好市多 (COST) 2001 Q3 法說會逐字稿

COSTCO WHOLESALE CONFERENCE CALL

Good morning and welcome to the Costco Wholesale third quarter earnings release conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions and comments following the presentation. It is now my pleasure to turn the floor over to your host Richard Galanti. Sir, the floor is yours.

Thank-you [_______________] and good morning to everyone. This morning, as usual, we will go through a review of several items. To begin with of course our third quarter fiscal 2001 operating results for the 12 weeks ended May 13, 2001, with EPS coming in at 23 cents a share versus 26 cents a share last year. This is, by the way, in line with the previous guidance we gave back in April 24, 2001. Our review of sales trends, which have actually picked up a bit in the last few weeks, we of course will report our 4-week May sales results, next Thursday. Other usual topics of interest will include expansion plans both for the remainder of fiscal 2001, which ends September 2, 2001, as well as preliminary plans for 2002. Also other topics are our ancillary business operations including our gasoline business, which is one of the factors that affected downward both our third quarter operating results and possibly our fourth quarter. Other initiatives of interest Executive Membership, Amex, costco.com, our special order kiosk merchandising program, our balance sheet figures, a little update on the Canadian reorganization, upcoming merchandise passport program, and a little bit more about energy conservation issues. And lastly, I will give a little bit of an outlook for the fourth quarter, the 16 weeks, which will end on September 2, 2001. With respect to fiscal 2002 outlook and direction, we have really just begun our 2002 budgeting process, but I will attempt to give you our thoughts, they are very preliminary at this time. With that let me start by stating that these discussions we are about to have 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 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. Now as many of you know, I didn't write that, but I am happy to report it. Okay, sales for the third quarter, 12 weeks ended May 13, 2001, increased to total of 12% to $7.56 billion up from $6.77 billion last year, and comps for the quarter coming back as I mentioned in the final few weeks of the quarter, so that the quarter overall was at 5% with the last few weeks of the quarter being at 7%. As compared to our original budget though, third quarter sales, they were below original budget, but not as below, if you will, as Q2 actual original to original budget. In Q2 versus original budget, we are about $380 million below our OB, whereas by comparison in Q2 we are $500 million for the quarter under our original budget, so we are picking up little bit there. Regarding sales let me give you also another quick geographic and merchandising sales breakdowns that I normally give. If you would, the first chart, right up here, two columns, third quarter and year to date, and for Norhtwest comps, this is geographic, by geographic region sales. The comps in the third quarter in the Northwest region were up 3, by comparison year-to-date they were up 1. California, in third quarter was up 6, year-to-date up 5, so again a pick up there. Northeast at 9 versus year-to-date of 6. Southeast at 12, versus year-to-date on 11. Midwest on 11 versus year-to-date 9. The US in the third quarter was 7 overall versus year-to-date of 5, and of course the year-to-date includes these third quarter numbers. Expressed in US dollars, Canada was at 0 in the third quarter and year-to-date of 1. Keep in mind the Canadian dollar relative to the US dollar has weakened over the last year, so in Canadian dollars we actually are doing okay at 6%

in the third quarter and 5% year-to-date. Same thing in the UK, the pound sterling relative to the dollar has weakened this past year such that in US dollars, UK was at 6% versus -1% year-to-date. But again parenthetically, the UK in the third quarter and pound sterling was a strong 17% versus a 10% year-to-date, so a good pickup in Q3. Other countries, I will sum up together, Taiwan, Korea, and Japan was -2 in the third quarter, and in local currency was actually +8, and year-to-date was +1 and again in local currency of +5. The thing I mentioned about those other countries is that we are doing in the mid teens in Taiwan. In Korea, where this past December and April we've opened our second and third units in the Seoul area, that's the South Korea market. Korea was down 19% in the third quarter, but again that's almost entirely indicative of the fact that we severely cannibalized our strongest volume unit in that market, but overall that's doing pretty well. Put all that together, total comps for the quarter were 5 and year-to-date 4. The one number that we don't consolidate in here of course is Mexico. In the third quarter, Mexico in dollars was at 21, in pesos essentially the same at 22 and year-to-date 20 and 21 in dollars and pesos, so again about a 20 plus in Mexico, a good economy, improving economy down there. In terms of comps by merchandising category, I will give you again, actually for some reason I wrote three columns here, the first quarter, the second quarter, and third quarter, and it is actually year-to-date. Food and sundries was at 4 in the first quarter and 3 in the second quarter and 6 in the third quarter. Nothing unusual there, the 6 reflects a little bit of tobacco increase, due to the recent price increase, but we've had the benefit of some tobacco price increases affecting Q1 and Q2 as well. Hardlines was at 1 in Q1, a -6 in Q2 and of course that was when we were

