Richard Galanti - CFO

Deborah Weinswig - Citigroup Charles Grom - JP Morgan Chase Gregory Melich - Morgan Stanley David Schick - Stifel Nicolaus Mark Husson - HSBC Christine Augustine - Bear Stearns Bob Drbul - Lehman Brothers Bill Cower - Key McDonald Adrianne Shapira - Goldman Sachs Gilbert Creedbark - EMG Investment Partners Robert Toomey - E.K. Riley Advisors

Good morning, my name is Meredith and I will be your conference operator. At this time I'd like to welcome everyone to the Costco Wholesale Corporation fiscal 2006 second quarter earnings conference call. (Operator instructions) Thank you, I would now like to turn the conference over to Mr. Richard Galanti, Chief Financial Officer. Please go ahead, sir.

Thank you, Meredith and good morning to everyone. As with every conference call, I'll start by stating that these 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 press release as well as other risks identified from time to time in the Company's public statements, and reports filed with the SEC. This morning, as usual, I'd like to review with you several items. To begin with, our 12-week second quarter of fiscal 2006 operating results. First, please recall that in last fiscal year's second quarter, while we reported EPS of $0.62, as I will explain in a moment, excluding a couple of unusual items, the aggregate of which added $0.08 to our earnings last year in the second quarter, we came in last year's second quarter at $0.54 per share on a more normalized basis. In terms of this year's second quarter, for the 12 weeks ended February 12, 2006, we reported $0.62 a share, so up 15%, or $0.08 per share over last year's normalized Q2 of $0.54. These results, as you know, were $0.02 a share above the top end of our range of guidance I provided you on our December conference call. Also, $0.02 above First Call's consensus of $0.60. In terms of our sales for the quarter, our 12-week comp sales figures showed an increase of 7%. In terms of the three retail reporting months of December, January, and February, our reported comps were 7%, 9% -- and of course this morning we're also reporting February same-store sales -- and for the four weeks of February, comp sales were 8%. I will speak more to the four week 8% February comp figure in a minute. Other topics of interest I will review this morning, our recent openings. We have opened a total of 12 locations since the beginning of fiscal year on August 29. Nine in the U.S. including one relo, so a net of eight in the U.S.; one new location in Canada, our 66th; one new location in the U.K., our 17th in the U.K.; and one new location, our 28th in Mexico. This latter one in Mexico, of course, we account for on an equity basis, so we don't include that in our total GAAP count of openings. We're still on track to open net new locations, that's net of relocations and net of any Mexico openings in the very high 20s for all of fiscal 2006. I will also discuss on this morning's call our ancillary business results, Costco Online, membership trends, our balance sheet, an update on recent stock repurchases, and lastly I will provide you updated directional guidance for Q3 and fiscal '06 overall. With that said, sales for the second quarter were up 11% from $12.4 billion last year to $13.8 billion in this year's second quarter. As I mentioned on a 12-week to 12-week comp basis, comp sales for the quarter were up 7%. For the quarter, our 7% reported comp figure was a combination of an average transaction increase of a little under 7%, and an average frequency increase of about 0.5% up for the quarter. Of the slightly less than 7% transaction increase, only about one-third of 1% was due to FX, so we're really seeing the benefit of that, if you will, to the comp number diminish as there's a little bit more stability year-over-over in the currencies that we operate in. Our cannibalization, about 120 basis points impact in this year's second quarter results, I think you've seen that in some of the previous months, the last couple of months as well as we have ramped up some expansion. Also included in the average transaction increase of slightly under 7% is about 70 basis points due to gasoline inflation year-over-year. That's about a little less than half the impact that gasoline inflation had on our comps in Q1. Of course Q1 was impacted greatly by Hurricane Katrina and the craziness of gas prices in September, and to a little extent in October. For the four-week month of February, in terms of some of the pieces of the puzzle for the 8% reporting comp figure, that included an average transaction increase of a little over 8% for the month. Again, FX was a little over 0.5% of that and an average frequency increase was about 0.75% up in the month, so a little bit more frequency than we saw for the quarter overall. Cannibalization, again, about the same, 120 basis points impact to this year's February results. Also included in the average transaction increase is about 80 basis points due to gasoline inflation. So pretty similar to the 50 to 70 basis points that we saw for the quarter overall. In terms of geographic and merchandising breakdowns for the sales for the second quarter, geographically for the quarter, we reported a 7% comp. Geographically, basically the Northwest, California and the Northeast generally were slightly below that 7% number, in the mid-single digits. The Northeast as well. Southeast was in the high single digits. Midwest and Texas in the mid-teens. So overall, the U.S. was a 7%. For Canada, we've actually seen very good numbers in Canada of late. If you go back to Q1 -- actually, all of '05, Canada and local currency was a 2% number, Q1 was a 5%. Again, these are local currency. Q2 was an 8%. February was a 10%. so we've actually seen some strength finally after a couple years of relative weakness up in Canada. Other international was for the quarter, 10%, 8% local currency. For February, it was actually minus 4% or plus 1% local currency. That has a lot to do with the timing of holidays in Korea and Taiwan where there are some major holidays that fell about three weeks apart from one another. I think we'll see a little benefit from that coming forward, but in other words, one week in each of those countries where we had in local currency, minus 30% plus comps. In one of the countries just last week it was plus 30% something. So again, it's just the timing of a couple holidays over there. Again, all told for the month, we generally saw a little bit of improvement versus Q2 overall. In terms of merchandising categories, food and sundries, and hard lines were pretty solid for the quarter, in the mid-singles and actually a little better than that in February overall. Soft lines, as it had been in all of last year and in Q1, was weak, slightly above a breakeven in comp in terms of comps for the quarter, and mid-singles for February. Fresh foods continues to be strong in the low double digits. Ancillary businesses, in the mid to high teens for the quarter and the month and a little lower than that without gas, of course. So again, total 7% comp for the quarter, 8% overall for February. Within food and sundries, there are no real outliers. We have nine sub-departments within food and sundries. In terms of the quarter, seven were mid-single digit, low to mid-single digit and two were low double digit, and February it was three of the nine were double digit. Hard lines, strongest subcategory continues to be majors in the low teens for the quarter, and the mid-teens for February. Soft lines, we saw strength in home furnishings, recognizing soft lines overall was a little above breakeven, but we saw relative strength in home furnishings and men's and women's apparel, and weakness in media. Gas sales taking a mid-20s comp, mid single-digit comp if you just look at gallons. Moving down the income statement, start with membership fees. As you saw, $269.8 million versus $245.5 million a year ago, so up 10% in dollars or $24 million. Again, with strong sales, it was down a basis point, but a very good showing given our continuing strong comps. Same reasons as you have heard I think for about three or four years now, continuing strong renewal rates, increasing penetration of the executive membership program, and of course new market openings. In terms of number of members at Q2 end, we had 16.8 million at Q2 end, that's up from 16.2 million at the end of the fiscal year, and up from 16.5 million at Q1 end. Primary business has remained at 5.1 million, rounded to 5.1 million still. Business add on, 3.5 million at Q2 end, for a total of 25.4 million, including the additional spouse card, 46.4 million total cardholders. At February 12, '06 Q2 end, paid executive memberships were around 4.8 million. These members represent about 20% of our membership base, and significantly more than that in terms of our sales base. The number we ended the second quarter with was an increase of 190,000 or 4% since Q1 end or 16,000 a week increase, and an increase of 522,000 or 12% since fiscal year end; so in a half a year, the absolute numbers increased 12%. Executive membership over the last two years, it increased in terms of the total number of members, 30% in all of '05, and another 12% in the first half of this year. This success, of course, negatively impacts our reported gross margin percentage by increased 2% rewards, but of course has an offsetting -- not a complete but a somewhat offsetting -- effect of slightly improving membership fees and of course improving SG&A percent with a higher sales base because of the success of these members. In terms of renewal rates, I sound like a broken record here, they continue strong and at our all-time high. The Q2 '06 end is essentially the same numbers that we saw at Q1 '06 end, 91% business, 84% Gold Star for an overall renewal rate of 86%. Going down to the gross margin line, reported gross margin was lower by 19 basis points, coming in at a 1,074 versus a 1,093 last year. As usual I'll ask you to jot down a few numbers to put a little light on these numbers. The line items would be merchandising 2% reward, LIFO, EITF 310, and total. What we'll do is I'll ask you to write down Q4 '05, Q1 '06, and Q2 '06. Basically, the merchandising component year-over-year was minus 24 basis points in Q4, minus 2 in Q1, and minus 9 in Q2. The 2% reward was minus 9, minus 9, and minus 12 basis points. These are the year-over-year components of how we got to the margin year-over-year comparison. LIFO was minus 4 in Q4 '05, zero in Q1 '06, and plus 2 in Q2 '06. EITF, you can actually take that line out, it is no longer around. It was zero. So