Costco F1Q10 (Qtr End 11/22/09) Earnings Call Transcript

Dec.10.09 | About: Costco Wholesale (COST)

Costco Wholesale Corporation (NASDAQ:COST)

F1Q10 Earnings Call

December 10, 2009 11:00 am ET

Executives

Richard A. Galanti - Chief Financial Officer

Analysts

Charles Grom - J.P. Morgan

Mark Wiltamuth - Morgan Stanley

Robbie Holmes – Bank of America Merrill Lynch

Mark Miller - William Blair & Company

Dan Binder – Jefferies & Co.

Adrianne Shapira - Goldman Sachs

Robert Drbul - Barclays Capital

Colin McGranahan – Sanford C. Bernstein & Co.

Peter Benedict – Robert W. Baird

Laura Champine – Cowen & Company

Deborah Weinswig - Citigroup

Operator

Good morning. My name is Brandy and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter operating results for fiscal 2010 conference call. (Operator Instructions) I would now like to turn the call over to Richard Galanti, CFO. Please go ahead, sir.

Richard A. Galanti

Thank you, Brandy and good morning. This morning’s press release reviews our first quarter 2010 operating results for the 12 weeks ended November 22nd, about two-and-a-half weeks ago. As with every conference call, I’ll 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, as you know we reported earnings per share at $0.60, same as last year’s reported first quarter earnings of $0.60. Last year’s first quarter results included a few items of note -- the first, a $28.4 million pretax charge to SG&A related to the stock market’s fall last November and a mark-to-market hit, if you will, to the cash value of life insurance policies covering about 800 Costco management and employees.

A second smaller item, a $5.8 million pretax charge to interest income related to security impairment of our short-term cash investments. Together, these two charges total $34.2 million pretax, or $0.05 per share hit at last year’s first quarter earnings.

In last year’s earnings release, it was also pointed out that one, we had very, very strong gasoline profits and two, the strengthening U.S. dollar last fall relative to foreign currencies which at the time we termed FX headwinds, resulted in our foreign earnings when converted and reported into U.S. dollars, effectively hit us last year in the first quarter by $0.03 a share.

In this year’s first quarter results, gasoline profits were actually pretty good but still about $0.04 a share lower than in the first quarter of fiscal 09 when the results were really unprecedented as gas prices were dropping precipitously.

And with respect to last year’s first quarter FX headwinds, are we now of course seeing strengthening of many of the foreign currencies relative to the U.S. dollar, such that this year in Q1 we actually benefited by about a penny a share from what you could now call FX tailwinds. The last item I’ll point out is ongoing higher employee benefits costs, mainly consisting of higher U.S. healthcare costs.

I mentioned to all of you actually last December 11th on our -- on fiscal 09’s first quarter conference call that such costs hit first quarter results by an estimate $0.01 to $0.015 a share above what they had been running, mostly in the last month, month-and-a-half of Q1, which is coincidentally when the stock market was plummeting and we had a sense from some of our third party providers that part of the reason of increased utilization had to do with that. I don’t know that. We also saw more higher-than-expected healthcare costs in Q3 and 4 of this past fiscal year and that trend continued in Q1, with such expenses still coming in a bit higher, probably an incremental $0.01 to $0.02 higher than expected.

On balance, this year’s $0.60 figure is just under last year’s. If you look at last year’s 60, add back in the $0.05 for the unusual charges, you get to a 65. If you look at this year’s 60, of course we had no charge, gas was $0.04 less, so that’s $0.04 of the $0.05, or where it is, at least. Then of course we had a $0.01, as I just mentioned, benefit from FX this year compared to last year’s base case. That $0.01 would essentially imply about $0.02 less year over year, which is about what we estimate on the healthcare side, so those are the reasons -- not excuses but just the fact that that’s where we saw it.

In terms of sales for the first quarter, our 12 week reported comparable sales figure for Q1 showed a 3% increase, plus 1% in the U.S. and then plus 13% internationally. Excluding gas price changes and the impact of FX, the 1% reported U.S. comp would actually be plus 2% for the first fiscal first quarter and the 13% international comp would be a plus 8.

And all told, the combination of those two, the 3% total company reported comp would remain at plus 3%.

Other topics of interest I’ll review this morning, our opening activities -- we opened a total of six new locations during the first quarter of fiscal 2010, which ended again two-and-a-half weeks ago on November 22nd. All six openings were in the U.S., including one in Phoenix in the Paradise Valley Mall; one in Redwood City -- we actually had closed that unit in a little under a year ago and on the same premise with a little bit of extra land, built a newer, bigger location; one each in Colorado, Missouri, and Ohio; and of course on November 12th, we saw many of you in Manhattan when we opened at 116th Street and East River Drive in New York City.

For fiscal 2010 overall, a plan of 16 to 18 new locations, 13 or 14 of which would be in the U.S., including the six I just mentioned, as well as certainly one and maybe two relocations -- it looks like it is one at this point.

Since Q1 end on November 22nd, we’ve opened two new locations, one new warehouse in Haywood, California, and one relocation in [Warrant], Oregon, on the coast. We currently operate 566 locations around the world, including the 32 in Mexico with our joint venture partner.

Also this morning I’ll review with you our online results, membership trends, further discussion of margins and SG&A in the first quarter, and give you our balance sheet information.

Again with sales, total sales were at 5.5% in the quarter to $16.9 billion, up from $16.0 billion. Comps, plus 3% and again taking all the noise from gasoline price changes and FX issues, the U.S. comp was a 2% plus without gas and the international and local currency was a plus 8%.

For the quarter, our reported 3% comp was a combination of an average transaction decrease of about 1.5%, with FX and gas being about a wash to each other that year. But we are still seeing deflation, which I will talk about in a minute.

And average frequency increase continuing strong at a 5% increase in the quarter.

In terms of sales by geographic region, no big surprises in the U.S., looking over the last couple of quarters, Q4 and Q1. Probably the biggest in actual percentage points improvement had to be California, although it was also the weakest in Q4, and slightly positive in Q1.

International again has remained in terms of local currencies our strongest to 7% in local currency in Canada, our biggest international operation, and a little over 8% in local currencies among the other international operations.

In terms of sales results by merchandise category, in the past few months essentially we’ve reported September and October and November, those 13 weeks for our retail reporting calendar. Within food and sundries, comps are in the low single digits with tobacco, candy, and alcohol being relative standouts. Keep in mind that throughout food and sundries along with fresh foods is where we have been continuing to experience a fairly hefty consumer products price deflation, also impacted of course by our increasing penetration of private label.

Our hard line sales showed positive mid single digit comps in [majors] [inaudible], sporting goods, and hardware. Within soft lines comps, which overall was in the low double-digit range, apparel, housewares, and jewellery were up in the low to mid single digits with many of the other departments like small appliances, domestic, media, furnishing up 10% to 20% each. Recognizing some of those really strong improvements are comparing against relatively weak numbers a year ago.

