Key questions from the fourth quarter earnings call conducted by Costco Wholesale Corporation on October 8, 2008.
Adrianne Shapira (Goldman Sachs): What gas impacted the first quarter of last year?
Richard Galanti: Gas last year was a lot less of an impact just because of sales. Anybody can take some numbers and just to assume to get to a weighted average when it was 92.8 a year ago in the fourth quarter and now it is 88.12 in terms of sales penetration on GAAP versus non-GAAP. Pick a number on the levered 12 range for the company and if we are reporting something in the high 10’s it has got to be 12-ish and then gas is in the low single-digits and you can get a sense of how it is impacting. So the impact was a lot lower last year because it was only 2/3 of the penetration, 8 instead of 12.
Adrianne Shapira (Goldman Sachs): If gas maintains these levels what is the mix impact to margins going forward?
If gas were going to go up 30% a year, the price of gas, then you would see that continuation of what we saw in fourth quarter. In the other quarters while the core was up which includes gas, one we had more margin initiatives. We had not anniversaried them yet. We were still in our first year of honeymoon there and the year-over-year gas was 8 going to 9 to 10 going to 11. Now, I look at it as the core itself was up notwithstanding the fact we have anniversaried and we are down to our second year of showing some margin initiatives but you have got hammered by this giant increasing gas penetration. Similarly if a year from now in fourth quarter 2009 gas penetration is tense because gas has come down another 50 cents a gallon that will be just the opposite. You will see a huge benefit to reporting gross margin on core merchandise margin. That is why I have tried at least to share with you the underlying components.
Adrianne Shapira (Goldman Sachs): You made a good improvement on the payroll benefits. how do you think about that on a go-forward basis?
Richard Galanti: What we find is we are good at predicting some times bottom line and the sum of the big three things; members, gross margin and SG&A, then you pick which one you want to change. Given that there is some expectation of some moderate year-over-year gas inflation, not gas deflation year-over-year that would give you a tailwind and benefit to SG&A. So, if you are modeling out there I would assume, and given the gas right now the trend continues so even if there is a modest amount of gas inflation not 36% year-over-year you will see that impact to margin mitigate and show not as big a detriment.
Mark Miller (William Blair & Co.): How much of the margin impact is coming from the faster growth, lower margin consumables versus the non-consumables?
Richard Galanti: You add up the 75-80% of the business, year-over-year it was up 19. What I will call food and sundries tends to be close to the company average if not a shade higher like in fresh foods. Where you get hit is having essentially flat or down constant soft lines. Soft lines is typically a higher than average. It is a higher than average gross margin business. So it is not only the gas, but weakness in soft lines has hurt you on margin. Hard lines tends to be more in line, a shade less than the company average.
Mark Miller (William Blair & Co.): What would the comp range for fiscal 2009 EPS be excluding gas, excluding currency?
Richard Galanti: It is in the mid singles. Our assumption is the underlying comp is going to be less than it was in September, our original budget. But, it is hard to predict. If you just think about on a base sales of $71 billion, every percentage point in comp is $710 million, arguably at 4.5% pre-tax, is like $32 million pre-tax, 4.5 cents per share. Somewhere between 4-5% pre-tax on an incremental percentage point. An extra two percentage point helps you by 8 to 10 cents and two percentage points lower hurts you by that amount.
Mitch Kaiser (Piper Jaffray): You have experienced good core merchandise margin expansion in the four major categories. How do you feel in terms of continuing that trend?
Richard Galanti: The sales strength, which gives me more confidence with margin strength, is in food and sundries, which is 40+ % of our business David. Fresh foods, which is another 13% or so of our business. So that is where I have the most comfort. The biggest challenge, we like many retailers out there have approached Christmas with toys and trim a home and trim a tree with the exception of things like the Wii, conservatively. Particularly we do not want to end up with any Christmas ornaments the day after Christmas since we do not like a lot of markdowns. So we are not being conservative but we are being less aggressive. If we are wrong, you can always get hit there but our merchandise is spread across so many categories there might be a weakness in that stuff but there is strength in apparel because of the availability of goods. We have some great names coming in.
Mitch Kaiser (Piper Jaffray): Is your optimism on food, sundries and fresh food based on the underlying input costs or better purchasing leverage?
Richard Galanti: Part of my confidence is the people in charge of those two areas exude confidence in our budget making as recently as yesterday. Recognizing that we feel comfortable that it is competitive out there and nobody is more competitive than we are. Notwithstanding that we have shown we can show some improvements there. So we do not see anything changing that model right now.
Mitch Kaiser (Piper Jaffray): Is it more costs rather than taking pricing?
Richard Galanti: More cost than taking pricing. But as we talked about buy-ins, there are again we buy-ins are offered to everybody from supermarket chains to Wal-Mart to Target. We think we have a unique ability with our depot and cross-talk operations that we can bring in an extra 6-8 week supply or two weeks or whatever the vendor will allow at a lower price. We will keep it low for as long as we can but still make on the tail end of it. Those things help you. The big underlying thing is just the stuff we sell every day and within, again the risk more is going to be on the weaker sales results like the big ticket items with the exception of apparel principally because we can almost sell and piece much of the stuff that we can divert or buy directly on brands you never saw before.
Charles Grom (J.P. Morgan): When you look at the gross profit outlook embedded in your 3-325 view can you give a range if you assume gas is neutral?
Richard Galanti: No.
Charles Grom (J.P. Morgan): MFI growth in the quarter was slower. Has there been any change in the churn rate and renewals for people in year two?
Richard Galanti: We have not seen that. Our renewal rates have been frighteningly consistent over the last several quarters. Frightening in a good way given what is going on in the economy. So, the answer is no we have not seen that. It is interesting, in a given week all of a sudden we will see a slow down or pick up in business membership sign ups or a slow down or pick up in executive members and inevitably what it is is what the marketing department here at central is pushing out to the warehouse in terms of activities that focus on this four-week period. What we have done, but nothing new this year, is when we see a weakness out there we put more effort into it and generally it works.