total in Q4 '05 margins year-over-year were down 37 basis points, in Q1 down 11, and in Q2 '06, down 19. As you can see if you look at these numbers, our overall merchandising gross margin was lower Q2 over Q2 by 9 basis points. The 9 basis points figure was pretty much in line with what I discussed with you back in early December when actually both on my October year end conference call and on my December 8, Q1 conference call, I stated that in terms of our '06 gross margin outlook, reported gross margins would probably be down a little due in large part to the gas/non-gas sales penetration issue, as well as in recognizing the fact that gas margins are significantly lower than the Company's margins overall, and to some extent, increased executive membership penetration. That's exactly what we see here. Of the minus 9 basis points figure reported for the whole Company, minus 12 basis points is gasoline-related. Gasoline gross margin in Q2 were down year-over-year, as well as sales penetration of gasoline was up, and you're talking close to 800-plus basis-point difference in margin between the core business and the gross margins for gasoline in this quarter. That would have that impact. But overall, gas, both a higher penetration, as well as its lower margins was minus 12 basis points of the minus 9. As well, lower year-over-year sales penetration of our core business and again, food and sundries, hard line, soft lines and fresh foods. These four major categories represent nearly 80% of our total sales. While they have much higher gross margins than gasoline, the reduced sales penetration hurt us. In fact, the aggregate gross margins for this 80% component of our business, food and sundries, hard lines, soft lines, and fresh foods, year-over-year in Q2, the gross margins for that 80% were higher year-over-year by 15 basis points; but because of the penetration issue and the significantly higher margin at a lower penetration, were a slight drag, a few basis points on total Company gross margin. Finally, our other ancillary businesses generally contribute a few basis points to margin improvement. I say other, I've already talked about gas. As I just mentioned in my membership discussion, our Q2 gross margin was impacted negatively by the 12 basis points. In terms of LIFO, please note that we took no charge in this year's Q2 versus a $2.5 million charge in Q2 last year. So overall, Q2 gross margins were okay, and pretty much in line with what I think I shared with you last quarter and the quarter before. I think more importantly, the core merchandising business gross margin improved very nicely in Q2 over Q2, at a rate of higher improvement year-over-year than we have in Q1; and actually significantly better than we had in Q4 as well. We're very pleased with that. Once I think we anniversary some of this, that will bode well for us. In terms of our gross margin outlook continuing into '06, reported gross margins year-over-year, again will probably be down a little due in large part to the gas/non-gas penetration issue. As well, the impact from increasing executive membership business should still be a hit to reported gross margin, but should start to trail off over the next several quarters. I should mention that the negative 12 basis point impact to gross margin in Q2, which was actually a little higher than in Q1, relates to concerted marketing efforts on our part in Q1 to drive executive member business. LIFO, notwithstanding that there was no charge for LIFO in Q2, I would still assume a little negative inflation impact, negative impact from inflation for the remainder of the year and therefore a possible small LIFO charge in Q3 and Q4. But it also could be zero. Most importantly, our core merchandise groups are doing well, once we anniversary the current increases in gasoline sales penetration and a slowing level of increased sale penetration of executive membership sales, we would expect these negative impacts to reported gross margins would stop being big offsets to otherwise very good GM core business trends. Before going on to SG&A, in terms of ancillary businesses, pretty straightforward if you take the numbers I gave you in terms of number of businesses we have at Q1 end. We added two to each, with the exception of print and copy center. So pharmacy, we ended with two more this quarter, to end the quarter at 384. Food service, 437, adding two; mini lab adding two at 434; optical adding two, now at 426, we remain at 10 print copy centers; hearing aids added two to be at 176, and added two gas stations to be at 235. In total for Q2, ancillary business comps were up 17%; up 11% without gasoline. Now, moving on to SG&A, I'm happy again to report positive trends in SG&A leverage in Q2 of '06, as you will see. Our SG&A year-over-year was lower or better by 2 basis points, coming in at a 953 this year, versus a 955 last year. Again, as I always do, I ask you to jot down a few numbers so I can shed some light on the components that impact SG&A and why I think some of these trends, once we get past this year particularly with stock option exercises, should bode well for these trends as well. Looking at all of fiscal '05, the first column, Q1 '06 and Q2 '06. In terms of core operations, fiscal '05, plus 14 basis points -- the plus means lower or good -- Q1 '06, plus 9, and Q2 '06, plus 7. Central, zero in all of '05, plus 2 basis points or better by 2 basis points in Q1; and plus 3 basis points in Q2. Stock options, minus 6 for all of '05 year-over-year; in Q1 year-over-year it was another minus 6; and in Q2, it was actually minus 8. EITF 310, it did impact the early part of '05, so in terms of fiscal '05, it was minus 5 for the whole year and then zero and zero. Quarterly adjustments, we actually have a new line item here. For all of '05, that was minus 1, that was a hurricane-related charge, and then zero and zero in Q1 and Q2. In all of '05, SG&A improved by 2 basis points; in Q1 '06, it improved by 5; and in Q2, improved by 2 basis points, or plus 2 basis points. In terms of a little editorial, again let me point out the following. As we were hurt, if you will, in our gross margin percentage from mix changes, strong gasoline sales helped us a little with SG&A because of the stronger sales base. We did benefit in lower second quarter over second quarter SG&A and improvement in our largest expense categories. Payroll improved, payroll and benefits are 70% of our SG&A. Payroll improved year-over-year in Q2 by 8 basis points, and our workers' comp and benefits expenses also are continuing to show improvement by a few basis points. These were offset by slight year-over-year basis point increases in items like utilities, maintenance, and the like. The 3 basis-point improvement in SG&A at central where total expenses increased only -- in terms of our total central expenses, not only here in this club, but all throughout the country and the world in our administration offices -- total central dollars increased only 7% versus top line sales growth for the Company of 11%. Again, we improved SG&A by 3 basis points in the quarter. Finally, our stock option expense was higher by 8 basis points year-over-year in Q2. Now, regarding the expensing of stock options, as you know we began expensing stock options at the beginning of fiscal '03. We now have 3.5 years of gradual expensing under our belt under FAS 123. FAS 123 was what I'll call the previous accounting rules, given that our option grants vest over five years, we of course have seen a hit to reported SG&A as each year, if you will, an extra fifth is added. In '03, it was just a fifth of the cost of that option grant for the '03 grants, in '04, it was a fifth of '03 and a fifth of '04. In '05, it was a fifth of each of the three years of grants. Now recently, FAS 123 became FAS 123R -- R for revised, which basically says you catch up from prior years. While this is our fourth year of expensing and we would have expected a small hit to SG&A in each of '06 and '07, once we then got to five fifths, we're basically doubling up in '06, because we're going back to '02 if you will, to include a piece of that one as well. So when the revised FAS 123R came out, we've now fully adopted this effect in the first quarter of fiscal '06. As I indicated in our last conference call, the impact would be an additional $15 million for the year. That's why we saw this hit of 8 basis points year-over-year versus probably 4 or 5 that we would have seen. The other important part of that is, is that once we complete fiscal '06 we will basically have been fully caught up on that and going forward all you'll see is year-over-year changes, the actual expense. Assuming that that expense grows similar to top line sales dollars, or perhaps even a little less, there shouldn't be a big impact, plus or minus a basis point to SG&A, where for four years now we've seen gradual hits to SG&A, the biggest one coming this year. In terms of the outlook for the remainder of '06 I'm very encouraged what we're seeing in each month's results. Once we complete this fiscal year, the year-over-year negative impact to our SG&A percentage from options expense will stop being an offset to the good stuff, if you will. Next on the income statement is pre-opening expense. Last year we reported a fairly large number, $22 million or something. That of course included a one-time catch-up that we had in Q2 last year, an unusual item, lease accounting, which many companies had out there. That was about $16 million pre-tax. Excluding that, pre-opening expense in this year was $4.6 million, versus $7 million last year, so a pickup of about 3 basis points, and $2.4 million lower. Lower pre-opening expenses basically related to a few new warehouses being open in the quarter. Last year in Q2 we had four openings, this year we had two, no surprises here. In terms of the provision for impaired assets, last year it totaled $4 million, this year $1.4 million. Again, that's simply our ongoing relocation efforts whereby the costs associated with closing what I'll call "to be relocated" units are expensed up front once the decision to relocate is made. So all told, operating income in the second quarter, excluding the unusual $16 million charge to pre-opening in last year's Q2, which again was explained to you in the press release, was up $25 million over last year's Q2 figure of $431.3 million, from the normalized $405.9 million last year. Again, we've discussed the impacts, some of the things beyond this year should be less of an impact on gross margin and SG&A. Below the operating income line, reported interest expense