Fresh foods up low single digits. A stand out continues to be unit sales increases, both in meat and produce, which we continue to enjoy strong unit increases. The challenge again is deflation in fresh foods -- we’ve seen a little let-up in deflation in the last month in the meat side of the business, but produce continues to be somewhat in the 10% plus deflationary area.

In the second quarter, which we are now 2.5 weeks into, we are so far enjoying positive impact of sales from year over year gasoline prices, as well, barring any future dramatic shifts in foreign currencies, which of course we certainly cannot predict, versus the U.S. dollar, the negative impact to sales earnings that we experienced since last fall are now reversed and are currently positives to sales and earnings. Again, we don’t know what will happen in the future with gasoline prices or with FX ratios relative to the dollar.

Moving down the income statement line items, membership fees were $377.4 million, up 2.23%, one basis point lower than a year ago in the quarter, up 5% in dollars or almost $19 million. Again, we -- since we talked about it last year when it was hitting us the other way, the positive FX, that $18.7 million, would have been about -- just under $14 million up without the benefit of FX. Still a good showing, we feel.

In terms of membership overall, we continue to benefit from strong renewal rates overall and continued increasing penetration of the $100 a year executive membership. Our new membership sign-ups in the first quarter companywide were almost exactly flat year over year, actually an improvement from recent prior fiscal quarters when new sign-ups were down 5% year over year in the third quarter of last year and down 3% in the fourth quarter of last fiscal year.

Overall, fewer openings do impact new sign-ups. I believe where we offset a little of that weakness is in the strong new sign-ups in places like Australia and Asia where in the last couple of months of fiscal -- in late summer, we opened one each in each of those four countries -- Australia, Japan, Taiwan, and Korea.

In terms of number of members at Q1 end, it was 21.9 million Gold Star members, up from 21.4 million at year-end; 5.75 million business, primary business, up from 5.7; business add-ons remained at 3.4 million, so all told 31.1 million households at Q1 end, up from 30.6 million at fiscal yearend on August 30th.

With spouse and partner cards of 56.4 million at the end of the first quarter, up from 56.0 million at fiscal year end.

As of November 22nd, paid executive members were just shy of 9.3 million, an increase of 341,000 in just the past 12 weeks. That represents about 28,000 a week increase. We did introduce the executive member program in the U.K. in Q4, so now that we operate that in the U.S. and Canada and the U.K.

The U.K. [added together] for about 25,000 of those 341,000, so even without the U.K. the weekly number of increased executive members was a little over 26,000 per week in the quarter.

In terms of renewal rates, they have continued strong, essentially the same rate of renewal as it was at fiscal yearend, 92% in business and 86% in gold star and 87.3 for the company. And that would be U.S. and Canada.

Now going on to the gross margin line, our gross margin in the first quarter was lower by 9 basis points at 10.88 versus a 10.97 last year. As we always do, we’ll jot down a few numbers -- the line items of these numbers are merchandise core, second line item, ancillary businesses; third line item, 2% reward; fourth line item, LIFO; and then total. Looking at three columns, all of fiscal 09, Q409, and Q1 of fiscal 2010. Now going across core merchandising and for all of 09, we were up year over year 18 basis points; in Q409, up 48; and in Q1, up 15; ancillary businesses in fiscal 09 was up 7; in Q4, down 3; and in Q1, down 20; 2% reward, minus 6, minus 9, and minus 3 -- of course the minus there reflects the increasing penetration of the 2% reward program; LIFO in all of last year was plus 9 basis points, in Q4 plus 22, when we took the credit at the end of the year; and in Q1, minus 1, a reflection of there was no LIFO charge or credit in Q1 this year versus a small credit last year. And all told, all of 09, 28 basis points up; Q4, 56 up; and Q1 fiscal 2010, 9 basis points down.

As you can see, while our overall reported gross margin was lower year over year by nine basis points, our core was up 15. Our lower margin gas business represented 9% of sales a year ago in Q1 and 8% this year in Q1, reflecting a little bit of gasoline deflation there. Those sales penetration of our higher margin core merchandise business was up year over year, about 15. Now, the actual four major departments here, food and sundries, fresh foods, hard lines and soft lines, which apprises a little over 80% of our business, those -- looking at just those sales and those margins, we are up 11 basis points -- again, the 15 reflects the fact that those represent a little bit higher mix this year than last year. But nonetheless, up as well.

Of the four major departments, food and sundries, hard lines, and fresh foods were up year over year in Q1, with soft lines coming in a little lower year over year.

In terms of factors impacting gross margin going forward, gasoline -- of course, gasoline margins last year in Q2 were substantially lower than first quarter, which was again an unprecedented positive last year in Q1, and we’ll see where it comes out this year. We won't have that [trend of comparison] though. In addition, as you know in last year’s second quarter earnings report, we took a significant number of markdowns during the -- really during the four weeks of December, trying to drive sales as commodity prices were quite deflationary but many of the procurement costs just hadn’t been reflected yet, but we chose to take a little over $30 million of markdowns that were unprotected. This is not currently happening this year.

Moving to SG&A, our SG&A percentage Q1 over Q1 was higher by four basis points, coming in at a 10.50 this year compared to 10.46 last year. Again, I’ll ask you to jot down the following line items for a little three column chart here -- operations, central, the third would be stock compensation RSUs, quarterly adjustments, and total. Again, the three columns would be all of 09, Q409, and Q1 of fiscal 2010.

For all going across, operations for all of 09 was a minus 47 basis points, meaning higher year over year by 47; operations, minus 61; and for the -- for Q4, rather and Q1, minus 16.

Central, minus 7, minus 8, and minus 3.

Stock compensation, minus 1, minus 1, and minus 3.

Quarterly adjustments, minus 3, plus 7 in Q4, and plus 18 in Q1 -- that of course relates to the -- that $28 million mark-to-market charge that we talked about earlier last year that hit us versus nothing this year.

All told, 58 basis points higher in 09 overall, 63 basis points higher in Q4, and 4 basis points higher in Q1.

A little editorial on these numbers -- while SG&A operations was higher by 16 basis points year over year in Q1, a big component of that, about 10 basis points of the 16 was gas mix change in the quarter. Our central expense was higher year over year in Q1 by 3 basis points, which is actually an improving trend from the fourth quarter when it was minus 7.

Central payroll, by the way, in the first quarter year over year was actually lower by one basis points -- that of course offset with what I mentioned earlier, the higher healthcare costs.

Our stock compensation expense again was slightly higher. Benefits, you know, we’ve talked about this -- Q1 year over year, the percentage of benefits -- benefits dollars had increased by 17%, a little bit lower rate of increase than in the past two quarters. About a third to a half of this increase is due, as I mentioned last quarter, to the greatly reduced employee turnover and therefore a smaller percentage of employee base who are yet to be benefits eligible. You know, a little over a year ago, the percentage of our U.S. employees that were benefits eligible was in the low to mid 80s. Today it’s in the high 80s to low 90s.

