a living.

Okay, thank you.

Looking at gasoline, the gasoline category, Richard, can you give us a sense of how same-store gallons moved and how the profitability per gallon was?

Well, as you know, historically in terms of the latter part of that question, profitability is -- generally is better when prices are going down and worse when they're going up.

Although in the last year both of those extremes have come into the center a little bit more.

So even when it's going up a little we're making a little more than we used to and when it's going down a little we're making a lot more but a little less than we used to.

In terms of comp gallons, if I look at comp gallons over the -- if I go back over the last year it was generally in the 10 plus range.

I think in the most recent month or most recent quarter it was 6%.

So still a positive.

All right, good.

Looking at how the consumer is behaving in this Christmas season, especially with the transition from the first fiscal quarter into the holiday season, how do you judge their discretionary spending move compared to where you'd like it to be or even last year?

Well, I mean I think we, again, began this fall Christmas holiday season aggressive in terms of merchandising and -- but still scared about the world and the economy and the purchasing power.

Again, I think we've generally done better than the consumer confidence indices would suggest.

But we're still not thrilled and we'd like it to be better.

Overall again I think -- I can't tell you what it is beyond November, but through November we were pretty pleased with the numbers.

All right, thanks a lot, Richard.

Sean Naughton, Piper Jaffray.

Thanks for taking my question.

This is actually [Mark Stenover] in for Sean.

Just a couple quick questions.

First, I wonder if you can just comment on anything you're seeing with the consumer right now, both negative and positive as far as trading down, trading up?

Increases that you're seeing in private label sales or anything like that?

And secondly, also as it relates to Asia overall, wondering what's your -- what you feel the opportunity is there.

It's up since the last time you commented on it.

I think in Japan you said that you believe you could probably have around 49, 50 stores there at full penetration.

I wonder if you're seeing anything currently in that market that might cause you to up that?

Thank you.

Sure, I apologize.

What was the first question again?

I was writing down the second question.

Oh, yes, absolutely.

So just anything positive or negative you're seeing in the consumer right now.

So as far as trading up, trading down brands or (multiple speakers).

In terms of trading up and down, we probably don't see as much of that as other types of retail, whether it's lower end discounters or general discounters and others, partly because we don't allow us to do it.

We try not to trade down merchandise in terms of what we're presenting, we're still trying to upsize, up quality merchandise.

Certainly nothing like we saw after late '08.

In the first half of '09 I remember we saw trading down in patio furniture and trading down in some of the meat items and things like that.

We're not seeing any of that right now.

In terms of increasing penetration of private label, again that's more evolutionary than revolutionary right now.

I would say in the first six months of '09 it was more revolutionary.

I think anecdotally I mentioned back then -- and again that was right after the financial crisis of late '08 -- in the first six months of '09 we saw up to 300 basis point increase in sales penetration of private label on the food and sundry side of our business, which is 60% of our business and that's unprecedented.

Normally in a given year you might see a 50 to 100 basis point improvement as we add items and so forth.

So I'd say it's more the evolutionary path right now, but we keep coming out with new stuff and we would expect to see that grow.

What Jim has been asked in the past -- recent past about that, if it's currently -- private label is currently in the low 20s kind of a goal over the next however many years, not two or three but not 10 or 12, we'd like to see it in the low 30s.

But that's going to take time.

Great.

And then as far as your opportunities in Asia (multiple speakers)?

Yes, Asia.

Look, we're doing more than we did a year ago and that was more than we did two years ago.

I think the 49 number you looked at in Japan goes back to when we had five units in Japan instead of the 12 we'll have by the end of this week.

Or the 11 that we'll have by the end of this week.

And what was -- and I think the 49 was based on -- I think I remember saying back then who knows what the heck it's going to be.

If we continue to be successful certainly -- and how do we do 49 instead of 50 I'll never know.

But at the end of the day if you look at the -- both the population and the retail economy of Japan compared to Canada where we have 85 units or so, it could be a lot more than 49.

