BJ's Wholesale Club Holdings, Inc.
Q3 2007 Earnings Call Transcript

Published: 20 Nov 2007

[Operator:]

Good day everyone, and welcome to the BJ's Wholesale Club Incorporated thirdquarter earnings results conference call. There will be some formal remarks madeby the company, and then we will open up the call for questions. t this time, Iwould like to turn the call over to Ms. Cathy Maloney, Vice President ofInvestor Relations. Please go ahead.

[Cathy Maloney:]

Thank you. Welcome everyone to the BJ's Wholesale Club third quarter earningsconference call. With me this morning are Herb Zarkin, Chairman, President, andChief Executive Officer; and Frank Forward, Chief Financial Officer. Before we begin, let me remind you that the information presented anddiscussed today includes forward-looking statements which are made under the Safe Harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. Actual results may differ materiallyfrom these forward-looking statements. The risks and uncertainties related to such statements are detailed in ourfiscal 2006 10-K and subsequent 10-Qs for fiscal 2007. While the company mayelect to update these forward-looking statements, the company specificallydisclaims any obligation to do so, even if the company's estimates change. Now I'll turn the call over to Frank Forward.

[Frank Forward:]

Good morning, everyone. Thank you for joining us this morning. For the thirdquarter ended November 3, 2007net income was $22.7 million, up $0.35 per diluted share. Comparatively for thethird quarter of 2006, net income was $18.3 million, or $0.28 per dilutedshare. Results for the third quarter of 2006 included a loss of $1.4 millionpost-tax, or $0.02 per diluted share related to the discontinued operations ofthe ProFoods restaurant supply clubs. Thus, the third quarter net income on anadjusted non-GAAP basis was $0.35 per diluted share this year, versus $0.30 perdiluted share last year, an increase of 16.7%. Net income for the first nine months of 2007 was $72.6 million, or $1.11 perdiluted share. These results included

[Herb Zarkin:]

Thanks, Frank and good morning, everyone. As we have discussed since myreturn to the CEO chair at BJ’s, our strategy is to build long-termrelationships with our members by having the right prices on the rightmerchandise and to present our merchandise in attractive, shoppablepresentations. In the third quarter, we continued to improve our offerings in all of theseareas. Our positive sales results for the quarter were driven primarily bycontinued strength in perishable foods, as well as stronger sales versus lastyear's through our fall members acquisition program. For the quarter, comparable club sales of our high margin perishable foodsincreased by approximately 8.3%, up from 7.8% in Q2 and 3.2% in Q1. As we havesaid in previous calls, perishable foods represents our greatest opportunity tocapture market share from supermarkets because of the outstanding savings weare able to provide on a wide assortment of items. Our team members are doing atremendous job of raising our standards of quality and presentations in thisarea, particularly in the produce and prepared foods, and we are pleased withour members’ response. Our fall members acquisition program, which began in late September and willrun through December, got off to a strong start, generating more trial membersand more program-related sales during the third quarter compared to last year.Some of the credit for these results certainly goes to our members acquisition andretention managers, or MARMs, who applied their experience from the springmembers acquisition program to the fall program, and have continued to build aculture within the clubs, focused on membership. Another factor that had a positive impact on our comp sales during thequarter was keeping our prices at competitive levels. We have been able toimprove our price positioning by putting more resources against this effort,both at the home office and in the clubs, by refining the method by which wemake competitive price checks and by responding more quickly to marketconditions. As compared to last year, while we reduced the number of couponsdistributed, we made more effective use of those that we did distribute. Let me talk about some other things that we're doing to ensure that ourmembers enjoy their BJ shopping experience. To make our clubs easier to shop,we've made a number of improvements in our merchandise presentation. Forexample, during the third quarter we tested a new waterfall display of large,high-definition televisions that quickly became the prototype for all clubs. Wealso installed a new Sony flat-panel television display, showcasing Blu-raytechnology as well as an attention-grabbing Nintendo Wii end cap. In the apparel area, we edited assortments and trimmed inventory, and at theback of the club we continue to upgrade presentations of perishable food byreplacing coffin-style refrigeration cases with multi-deck cases. Another way that we improved the value of membership during the thirdquarter was through the introduction of the BJ's Visa card. All BJ's purchasesmade with this new card become eligible for merchandise rebates that are mailedwith the members' monthly statements. Looking out to the fourth quarter, I am very excited about our assortmentsfor the holidays. The majority of our holiday merchandise was selected by theteam of buyers that Laura Sen put into place last January. I believe they've done an outstanding job of meetingof their three objectives, which are