was substantially down as it has been of late, so that showed a $6.1 million year-over-year improvement, in line with what we expected. It came in at $2.9 million this year versus $9 million last year. This again reflects both the June 15th, 2005 payoff of a $600 million debt instrument, and lower interest expense on our convertible debt as more of its holders convert it into our dividend paying common stock. In interest income, and other was significantly higher year-over-year, notwithstanding our recent use of cash to repurchase in the past several months about $1 billion of stock. So interest income in the quarter was $35.2 million versus $24.8 million last year. Again, virtually all of this increase was due to much higher investment income and still higher cash balances, also earning higher average rates of interest, given with what we've seen with interest rates over the last year. These numbers probably for this year, while it's a nice increase over last year, was probably about what we expected. Because rates have come up a little higher than we expected, cash balances are a little lower given the fact that we've used cash to repurchase stock. So overall, pre-tax income was up 10% versus last year's Q2 from the normalized $421.7 million figure last year, to $463.6 million this year. In terms of our effective tax rate, it was 37.55% last year in the quarter, and again, that excludes one time tax credits last year of $52 million. As compared to 36.11% in Q2 this year. And a 36.86% for the first half year-to-date. That came in a little lower than our plan, which is good. Again, I think it reflected an improvement in our expectations in Canada tax rate. For the remainder of this fiscal year, we would still expect about a 37.5% number going forward for this year. In terms of a quick run-down of the other usual topics, I'll start with our balance sheet, I might add that posted to the website before probably 9:30 this morning Pacific Time we'll have some Q&A which would include cash flow and balance sheet. But for right now, I'll give you the balance sheet. Cash and equivalents, $3.517 billion. Inventories, $4.278 billion. Other current $657 million. Total current assets, $8.452 billion. Net PPE, $8.067 billion. Other assets, $657 million, for total assets of $17.176 billion. Short-term debt, $62 million. Accounts payable, $4.394 billion. Other current, $2.794 billion; for total current of $7.25 billion. Long-term debt of $537 million. Deferred and other of $261 million. Total liabilities of $8.048 billion. Minority interests of $61 million. Stockholders' equity of $9.066 billion. To be at $17.175 billion. I think there's some rounding. It should be [$17.176 billion]. Let me point out a couple things about our balance sheet. It's, again, very strong debt-to-capital of well under 10%, plenty of financial strength. Again, notwithstanding the fact that we've spent since last June, a little over $1 billion on stock repurchases, we still have less than half of that was a decrease in cash and equivalents, as our cash flows exceed our needs for capital expenditures, dividend payments as well. In terms of accounts payable, which is a number we of course look at, reported accounts payable as a percent of inventories was 100% last year in the quarter, and improved to 103% this year. If you look at just merchandise accounts payable -- so not other types of things like construction accounts payable and the like -- last year was at 81%, up again 3 percentage points to 84% this year in the second quarter. Average inventory per warehouse a year ago was $9.656 million, this year was $9. 418 million, so an increase of $238,000 per warehouse or total inventories on average per warehouse were up 2.5%, not bad with an 8% recent comp. Reasons for being higher, very minimal FX impact now. We continue to have higher, as planned, higher consumer electronics inventories, that's about $100,000 of that $238,000. Jewelry is about $50,000 of that $238,000 again, that was a concerted effort on our part to get into improved jewelry cases and drive those sales. Probably about $50,000 actually was some buy-ins on paper products and tires that we've done where those things have been fairly inflationary and we had an ability to buy in a significant amount prior to the prices going up. We expect to be well out of those excess inventories by year-end. All we can buy is six, eight, 10-week supply, that's about how much room we have in our depots. Finally in terms of inventories, our inventories are quite clean coming out of Christmas, and in terms of post-seasonal markdowns, we also had our best inventory results ever in terms of taking physical inventories in mid-year. When I say best, it's best by a basis point, but still the best. In terms of CapEx, in all of '05, we spent $995 million. Our projections for this year of about $1.2 billion to $1.4 billion. Again, this is for the 28 to 30 planned in new openings, plus three relocations, and our share of two new units in Mexico, as well as everything else. Maintenance CapEx -- CapEx as it relates to depots, and central IT and what have you -- year-to-date for the first 24 weeks we're right at $500 million in CapEx. In terms of Costco Online, it continues extremely strong and whereas in Q1 we had a 51% year-over-year increase in sales, in Q2 we had a 74% increase in sales so really doing well in Costco.com. It should exceed $850 million for the year. Next on the discussion list, expansion. I'm happy to report that for the first time in several years, I think, the planned number of openings for this fiscal year is holding. Usually by mid-year I'm ratcheting down the number quite a lot. As you know, before the year started last August, our direct was that for '06 we would be around 30. And today we expect some number in the very high 20s, 28 or 29. In terms of quarters, Q1 again we had nine new, less one relo, so a net of eight. Q2 we had two new and no relo's, so a net of two. That's the 10 that are in that number, plus we had one in Mexico. In Q3 we anticipate opening eight new, and we're including one relo, so an increase of seven. In Q4, 13 new with one relo, so a net of 12. As well in Q4, we'd expect one more in Mexico. For the year, we expect 32 openings, less the three relo's would be 29, and in addition to those 29, two. Could it flip? Sure. With 13 in Q4, it is fairly spread out during the quarter, but the fact is, is that I'd be willing to at least place a bet that it will be in the 27 to 29 range. As you know in the last couple years, when we started in the mid to high 20s, we ended up in the high teens to the very low 20s, and clearly we're going to be still at the very high 20s this year. Assuming 29 on a base of the 433 we started the fiscal year with, then it would be about 7% unit growth and about 8% square footage growth. I'd also like to point out that based on what I see right now in our expansion list for '07, we would expect fiscal '07 to include at least 30 net new units and perhaps 35 net new openings next year. As I had stated as far back as April 22, last year when we were having a fun conference call downgrading earnings a year-and-a-half ago, that we had a lot more in the hopper going into '06. We did, and we certainly have a lot more in the hopper going into next year as well. Lastly, let me talk about stock repurchases. As you probably know, if you go back a year-and-a-half, we had an existing common stock repurchase program which allowed us to purchase up to $500 million of stock. Beginning in June of '05, which was near the beginning of our fourth quarter of '05, and through fiscal year end, so basically those three, three-and-a-half months, we had approached approximately 9.2 million shares at an aggregate price of $413 million or $44.87 a share. We still had repurchase authorization at that time under that original program of $87 million. In October, beginning of this fiscal year, we announced a new program that allows us to repurchase up to an additional $1 billion of stock, so with that authorization we had $1.87 billion remaining, if you will, at the beginning of the fiscal year. In the first quarter, which is August 29, through November 20, we purchased an additional 4.352 million shares at an aggregate purchase price of $206.7 million. Since Q1 end, we have repurchased an additional 8.984 million shares at an aggregate price of $443.7 million. So all told, since the beginning of fiscal '05 Q4 if you will, early June of last year, we repurchased a total of 22.541 million shares at an aggregate purchase price of $1.064 million or a little over $47 a share. Under the previously approved authorizations, we can still repurchase an additional $436 million of stock. You should expect continuing purchases of stock. We're not rushing to do it, but we're also not slow about doing it, and I would expect as we complete this authorization, we would have a review with the Board, see what we want to do. You should expect more of the same in the future, all things being equal. Finally, before I turn it back for Q&A, some direction for Q3 and '06 overall. In terms of First Call consensus, as you know, it was $0.60 for the quarter, we came in at $0.62. As of last week, First Call for Q3 and Q4 was $0.50 and $0.76. That would have given a First Call for the year of $2.30, just at $2.32, because we actually beat that First Call number for the second quarter. From that starting point, the question is, is what does Q3 and the remainder of the year look like? Again, First Call is at $0.50. That would imply a 16% increase over $0.43 last year. We feel comfortable with that. I guess that's a slight better improvement than the past when it says the top end of the range, but certainly that's a number that's at or near the top end, and hopefully we can do a little better. In Q4, the current consensus is $0.76. Again, we feel comfortable with that. Assuming those two midpoints you would be at, I believe, again 2.32 a share, which is about 13%, 14%. And we'll see. So far so good, and again, I think as we get through this year, some of the negative impact trends to margin and SG&A, some of them are definitely not recurring like stock option expense, in terms of a year-over-year change. As well, executive membership, while it impacts a little bit, has long-term positive implications for us. Finally, before I turn it back over to Meredith for Q&A, please know that again, as I mentioned on our website, you can find additional Q&A, including our second quarter cash flow and balance sheet, and it should be posted within the hour. With that, Meredith, I'll turn it back to you for Q&A.