But right now opening four this year is a lot more than one or two and we've got more in the pipeline.

So we'll just keep going north.

But I can't predict what it will ultimately be.

I know in Taiwan and Korea if you go back five years ago in those kind of templated slides where would we be -- what's the potential in the market.

I think in each of those countries we had five to seven units, we said one day we might have 15.

More recently in the last year I've seen that slide that says a potential 25 each.

So again, the number is increasing.

It's still going to be slow, it's not like you're going to see us open 20 units in year three hence from now.

All right, well thank you and best of luck.

Peter Benedict, Robert Baird.

A quick question, have you seen any change in the pace of new member sign ups, either Gold Star or Executive, since you guys raised the fee on November 1 for new members?

No, it's been a non-issue so far, recognizing the big question is what are renewers going to do, not what a new person coming in the store -- the warehouse is going to do starting November 1.

But even when it was originally announced in the press release, I mean in talking to our head of marketing and membership yesterday, he basically indicated it's in the low -- very, very low hundreds of even comments in blogs and twitters and Facebook things.

And 90% of them are positive.

Anecdotally like are you kidding?

I say that every week when I get gas.

Are you kidding?

I say that every week when I get flowers.

So I think our members are our best defenders of the fact that it's not been an issue.

We'll have to -- we'll give you more color on that in a quarter and two quarters from now when we've got three and six months of renewers under our belt.

Okay, great.

And then just did you give us the average price per gallon of gas in the first quarter?

That's a number we'd like it if you have it.

Thanks.

It's up 26% and Q1 it was $3.52, in Q1 a year ago it was $2.79.

All right.

Great, thanks so much.

Greg Melich, ISI.

I wanted to follow up a little bit on the gross margin.

If I caught it right you said that non-food was actually up slightly a little bit.

So I was curious, was that category or mix or what areas was that occurring?

It was more in hard lines and soft lines.

But -- yes -- and I don't think -- I don't know off the top of my head.

I haven't looked at the sub detail, Greg.

Okay, so maybe the other way is all that pressure you did see there, the 6 basis points, since it was all on the food side I imagine the cadence through the quarter was that it would be more towards the end.

Is that true?

And given that it's a holiday kind of focus and your quarter ended the 20th remind us of how your holiday sales tend to play out.

I imagine the weekend before Thanksgiving is a pretty one big one for you.

But if you could remind us on that, that would be helpful.

Well, a lot of it was not just seasonal -- I mean it was seasonal fall as well.

If you recall, even in Q4 year over year kind of the quarter was up only 2 basis point net of gas inflation which was less than it was in Q3 and Q2 going back year over year it was much more positive.

So I think it's trended a little bit.

I wouldn't suggest that the last month was much more of an impact than the first month, other than sales penetration in the last month, but not in terms of percentages, maybe a little but not much.

I don't have all the color on that in front of me.

Okay.

And then just going back to the first part of the question on the non-food side of it, was there any impact from the runoff of some of the Apple product that you were cycling?

I guess -- I know you got rid of them around this time last year.

We finally anniversaried the sales into that, so that's a small help going forward.

I wouldn't see -- probably -- a big chunk of our Apple sales were iTunes cards which had a decent margin, probably on the iPods it was a little lower than average margin but not meaningful, not a meaningful delta to impact our numbers.

So that will not change it, okay, great.

Thanks.

Chris Horvers, JPMorgan.

Good morning, it's actually [Aaron] for Chris.

Can you maybe dive into the core SG&A margin rate?

And do you see -- or do you expect a leverage point to improve throughout the rest of the year?

How is healthcare cost impacting that as well?

Yes, healthcare is still -- dollars are still rising in the high-singles, which is a little better than the low doubles in terms of dollars.

Workers comp has turned the other way a little bit so it's hurting as a little more, although workers comp in aggregate dollars is not nearly as big as all of healthcare.