We don’t see a lot of relief right now, although again the rate of increase of dollars in Q1 was a little bit lower than in Q3 and Q4.

I mentioned the quarterly adjustment, the positive 18 was simply a fact that there was no unusual charge this year whereas in Q1 last year, we had that $28.4 million pretax charge for life insurance.

Overall, not a bad SG&A [ports], given sales levels, a little gasoline deflation, and increased benefits costs.

In terms of pre-opening expense, last year was $12.8 million -- this year $10.8 million, so $2 million better, or two basis points lower, and no big surprises. Last year we had 8 openings in the quarter and this year we had 6, as I mentioned earlier.

In terms of provision for impaired assets and closing costs, last year we had charge of $6.8 million in the quarter. This year we had a charge of $2 million, so an improvement of $4.8 million year over year positive swing.

All told, operating income in Q1 was up 1.6% from $420.9 million, up $7 million to $427.7 million this year.

Below the operating income line, reported interest expense was about the same in both first quarters, with Q1 this year coming in at $24.1 million, actually a shade lower than the $24.6 million last year. These amounts mainly reflect, of course, the interest expense on our $2 billion debt offering that we did in February of 07.

Interest income and other was lower year over year by $3 million, $18.2 million this year in the first quarter versus 21.2 a year ago in the first quarter. Actual interest income was up about $400,000. The other big change was our half of Mexico’s earnings since we don’t consolidate Mexico -- half of the earnings of that operation go into that line. Our half of those earnings were lower year over year due to -- principally to the weak Peso. Again, there was about $3 million less of income. In Pesos, profits for the Mexico operation were up in Q1.

Overall, pretax income was up 1% this year in the quarter, $421.8 million this year versus $417.5 million last year.

Our tax rate, not a big difference, a shade lower -- this year the tax rate came in at 36.1%, again slightly lower than the 36.4% a year earlier.

A quick run-down on the balance sheet -- the cash and equivalents and short-term investments, $4.189 billion; inventories, $6.223 billion; other current, $1.215 billion; all current assets, $11.627 billion; net fixed assets [at PP&E], $11.115 billion; other assets, 736; and total assets, 23.478.

On the right side, short-term debt, 81; accounts payable, $6.318 billion; other current liabilities, $3.886 billion; total current liabilities, $10.285 billion; long-term debt, $2.292 billion; deferred and other, 470; all liabilities, $13.047 billion; minority interest, 86; stockholders equity, $10.345 billion -- again, total side of the right of $23.478 billion.

We will have a cash flow later, not today though, but depreciation and amortization, so you can put that in your model. For the first quarter, it was up to $184 million.

Balance sheet again quite strong, debt to cap, 19% -- plenty of financial strength there. Accounts payable, per the balance sheet, accounts payable as a percent of inventories last year at first quarter end was 99%. It was three percentage points higher this year to 102%. That includes, of course, all construction payables and other payables. Looking just at merchandise payables to merchandise inventories, we improved 5 percentage points from 83% a year ago to 88%.

Average inventory per warehouse, up about 2% to -- and of course we built up for Christmas both years but -- so it’s a little higher during the year as well but on a quarter over -- first quarter over first quarter basis, it was up $245,000, averaging $11.676 billion versus $11 billion -- I’m sorry, $11.431 million a year ago.

The main reasons, strong FX represented actually more than $245,000 -- it represented $372,000. With the core merchandising areas, the notable three departments, toys were down about $160,000. I think a big chunk of that just has to be -- do with less big ticket electronic toys relative to a year ago, less quantity. Jewellery was down about $115,000 and what majors, what we call majors, which is electronics, was up $138,000 -- very prominent in our locations.

In terms of CapEx, in Q1 we spent $307 million. For the year, we’d expect it to be right around the $1.3 billion, maybe a shade higher if we get a few more warehouses opened. We are working on some -- we’re not sure when they will close.

In terms of expansion overall, as I mentioned in the first quarter, we opened six new units, no relos. That Redwood City I mentioned was not considered a relo because we actually closed it outright a year ago and then it went out of the number last year and put it in this year. In Q2, we expect to open two new units, one of which is a relo, so a net of 1. In Q3, one new one, no relos, so a net of one; in Q4, 8 new, no relos, so a net of 8; all told for the year, that would be 17, less one relo in Q2, for a total of 16. And as I mentioned, we’d expect somewhere in the 16 to 18 range this year.

In fiscal 09, we added about 3% to our square footage and ended the year with 543 locations in operation. In fiscal ’10, assuming the 16 here, another 3% square footage increase and be at 559.

As of Q1 end, our total square footage in operations stood at 75.813 million square feet, again some of you had asked for that, so that’s the number there.

Two final items before I turn it back over to Brandy -- as usual, later today, later this morning you will see the supplemental information packet online, which includes some [useful] stats and our detailed balance sheet. That will be posted on the Costco investor relations site later this morning.

One other little quick thing -- this quarter, this year, we adapted a new accounting pronouncement related to the accounting and disclosure for non-controlling interests, formerly referred to as minority interests. The results of this adoption on our financial statements is to separately list on the face of our P&L the amount of earnings attributable to non-controlling interests below the net income -- below net income, to arrive at a new sub-total referred to as net income attributable to Costco. This amount was previously included in the interest income and other line. Additionally, on the balance sheet, minority interest, which was formerly outside of equity is now included in the equity section, listed as non-controlling interests. Again, I think this is just a small accounting announcement but we did it and so if you are questioning why there is a new line item on the income statement, that’s it.

With that, I will open it up for Q&A and turn it back over to Brandy.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Charles Grom with J.P. Morgan.

Charles Grom - J.P. Morgan

Just on the gross profit, the core was up 11 basis points, I think you said, and in the fourth quarter it was up 6 -- just wondering if you could give us some color by category.

Richard A. Galanti

I don’t have -- I think if I recall in Q4, two of the four sub-departments were up and two were down slightly, but still net positive, whereas we had three of the four this year in the first quarter. There’s really nothing that discernible there. Overall I think the trend in the core business has generally been up for the last several quarters, up slightly.

Charles Grom - J.P. Morgan

Okay, and you alluded to it on your prepared remarks regarding the cycling of items, the seasonal markdowns, the aggressive pricing -- how should we think about gross profit margins and SG&A over the next couple of quarters? I know you don’t want to give guidance but just can you hold our hand a little bit on how we should think about those two line items?

Richard A. Galanti

Well, look a lot of it depends on sales, of course, underlying sales. You know, we’ve got our fingers crossed. I think overall Q1 was good, November was a little shakier than September and October, nonetheless overall was pretty good.

You know, clearly the biggest item is the fact that we took $35 million of commodity price markdowns on milk, cheese, butter, chickens that wasn’t covered and we haven’t seen any of that to date. And I’m not suggesting tomorrow either but again, so far, so good there.