Thank you. (Operator instructions) Your first question is from Deborah Weinswig with Citigroup. Deborah Weinswig - Citigroup: Good morning, Richard. You gave us a tremendous amount of detail on gross margins. Can you also help us understand right now where you are in private label penetration, the benefits to growth, and kind of what your goals are and help us think about that longer term?

Well, private label is somewhere around 16%, 17%, I don't have the exact number in front of me. And I say 16% to 17%, I think it was up around 17%, and actually it was around 16% -- I know very recently we added a very significant private label in the form of a private label diaper. If you go back five years ago when the number was probably in the very low double digits, and our guess was five years hence it might be in the mid to high teens, and maybe even 20% 10 years from now. I would say today, when it's in the 16%, 17% range, within five years it's probably in the low 20% range. Who knows where it goes 10 or 15 years from now. Certainly it's a success for us. It provides value to our members. We've truly created a brand name of quality, but we also recognize that part of our success is based on our members being able -- First of all, we're not going to put our name on certain items like televisions or jewelry or a branded watch or whatever. But by the same token, we want our members to be able to compare our prices on branded goods. Does it go somewhere above the low 20s beyond five years from now? Probably, but we're always going to be primarily a branded retailer of merchandise with this being an important component. Now, in terms of the metrics of how it occurs, what its impact is, certainly the lowest-hanging fruit is the first 16%, 17% of sales penetration here, where you've taken items that perhaps might have been commodity items, that are historically footballed by traditional retailers where we (A) can't save the customer a lot of money, and, (B), work on a modest margin because it is a commodity item. That can be anything from toilet paper to light bulbs -- no, not light bulbs, we don't have light bulbs -- toilet paper to dairy products, milk, where we've tested some private label. If you look at it that way, I think the lowest-hanging fruit has been taken. I used to say that when we switched from a football to commodity branded item, somewhere in the mid to high single digit gross margins and replaced it with a private label, there might be 20% or 30% lower price per unit to the member for equal or better quality, but it might have a margin 500 basis points higher; something in the 10% to 14% range or 10% to 15% range. My guess is, is that spread of 500 or 700 basis points on average going forward on incremental stuff is 300 to 500 or 200 to 500, because again, we've had a lot of low-hanging fruit. We continue to surprise ourselves. The private label example is a good one with diapers, and certainly then we've added some things where we had very little presence in the category, like cosmetics. As you know, we, about eight months ago, did a test with Borghese cosmetics, and Kirkland Signature by Borghese where we're selling about 20-22 SKUs of savings of 50% to 80% versus department store retail prices for these same brands -- for the brand we're talking about. We have now rolled that out. It's small potatoes when you talk about the total company, but it's growing and it's a healthy margin and a fantastic savings to the customer. I think it's a piece of the puzzle but it's something that we'll still have a good bang over the next five years, but not like we had over the last five. Deborah Weinswig - Citigroup: Last question actually has to do with gross margins as well, in terms of thinking about the kind of paid executive memberships. Are you at all surprised in terms of penetration? Where do you think that ends up longer term? And then also you mentioned I think concerted marketing efforts in the first quarter to drive that business. Can you maybe expand on that as well?

What was the second question? What was the last part of that question? Deborah Weinswig - Citigroup: The marketing efforts to drive the executive membership business in the first quarter.

Well, we did some tabling activities. Over the last six or eight months, I think we had reprogrammed our registers with some programs which allowed, at the register -- when you came up and we swiped your card, it immediately prompts the cashier to ask you something, assuming, looking at your prior 12 months of history -- not that that cashier could look at that number, but it would just tell the cashier, this is somebody that is above breakeven on the incremental $55, based on their prior history with us. So it would be prudent to ask them and remind them about the executive membership. Then right up there at the -- and we have people roaming the front end to ask you, and we also have tabling activities, so if you were prompted successfully, right before you left the warehouse you could stop at that little desk and sign up. That being said, as you know we sometimes can be a little direct and not as tactful, and as you might expect also, since we continually increase the frequency of our shoppers when you've got a member coming in every couple of weeks in many instances, they don't want to be hit up if they're not interested, even if they are well above breakeven. Recognizing some small businesses are all cash businesses and they choose not to use credit cards or have anything like an executive membership. That's their prerogative. So we've slowed off on that, purposely. We know that's not something that's going to be ongoing, but that was essentially what we did. I'm not surprised, given that we had those efforts, that we would, not that I really focused on it, but given that I know subsequently I saw we were doing these efforts, I'm not surprised that the impact to Q2 gross margin was 12 basis points. That in effect implies that the increased sales penetration of the executive membership, just in that quarter, in that 12-week period versus a year ago was 6 additional percentage points, was 2%. Using all the numbers I've given you for the last four years, since the executive membership member reward, which again is a direct impact to reported gross margin, is closing in on 80 basis points. That would imply 40% of our sales are receiving a reward, recognizing that some items aren't rewardable -- tobacco, alcohol, and gasoline. Gasoline, because of the various state laws against discounting, and the other two because it's just extremely low-margin businesses. So this 20% of our members is darn near close to 50% of our sales. Would I expect that to grow? Absolutely. I don't know what the number is. Is it 60 or 70? It's not 90 probably, unless we eliminated the other membership, which I don't expect us doing. So I think it will keep growing. Versus my own estimates for this fiscal year, I would have expected the impact to net margin would have been a little less than the minus 9 in Q1 and the minus 12 Q2 but again, at the beginning of the year I wasn't aware that we were doing additional marketing. Clearly the program works and long term, it's a no-brainer, recognizing that immediate impact as you see it on that line. Deborah Weinswig - Citigroup: Okay, great. That's helpful. Thank you, Richard and congratulations.

Thank you.

Your next question is from Charles Grom with JP Morgan Chase. Charles Grom - JP Morgan Chase: Good morning, Richard. Could you speak to your embedded assumptions for both gross profit margins and SG&A and interest expense for the back half of this year?