But again, core SG&A, the payroll was good; I would hope and expect that to continue.

I mean one of the [emphasis is emphasize] -- and one of the things that we emphasized in the last couple of quarters is overtime.

And as wonderful as we think we are sometimes in terms of efficiency of operations, by just focusing on it in the warehouses we've cut thousands of hours of overtime.

And so, time and a half is a lot more expensive than time.

So again, that's a piece of it.

But I think again nothing does more for you than a tough economy to make you focus on it.

So I don't know if it's going to get -- if the inflection points or the threshold points based on sales comps have come down a little, I think it's come down compared to a few years ago and I think we've got further to go.

As you know or as I mentioned to many of you, probably 30 plus of Craig's 40 plus years in retail have been in operations.

Clearly he is focused on that and then of course he has a great merchant in Doug and the people under Doug on the merchandising side to worry about more merchandising things.

But I think Craig is very focused on the operations side of our business and driving costs.

And that being said, it ain't easy and, again, I think if you look over the last eight quarters of what we've said, it generally has been towards -- payroll has trickled in a little better and probably a little bit better than better in the last couple quarters.

Great.

And then maybe just looking at gas prices have receded a little here.

Have you seen any negative impact at all on traffic trends?

No, our traffic remains at 4%, it's almost scary to us because we keep saying when is it going to subside a little bit, and it's just month after month we're doing pretty well.

As I mentioned, the gallonage comp in Q1 was 6, I don't have Q4 in front of me -- I don't have the exact number.

I bet you it was 8 to 11, I don't remember exactly -- let's call it 10.

So yes, it's come down a little, but the overall frequent -- and when we talk about that frequency number, that's front-end frequency, not gas.

To the extent we have more people coming in to get gas, a fraction of those people are coming into the warehouse.

Great, thanks and best of luck.

Colin McGranahan, Bernstein.

First question just on the other income, there was a big variance.

And I think I understand the $8 million piece that is -- the hedge on merchandise purchasing, but help me understand the $15 million piece on cash a little bit.

And how much cash are you holding in Mexico and if the peso weakened versus the dollar over the course of the quarter and certainly versus a year ago why is that such a big benefit?

Well, that's exactly what happened.

So what happens is any company in any country if they hold foreign currency they have to mark it to market at the end of the fiscal period.

So in Mexico our strategy from time beginning or for many years has been not exactly but to hold about half of their excess cash in dollars.

And that has basically been agreed to by the shareholders of Costco Mexico, us one half of that and Comercial Mexicana one half of that, recognizing that the peso historically has been weaker.

And recognizing further that we end up buying a lot of US goods.

But that's not to do with managing payables each month but that has to do with on an ongoing basis we buy US -- we buy goods that are payable in US dollars.

So when Costco Mexico I think in year-end in dollars -- not how many dollars they held but if you converted their entire cash into dollars it was around $300 million.

So let's say -- these are not exact numbers, but let's say half of that was being held in US dollars that would be $150 million.

During Q1 the peso weakened quite a bit.

I don't have the exact number but it was 10% on $150 million, there's $15 million.

And now by the way, that has hit us and hurt us.

Last year in the same fiscal quarter -- in Q1 of '11 we had a $3 million hit.

Now we didn't talk about it because it was $3 million and its noise because there's lots of things in our P&L that go positive and negative.

The other thing that makes this line item stand out more than ever before, it was fiscal '11 when we started to consolidate Mexico into our numbers rather than just having half of Mexico's income on this line.

So it's still a little convoluted, but again this bigger volatility, it could easily have been the other way if the peso strengthened.

Now I hope that I don't have to in the future every quarter talk about another line-item here, but because it was so -- such a big amount.

If I look at the last four fiscal quarters, just this particular item, it was again about $9 million of -- I'm sorry, about $11 million in Q1 '12 to a positive, but again -- I'm sorry, about $9 million Q1 '12 to a positive again -- I'm sorry about $11 million to Q1 positive.