The fact that we lost a little money in gas last year and so far we haven’t this year but again, tomorrow’s another day there too, but those are at least directionally positive for us.

If Jim were sitting here, I think he would say margins aren’t our problem, our challenge -- we feel that we’ve been able to do a little of both here, to be able to be competitive and to improve margins slightly.

Charles Grom - J.P. Morgan

Okay, and then just a last question on deflation -- you spoke to still seeing it in produce, meats letting up a little bit -- can you talk about dairy? And then also maybe the center part of the store, Kroger talked about their grocery deflation getting worse. Are you guys seeing that or did you see that earlier in the year?

Richard A. Galanti

I think we probably talked about it earlier than the supermarket chains did. I think they probably were starting to incur it as well. We of course probably had been pushing a little harder private label, which does two things -- one is as you replace some of the -- you know, even though the gross margin dollars are generally pretty good there. You know, the average private label penetration is down 20%, 25% versus the price we sell the branded good and once that drives business, the brands come back and lower prices a little bit too.

You know, again this is not statistically perfect but last quarter I know we took, or a couple of months ago we took a look at the top 20 highest volume like items in each sub-department. Which is probably half of our sales in terms of dollars and it was in the 5% to 6% range on pricing. Now, I don’t know if that means it’s four or five but it’s certainly now one or two, but has it gotten worse? I don’t think it’s gotten worse. We’re still cycling through this major year of big deflation. I think once we get into January, February, hopefully that cycle will be broken a little bit and it won't be ongoing.

I will tell you that talking to Tim Ross, who is head of the 50% of our business which is food and sundries in the U.S., his view is is when asked, I’ve been asked by many of you about the competition with the supermarkets because of all the pricing. And his view is look, any lower prices, it’s not a positive but we really don’t see -- feel a lot of impact from the supermarkets. Most customers, most members are shopping both places and sure they are going to pick up some sale items there and some smaller sizes or whatever, but from a competitive standpoint, he doesn’t feel that our pricing has been impacted by what the supermarkets have been doing.

Charles Grom - J.P. Morgan

Okay. Thanks for the color.

Operator

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

Mark Wiltamuth - Morgan Stanley

I wanted to dig in a little more on the private label. You had a slide on that at your analyst day up at the Harlem store opening and you were talking about getting the private label to go from 22% to 37% -- what’s a realistic timeframe to get to that number and what are you thinking about for private label penetration category wise in the year ahead?

Richard A. Galanti

Well, I think when Jim showed that slide and there was a couple of follow-up questions on it, I think he acknowledged that that was a slide that was done about a year, year-and-a-half ago and looking out, I think three and six years at the time. And so now four years from now or something, I believe that was correct -- the implication would be we go from the low 20s to the mid 30s. I think he chuckled and said those are our goals -- those are stretched goals that we are shooting for -- the timing is probably longer and I think when pressed, he obliged that -- who knows how long -- it’s certainly more than four years. I think trend wise, we will keep -- you know, private label works for us and so does branded goods, by the way. We want to be able to sell both and it will keep going in that direction.

Mark Wiltamuth - Morgan Stanley

And anything notable in the year ahead, and which categories are you going to be emphasized in the year ahead as you are doing more private label?

Richard A. Galanti

I think all of the above. I mean, on the food and sundries side potentially there’s probably a little less on the non-food side. You see it in -- you certainly see growth in apparel on the private label. We’ve seen growth at private label in even some of the holiday items, a lot of the trim at home and things like that. Again, we’ve already done luggage. More of it is on the food and -- on the traditional supermarket side, I would say.

Mark Wiltamuth - Morgan Stanley

And longer term, do you think this is one of your primary margin levers or is it more secondary?

Richard A. Galanti

I would say it’s up there with other initiatives. It is certainly a chunk of it.

Mark Wiltamuth - Morgan Stanley

Okay. Thank you very much.

Operator

Your next question comes from the line of Robbie Holmes with Bank of America Merrill Lynch.

Robbie Holmes – Bank of America Merrill Lynch

Just a couple of quick questions -- first, Richard, I was hoping -- I see that Coke is going back into your stores. Was there anything you learned for that brief moment of time it was out of there? If you could share with us about what cycled up when that was pulled out? Was it your private label, was it other national brands? And are there other brands like Coke that we could see a similar situation with?

And then the second question is the slow-down in your traffic growth in November, is there anything anecdotal you can speak to and whether there’s been a rebound from that in December at all? Thanks.

Richard A. Galanti

Well, the Coke thing, I think it was just -- I don’t think we’ve announced anything but it is correct. I think effective this coming Monday, Coca-Cola products will be back on our shelves. Look, I mean, I think our sign that we had in store everywhere basically said it all -- it says until we can provide our members with these products at competitive prices and provide our members a value, we are not prepared to sell it and we now going to sell it, so I think that’s really all I can say at this point.

You know, we have a long-time relationship with Coca-Cola, they are a great brand and we are happy to have them on our shelves.

I don’t think it -- I know everybody wants to know a little bit more dirt on it but that’s all you are getting.

On the transaction, traffic size, when I look at September, October, and November, traffic was huge in September. It was like what, 6.5, 4.5, and 3.5 basically, Bob? Traffic -- almost 4 in November -- all those are great numbers, guys. I can’t say anything about December so far, until early January but again, we -- everybody -- given September and October was pretty darn good relative to where it had been, you know, everybody wanted a little more in November, so did we -- we felt all three months, including November, were pretty good and going into Christmas, we felt pretty good. Going into Christmas, we feel pretty good.

Robbie Holmes – Bank of America Merrill Lynch

Terrific -- hey, thanks a lot, Richard.

Operator

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

Mark Miller - William Blair & Company

Building on the traffic question, what do you think is the normalized run-rate for traffic and given the exceptionally strong volume growth you had in fiscal 09, do you think we should expect it to be somewhat lower in fiscal 10?

Richard A. Galanti

Yes. If you look at -- and some of you have heard this before -- at 10 years of monthly comps, up until when gas prices really started going through the roof in the spring of 08, it was never below minus 1 in a given month or above 2, and generally between a half and -- zero and one-and-a-half. And never was it above 2, other than a timing difference of how a July 4th fell or something like that. All of a sudden, it was in the 2.5s, and the 3s, and of late the last several months, it’s been in the 3s to 5.5s, one month, 6.

So I don’t think we can assume that on a 4 -- let’s say a 4 average over the last 12 months, we can keep doing 4s on top of 4s, given that for 10 years, we were doing 1s on top of 1s.

But I also would hope that it’s still a positive number and not a negative number, meaning that we kept this frequency level and people that have gotten used to shopping with us more frequently, arguably for food, arguably this economy has helped enhance that frequency. I think we would hope that it would at least be -- have a plus sign in front of it.