Well, let's take the easy one, interest expense; it should be similar to Q2 for Q3, plus or minus a little because it's the same number of weeks, Q4 is a 17-week quarter. Normally Q4 is our 16-week quarter, but this is a 53-week year, so I would take 17/12 of that number and maybe add a little bit because they say he's going to raise rates again, tomorrow or whenever, or next week. In terms of interest income, that's going to, as those rates rise on the interest expense side very little, it will be comparable on the income side. In terms of our assumptions, my guess is again that reported year-over-year gross margins Q3 and Q4 will be down a little. I hesitate to define "little". Let's assume -- just the impact from executive membership is something in the high single digits. It should trail off. We're not doing any current renewed marketing efforts for it right now, giving our members a little break from being hassled, if you will. But without that, there are people that do want it when we let them know. So that's going to still be an impact. My guess is that it's something in the high single digits for the second half of the year, and something in the mid single digits next year. Again, implying 2% or 3% sales penetration improvement next year. What you won't have -- what you shouldn't have, I won't say won't, is the big impact of gas penetration. Now, I say that recognizing that I've also jokingly said from time to time that there's only going to be four or five more unprecedented increases in gasoline prices over the next decade. Every time there's another unprecedented increase of $0.30 to $0.50 a gallon and reaches a new level, we got a lot of press, we see a lot more sale penetration. Year-over-year in the first quarter, it was over 200 basis point increase in sales penetration that gas represented. Well, when you're talking about 700, 800, 900 basis points of difference in gross margin, that's a hit to your reported margin. It also is a help, not to the same extent, to your SG&A.. But nonetheless once we anniversary that again, I think that will help. My hope next year, if we can continue to show strength in our core, which we believe we have the ability to do, I don't know if it's going to be plus 5 or plus more than that, it was plus 15 in Q2. I think that will be helpful to us. But again, all that, I think I try to paint a picture that is cautiously optimistic, we're never going to do anything that compromises our competitiveness. Rest assured that we never have, in 22 years and we won't in the future. In terms of SG&A guidance, again, some of the things that helped us with gas has also helped SG&A. So to the extent we anniversary that, we get a little less positive impact on the SG&A line. I would expect to still see small baby steps of improvement in SG&A and payroll and healthcare. Again, I would hope energy costs year-over-year next year aren't a few basis points hit, but are the same. So again, some negatives becoming a non-issue. I think the most important thing in terms of reported SG&A, while it's not a cash expense right now, the stock option expenses, these incremental hits over the five years, over really now the four years, because the last two years were both in this fiscal year -- that's close to a 20, 25 basis-point hit to SG&A in the aggregate. Eight of it coming in to year-over-year in Q2. Once we get past this year, if we do nothing in terms of just do normal similar types of stock option or related type of grants -- I mean, we've looked at other things as well, like restricted stock units and things, but for right now let's assume stock options and the impact, by the way, of anything would be about the same -- if it grows with our growth, if we have 8% unit growth or 7% unit growth, that's 7% more warehouse managers, that's 3% or 4% more buyers, it's hopefully 2% or 3% more, or 1% or 2% more accounting managers, whatever it might be. Then you'll see flat SG&A or maybe even a basis point of improvement there. So that's hopeful. I hate to put a whole budget on it, but those are the factors that I think about when I look at those two components. Charles Grom - JP Morgan Chase: Great. Thank you very much for that color. Second question, could you speak to the potential for implementing a return policy on consumer electronics? Largely the flat screen TVs, and add a little color on maybe how much that actually negatively impacted margins in the quarter?

We did have a little negative impact in Q1, and a similar negative impact in Q2 for markdowns on TVs. Many of you who have known us and followed us for several years, the only return policy we have ever changed, if any of you saw Jim Kramer on Mad Money a couple of days ago, he talked about our wonderful return policy of three years. I don't know where he got three years. I'm pleased that he likes us, but or policy historically has been forever on everything, bring it back and we give you your money back. Of course there was a lot of abuse of that in desktop and laptop PCs: such that in 2003, we had 28,000 PC's returned; 14,000 were over a year old and 1,000 were over five years old. Of course, that's nonsense. Recognizing there's a lot more gaming, if you will, with PC's, you had college kids coming home at Christmas buying a PC to do their term paper and turn around and then bring it back. You had kids buying computers for their parents, and the parents never used it and they returned it, and then you had people who just abused the privilege. So about 12 to 18 months ago, for the first time in our history, we changed our return policy on that item, laptop and desktop PCs to, still the best -- to our knowledge -- the best return policy of any major chain, electronic chain, discount chains, you name it, non-food chains, is one month in the box unopened. If it's opened, there's usually a restocking charge. At Costco we went from infinity to six months, bring it back, we give you all your money back,. It doesn't have to be in the box, you still don't have to have a receipt. So still very much the best policy out there. That being said, for those of you who know Jim, it drove him crazy, and he warned everybody, he says don't come to me anytime soon. This crazy success we've had with flat screens, with plasmas and LCDs, in fiscal '05, we sold 1.5 million TVs. I don't know what the number is so far this year, but anecdotally, if four Christmases ago the 10 or 12 weeks leading up to Christmas, when the 42-inch plasma was $6,000 at retail and we could get our hands on a few diverted and sell them for $4,000; maybe we sold $5 million worth or $10 million worth because there was none to be had. That improved each year as production capabilities increased around the world, as more manufacturers like Samsung and Pioneer and others were prepared to sell us direct now. Such that for this Christmas, there were single items, single 40-inch and 32-inch and 50-inch TVs where we ordered and bought and sold 20,000 of one item at $2,000 a pop, or $40 million. So you're talking about well over a couple hundred million dollars of flat screens. Now, that's the good news. The bad news that we talked about in Q1 and this quarter a little bit again, it's a big dollar number, it's a small mid-single basis point impact. Is that our return policy is "bring it back". One of the things is that if you've noticed, all our TVs look great in the warehouse, they're all HD satellite fed, and we actually put signage up saying this picture may be better than what you see at home for a variety of reasons: you don't have an HD converter box, you have to call Comcast or DirecTV other whoever you use, it's not as easy as screwing in that little thing on the cable that it used to be when you brought your TV home. You get it home and you realize it's a tuner in some cases, not a TV. For a lot of reasons, and given our return policy, we've seen returns in excess of what the manufacturers will authorize for full credit. We're dealing with that, it will not be an issue a year from now. I can't tell you what we're doing. I can tell you that Jim feels pretty strongly about not changing the return policy on it, but we're also looking in terms of possibly including installation services or certain other things with some third parties. But rest assured, we will not see that impact next year, is my guess. Charles Grom - JP Morgan Chase: Okay. I'll pass it on to others. Thanks.

Your next question is from Gregory Melich with Morgan Stanley. Gregory Melich - Morgan Stanley: Hi, thanks. Two questions, Richard. One, we haven't talked about it in a while, but when you launched the Amex cards a few years ago, do you think that's helped? (1) What percentage of sales now are done on the card? (2) Has that been helping ticket a lot? How important has that been?

Well, it's been a great relationship, and I think it has been important for a lot of reasons. Recognizing there is a merchant fee, and I contractually can't tell you what it is, but there's lots of marketing initiatives, co-marketing initiatives that I think have helped both parties tremendously. When we did the deal four years ago, we were in 28 states, I believe, not the 37 or 38 states we are in today. In those 28 states, I think we had about 11 million members and they had about 11 million cardholders. The good news is that at the time, I think they had a market share in the teens or low 20s and significantly higher of Costco -- still only about a little over a third of those members were Amex cardholders, and a little over a third of those Amex cardholders were Costco members. So there was an opportunity for us to market Amex to 7 million or plus of our members at the time, of course that's been expanded, because we expanded the program to Canada and we've expanded to the other states and the other warehouses we're in. Clearly they could market the benefits of Costco to significantly more millions of members now that didn't have a Costco membership. The Amex -- hold on I'm looking at my sheet here. Amex is about a third of our sales in total company. Actually, in the U.S. it's about a third of our sales. That's up about 2.5 percentage points from a year ago. It's continuing to grow. In terms of what that number means, if you took what the average ticket in the U.S. for all of our members, which is somewhere in the $120-$130 range, it's higher if they have an Amex card, and it's higher if they have an executive member card. Higher in both average purchase and average frequency. If they have both a co-branded card and an executive member card, it's off the charts in terms of being the highest group. So now you have to look through the numbers and understand some of the things. Some of that is natural selection, the highest volume member is going to be getting an executive membership, the highest volume member might be somebody that sees the value of the American Express card. But clearly the more we can push people to either of those or both of those programs, we think long term, that bodes well for us. Clearly the loyalty factor, the renewal rates for those members are the highest. Again, part of that, they were the highest to begin with, but as we increase the penetration, we see improvement in those renewal rates. Gregory Melich - Morgan Stanley: You don't worry about that number? You'd be happy if that 30% went to 50% or 60%?