[Frank Forward:]

Thanks, Herb. For the fourth quarter, which will include 13 weeks of salesthis year versus 14 weeks of sales last year, we are planning for total salesto increase in the range of 0.5% to 2.0%. We estimate that the negative impactof last year's extra week of sales will be worth about 7% to total sales. Comp sales increase of 4% to 6% which includes a favorable impact fromgasoline sales of about 150 basis points to 250 basis points, and anunfavorable impact from the absence of pharmacy sales worth approximately 40basis points. Our fourth quarter merchandise comp sales, excluding the impact of gas andpharmacy, is planned in the range of 3% to 4%. However, our Q4 sales guidance does not flow evenly across the months. Weare planning for merchandise comp sales, excluding the impact of gas andpharmacy, to be around 4% for the months of November and December combined, andflat to up 2% for January. The lower January cost is primarily due to needingto cycle last January's high levels of merchandise markdowns, taken as a partof our corporate restructuring. We expect membership fee income and other to increase 4.5% to 5% in dollars.As compared to previous quarters, the Q4 percent growth versus last year will moderateas we fully cycle the benefits of the $5 membership fee increase that went intoeffect in January of 2006. We expect cost of sales as a percent of sales to increase 5 basis points to15 basis points, an increase that is lower than in previous quarters this year.It does reflect an unfavorable impact of planned high gasoline prices andweaker gasoline margins, as well as unfavorable leveraging of buying andoccupancy expense, due to the extra week of sales from last year's 53rd week. However, it also reflects the benefits from a strong increase in merchandisemargins, excluding gasoline, due primarily to the unusually high level ofmarkdowns taken last year as a part of our restructuring; and a better mix ofsales in the fourth quarter of this year, with stronger results expected fromhigh margin departments such as perishables, apparels, jewelry and holidayseasonal items. We expect SG&A expense as a percent of sales to decrease 100 basispoints to 110 basis points, due to the following factors

[Herb Zarkin:]

Thanks, Frank. Before I turn it over to Q&A, let me say that we haveevery reason to be optimistic about our fourth quarter. Inventories are ingreat shape, we have exciting merchandise with tremendous values, and our teammembers are energized and enthusiastic. While we recognize that concerns about the housing markets, rising oilprices may dampen discretionary spending, we believe that comp sales willcontinue to grow, particularly in perishables, consumer electronics andtelevisions, which have been strong all year. Our forecast is for a merchandisecomp increase of about 4% for November and December. But with that said, ifthere's an upside potential for fourth quarter earnings, the improvement wouldcome from higher comp sales increases. If there is a rush of business, we arein a very good position to take advantage of it. Now I will open the call to questions.

[Operator:]

Your first question comes from Deborah Weinswig - Citi.

[Deborah Weinswig:]

Herb, I know that there's been a lot of work that's been done in terms ofthe SKU reduction/rationalization program. Can you talk about where you arethere in terms of number of SKUs and what you hope to achieve by the end of theyear?

[Herb Zarkin:]

Well the number of SKUs that were down in any given quarter varies becauseof seasonality. We've been running down 700, 800 SKUs in the third quarter. Inthe fourth quarter we think we'll be in that same kind of range. Certainly atthe end of the quarter we'll have less SKUs because a lot of the seasonal SKUswill disappear. This is an ongoing battle; we are not done yet and we are not rushing to getit done. We are doing it in an intelligent way. We review every time we makethese judgments. We see what the results are, we see if the other SKUs thatremain pick up the slack, what happens with it. So it's an ongoing process. –We are not going to be done with SKUrationalization, let me put it that way. We think there's another pickup nextyear of some number -- it might be 100, it might be 200 SKUs, there's no magicnumber to it at this point in time.