It was -- in Q4 it was not that big of a positive.

In Q3 it was a $4 million loss and in Q2 it was a $2 million loss.

So again, historically we really haven't talked about it, but it was -- this is the biggest it's ever been and it really stood out.

Okay, so the fact that you're holding US dollars in Mexico that is what you mark to market, not pesos to dollars?

Right -- right, because Costco Mexico's P&L is recorded to have a gain based on its dollar holdings, half of that gain is ours.

Kind of silly (technical difficulty).

And you're just marking to market over the course of the quarter, so if the peso stays where it is it doesn't matter where it was a year ago?

Exactly.

We can't really predict this going forward other than watch the peso over the course of the quarter?

Right.

If you look at -- again, none of us know exactly where it's going to go.

But if you look at what's happened generally there's been a couple of big jumps in the peso weakening versus the dollar on a long-term basis.

And so by doing this it's been a little bit of a benefit, but certainly not something you can count on.

Okay.

And then I may have missed it, can you talk about eCommerce.com growth?

Yes, it was up 9% in the quarter.

I think that's down from the low-double-digits in last year and in the fourth quarter.

The only other big news there is we are looking -- we're in the process of re-platforming Costco.com, that will happen towards -- probably sometime in the second calendar quarter of next year.

As I've shared with people as they've asked, right now our .com site, the search engines can't search on it.

So if you just punch in Kirkland Signature into Google you're going to be ways down before you see Costco.com.

So there's something simple things that we're doing there and, of course, we're looking to expand .com overseas but that will be not next Thursday that will be over the next two to three years.

Okay, anything particular about the deceleration?

No.

Keep in mind, we've taken a relatively slow approach to .com.

I mean we don't do a lot of marketing for it, we sell a lot of big-ticket items, we have less than 37 or 800 items on there.

And I think again one of the big things is since search engines can't search, you punch in television or something else Costco.com doesn't come up.

If you punch in Kirkland Signature and the first thing -- I'm not going to tell you who, you'll all go do it now.

But the first thing doesn't -- Costco.com doesn't come up.

That's because we have an old system that we, starting about eight months ago, began the process of investing to re-platform it.

Okay.

And then finally, I know we've kicked this around a bunch already, but on the little bit more aggressive pricing, it sounded like there was a little bit of a philosophy change and obviously this is the first quarter of core merchandise margins down that we've seen in a couple years.

What exactly did you see or feel that you said, you know, now is the time to kind of get a little bit more aggressive on the margin?

I don't think -- I don't think it was a great aha moment around here.

It was more we've had good numbers, particularly doing well in overseas countries and, as I've said many times over the years, Jim has been toughest one we're doing well and that's a good thing.

It keeps us reminded that we got to where we are because we're tough on pricing and let's make sure we continue to do that.

So again, I'm trying to walk the line between not -- we don't view it as big of an issue other than it's certainly part of the issue and I felt obligated to let you know that certainly part of the margin issue is it.

But it's not this giant mindset change in terms of what we want to do.

Okay, that's fair.

I'll slip one (multiple speakers) last one in here.

Are there any additional political contributions we should know about going forward?

No, absolutely not.

Okay, fair enough.

Mark Miller, William Blair.

A follow-up on eCommerce.

Your growth here is tracking now similar to your overall business ex gas whereas the consumer is obviously shifting faster to eCommerce.

And so, do think that re-platforming change will change the trend for you or what other changes might the team be thinking about?

And then specifically as it relates to shipping, we're seeing more retailers moving towards incentives in that area.

Might that be something you'd also consider?

There are several things we're looking at.

But again, I don't want to overemphasize that because keep in mind it's -- there's -- it's 2% or 3% of our -- 2.5% of our business.

And we -- our goal is to get you in the store with the giant chickens and the gasoline and everything else.

Great giant chickens I might add.

And so we're great merchants out there doing that.

We recognize that this is a very profitable business, as a percent of sales it's more profitable than our whole company overall.