I would expect it to over time. Gregory Melich - Morgan Stanley: And then --

Given that God knows what other forms of payment occur in the future. Gregory Melich - Morgan Stanley: The other question was just an accounting one. On the electronics and the returns, do you provision some expected return rate given it's such a new category for you guys, it's ramping up quickly?

We don't provision in the sense that we assume, As an example in apparel, like I would assume most apparel companies, retail, traditional apparel companies, we include in cost of sales a markdown reserve. We know full well if we have cashmere sweaters out there, as successful as we'll be with cashmere sweaters, at the end of the season -- forget about the end of the season -- in the middle of the next summer, we'll have somebody return three of them that have been worn. As well, there will be a few that have been stepped on and you're always cleaning out the odds and ends. I'm sure, compared to traditional retail apparel industry, we have a relatively small amount of down reserve included in our cost of sales. In electronics we do not, so we do no provisions in our prices. What we see as an impact is what we call D&D, damage and destroyed. D&D is simply when a bottle of vinegar falls over and breaks, that's D&D at the warehouse, when a customer returns something, it either goes into one of three or four bins: goes into 'go back', meaning go back on the shelf because it's unopened, and it's fine to go back; 'destroy and eat it', destroy meaning eat the hit yourself, or 'destroy for credit'. In some cases, particularly on the food side, you'll have manufacturers give you a markdown reserve. The reality is on electronics, on TVs, we don't have any provision built into our cost. Our view is, here's the problem, it raised its head for two reasons: (1) the tremendous supply increases and availability; and at the same time everybody wants one now because it's finally broken below $2,000 bucks; (2) The HD issue. I think people don't realize it's not as easy as it used to be, just bring it home and plug it in. We're going to fix that. Gregory Melich - Morgan Stanley: Okay, great. Thanks a lot.

Your next question is from David Schick with Stifel Nicholas. David Schick - Stifel Nicolaus: Good morning. Three topics, if you could just talk about how you're thinking about them long term. You talked about Costco.com hitting 850 for '06. How do you think about that business over the next few years? Then update us on that store you opened in Oregon with the larger footage devoted to fresh. On Costco Home, how are those things working relative plan, and how does that make you think about a three or five year big picture outlook on those businesses? Thanks.

Well, dotcom, I think Jim said to somebody or a group of you guys on one of the phone calls, when I think maybe that infamous April 22, call in '05, that it's doing well and we would expect it -- it's an important part of our business, and we recognize it as a percent of our total business, even in at $1 billion it's a little under 2% of our total company, a little bit better than that in terms of bottom line. He hasn't really defined it is five or ten years, but he sees this as a $5 billion plus business. Frankly, it's growing a lot faster than we budgeted ourselves. A lot of that has to do with the success of electronics, and with some of the other big-ticket items you see on there. We've been successful with furniture, to our surprise. But when you look in some of these high end catalogs where a standard very nice leather sofa and ottoman and chair is $2,800 and white glove delivered to you is $12.99, the numbers are big. So I think that's the type of thing that we think it can grow. Now, there's a lot of things we don't do. We don't advertise, we don't pay for placement on other websites. So if you're looking for something, our item is not going to come up. So 99% plus of these sales are to our members. Notwithstanding that, it's growing like a weed and I sometimes joke we're doing it despite ourselves, but we're doing it the way we feel comfortable doing it. In terms of Costco Home, we have two open, we'll open a third one, I believe, in the Oregon market in this fiscal year. This calendar year will probably open another one somewhere on the West Coast. It's profitable, we still want to make sure it has legs, recognizing it doesn't get the frequency of shop that a regular Costco does, although its frequency of shop is still significant compared to traditional furniture retailers. We've changed our mix over time. There's still some impressive $20,000 bedroom sets for half that price, but there's a lot more home furnishings in what I'll call medium and big-ticket impulse items. Some of the same things you see in a warehouse. I just saw the other day a beautiful chair, something you might buy two of for your living room to put next to a sofa, these are a $1,000 chairs for $379. Who would think you could sell an impulse item for $379? But we do. In terms of Hillsboro, Oregon, it's doing fine. It's a 205,000 square foot unit compared to our current prototypes of about 148,000. The goal here was to have some testing space close to home, and that was as close to home as we could get as quickly as we wanted. It has greatly expanded fresh foods, including home meal replacement, additional cheeses, you name it. It has a greatly expanded floral department, including service provided to florists, where they can come in and buy the three dozen pack of uncut roses at a price better than we believe they can get at wholesale. It has probably 20,000 feet devoted to furniture and home furnishings. And we recognize that there will be some markets around the country, even if Costco Home is greatly successful long term, there will be markets where it doesn't make sense. There's not enough population, we only have two locations in that city or maybe we have four or five, and maybe even in a market where it doesn't make sense to have a stand-alone, but we have four or five locations, maybe one of those locations should have an extra 20,000 or 30,000 feet. So those are the types of things we're testing here, and believe me they're all non-scientific tests. We're out there entrepreneurial-like, doing the stuff and seeing where it goes from there. The unit is doing fine, by the way, no issues there. Getting back to a previous question, by the way, Dave Patterson our controller mentioned, in terms of asking about the provisions for electronics, we do include, as we do every quarter, we assume that their prior purchases that will be returned subsequent to that Sunday night, some things that were bought the previous day, some things that were bought two years earlier. We, having studied that, we have an estimate -- we assume -- we reduce our sales each quarter and reduce our gross margin associated with those sales for the estimates for returned merchandise. So electronics, like any other item, are part of our estimated sales returns reserve but no special reserves on top of that. To the extent that we've had higher sales of those items, that's implied in that.

Your next question comes from Mark Husson with HSBC. Mark Husson - HSBC: Good morning. When other retailers talk about utility cost increases of something like 8 to 25 bips in SG&A and in gross margin, I was just wondering, considering you've got a lot of freezer equipment and chilled equipment and lights, how you're doing it?

Well, first of all, we've got more skylights per square foot than anybody I know. That helps. We have, relative to traditional supermarkets, a lot fewer coffin coolers and open cooler space in more doors. All that stuff helps. And relative to our sales, also relative to supermarkets, we're selling a bunch of stuff that doesn't require electricity like TVs and everything. So compared to a supermarket where whatever percent of their stuff requires refrigeration, as a percentage of our total sales, it's going to be significantly less. The other thing I'll point out is that our utility costs hits SG&A, not cost of sales. I know you can do it either way, we've always hit SG&A for utility costs. In terms of utility costs, I'm just looking real quick at my components here, in the quarter it was about a 3 basis-point hit. Mark Husson - HSBC: Congratulations. Just one final thing on a small part of your business, the pharmacy business,. You probably haven't seen much shift yet from Medicare Part D. Do you over-index or under-index on old people in terms of the penetration of your prescription business?

We significantly over index. As I understand, in the traditional chain drug stores out there like Walgreen's and CVS, the ratio of customers coming in on plans versus customers coming in and paying for it, is 90/10. At, Costco, it's 50/50. Why? Because our prices are so much lower. Anybody that has to pay is coming to us. This does impact somewhat, not to any extent how it impacts in our view the bigger chains because the margin structure is so different. Our costs are already very low, and so some of these component costs, even negotiated rates while it will have a slight negative impact, it's not nearly, I think, as meaningful as some of the bigger chains. We're offsetting that with other ways. We have become -- I think this was just more coincidence than how do we brace ourselves for any change in that. We, over the last couple of years, we've done more marketing, if you will, to third parties out there, third-party plans where we can go out and talk to them. Part of that is, not a lot of marketing. I mean, but we, more than just waiting for the phone to ring. Mark Husson - HSBC: Will you lose any share? Will people who sign up for Part D go to a Walgreen because it's more convenient, do you think?