But we can’t sustain 4s and 5s.

Mark Miller - William Blair & Company

Richard, as we think about leverage point on expenses for comps, to the extent that deflation moderates at some point, I know it’s tough to call that exactly but should we think about some moderation in the leverage point for which expenses could be favourable versus sales?

Richard A. Galanti

Well, clearly -- I know I’ve said it before and I just read it somewhere else yesterday -- a little inflation would be nice for the bottom line standpoint here -- not a lot of inflation, but a little. You know, again, as it subsides, it helps us, or hurts us less in the case of if it’s still -- it’s inflationary.

Mark Miller - William Blair & Company

My last question -- looking at the November sales relative to the 12 weeks, it looks like the 13th week grew quite a bit faster so the beginning of fiscal second quarter, was anything unusual around the timing or your Thanksgiving, post-Thanksgiving experience? Because it looked like it picked up quite a bit for you.

Richard A. Galanti

Well, I think -- I haven’t -- I think the math does work out that way, so good analysis. There’s nothing unusual in that.

Mark Miller - William Blair & Company

Okay, thanks.

Operator

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

Dan Binder – Jefferies & Co.

A couple of questions -- first with the obviously the low in store growth here, can you just give us a rough idea what you think the membership growth dollars should look like, and excluding FX, so local currency membership growth dollars in the next couple of quarters? Secondly, if you can give us a little bit of color on the new store productivity, particularly in the newer stores, Harlem and I think also the mall-based store in Arizona, that would be helpful.

Richard A. Galanti

Well, I can't give you any direct guidance on membership dollars. The drivers of course are increasing conversion and penetration of executive membership, which we do every quarter -- we just didn’t give out those numbers and the fact that we are still adding 20 -- even net of the U.K., which is brand new, just in the U.S. and Canada we are adding 25,000, 26,000 either conversion or new sign-ups a week, is pretty darn good in that regard. That helps.

There are no current plans to raise the base membership. As you know, historically we’ve done that every five or so years and we did it I think three, almost four years ago, so it’s still a while off before considering that.

But again, certainly -- and in terms of the slowdown of openings, I think one of the things we talked about -- I think it was the New York opening, that while we opened I think 15 or 16 in 09, a net of 16 or 17 this year, 16 to 18, that we would expect -- we are hoping that and planning for that number to be in the low 20s in 2011 and 12 and that the mid to high 20s would be on that.

Now, before but certainly our efforts are to push that number upward in terms of openings. That doesn’t impact the next two quarters, of course, but that’s where that is.

And what was the second question?

Dan Binder – Jefferies & Co.

The second question was just around new store productivity, just curious how you -- your early results on the Harlem store and then any additional color on the mall-based store in Arizona.

Richard A. Galanti

We’re not going to give specific numbers but the malls overall have done well. I mean, we opened a year-and-a-half ago in Houston, [inaudible] We’re in Cumberland in Atlanta, in North Atlanta, which has been very good. I think so far the results have been fine. I can't give you specific numbers.

New York is doing as we expected -- now that doesn’t help you a lot. I can tell you sign-ups are good. We are getting very strong weekend traffic, as expected, because people actually go out and do stuff, rather than on the way home from work say hey, let’s go to Costco, like they do in the suburbs. And we are building that small business business, so we are pleased with where we are. This is -- it’s not like a Tokyo or a Taiwan opening, which is mass hysteria of positive. But it’s so far, so good.

Dan Binder – Jefferies & Co.

Given that that store is a bit smaller and the results are as you expected, would you consider opening up smaller stores in markets where real estate is a little bit tougher to get, maybe the size of store that you’d want but would you think about duplicating that elsewhere?

Richard A. Galanti

Well, you know, never say never -- I mean, Manhattan is unique. I can tell you that several years ago, there was a great location in a very affluent part of Atlanta that was six or seven acre site, not a 10 or 12 acre site and it required two floors of parking. And at the end of the day, as much as we wanted to do it because there was really nothing in that area, I think the discipline of saying no was due to the fact that when you’ve got double-decker anything, it’s more expensive and we should not allow ourselves to go down that road unless we are -- it’s the last thing that we can possibly do.

So I think -- will there be more in the future? Yes. This by the way, recognizing in Manhattan you don’t sell a lot of patio furniture and 50 pound bags of dog food, so some of the bulk was taken out of it, bulk items. Clearly it’s smaller but in addition, we are fortunate that give this is a five-storey retail structure, we had the ground floor, on the ground floor there’s basically two things -- us and the receiving docks for the entire facility, the entire five floors of retail. So we have great receiving without freight elevators, without escalator ramps because of two floors of retail, and so there’s some -- you know, for a city like -- relatively speaking, it’s great relative to what we thought we could ever do in Manhattan.

I don’t -- could there be some more, yes. I don’t think we are going to be rushing to do a lot. Now, could we -- if there were two more sites in Manhattan and other parts, would we do it? I think we’d do it in a second.

Dan Binder – Jefferies & Co.

And just finally, the late month surge that you saw in November business, has that continued into December?

Richard A. Galanti

Yeah, we can't comment.

Dan Binder – Jefferies & Co.

Okay. Thanks.

Operator

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

Adrianne Shapira - Goldman Sachs

Thank you. Richard, you talked about your not really being impacted by the supermarkets in terms of pricing but give us a sense of what you are seeing the competitive environment out there -- we’ve obviously heard a lot of chatter about Walmart getting more aggressive. Give us some thoughts, especially as you are heading into that easy margin comparison into Q2.

Richard A. Galanti

Well, again, I don’t want to belittle the supermarkets or Walmart -- they are both -- the industry, if the supermarkets and Walmart are both incredible retailers. We -- let’s not forget the fact that our average mark-up is 11% and supermarkets’ average mark-up is in the mid 20s and Walmart’s, depending on their format, is -- you know, not Sam’s but the Walmart stores, are probably somewhere from the high teens to the low 20s, depending on the format in the departments.

So at the end of the day, it’s hard to beat our pricing overall. We recognize that people still shop at a Walmart or Target every week. We recognize that everybody still shops at a supermarket a couple of times a week but we are getting more of that dollar than we’ve ever gotten before, given our frequency and given that’s what people are looking for first and foremost. So in terms of pricing, I don’t want to be arrogant about it but I can't predict what the future will hold but we’ve held our own pretty well in very tough times and as I mentioned earlier in this conversation about the supermarkets, we don’t believe that they have impacted us a lot on our pricing.

Adrianne Shapira - Goldman Sachs

Okay, so really no change in the competitive landscape this holiday season?

Richard A. Galanti

That’s your -- those are your words. I’m not trying to say yes or no.