[Deborah Weinswig:]

I believe that not all of the clubs had MARMs as of the end of last quarter.I don't know if you've been able to close that gap by the end of this quarter,but can you talk about any differences in terms of membership acquisition inthose clubs that did have the MARMs versus those that didn't?

[Herb Zarkin:]

We've been running about 160 MARMs right now for this quarter, which isabout as high as we ever thought we were going to truly get and we are pleasedwith that. We don't quantify the differential by location with MARM or withoutMARM. We're going to do a thorough review of all the activities the MARMs havedone this year during the spring of this coming year when we get a chance tosee everything as it flows through. We may or may not at that time give you some more information as to  what the MARMs produced or didn't produce.Most of it is very confidential, we certainly don't want it to be displayedpublicly as to whether their performance has really helped us or not helped us,so we are reluctant to give you too much information.

[Deborah Weinswig:]

Frank, I believe that CapEx guidance as of the end of last quarter had been$110 million to $120 million for this year and now it's $90 million to $100million. Can you talk about the differential between the guidance in the twoquarters?

[Frank Forward:]

We are still holding in reserve some money for some clubs next year and thenjust generally some spending almost in all areas has just been a little bitless than what we had expected. We are trying to give you the best number weknow right now.

[Deborah Weinswig:]

But no changes in remodel activity?

[Frank Forward:]

No. We will give you an update at the next quarter call as to what we areplanning for next year. We are going through those plans right now.

[Operator:]

Your next question comes from Chuck Cerankosky - FTN Midwest Securities.

[Chuck Cerankosky:]

Frank, in looking at the working capital, it was a great performance there.You mentioned some of it was due to SKU reduction and yet the sales seem to bepicking up. Are you comfortable that inventories are not too tight going intothe quarter?

[Herb Zarkin:]

We are very comfortable with our inventory position. A lot of it does comefrom SKU reduction, there is no doubt about it. But a lot of it comes from theflow of inventory. How we purchased the inventory, how we flowed it intocountry if it is an overseas purchase, or even manufactured here in the United States or distributed through United States. We have gotten much moresophisticated as of late of how to think about just in time inventories andit's made the clubs a lot easier to present the goods and show the merchandisereally well. The clubs have done a great job in how they present the goodstoday. We are not the least bit concerned about the reducing of the inventorylevels. It just makes it good for everybody in our organization, and it is verygood for the membership because the customer can come in and she can clearlyidentify the products much more so this year than she would have done last yearwhen she was shopping. It’s a good thing, but the level of inventory has nobearing whatsoever on our ability to do some big sales.

[Chuck Cerankosky:]

Do these flow improvements include both food and general merchandisecategories?

[Herb Zarkin:]

Absolutely, yes. There is more opportunity in general merchandise,especially on importing for the next year or two because we are learning moreabout that as we go. But most of our food products or almost 90% of the foodproducts we carry are replenish on a regular basis. It's just a question of theskill sets of how we bring the merchandise in. Also, we did a lot less promotions this year which helped us roll in theinventories and make it cleaner and crisper for the clubs to be able to takecare of the merchandising. In the past if we ran a big promotion and it didn't sellout well, what did we do with the merchandise? We didn't have a home for it, itwasn't a natural item. Today, we are promoting – when we do promote, which is not that often -- wedo promote natural items that have a home going forward so if it's a success,we buy more; and if it wasn't a success, we don't reorder next week and we areright back on the inventory level.

[Chuck Cerankosky:]

Tires disappointed again, Herb. Any thoughts on that category?