I think on the cusp, yes, but in talking to Charlie Burnett, who's -- I think Charlie and Jim have known each other close to 50 years, starting at Fed Mart, then Price Club and then Costco, Charlie and his staff really started the pharmacy business about three or four years into Costco's beginnings back in '83, we think it's manageable. But I would say it is a slight negative, not a breakeven. Mark Husson - HSBC: Okay, thanks very much.

Your next question is from Christine Augustine with Bear Stearns. Christine Augustine - Bear Stearns: Thank you. Richard, I wanted to ask you about the year-over-year growth rate in the membership fee income. It was sub-10% in the second quarter, and it has been decelerating, so could you maybe explain why that might be happening? Would you be willing to comment on any updated thoughts with regard to raising the membership fee? Thank you.

Sure. Actually, what you see in this reported membership fee increase is membership fee income based on the deferred accounting. Actually, on a cash basis in the quarter, while as our membership fees year-over-year were down one basis point, implying that the growth rate in that reported membership fee dollars were slightly below our top line sales growth rate -- which by the way you would expect a little bit from the standpoint that each member's buying more each year, offset by increased penetration in executive memberships. On a cash basis, our membership fee income year-over-year was actually up one basis point. Again, part of that is, to the extent that you're growing your cash basis a little higher, 11/12 of that is deferred until the next 11 months. So actually, I'm glad you asked that question. Christine Augustine - Bear Stearns: Okay, well how about answering the other one?

Well, the answer I'll give you is, is the one you've heard for a couple years. We'll let you know. We do talk about it occasionally. We have not made any decisions yet. But when we do make a decision, it's a matter of once we say do it, it would be a couple months off from there, because of just the timing of when you do mail out renewals and what have you. I'm not trying to be cute and suggest it's two months from now. It's not. We do, about every four months -- when I say we, we have what's called, it's informal. I guess it's formal. It's an executive committee, which is Jeff and Jim, the two founders, plus about 14 senior executives, all of the EVPs, and a few of the Senior VPs in merchandising. We go away for a couple of days and talk about exactly those types of issues, and as we have in the last couple of meetings like that, four and eight months ago, I'm sure we'll do it again next month. But there's -- will we do it? Yes. When? I really can't tell you. Some have asked us, does it make it easier for us to do it now, now that our two competitors each raised their fee by $5, recognizing that our base fee is still higher than Sam's by $5 and $10, instead of by 10 and $15. Not to sound arrogant, on the margins that is another little positive, it's not a real big impact. The bigger impact was, in California, membership fees are not sales taxable as long as they're de minimus. And de minimus until January 1st '06 was defined as $45. De minimus has been recalibrated to $50, based on the last five years of the CPI in California, and so at least that, again, that's a slight net positive of -- does that mean it's more likely than less likely? Yes. But there's no rush to do it. We'll let you know. Christine Augustine - Bear Stearns: Thank you.

Your next question is from Bob Drbul with Lehman Brothers. Bob Drbul - Lehman Brothers: Hi, good morning Richard. Two questions for you. The first one is, can you talk a little bit on how you expect the Easter shift to impact March and April in your business?

Given that I'm getting ready for my son's bar mitzvah, I need to find out when Easter is here. Jeff will tell me here. So Easter's moved forward this year, it's further in the future? Bob Drbul - Lehman Brothers: April, yes.

It's earlier. Jeff says, his guess is it will cost us about 1.5 percentage points this month and an improvement in April. Bob Drbul - Lehman Brothers: Okay. And can you talk a little bit about any inflation that you're seeing on the food side of the business?

Well, paper products is the big one. Big one in terms of dollar size of those sales. We've seen numbers in the 4% to 8% range. If l look year-over-year last month in terms of inflationary items, percentage-wise, nuts are the biggest, Pistachios year-over-year are up 32%, olive oil is up 24% to 29% on a couple of items, plastic bags up 16% to 20%. Not all plastic bags. Again, part of its based on when these things hit us as well as based on, did we buy in? Did we have a commitment for six months, or whatever. So percentage-wise, I would say nuts, and oils are a little higher, significantly higher. Then on the downside, of course, electronics, if I look at the top 20 items in terms of deflation year-over-year, I think all but three or four of them are electronics, and they average 20%-plus, 12% to 35%. Looking down the list, is there anything -- gas is actually down year-over-year in the month by about 11% from year end. These are all not year-over-year, they're as compared to August 29. Butter is down 23%. Those are the big things. Bob Drbul - Lehman Brothers: Richard, your competitors have talked about reinvesting some of the membership fee increases into price and into higher products. Are you at all concerned about that going forward in terms of from a pricing standpoint on similar products?

We've never viewed it that way. Recognize we looked in our P&L, there's two line items that have pluses, membership income and gross margin. A bunch of items, some items that have negatives, like SG&A and what have you. We compete with blinders on, as it relates to membership fees. I know who you're talking about who said that, there's been a higher level of competitiveness relative to our major competitor for the last two years now, and we haven't seen anything change in the last six weeks. It's still a high level of competitiveness, but keep in mind, if you go back to '01 and '02, we were the ones opening up just in those two years, 45 or 46 units in their markets, and probably over a five-year horizon, have opened probably 70 units in what were for us, brand-new markets but for our competitors, were markets that they had been in for at least 15 to 20 years. By doing that, that had a great impact on margins, and so I think there's plenty of pressure they put on us, and plenty of pressure we put on them. I don't view that as a meaningful difference. That would not be a reason why we would do the membership fee increase. We believe that our membership fee, even when it's $5 and $10 higher than others, and frankly, even when it was $10 to $15, is still the best value, and we're going to look at our membership fee based on what additional values we brought to the table, what is now a little over five years. So it's going to happen, it's just a question of when, but it hasn't, nor will it ever impact what we do in terms of competitive pricing. Bob Drbul - Lehman Brothers: Thanks, Richard.

Your next question is from Chuck Sarankoski with Key McDonald. Bill Cower - Key McDonald: Hello, this is Bill Cower on instead of Chuck. Could you just discuss briefly what's new in the clubs regarding prepared foods? Thank you.

Chicken soup. That's the best new item. I don't know if it's rolled out on the East Coast yet, but it will be within a few months. That's an interesting story. We have a rule of thumb that no rotisserie chicken can be over two hours old sitting there, because it starts to dry out, it's essentially cooking a little bit under that lamp. And at five minutes to 6:00 on Sunday night, there better be fresh hot juicy chicken sitting there. And at the end of the day, it's not an item that you can give away to charity because it's a prepared item, there's safety implications, and it's not an item you want to just be able to give to your employees, because you don't want any incentive to make extra chickens for the end of the day. What you end up doing is throwing away chickens every night, to the tune of $5 million plus a year in our Company. One of the things we've done is, I don't think it took a rocket scientist, but it was a great idea, is to make two items: one is a chicken burrito, and one is chicken noodle soup. And the chicken noodle soup is out of this world, I think it's a 64 ounces in the fresh counter, 64 ounces with great vegetable stock, oversized noodles, and the rotisserie chicken breasts from our -- we're greatly exceeding, by the way, the use of just those chickens, we're having to make extra chickens just for the noodle soup. Personally, I've eaten a whole 64 ounces at once. What else is new in fresh foods, in the home meal replacement? I know we've had some additional salads, we've had some additional -- if you call me separately I'll find out. I'm just having a--. Jeff is saying we're doing a lot of flash cooked, or precooked items, where you heat and serve. I know we expanded our take home pizza selection, chicken fettuccine, we've got some pasta dishes. These are all a subset of what we do in Hillsboro, Oregon, there we've committed substantial space to doing more home meal replacement as well. Sorry I can't be more informative. Bill Cower - Key McDonald: No, that's very good. Thank you.