Adrianne Shapira - Goldman Sachs

Okay. And then just talking about the categories, obviously we are seeing some encouraging non-food trends versus food -- give us a sense of what you are learning in the basket, where the interest is, and what you have done in terms of the mix to perhaps improve that non-food trend. I mean, we’ve seen actually TV unit sales have actually started to come down pretty dramatically -- you know, the plus 30s. I think last month was only up 15%, so give us a sense -- you are obviously seeing some recovery in the non-food but where is it coming from and have you done anything in the mix in terms of pricing to spur that?

Richard A. Galanti

We’ve done nothing with regard to pricing. Again, there’s no new sale items or new lower priced items on stuff. I think part of it has to do with the fact that we are starting to compare against the weakness from a year ago, part of it is the fact that people are staying home a little more -- I mean, if you looked at some of the categories like housewares and domestics and things like that, I think apparel, it’s a combination of what I just said as well as availability of goods. There’s still a lot of great availability in there and continuing better brands and what have you.

You know, if anything, a lot of the focus -- I think that our non-foods buyers are just relieved that it finally turned after suffering something that they hadn’t suffered in forever -- something with a negative in front of it.

Bob was just saying here it really is all categories across the board. There’s not -- you know, on the electronics side, I think we are doing okay, given the fact that it was even 15 or 18 in the last month or two. That’s on top of a 40s and 50s a year ago. Clearly we can't sustain that but fortunately as the unit growth has come down some, still growth, so has the level of deflation in those categories.

And again, electronics is helped by the fact that people -- you know, our camera business is quite strong -- deflationary but unit sales are still making a positive, and PCs, with the netbooks and everything else, deflation is strong but unit sales are stronger and frankly I think it’s all -- it really is all of the above and the continued improvement in our fresh foods area. Every day we feel better about our fresh foods selection and growth and how it separates us from the rest. I think people brag about our stuff because of the quality, the size, and the price.

Adrianne Shapira - Goldman Sachs

Okay, and then your point about some of the opportunistic buys, any change there? I mean, everyone seems to have been focused on leaner inventory -- is that still as fresh as we saw, or is it getting tougher to find those buys?

Richard A. Galanti

In terms of the direction, throughout this time, even a few months ago as we were getting ready for the Christmas and the Fall seasons, the message from Jim to the buyers was be aggressive. We are in a unique position that when we make a mistake, it means we’ve got six or eight weeks of inventory instead of three or four and the stuff we sell aren’t -- you know, you’ve got to be a little more careful let’s say on gift baskets, because there’s a short window before Christmas on those, not a 12-week window, and -- but you can afford to be aggressive relative to our complementary retailers.

In terms of -- there’s less -- you know, a year ago, there were some really unique things out there because some of the really high-end apparel and related goods and electronics -- I mean, remember we were selling the two-pack of TVs at ridiculous prices relative to what they had been a week before, that had to do with the fact there was inventory backed up as traditional retailers were cancelling and we -- there’s not as much of that because the manufacturers have planned better this year knowing what the economy was doing.

Adrianne Shapira - Goldman Sachs

Great. Thank you.

Operator

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

Robert Drbul - Barclays Capital

The question that I have is on the electronics business a little bit, can you talk a little bit about demand and pricing and sort of how the lower price points or the lower screens are doing versus larger ones and how you see that playing out?

The second question that I have is when you look around at the business from the perspective of the gasoline business, how competitive has that been or what are your expectations around that? Because the supermarkets also have talked a little bit more about their gas pricing and the challenges there.

Richard A. Galanti

I think the trend overall in gas has been -- it’s still volatile and still requires a thick stomach lining. I think the bad weeks are not as bad and the good weeks are better than they used to be, so overall it’s become a little bit more profitable business and I am only speaking of the last 15 months or whatever, but I actually remember when we had -- not a lot fewer stations but fewer stations two or three years ago, a bad week you could lose $3 million or more. Today it seems like a real bad week is in the low 2s. And again, that’s anecdotal but at least it’s directionally it’s been a little -- still volatile. If you look at last year, again in Q1 we had great profitability, Q2 and 3 we lost money -- not a lot, and then Q4 we made a decent amount. So for overall, we did fine for the year, our best year ever but it was certainly volatile. And as I mentioned earlier on this call, Q1 is starting out -- I’m sorry, Q1 did actually pretty good but it was comparing up against ridiculous good a year ago. And Q2, we lost money last year -- two weeks into it, we are making a little but again, nothing -- you never know what can happen tomorrow.

The other part of that question -- electronics.

Robert Drbul - Barclays Capital

Yes.

Richard A. Galanti

Our sweet spot actually is still the bigger TVs. Those still are cheaper. I mean, there’s lots of 40 to 55 inchers in the $800 to $1600 range. And are we selling some of the smaller ones? I think on the TV side, our chart, our graph would be skewed to the right with price points going up to the right.

On the netbook side, they are doing fine. We still sell more of the full line laptops and desktops, recognizing a really good full line laptop now is $600 to $800. Our challenge is to keep putting more into it so we can drive the price point up a little and still be a great value.

Robert Drbul - Barclays Capital

Thanks, Richard.

Operator

Your next question comes from the line of Colin McGranahan with Bernstein.

Colin McGranahan – Sanford C. Bernstein & Co.

I really just wanted to focus on SG&A dollars -- so if I back out the $28 million charge from last year, and then I don’t know if my math is any good or not but try to adjust it for currency, it looks like the SG&A dollar growth year over year was about 6.5% adjusted for currency, a little bit faster than in the fourth quarter but obviously the sales, the underlying sales improved a little bit. But you managed to leverage payroll -- now, could you just give us anymore color on anything you were able to do to kind of keep the SG&A dollars in check during the quarter and maybe how to think about that growth rate going forward?

Richard A. Galanti

Well, for those of you on the phone that have known us for a long time, you know, used to always say that there aren’t a lot of silver bullets, we’re pretty efficient. I think in the last year, we’ve gotten better. Everybody is looking everywhere else -- every supervisor is looking to see where they could save a little bit. It’s hard but I think we’ve taken our -- we’ve tested this at some regions, taking our ratio of full-time to part-time to warehouse from 50-50 to maybe 55-45, recognizing if you have more full-timers, you have a few less full-time equivalents, you have the same payroll dollars perhaps but a few less people on benefits, because everybody is still eligible but there’s just a few less full-time equivalents.

That’s not everywhere and it does work but I am trying to think of what else --

Colin McGranahan – Sanford C. Bernstein & Co.

[inaudible] think about healthcare going forward? You are now beginning to anniversary some of those higher costs. It looks like maybe the employment situation could be bottoming just from a year over year change in employment. How do you think about that going forward in terms of the impact of healthcare costs on the SG&A dollars?

Richard A. Galanti

Well, I don’t know if we have all the right answers, or any of the right answers yet. One of the things we are talking about, one of the things is moving slightly the ratio of full-time to part-time, recognizing as you do that, it’s harder to manage the business because part-timers allow you a little more flexibility. We are -- what was the question again? I’m sorry, somebody was asking me something.

Colin McGranahan – Sanford C. Bernstein & Co.