[Herb Zarkin:]

I am disappointed in our performance in tires. I think most of theperformance is very directed inward, I'm not going to blame the outside worldfor tires or anything else. I think we haven't put the resources that arerequired to really do the tire business the way it should be done. This was the decision I made at the beginning of the year. I don't havemoney for guns and butter, I don't have enough people that can do all of thismulti-tasking, 700 different attempts to get everything done. Tires is one of the decisions I've made. I was just going to watch it and seewhat happened this year. We are meeting on a regular basis on the tire businessto try to find better ways to promote the tire business and to run the tirebusiness. We're not happy with its performance at the present time; but as Isay, again, I think most of it's internal.

[Chuck Cerankosky:]

Are there any thoughts about using that space for other categories?

[Herb Zarkin:]

We always look at the size of the clubs as to whether we are undersized inthe back of the club, if we put the tires in the tire bay to sell them there orwe build an appendage to sell the tires. These are things that we do on aregular basis. But by and large, with the exception of one or two huge clubs --Queens, New Yorkfor example is one -- where we needed the tire bay space, we needed where thetires were in the back of the club, we needed that space. Today we don't haveany real plans one way or the other what we're going to do; it's in the processof being formulated and we'll share that with you come next spring when we finallydecide what we are going do with it.

[Chuck Cerankosky:]

On the Membership Acquisition Program, any read so far on what kind ofretention you're getting from these people who are signing up? How likely are theyto become permanent members?

[Herb Zarkin:]

All we are going to say is we are very pleased with the results of theMembers Acquisition Program at this time. As I say, it's not an easy thing tomeasure because it rolls over and it rolls over. Some members renew right away,some members renew in three months. So we have to have a period of time to beable to shake all this down. As I say, probably next spring we'll make some comments about it but at thispoint in time they are not going to be very specific, but there will be somegeneral comments. Other than to say we are very pleased with what the MembersAcquisition Program has produced, and we're very pleased with what the MARMsare doing, and we're very pleased with what the whole clubs are doing now,because management of clubs are very much involved in this. They understand howimportant this is for the membership, and for the success of the company. Generally,it has really helped make the culture that much better in the clubs.

[Operator:]

Your next question comes from Daniel Binder - Jefferies.

[Daniel Binder:]

The couponing that you talked about that occurred last year, a lot of whichhas not been repeated this year, can you give us a little bit of a sense ofwhat kind of margin benefit that may have provided? Perhaps what kind of sales detrimentit may have been? Also, what should we expect over the next couple of monthswith regard to couponing versus last year?

[Herb Zarkin:]

The only thing we're prepared to say is that we ran substantially lesscoupons this year than last year and that the coupons that we did run this yearproduced a wonderful result and we're pleased with that. But we don't want toget into the margin impact of couponing. The only part we will get into is thatwhen you have couponing on a global basis it does tend to build inventories,slows down your turn and makes it more difficult for the clubs to function; makesit more difficult for the consumer to find the inventory in the club, andthat's really where the big benefits come to us. Everything else is just part of making up of the meal, if you would. Those arethe key things that we wanted to get out of it, and so that's about all we'regoing to talk about at this point in time.

[Operator:]

Your next question comes from Charles Grom – JP Morgan.

[Charles Grom:]

Frank, a question on your gross profit margin guidance for fourth quarter, 5basis points to 15 basis points of expansion. Provided that the fourth quarterlast year compressed, I believe, a 110 basis points to about 8.9%, the guidanceseems pretty conservative to me. I'm wondering if you could discuss some of the assumptions embedded in youroutlook?

[Frank Forward:]

I'm not sure if I would classify it as conservative. It's our best guess ofwhat we think the quarter's going to be. It certainly was built in there ascontinued strength within the perishable business, which have a higher margin.We are expecting some comeback in strengths in the apparel and jewelry margins,which would help some, so we'll have to see how that works out. Generally, obviously the absence of the fairly heavy round of markdowns thatwe took in the fourth quarter last year, put that all together and that's whatour modeling is coming up with.

[Charles Grom:]

Just to your apparel point, I know October is a little bit soft, we've heardalmost universally that November is improving. I'm wondering if you could giveus a little sense for how things are breaking here, month-to-date?