Your next question is from Adrianne Shapira with Goldman Sachs. Adrianne Shapira - Goldman Sachs: Thanks, Richard, I guess we know chicken soup is going to be at the bar mitzvah. As far as you mentioned, the membership fee GAAP narrowing relative to Sam's and BJ's. Any marketing plans in place to highlight that narrowing difference that could help drive better conversion plans?

I'm sorry, could you repeat the question? Adrianne Shapira - Goldman Sachs: You talked about the narrowing membership fee gap between Sam's and BJ's not helping all that much yet, but do you have any plans in place to perhaps drive some marketing to highlight that the difference is narrowing between you and Sam's and BJ's?

No, all our focus is on highlighting what we do in terms of the chicken soup, the best prices on paper goods because we bought in, all the things that you do as a retailer, and coming up with new stuff. I think that's what makes us exciting. Frankly, it would be kind of hard to market, guess what, we're only $5 higher now. Clearly with BJ's, arguably our volume per unit is significantly higher than BJ's, and BJ's is taking a little bit of a different tack in terms of the significantly larger number of SKUs, perhaps a little bit more retail orientation, their membership fee is $45. While I'm biased, I think ours is a better deal. I don't see us doing anything related to that. Adrianne Shapira - Goldman Sachs: Okay. So no real change in conversion rates in markets you overlap with BJ's?

I checked yesterday with some of the regional operators and anecdotally, they checked with a few of the warehouse managers. They said yes, they've heard a few more comments of somebody saying I'm switching, but nothing to the tune where that was a pull question, not a push question. I called them, they didn't call me to say, hey, guess what's happening. Adrianne Shapira - Goldman Sachs: And then obviously the West Coast so important, can you talk about what the entrance of Tesco means for you?

Well, Tesco is a great company, in fact, up until a couple of years ago I didn't appreciate their greatness until I saw their market capital and looked more closely at what they do. Certainly people like Jim Murphy and Jim Sinegal, of course knows a lot more about them than I do. I think, any player that sells general supermarket-type items, it's another place to buy them, other than Costco. So from that perspective, that's an issue. I think it's much more impactful to traditional supermarkets than to us. It's a much -- it's kind of, again, everybody is trying to guess what format it will be. The sense is it's going to be something bigger than what they do in some other countries, bigger than a convenience store, but not nearly as big as a supermarket. So it will be some hybrid in between there, with a lot of focus on take out and produce as well. Again, I think the impact is much more impactful because it's an added convenience for that same customer that's going to the supermarket 2.5 times a week than it is to us. But I would be remiss if I didn't say is it a negative? Sure it's a little negative, but we're anxiously waiting to see what it is, we don't view it as a big issue. Adrianne Shapira - Goldman Sachs: Thank you.

Your next question is from Gilbert Creedbark with EMG Investment Partners. Gilbert Creedbark - EMG Investment Partners: Good morning, congratulations on both a great quarter and on your son's bar mitzvah. I wanted to ask you one question regarding dividend policy on the common going forward. Any thoughts that you might share with us?

I think the policy as discussed historically, once we initiate it, at its first anniversary, we raised it from, on an annual basis, from $0.40 to $0.46, a 15% increase. I'm not sure, we haven't decided, the Board has not actually made any decisions. The discussions have always been around, do you do something on a regular basis so every year people come to expect something or do you do something on a generally regular basis where you're not -- if you miss -- if you do it a quarter early or a quarter late, nobody's going to care. I think the general feeling of the Board has been on a long-term basis, assuming all things being equal in terms of the Company and its growth and its ability to more than adequately fund capital expenditures and organic growth, that we should continue to grow it, such that five years hence people can look back over five years and say, hey, on a generally regular basis, maybe not exactly every time we would do it. Clearly, we're also returning significantly more capital currently through repurchase, and again, philosophically, I think the feeling of the Board is that first priority is capital expenditures, and second priority is return of excess capital. I would expect and hope that, again, five and eight years from know, you look back and say this is a company that can grow its company and do both of those other things well. Gilbert Creedbark - EMG Investment Partners: Okay, terrific, I appreciate your thoughts. Thanks very much.

Your next question is from Robert Toomey with E.K. Riley Advisors. Robert Toomey - E.K. Riley Advisors: Good morning, just one quick question, Richard. If you look at the last few months or longer term, of course you continue to outperform your peers both in the warehouse club industry and outside, in terms of comps. It's been very pronounced the last few months. I know what you talked about how individual product lines are doing and that's sort of individual categories. Is there anything else you can add color on that, why you think you're doing better than 2X on average, what I call your peer competitors in terms of comps?

Well, if you'd asked Jim it's that constant focus on not being afraid to try new things. Our culture, for those of you who've known us for a long time, I'm trying to think of some of the qualitative things. Our culture has always been try stuff, if it doesn't work, don't worry about it, just don't do the same dumb thing twice. A constant pressure on buyers in a positive way, we're not interested in what you've done for us lately, but how are you going to take that item, improve the quality, increase the size and lower the price per unit next year, so you can increase unit sales? Jim is very focused on top line because top line solves a lot of other things. Recognizing we have to acknowledge the other lines, but clearly that helps a lot. He would certainly say that having one major business helps because everybody's focused on one major business. Anecdotally, one of the things that we were going to test a couple years ago was in addition to Costco Home, was a site called Costco Fresh, it was going to be a 100,000 square foot version, it was going to be a little bit of Costco fresh foods, a little bit of Trader Joe's, a little bit of Whole Foods, a little bit of Zabars, a little bit of Itzes in Dallas, a little bit of everything, a little bit of the Harrod's Basement in London. Recognizing not nearly as fancy. During that 12-month process, I think two things happened. I think he realize that fresh foods is a major driver in our warehouses, let's figure out what we can do in our warehouses. But in addition, you had half the people in fresh foods working on this new concept where it made more sense to focus on how do we drive the 470 brick and mortar Costco warehouses. It was getting back to that singular focus of doing what we do to drive sales. Jim is much more interested in looking at Costco Home, not can we get 50 of these open in one day that are profitable in however many states we're in? If it goes to 50 or if it goes to 5 or 10 and stays there, what additional vendors has it provided us, what additional things have we tried because of it, and have we learned from it? Be it promotional items or in-line items. Those are the types of things I think that has made us strong. Clearly all the positive press we get nearly daily, I got to tell you, again, you know we don't have a PR department, so a lot of calls come to me at least to disseminate to others here. A day doesn't go by where some newspaper or TV station wants to report on how well we treat our employees. Let's face it, we do, and that's great press both from our employees' perspective, because they know it, but also from our customers' perspective. I think all those things help us. The last point I would say on that, I haven't seen it lately, but Jim has a list of the things that we should live by around here, like obey the law, respect and take care of your customer, and all that stuff, but there's have been a few additional ones on that list, that have been on the list for a long time. It's important we operate in a healthy state of paranoia. That starts with Jim, Jim is out there three, four days a week, around the world visiting not only Costco's, but Sam's and BJ's and other retail formats to find out what they're doing. Every four weeks when we have a two-day budget meeting, each of the eight regional Senior VP's, and four EVP's of operations are up there. Part of each of their 30 or 40 minute presentation is detail, what's going on with the competition -- I don't mean just with Sam's and BJ's. What have we tried lately? So it's that entrepreneurial focus and the incredible strict discipline that I say half tongue in cheek and half seriously, that we don't cheat on stuff. We won't raise the price of an item, just to raise the price. We won't increase the pack size unless we can lower the price per unit. We won't do a private label item unless it's at least a 20% better value than what we sell the branded value for. Sometimes a private label will be at a higher price but we've increased the value and the quality significantly more than that. So those are the rules we live by, and they are tough sometimes but what we've ended up with is something pretty good. Robert Toomey - E.K. Riley Advisors: Great, thanks very much.

At this time, there are no further questions.

Well, thank you everyone, and Jeff and Bob Nelson, Jeff Elliot and I are here to answer any questions you may have. Have a good day.

Thank you. This concludes today's conference call. You may now disconnect.