comparing to Y2K and that's a big part of that, and back up a little bit in Q3 to 3% positive. Again the Y2K was a big issue there. Categories of interest hardware and garden are strong, office and majors were still just slightly below zero, but actually that's an improvement from where they were in the last couple of months. Our softlines was at 4 in the first quarter, -2 in Q2, as well -2 in Q3, again nothing to speak up there. Apparels were slightly negative and some of the other bedding and things were also slightly negative. Fresh foods continue strong, which was 12 in Q1 and 9 in Q2 and 11 in Q3 and again fresh foods has been one of our strong points and certainly one of our Signature departments. Ancillary businesses was at 20 in Q1 and parenthetically about 7 without gasoline, it was at 16 in Q2 and parenthetically a 5 without gasoline, and in Q3 it was at 12 and parenthetically at 9 without gasoline implying that the gas I think in Q3 was about 19 and again the total was at 12 for Q3. So, again all told 5 in Q1 comps of the company, 2 in Q2, and a 5 in Q3. Overall, I'd have to say that our sales outlook looking forward today represents a little bit of an uptake from our forward-looking sales outlook on April 24, 2001, when we had our earnings conference call, we discussed our earnings revisions, but that's because sales had picked up a little over the last several weeks. We will see what tomorrow brings and hopefully this is a start of something little better, and I guess we are pleased with what we see so far. Continuing down the income statement line, our membership fees continue to be quite strong. We still consider this a good sign going forward. Our reported fee income in the third quarter was $155.4 million or 2.06%, up 23% from last year's $126 million and up 20 basis points, and again on a reported basis that represents nearly $30

million increase in reported membership fee income. By comparison in Q2 year-over-year, we were up $23 million, and in Q1 up $19 million so again that strength continues and again that's partly a function of the $5 increase that we did last September-October, as well as increasing sales of our Executive Membership which I will discuss in a minute. Probably more importantly on a cash basis, again we report membership fees on a deferred basis, on a cash basis our membership fee income was a $162.2 million, up 31% from last year's $123.9 million or up $38 million year-over-year or 31 basis points. So again a very strong showing here and as you will see in our, some of that of course is an offset to the Executive Member reward program which I will discussed when I talked about on gross margins moving up. In terms of the number of members at third quarter end, we had 11.7 million Gold Star Members or about 300,000 more than at Q2 end. Primary business members up 100,000 from the prior quarter at a 4.3 million, and add-on members actually down about 100,000 at 4 million from 4.1. That's simply a function of some people converting from a business add-on member to their own Executive Membership, which [_______________] become an Executive Gold Star Member. All told, we are up about 250,000 members during the quarter to 19.95 million from 19.7 million at Q2 end and including spouse cards 35 million versus 34.3 million at Q2 end. Again you basically shave these numbers by about 14% given our 86% renewal rates since we keep people in the membership database for up to a year after their renewal date if they haven't renewed. At May 13, 2001, our paid Executive Members totaled 840,000 versus 682,000 at the prior quarter end.

That represents about 13,000 new conversions to the Executive Membership program per week in Q3, up from 10,000 a week in Q2, so again we're still getting some good sign ups there. Executive member sales penetration is approaching 13%. And in terms of the Executive member services which is the other part of this equation, in addition to the services that I have certainly discussed over the past several years, credit card processing, checks and forms printing for businesses at residential and business long-distance telephone services, small business loans, real estate marketing and mortgage services. We have a couple of new things on our plate. We have offered in the past in some markets auto and homeowners insurance. We have a new program, which we think is even better being offered by American Express Property and Casualty Company. It is currently rolled out in Oregon, it is a test, and we actually are also getting ready to roll out by August, just to our Executive Members, in 7 additional states and D.C. and including California and as well as a couple of East Coast states, Maryland, and Virginia. So far what we are seeing is an 85% quote rate when people request a quote which is again a relatively high number for quotes, and a 23% conversion rate of those people, again I am told those are very high numbers and we are seeing good savings there. Again this is a slow process as we have seen with member services, but we think that over time that this will continue to build. There are actually 4 more Executive Member Services that we plan to roll out in July and August, and as we get there I will let you know for competitive reasons. We will discuss those, of course, the next time, but I'll probably discuss them with you guys as we roll them out in July and August. I think what it says overall is that we are committing to making this work and we know that we are in here for the long haul and again we see signs of life, and the services although are small numbers to start with. Before I discuss third quarter gross margin results, just a couple of quick comments on Amex, in addition to the property casualty reinsurance offering. Overall the relationship is going fine and as planned, a very good partnership for both sides, we believe. We just