No, I was just thinking about the increased dollars dedicated to healthcare. I understand you are trying to --

Richard A. Galanti

We are doing a lot of -- we are doing proactive things that long-term I think help that don’t help this quarter or next quarter. What we are not going to do is charge the employee a lot more. They certainly are paying a little more because the costs [of things] is going up but they are not -- they are not taking the brunt of it.

The -- there was one other thing I was going to mention on the healthcare. It escapes my mind. I apologize. I’ll think about it as we go along here.

Colin McGranahan – Sanford C. Bernstein & Co.

Thanks, Richard.

Operator

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

Peter Benedict – Robert W. Baird

A couple of questions here -- first on private label, can you remind us what the penetration was for fiscal 2009 in total and then what it was in the first quarter?

Richard A. Galanti

It’s up about 2 percentage points year over year. I would say it’s approaching 20 -- I need to get a better look at it but I think it’s probably right around 20, up from maybe 18 a year ago. On the food and sundries side is disproportionate. It’s probably up 300 plus basis points on that side.

Peter Benedict – Robert W. Baird

And that’s for the first quarter or is that for last -- fiscal 09?

Richard A. Galanti

I’m just thinking of year over year.

Peter Benedict – Robert W. Baird

Okay.

Richard A. Galanti

By the way, getting back to the previous question about healthcare, there’s two other things -- one of the things that have hit us hard in the last year that has added insult to injury here in dollars is the increased percentage of our employees that are eligible because we haven’t opened as many units and because people aren’t leaving. And again, for years we were in the very low 80s in terms of those eligible because your new hires generally are part-time hourly. They take on average 6.5 months to become eligible. Having opened a fewer number of units and having existing -- our annual turnover has gone from a very attractive low 20% number to 12% in the past year.

Now, as the economy gets better, it’s not going to just jump back to the low 80s in the case of the -- from the low 90s in terms of eligibility. My guess is over the next three or four years, we will get incremental improvement in that number. That will help you a little bit, or help offset some of the increases.

The other thing is that in these tough times over the last year, and we’ve done -- this is anecdotal but in discussing this with our third party administrators like the Aetnas of the world, it’s not just at Costco -- what is just at Costco I sometimes think is that we have a very generous plan where the employees pay a small piece, so we are getting hit with a little bit more of the burden.

But what has happened over the last year, there’s increased frequency in utilization -- the stress on people’s lives, at least on the surface, it would appear that people are doing more. It’s not that we are -- we are still devoting as many dollars to safety, worker safety in the warehouse. People are just doing more things -- I’m not talking about workers’ comp, in general, whether it’s stress, accidents, you name it. And so that too I think as the economy gets a little better anecdotally should improve a little.

You know, we are being very proactive and these are longer term issues, like all companies out there, on things like weight loss, smoking cessation, how do you incent your employees to do that without being punitive? What we don’t want to do is say if you smoke, it’s this much more and -- but at least, what about if you try, tried to do a cessation plan. You don’t have to succeed but you have to try.

These are the types of things that we are doing and looking at. These are more long-term than the next quarter or two.

Peter Benedict – Robert W. Baird

Okay. Sticking with the healthcare theme then, you said earlier in the call that it was $0.01 to $0.02 higher than expected. I recall on your prior call, you said you expected the hit to be $0.03, so was the hit $0.04 to $0.05 or was the hit just $0.01 to $0.02? It’s a little bit better than what you thought it would be?

Richard A. Galanti

What did I say earlier about the -- I don’t recall that.

Peter Benedict – Robert W. Baird

I thought on the fourth quarter call you said you thought the healthcare hit in the first quarter was going to be about $0.03 a share.

Richard A. Galanti

You know, honestly I’d have to look to the notes. I don’t think its $0.04 to $0.05 but I want to see how I used that $0.03. I’m not trying to dance around it -- I just -- I don’t believe it’s $0.04 to $0.05.

Peter Benedict – Robert W. Baird

No problem -- and then on the trends in California that have been getting better, can you kind of maybe break that down between kind of the core business, because I’m sure some of that is gas getting less negative -- if you strip out gas, how has the California market been performing 1Q versus 4Q?

Richard A. Galanti

Still better.

Peter Benedict – Robert W. Baird

Is it positive?

Richard A. Galanti

It was ever so slightly positive.

Peter Benedict – Robert W. Baird

Excluding gas?

Richard A. Galanti

Hold on a second -- I think I had that. Ever so slightly negative.

Peter Benedict – Robert W. Baird

Okay, ex gas. And then lastly -- thanks for that -- and then lastly, the depreciation number you gave, I think that was about 19% higher than last year. It has been growing more like 11%. Any reason why depreciation accelerated?

Richard A. Galanti

Probably the single biggest thing is we -- historically we had used outside disaster recovery for our IT, we had used outside disaster recovery sites and we finally took the plunge about six months ago, eight months ago -- a little longer than that, maybe nine months ago and in eastern Washington, rather than in Sterling [Parks] New York or Boulder, Colorado, using outside parties in eastern Washington, we basically expended I think close to $30 million on computer equipment in that facility over there, that’s a dedicated facility for many companies, that’s a disaster recovery center where we have our caged in areas and we are also running something over there but unlike a lot of -- you know, the banks that have mimicked IT systems all over the country or world, we historically have been here and used third-party disaster recovery. Most of that equipment has five-year life, I believe and a little of it may even have three year but let’s say most of it has -- let’s say on average four to be safe here. So that alone is a chunk of it.

Peter Benedict – Robert W. Baird

Okay.

Richard A. Galanti

The other thing that we have really pushed in the last couple of years, which I think we are seeing a little bit of increase and you will still see it, is remodel activity. We are -- one of the things that we are notable for historically is all the places look pretty good and have the latest and greatest and that’s -- we’re taking the offense on driving business and when things were -- we were spending a lot of money like on fresh foods and refrigeration and frozen foods. Those penetrations, those are profitable departments, of course, and penetrations are up and we are devoting a lot of money to things like that.

Peter Benedict – Robert W. Baird

Okay, great. Thanks so much.

Operator

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

Laura Champine – Cowen & Company

Could I get just a clarification on an answer that you gave to another caller? When you said that the comp is unlikely to stay up in this sort of 4% plus range but you are hoping to have a positive sign, it seems like you might get to 4% plus just on currency and gas having a better impact. Were you talking about the total comp or were you just talking about the merchandise comp?

Richard A. Galanti

Actually what I was talking about was the traffic frequency -- the frequency. So there was -- comp is always the product of average ticket and average traffic, average frequency and we have been enjoying it for 10 years. The frequency component, the shopper frequency, so for every 100 shops that existing members did this year, they would do 101 or 101.5 next year, so frequency was up 1%, 1.5%.