[Herb Zarkin:]

When we see cold weather, we see cold weather goods fly out of the building.Cold weather for one day -- you need cold weather for two, three, four days. Whenwe saw the cold weather hit, it was very rewarding, we felt very good and wesaw good sales across all cold weather products.

[Charles Grom:]

Herb for you, on the MARMs, beyond what that program is going to do foracquiring and retaining new members, I'm wondering what the benefits are fromthe MARMs to the store as a whole, including the store manager? If you couldjust speak on what that's doing to allow that store manager to free up time tofocus on end caps and to focus on areas of profitability within the store?

[Herb Zarkin:]

Well it does just what you described. The MARM is really in charge of makingsure that the organizations below the management level truly understand how tospeak to a member, a potential member, and how to reinforce the membership;training, promoting, whether the cashier is doing the work, the service desk isdoing the work, all these different categories. This person has taken this burden away from the rest of the management. Atthe same time, this person has been helping that happen. We have been adding --I won't say a burden -- an opportunity to the management through a lot oftechnological issues and a lot of ability to do things that they could never doin the past. So today in the typical club, if you run into one of the managers walkingaround, they will have a Telxon gun on them, and this gun will trigger on a SKUand it will tell them not only how many they sold last week, how many they areselling this week, what the cost is, what the margin is, how much inventorythey have on hand, how much is coming in, but they now have the ability to usethat information to select and put items out on the floor themselves in anumber of key areas -- certain key end-caps, the front of the club areas -- andthey are all taking a great deal of pride in that. They are also ordering special items that they now can do at the beginningof every month. They get together with their regional managers in their five orsix district stores, and they pick items that they bookmark to get after, andthey get special quantities of that in, and then they monitor that as well. They are becoming truly entrepreneurial merchants at a lower level, butmoving along in that area. That's something we have never asked them to dobefore. We've only asked them in the past to be, “do what we tell you to do.” Nowwe are asking them, what do they want to do. Or by the way, here are somethings we think you ought to be doing and it's ended up with a very, very highlevel of confidence on their own part in participating and helping make a bigdifference in what happens in their own clubs from a merchandising point ofview. So it really is the beginning of a long process that takes some period oftime, but it's allowed the management now to really get in and train and do thethings that they want to do and produce the kind of results we are seeing. Wethink there is no doubt about  the salesbenefit that is certainly coming from great selection and all the other thingsthat we've talked about, but a good manager can make a substantial differencein any particular club. So we now are allowing them to be even better managers than they wereallowed to be in the past. I think theMARMs aren’t the only reason for that, but that's one of the good reasons wehave gotten the benefit out of this.

[Operator:]

Your next question comes from Robert Drbul - Lehman Brothers.

[Robert Drbul:]

Can you talk a little bit about your expectation for the toy category andhow the trends have been and your expectations for the fourth quarter? On the apparel side specifically, or even throughout the store, can you justtalk a little bit about private label penetration, if you've seen the consumertrading down or trading into private label any more than you had in the past?

[Herb Zarkin:]

Our private label, we have taken a number of SKUs out of private label becausewe weren’t happy with the quality of them or the packaging of them, et cetera.But our penetration is about the same as it was last year, if I recallcorrectly. On the toy business, the toy business was doing well for a while. We hadsome very exciting items in it, producing some extra business for us. With allthe recalls it has had an impact on the toy business, there is no doubt it. Weunderstand that from what we hear around that the toy business, generally, itis not good at this early stage and we are like everybody else concerned aboutthat because it is an important part of our business. We do believe, though, when Christmas comes -- which it will come -- this isthe longest distance we have between Thanksgiving and Christmas Day. It's thelongest number of selling days in the course of a seven-year swing. We dobelieve toys will still produce a good result. Whether or not they are going toproduce the kind of result we originally thought six to ten months ago is anotherstory altogether, but every time there is a recall, it has some negative impacton the toy business, especially with so many of them all at one time.

[Operator:]

Your next question comes from Christine Augustine - Bear Stearns.

