Key questions from the first quarter earnings call conducted by Costco Wholesale Corporation on December 11, 2008.
Deborah Weinswig (Citigroup): How do you expect food disinflation to impact your business in 2009?
Richard Galanti: Inflation was a short-lived word at least right now. If I looked at our various LIFO pools, what we call food and sundries, in first quarter it was still up about 0.50% in pricing. In sundries it was up about 0.50%. In electronics and computers and what have you, it was down 2.5%. Gas which also includes sporting goods, office, automotive, was down all because of gas. And tobacco, beer and wine was essentially flat. In something as basis as ham and bacon and butter, are all down about 50 cents on $9 and $10 price points so down 4% or 5%. These are recent price decreases. Cheerios down 50 cents on a $5.50 item. Canned tomatoes down 80 cents on a $7.50 item. Forty cents down on juice, orange juice. A year ago New York steaks were $7.99, they are now $5.99, that is all because of a lower demand. But we are doing a heck of a job with that stuff. And on the non-food side, Kirkland Signature Diapers and Kirkland Signature Baby Formula are both down a couple of buck on $20 and $40 price points so 5% to 10%. So we are seeing some of this come down. Gas is way down.
Deborah Weinswig (Citigroup): Can you talk about the trend year-over-year in terms of the instant manufacturer rebates which are vendor supported markdowns?
Richard Galanti: There are a lot of instant rebates, and what it is is the manufacturers who have a lot of inventory pushing it out and we are well known for taking large massive quantities of big-ticket items. The television example is a great one but whether it is a high end vacuum cleaner, or high end luggage or apparel, we are getting some great brand names out there in big quantities and that stuff is selling by the way. It is not selling like it was but we can push through that with great confidence and so I do not see that changing other then the fact that some of these manufacturers have not continued to build as if things were getting better next week so maybe there is availability next year, but going into Christmas and the pressure on the buyers here as you would expect, among other pressures like going back and saying, the price should be coming down now, is to find those items that we can either divert or buy indirectly direct or buy direct.
Deborah Weinswig (Citigroup): Can you talk about anything different in terms of your business model now versus three to four years ago where you could expect continued SG&A performance as such on a weak comp?
Richard Galanti: Over the last several years we improved in healthcare other then the spike last month. But we have improved in healthcare with the changes that we implemented back in late 2003 early 2004, that had a four-year tail to it because of how those changes to the healthcare plan changed and that helped us. We have done a great job on Workers’ Comp. We brought in a couple of great people about three years ago that are getting people back to work safely and more quickly and getting them off Workers’ Comp. We have, aside from the great changes in legislation in California that was killing us six years ago, we are seeing still improvement at Workers’ Comp and again that is being proactive on that side. There are some other things that help margin and SG&A that are little things. You are seeing a lot of square packaging. What used to be a round bottle, a round tub of detergent is now square. It is now triple concentrated and milk you have seen the new Costco milk carton which you can get more on a pallet and therefore less freight per item. At our Annual Manager’s Meeting in August we had an example and on the slide it was 12 or 15 bulk high volume items like paper towels and toilet paper and facial tissue and water and just in terms of changes of packaging much of which is being done by the manufacturers but with help from us and other major retailers, just in those 12 items in the United States we were going to save on like volume reduce our pallet through-put by over 200,000 pallets. That is a lot of trucks that you do not have to spend money on. A lot of that goes into needless to say the freight goes into reduced cost of sales but it also means that forklift operators are not schlepping 200,000 pallets through the warehouse. So all those things, a million here and a million there, it does not add up to a lot of basis points but at least helps. We are not as you would expect changing our wage rates. We are not going to charge our employees a lot more for healthcare. Those are the types of things we have in place and what we pride ourselves in. But we are not giving up, we are looking for where we can save money.
Deborah Weinswig (Citigroup): Do you need a lower comp to leverage going forward then you have historically?
Richard Galanti: In fourth quarter this year it is 12%. In first quarter it was over 9% and it still rounded to 9%. Directionally it still impacts it.
Dan Binder (Jefferies & Company): You have talked about four to five core comp of where you can achieve expense leverage, if we look at something more like a three, what would you say is a reasonable range of expense deleverage in terms of basis points for every comp point under four?
Richard Galanti: On $71 billion in sales last year, one percentage point is $710 million. When we have done our own regression analysis if you will, is what is that on the margin. It has been a long time since we have done a regression analysis but the fact of the matter is that incremental dollar of sales be it lost or gained, is about 4.5% of pre-tax profit.
Dan Binder (Jefferies & Company): What are you doing on the pricing front in the Club?
Richard Galanti: It is in our DNA that our first order of business is to drive sales. A company with a 5% minus comp versus a 5% plus comp operates completely differently. You are spending your time worrying, employees are spending their time worrying about being cut hours and laid off and we want to do everything possible to drive sales.
In a given month, in the last month of the quarter the head of merchandising came to Jim as Jim had asked for, I want markdowns on key items be it produce or high profile items like, I do not even know if these are the items we did but it could be soda pop it could be Tylenol, it could be butter, it could be Tide detergent. But at the end of the day it was a couple of cents a share. And we are still doing some of it this quarter. It is not 5 and 10 cents but it is not zero.
Dan Binder (Jefferies & Company): Are you pleased with the results that you are getting on the items where you have been able to cut prices in terms of unit increases?
Richard Galanti: It is hard to quantify what it would have been with and without. I can tell you anecdotally when the operators are going around, as an example, we took our famous rotisserie chicken back to $4.99 in many markets. We saw a big pick-up in unit sales of chickens when we did that.
Dan Binder (Jefferies & Company): There is a spike as a result of spouses becoming unemployed and getting on with the other spouses healthcare. Is that something that you are seeing and then what may be causing it and does that mean that it could continue?
Richard Galanti: 90% of our employees are hourly. Many of them who are married, our average employee who is in the plan, there are over two people covered by that person from that person, so there is an extra one and a quarter people, be it spouses or children. A lot of them are already in our plan because we are the plan of choice. If their spouse is working for another company in a comparable job, eight or nine times out of 10, they are coming to our plan because it is a much more favorable plan. We will not be hitting ourselves with it forever.
Charles Grom (JPMorgan): Do you have any color post Black Friday sales trends?
Richard Galanti: There has been a downward trend from September to October to November. There has been no change, there has been no uptick since then.
Adrianne Shapira (Goldman Sachs): Traffic has remained strong despite the fact that gas has pulled back. Is that a function of the lower food prices?