Since gas spiked in the spring or early summer of 08, we started seeing the frequency improve like never before. I think it’s improved even more with the economy and with people, with our [MVM] mailers, with people shopping more often to keep more cash in their wallet, with people, with the penetration of food and sundries, certainly unit penetration, people are shopping for that versus bigger ticket discretionary items. They are coming into Costco more frequently.

So what I was saying was is that frequency in the last year has been in the -- has started in the three range and headed up toward five plus -- clearly we are not going to see it go five on top of four on top of four on top of four on an annual basis. I’d be happy if it was -- if we maintained it and were able to keep growing it back to the old, good old days when it was one.

Laura Champine – Cowen & Company

Got it. Great, thank you.

Richard A. Galanti

I’m going to take two more questions and call it a morning here.

Operator

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

Deborah Weinswig - Citigroup

On the fourth quarter call, Richard, you talked about for holiday you brought in some seasonal items a little early I think into mid-August rather than early September. Did that change the cadence of sales? Did that give you an early read through? What did that allow you to do differently -- let’s say holiday 09 versus holiday 08, if it did?

Richard A. Galanti

Well, less markdowns. I think it gets back to what Jim talked about, is being aggressive and if you’ve got great merchandise at great prices, let’s get in there a little earlier and people see it here first and buy it first here. And we have the luxury in our model to be able to do that.

I view it as it was again more being -- taking the offense and also impairs giving us a little more time if we did need to sell through, to sell through without markdowns.

Deborah Weinswig - Citigroup

Okay, and then at the analyst meeting that you held in New York, you elaborated on your central fill initiative. Could you provide some additional details in terms of what that has allowed you to do in terms of improving your pharmacy operations and are there additional plans to open more central fill facilities?

Richard A. Galanti

Well, what we talked about was A, there’s a shortage of pharmacists in the country because everybody has pharmacies -- not just pharmacies, you know, the Walgreens and the CVSs of the world, but the supermarket chains, the Targets, the Walmarts, the Sams and the Costcos. And so in that regard, there’s a shortage.

The average cost of -- and so these central fills could do high volumes, very automated for the most popular prescription drugs and we can cut by almost two-thirds the all-in cost of filling a prescription. We’re not the only ones doing it but given our volumes, it’s kind of like we take most advantage of our cross-stock operation versus traditional distribution centers in the retail industry -- we take more advantage in our [feeling is here] because of the volume. We have a couple of these places doing upwards of 15,000 prescriptions a day with three or four pharmacists and the number of techs supporting it but it’s a highly automated system. And so will we do more? I’m sure we will.

I think what it has enabled us to do is to maintain our very strong profitability of that business over the last few years, particularly in the markets where we have these three on the West Coast, while everything in that business is tougher. You know, the 100 pills for $10 and Medicare part D, which I use one of my relatives as an example, who takes several different prescriptions of more expensive state-of-the-art drugs and the annual cost at Costco before Medicare Part D was about $6300 -- overnight it went to the low 4s, about $4200, $4300. That came out of the retailer’s gross margin.

So I think with those kind of -- notwithstanding all that, this has helped us maintain a good profitability in that industry, which is an ongoing -- it changes daily.

Deborah Weinswig - Citigroup

Okay. And I know there’s been a lot of questions on this call about deflation, et cetera, but what are you seeing with regard to list prices from your vendors as input costs are coming down? And then I thought you had some very interesting insights with regard to your approach to private label and how that is also changing some of your vendor relationships, so how might that also might be changing some of your list prices?

Richard A. Galanti

When you say list prices, you mean on branded goods?

Deborah Weinswig - Citigroup

Correct.

Richard A. Galanti

Well, I think -- look, it’s a circular thing. I mean, one plays on the other. I think the fact is one of the -- you know, people always ask, are our buyers better than some other retailer? One of the things that makes our buyers better in some regards, or good in some regards, is the fact that we have to manage fewer things. We are managing two SKUs of canned peaches, not 30. We are putting all our buying power into two SKUs, not 30, which allows our buyers to get much more in-depth and understanding of every component of production cost. I think sometimes we drive vendors crazy with that but it has helped us and it has given us in our view an advantage out there.

And not to take anything away from any other retail buyers in other companies, but we spend a lot more time focusing on the component costs from direct labor, electricity, packaging, where are you getting your resin from -- you name it and all that goes into helping, I think, us do a good job.

As Jim has said a number of times, we want to be both a seller of great private label goods, which does a lot of good things for us and the customer -- great value and prices to the member, allows us to protect our margin and enhance loyalty because the only place you can get our product with the Kirkland signature is here. But it also allows us to be more competitive.

Time and again over the years, as we’ve introduced the Kirkland signature item, that very strong, very brand loyal brand item has had to come down in price from already great prices to regain some of the lost market share. And so it’s ultimately it’s what our mission is, is to provide our members with the greatest products and quality at the lowest prices. And so we think there’s plenty of opportunity.

We also, as you’ve heard us say, there’s a lot of great branded manufacturers out there and it’s -- everybody can tell you it makes them better too, but it does. We all know who some of the best branded suppliers out there are in terms of innovation and as they lose an item or a portion of a sale of an item, they are coming out the next day with something that’s the third level up or ultra this or improved that or completely new items. So that makes it better for all of us.

Deborah Weinswig - Citigroup

Okay, and then I think that if memory serves me correct, in the last few months you started -- or you rolled out EBT to the New York City area. I just want to confirm that you are going to roll it out to the rest of the chain and if you can maybe provide any color around what you have seen in the New York area as a result.

Richard A. Galanti

It is now everywhere in the U.S. The only place it may not be, there was a time delay in the state of New Jersey and it had to do with some regulations of how you do it, so it’s more of a -- it’s a timing issue, not an issue of not doing it. And I could be wrong but it may already be in there but I know it wasn’t in the first few weeks after we announced it.

Look, it’s a slight net positive. It’s still a very small percentage but we’ve gotten a lot of positive responses from -- we’ve also gotten some new members. You have to believe on a macro basis there were some members that prefer to shop at Costco but chose not to for one reason -- they are on food stamps and we did not accept them. So from that perspective, we are gaining incremental new business and at the end of the day, some of our reasons for not doing it historically had gone away. Is it still a small percentage? Yes. But has it slowed the front-end up a lot? No. It used to when you had to separate the basket into food stampable and non-food stampable to two separate transactions. You had paper value coupons, not electronic debit cards, effectively. And so we probably waited a little too long but it’s a good thing we did.

Deborah Weinswig - Citigroup

Okay, so I’m sorry, what was the date that it was rolled out to the U.S.?

Richard A. Galanti

It was over several weeks -- I want to say two to one months ago.

Deborah Weinswig - Citigroup

Okay, so [inaudible]. Okay, thanks so much, Richard, I really appreciate it and best of luck for the rest of the holiday season.

Operator

At this time, there are no further questions.

Richard A. Galanti

Thank you, everyone.

Operator

This concludes today’s conference. You may now disconnect.

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