But we also want to stick to some of our disciplines.

We recognize we continue to change a little bit and we'll continue to do that.

But we don't want to go crazy and say, oh my God, I do believe that some of the promotional stuff and free shipping stuff which is catching everybody's attention, that hasn't helped us for sure, but I don't see us going to a free shipping model, certainly that has not really been talked about other than how do we communicate to our members what our -- we feel very open and honest about communicating what our all-in price is.

If we keep having great value, and time and again we have great value relative to all the other guys out there, we'll continue to drive that business.

And if it starts heading the other way we'll figure out what we need to do to change that.

But we don't really see that other than certainly there's been a lot more cyber promotions out there right now that we're not prepared to do.

Okay, and then just on the gross margin, there's a want of puts and takes, but as we move through this fiscal year you're going to come across some normalization presumably in this gas price impact on the margins.

Do you think that later in the year the Company might be in a position to see rising gross margins again based on what you see today or is the more aggressive pricing possibly offsetting that opportunity?

I'd love to give you my thoughts, but I can't really guide you there.

In terms of just looking at inflation versus deflation in gas, that's the $64,000 question.

In Q1 a year ago, as I mentioned, the average selling price was $2.79.

In Q2 the average selling price a year ago was $3.01.

In Q3 it was $3.63 and it was also $3.63 by coincidence in Q4.

It actually went down a few cents in September, $3.58, $3.48 in October and $3.44 in November.

So it actually is ever so slightly deflationary.

But as compared to Q2, if the price in November of $3.44 and the price in Q2 last year at $3.01 -- so that's 40 -- that's a 13% or 14% increase, not a 26% increase.

So it will be less of an impact and all things being equal it will finally pencil out, but who knows.

Yes, if it doesn't change the back half of this year there will be very little impact.

Okay.

And then my last question is on the membership fee growth ex currency.

How do you look at the trend here versus where you were through the back part of last year?

We don't get exactly the membership for your revenues ex that currency, so how do you look at the trend?

When we look at (inaudible) budget we feel great.

I mean everything is -- we're signing up new members even in the US, net new members which is a positive given as a percent of -- openings as a percent of total US openings.

We're seeing our renewal rates strengthen a little bit in the US and they're only going down overseas simply because you've got a lot of new units that have lower first-year renewal rates.

And so assuming those trends continue I think we feel very good about it.

Great, thanks.

Best of luck in the holidays here.

Dan Binder, Jefferies.

In the past and still now you've been sensitive to keeping the comps at a certain level.

Your comparisons start getting more difficult, obviously you had a pretty good year this past calendar year.

I'm just curious as you lap some of that if you have any plans of doing incremental investment in either inventory or price to keep that level up?

I'll let you know when we get there.

Certainly traditionally those are the kinds of things we do, but we're not going to go crazy.

Certainly opening more units overseas helps your comps a little bit because they're starting off at a higher rate -- helps your sales growth a little bit, not your comp necessarily.

But as Jim mentioned to us in the budget meeting last month -- I think it was last month, he said, guys, it's no secret that this is what we do for a living.

But I don't want -- I'm trying, again, to explain Q1, but not get people concerned that there's this big sea change out there because there's not.

Right.

What about in terms of the online business?

As you noted before there's a lot of cyber promotions out there.

But if you look outside of just around the Thanksgiving day weekend, you've got a lot of retailers, both big-box and pure online that are enhancing their Web offerings.

Is there anything that you're doing other than the search changes that you talked about to stand out in the crowd a little bit more, whether it's adding more items at the site or offering more discounts or whatever?

No.

We want to -- we have to recognize that the Internet is different than brick-and-mortar, we also can't be too alarmed us to about what's going on out there.

We're going to -- we are doing a few more MVM, multi-vendor mailers.

There's some more couponing for just Costco.com.

Other than that I don't think we're doing a whole lot more.

Okay, great.

Thanks.