[Christine Augustine:]

I think one of the things that you've been working on is trying to boostyour in-stocks in order to help business on the weekend. I was hoping if you could give us an updatethere? The other question I had is on inflation. Are you seeing any increases incost of goods sold for products that you're looking to import? Apparel or otherimported products as you're looking at the forward buys for '08? Could you tell us what the private label comp was in the third quarter?

[Herb Zarkin:]

We've done a tremendous job in restocking the clubs for the weekend. We'vedone it by re-shifting the management, when we reorder, how we reorder, theschedules of the people that are working in the back of the clubs. We've had atremendous improvement in being in-stock. We are seeing Sundays continue to begrowing at a greater rate than any other day of the week, because it has becomea very good shopping day for us across the board, and at the back of the clubparticularly. So, we've made a lot of good inroads there with a lot of efforts both interms of logistics department, in terms of the buyers, in terms of the clubsthemselves, it's working out very, very well as far as that's concerned. As far as inflation is concerned, we didn't see a lot of inflation up untilrecently and we haven't seen that much right this second other than obviouslythe price of gasoline. What we have seen now is a number of companies postingprice raises for next year. These are large CPG companies,petroleum products companies, Proctor & Gamble and people like that, Kimberly-Clark, and these are coming in. Sofar we see them, these are posted prices, and I'm not sure what they will fleshout at the end; around 6% on balance, some may be higher, some may be lower. We did see inflation come in dairy products right at the beginning of thisyear, which we've talked about before. More in milk, the assorted other dairyproducts didn't seem to have quite has much inflation built into them as thebasic milk product seemed to. But we're pretty sure that we're going to see unusually high inflation, letme put it that way, next year based upon the price of oil and what else isgoing on. We've seen this in some non-food products as well. Anything that'sgot plastic in it, anything that's oil-driven, we've seen that as well. As far as imports from overseas, I myself haven't seen much so far. Most ofthat merchandise is designed to enter the private label products, a goodportion of it. It's designed for us, we candesign the product to be “super duper duper” or we can just make it “superduper”. You have some control on what goes in the product and what the costsare going to be as far as that's concerned. Your third question, I think had something to do with private label, but Iforgot.

[Christine Augustine:]

I was wondering if you could give us what the comps were for the privatelabel in the third quarter. I think it was 9% in 2Q.

[Herb Zarkin:]

I don't have the exact number. I think it was about flat. Keep in mind thatwe've reduced the SKUs by about 10% in the private label area. I think it was about flat. I have to get backto you with an exact number.

[Operator:]

Your next question comes from Peter Benedict - Wachovia.

[Peter Benedict:]

First, I'm interested in the slight contraction you saw in the Inner Circle renewal rates. When did you start to seethat?  How does that compare to behaviorthat you guys witnessed historically when you've raised the fees?

[Frank Forward:]

It is running historically with when we've raised fees in the past.Historically I think we've done it about three or four times and it has run ina similar pattern. The thing to understand and the technical way we calculate it, it's done alittle bit on a lag process because the renewals always come in, a goodpercentage of them come in one month, two months, three months late. So it's aconsistent way we've done it since we've been a public company. I wouldn't maketoo much of it. It is a little bit short and we believe it's just due to theprice increase of last year.

[Peter Benedict:]

Fair enough. Can you talk about the traffic in average ticket assumptionsbehind the fourth quarter comp guidance and what you are thinking there to getto 4% to 6% for 2008? Thanks.

[Herb Zarkin:]

The average ticket should be fairly high in the fourth quarter, because ofthe nature of what we sell -- televisions and Christmas gifts and electronicsand things like that tend to have a higher ticket, plus the food selling withthat, so much gifting and partying and stuff like that. We would expect to seea high average ticket transaction. We would love to see and we continue to hope to see sooner rather then lateran improvement in our average transaction. We think that's an important metric.It’s not the end of the world, but eventually, you have to have more trafficcoming into your building. We are cycling through a whole bunch of competitionand cannibalization. Most of our clubs have a competitor existing anyhow so it’sa little more difficult for us to get to as fast as we want to get to it. I could get some more traffic tomorrow morning, but I wouldn’t be happy theway I did it. We're trying to do the right thing and run the business the rightway rather than just arbitrarily run a promotion and promotion and promotion toget more people in the buildings so that I can say my traffic went up 1% or 2%.I really don't want to do that, I really want to build it the right way. Hopefully that will happen next week, next month, next quarter, I don't knowwhen for sure. I can't predict it. We will talk more about it come next springas to where we are and where we are going to get. But right now, we are allaware of traffic and we also love to see the average ticket, which has beenpretty strong. In the fourth quarter we think that kind of mix will still be what it is goingto be, we'll see. I don't expect a dramatic change, all of a sudden that we aregoing to have 5% more transactions in the next three months that we've had up untilnow.

[Operator:]

Your next question comes from Chuck Ruff - Insight Investments.

[Chuck Ruff:]

Can you break out the impact of inflation on the same-store sales for thethird quarter?

[Herb Zarkin:]

As I said, we haven’t seen very much inflation with the exception of dairy,a couple of dairy products. So far it's been a miniscule impact. It's more of agoing forward thing. We are starting to see a whole bunch of posted increasescoming for the future and that will have a pretty meaningful impact on it and we’vefactored that into next year's plan a little more. We gave you a range of 4% to6% comp increases because we are certain there is going to be a substantialimpact going forward, but it's minuscule right now, It is not important enoughthat we can really identify it right now.

[Chuck Ruff:]

How much of that 4% to 6% next year is just inflation, do you think?

[Herb Zarkin:]

I play around with this number all the time and I throw this number out andthis is nothing scientific, I want to make it perfectly clear. If half of ourbusiness is done in products that are subject to inflation, the consumerproducts or gas business and stuff like that, and we get a 2% increase on thosekinds of goods that means a 1% increase across the board on the balance, if wedo $8 billion. You can play that; I just picked an arbitrary number. It could be $8 billionworth of our sales that are all subject to inflation. I think inflation is going to have an impactand it could be 1% or 2% I think. I wouldn’t be surprise if its 1% or 2% nextyear on balance, bottom line effect.

[Chuck Ruff:]

Of your CapEx, how much of that is what could be termed maintenance CapEx,before new stores and expansion?

[Herb Zarkin:]

We generally say about in the low $40 million is what we need to maintainthe properties the right way and to maintain the systems and all that sort ofstuff. That’s for the quarter, and that has been consistently around thatnumber.

[Chuck Ruff:]

The guidance for next year, does it assume the tax rate stays about where itis now, 40% to 41%?

[Herb Zarkin:]

Yes.

[Chuck Ruff:]

Can you tell us what you are assuming for shares outstanding?

[Frank Forward:]

I would rather get into more of the detail at the year end conference call.Certainly we are assuming, like I mentioned, over the next 12 months to 18months we would be buying back $150 million to $200 million in buybacks, sothat obviously brings your numbers down. We’ll go through more detail at year end.

[Operator:]

Your next question comes from Thomas Forte - Telsey Advisory Group.

[Thomas Forte:]

With the increased effort on being more competitive on price, I want to knowif you are seeing a competitive reaction?

[Herb Zarkin:]

We track ourselves pretty religiously on a regular basis now and we’ve beenabout where we want to be in relation to everybody else for the last severalmonths. I don't see them, other than once in a while somebody will do somethingwhich is their choice to do, we think the relationship has been pretty stablefor the last few months. We don't see anybody -- Costco and SAM's we aretalking about. Against the supermarkets or the super centers, it's a littledifferent. We feel pretty good about it and we have narrowed the gap about where wewant it to be. I think we may improve it a little bit more, but we are notlooking to get into a price war with anybody. That doesn't benefit anybody andso we are not going to do that. But we are going to be comfortable where we areright now.

[Thomas Forte:]

With the improvement overall in the clubs performance, what would it takefor you to increase the number of store openings in the future?