(inaudible), Consumer Edge Research.

Why we take two more questions.

Hello?

Can you just talk a little bit about private label in the quarter, what you experienced and also how that flows through if at all to the gross margin?

Well, private label is up slightly.

Generally speaking and looking at the past few years private-label penetration has been up anywhere from half to 100 -- 50 to 100 basis points year over year.

Probably in a given quarter you're not going to see that much of a dramatic change other than we're adding new items.

And then the same thing with margins.

The difference between a brand and a private-label margin could be as much as 600 or 800 basis points and as little as 100 or 200 basis points.

It's on an item-by-item basis.

A lot of times -- I use the example years ago when we went to a private-label diaper.

Because diapers are an item that is retail footballed all the time, it was an item that our realized gross margins across the country on $300 million of branded diapers was probably in the mid-single-digits.

We shifted at a lower price point because private-label is a lower price point, but we shifted to a price point in the low-double-digits.

So there you've got 500 plus basis points.

I'm sure there are plenty of items where it's a lot less than that.

But net-net it's a positive.

So it's a positive, so --?

I would guess -- yes, did it move the needle in Q1?

I don't know.

Okay.

All right, great, thanks a lot.

We'll take two more questions and I think that will be it.

Joe Feldman, Telsey Advisory Group.

Joe left.

Next?

Charles Grom, Deutsche Bank.

I was just hoping I could ask a question about if you expect any major operational changes with Mr.

Sinegal's departure near term?

Not really.

Keep I said in the press release, he's going to be around for the next year in a consulting capacity.

Any of you know Jim that's a big shadow there and he's going to spend a lot of time no doubt traveling with Craig.

And we don't really see any sea changes out there particularly -- and when Craig has been interviewed even in the local newspaper his view is it's more of the same, focusing on value.

If anything I think since Craig, 20 or so months ago, became President he's elevated his game in terms of understanding what has gotten to us, where we are in terms of that discipline of value and you can see the DNA around here is pretty intact.

Great, thanks.

And just one follow-up, just wondering if I could get a little bit more color -- I know of a lot of people have asked, but just about less leverage in the 1Q kind of versus (technical difficulty) despite the better core comp.

Just if I could get a little more detail I'd appreciate it.

Thanks.

I'm sorry, say that again.

Trying to get a handle on a little bit less leverage in the first quarter kind of versus fourth quarter despite the better core comp.

I can't -- it's so hard to pinpoint.

There's hundreds of things going on -- penetrations in different countries, year-end accruals that -- either way.

We try to look at the big ones and let you know what they are and -- but I can't necessarily put my finger on that exact -- other than the trend has been good.

If it was a little less in Q1 than Q4 so be it.

Thank you.

Robert Carroll, UBS.

Just one quick last one on the pricing.

Is there any link to be made with the timing of some of the mild pricing investments along with the membership fee increase?

Should we think about that as a way of almost investing in price in order to ensure continued high renewal rates for when the members see the increase?

Money is fungible whether it's pricing or membership and everything else.

We're going to keep doing what we're doing.

Clearly it's not an exact direct link because fee increases, in terms of when we earn them, aren't starting really until January when we're getting the cash and into Q3 when we're getting something in the book.

So I view those as independent.

So then as you start to see the membership fee income ramp up by something that's recognized over the next couple of years, we shouldn't necessarily think about a curve on pricing investments following that?

What I've read into some of the analysts out there, some of them assume majority of it's going that way, some of them assume the minority of it's going that way.

We really can't predict that other than saying that as our numbers are good and -- numbers for the Company, not membership, but just as our earnings continue to progress and we feel strong about member loyalty and we look at the economy, we're going to continue to work to drive sales.

And this is just another arrow in the quiver.

Great, thank you.

Okay.

Well, thank you, everyone, and have a good day and holiday.

Go shopping at Costco.

This concludes today's first-quarter fiscal year 2011 operating results conference call.

You may now disconnect.