[Herb Zarkin:]

Well, we'll talk more about that in the first call, but I believe that partof our model requires that of us, and it's important for us for a whole bunchof reasons -- nothing to do with economics but as well, there are a bunch ofeconomic reasons to do it -- to open up more clubs and we are aggressivelylooking for more locations. We feel we'll probably step up in 2009-2010 --calendar '09, calendar '10 -- up another notch or two, but we will spend more orabout that now. Right now we are looking at somewhere between 40 and 50 locations, all inmarketplaces where we believe we could be successful. Not all markets will comethrough at any given time, nor will all of them come through. The first year I wasn't anxious to grow any clubs to any great extentbecause I really want to make sure that the business is doing all it's supposedto do. Come next spring, we'll see how we're doing, which is good. We'll havethis ability in the year after to bring clubs in and move them out, dependingupon how well we are performing against our own standards. We think we're on the way to getting to the standards that we want to get toon a regular basis but we've still got some work to do.

[Thomas Forte:]

I want to know if you view the category sales of cigarettes any differentlythan you have in the past, and if you're cutting back on the number of clubsthat are selling cigarettes?

[Herb Zarkin:]

We've cut back on a regular basis the number of clubs; selling cigarettes atcost or below cost is not a good way to run a business. We have not found thoseparticular customers to be loyal customers on any other product line. They tendto buy the cigarettes and walk out the door. That may not be true in all cases.But we sell cigarettes where we're servicing the general consumer. If I had mychoice, I'd be out of cigarettes tomorrow morning, but it's still a largevolume and still to the casual shopper or to our Inner Circle member, they buy cigarettes, we have tohave them for them. I just think in the long run, we'll be out of the cigarette business, andwe’ll be better off. The team, everybody would be healthier, but that's asocial issue, which I don't want to get into, so all right?

[Operator:]

Your next question comes from Gregory Melich - Morgan Stanley.

[Gregory Melich:]

With the store openings, the 40 or 50 you were talking about, are thosebasically in the markets you are in now or would you consider going into newmarkets?

[Herb Zarkin:]

They're all inlocations adjacent to or part of marketplaces where we currently exist.

[Gregory Melich:]

Can you just describe the CE business a little bit more this holiday, andhow you're positioned for it? Are you seeing competitors change their warrantyofferings, change their service offerings? Are you seeing margin degradation fromothers there, and because of it have you seen ticket and comp increases? Canyou just describe that category a little bit more, and especially at holiday?

[Herb Zarkin:]

We are very pleased with how we're positioned. We always have had astandardized policy. I think when Costco changed its policy a couple of monthsago I was upset because I was telling our customers to bring it back to Costco,which didn't work out too well. But we've always had a tight schedule on watching them bring it back within30 days or when it has to go to a third party or what goes back to the companyitself. So that's been consistent. Our pricing has been attractive. We've gotten some very good products andwe've seen the customers respond to it across the board. I don't believe we've seen anythingdramatically different in this past few months than we have say six or eight orten or 12 months ago.

[Gregory Melich:]

In terms of how the square footage is allocated, you are comfortable? That'sthe same as what it was last year?

[Herb Zarkin:]

Well we've made better end-caps, we've made some stronger statements on thiskind of merchandise. If you go in, you'll see some really strong end-caps withconsumer electronics on it, or the Nintendo Wiis and stuff like that. GPS isobviously very important to us and the only thing in GPS is the prices arecoming down like a rock. But we're selling it very, very freely; and iPods, stuff like that.  Those are very, very important. But the digital picture frames are just taking off like crazy. That's agreat item and the bigger size that we are bringing in now too, the customersseem to really like that. That's a new thing for their home and for theirgrandmothers and grandfathers to have it; it's a big thing. Anything that's really nice and unique and different and serves a need likethe digital picture frame, it's a wonderful, wonderful category and one that will explode over thenext year or two to monumental proportions, quite honestly.

[Operator:]

At this time I will turn the conference to Mr. Herb Zarkin for anyadditional remarks.

[Herb Zarkin:]

Thank you very much, I appreciate it. We'll talk to you in a few months.Thanks.

[Operator:]

That concludes today's conference. We thank you for your participation.