had our first annual meeting of the senior people and everybody felt pretty good about it. At third quarter end we had 1.2 million cobranded cards out there, about 9% to 10% increase from second quarter end. So again about 100,000 increase from just the last 12 weeks, and 1.8 million card holders overall including spouse cards. Amex represents both between cobranded acceptance as well as Amex acceptance overall 18% sales penetration of our company sales. We are seeing new membership sign ups. We are seeing new and continued cross marketing initiatives and one of the things I'll talk about when we discuss our Passport program later in the call, as well as good overall sales results. Moving on to the gross margin lines, gross margin as you saw was down 36 basis points to a 9.76% of sales in Q3 this year versus 10.11% last year. I'll go through the chart in a moment, as you'll see when I walked through the gross margin components, of course, the gross margin offset if you will due to the 2% Executive Member reward program, as well as one of the things that I talked about on the April 24th, conference call, the fact that with rising gasoline prices, we saw a big downturn in Q3 in the gross margin of our gasoline business. I am happy to say that it has come back and we will talk about that in a minute, but that alone represented 18 basis points, just for gasoline. I had absolutely no concern about this, [_______________] margins are, and we see the ability to upper current those underlying gross margins going forward, while maintaining our strong competitive position. If you would again, jot down a few numbers in this chart here and we'll just again have 2 columns Q2 and Q3, and the first line item would be the core warehouse business, which would be just basically food and sundry, hardlines and softlines in fresh foods. In Q2 that was +12 basis points, in Q3 year-over-year it was -1

basis points or essentially flat, 2% reward program, detriment of 21 basis points in Q2 and a detriment of 23 basis points in Q3, again representing an increased sales penetration of those members, ancillary businesses +11 in Q2, and -14 in Q3, again that is gasoline, I'll talk about that in a minute. International +3 and +2, and [_______________] and other zeros and zeros. So total Q2 year-over-year, we showed a total gross margin improvement of 5 basis points and in Q3 a negative 36 basis points. Again let me go through these real quickly, in terms of the quarter being essentially flat, there is increased new market locations penetration year-over-year that cost us about 8 or 9 basis points, and in the delta unit from Q2 year-over-year was about 4 or 5 basis points, so we see that again trending. That has continued to hit the gross margin because we are going into new markets where we are being even more competitive to start off with. As we have seen historically, we are certainly competing in many of our markets with other competitors, and we see that improving each year in these new markets over a 3- to 4-year period. Within the core business, the food and sundries gross margins were actually a little better, offset by hardline and softline gross margins coming down a little bit, again that offset was a little more negative than the positive influence of sundries. And again that's where the weakness in sales is, the markdowns are actually pretty good, not being a big component, but again this is a little bit more competitive area. Again I see that core component bouncing back in Q4 and beyond. Next gross margin component with 2% reward, it's very straightforward, I think one thing that's comforting here is that if we look back year-over-year the detriment to gross margin in Q4 last year, it was -12 basis points, prior to that it was essentially 0 or -1 basis points

because we are just starting the program. In Q1 year-over-year it was -17, in Q2 as I mentioned -21, and in Q3 -23. So whereas, in absolute terms, as we increase sales penetration, this should be a slight increase in the detriment to gross margin, but that detriment will start to decline in Q4, since we are now starting to compare against the detriment from a prior year, and the delta year-over-year will be less and I would again, much like the Amex card effecting SG&A over the last couple of years I would expect the year from now this to be a non-issue in terms of effective gross margin and much lesser issue in Q4 and Q1 going forward. Just one brief point on the Executive Membership program, for the year our original budget was on a book basis because of deferred accounting, because we have a lot history on any slippage of the rewards that we pay out, [_______________] cash. We budgeted at $16 million on a book basis, pretax P&L at about 2 cents a share and so basically it will be slightly profitable on a cash flow basis. The book is about where we see we are coming in and the cash flow is actually a little above breakeven, so again pretty much in line with what we expected. Now the ancillary component of gross margin, as I mentioned, in Q3 it was 14 basis points year-over-year down versus 11 up in Q2, so what happened there, again this is the factor I explained on the April 24th conference call, gasoline margins were way down in Q3 representing for the company overall, an 18 basis point drop year-over-year on gross margin. Again I am pleased to report that at least thus far our gas prices are not only stabilized but even the outlook for gas prices this summer have gone from ever increasing on the news every night to steadying. We will keep our fingers crossed for Q4, but at least for the first 21/2 weeks it looks a lot better, and it is profitable instead of unprofitable. Nothing really of import related to international with LIFO as I mentioned. In

terms of LIFO inflationary areas, of course, the cigarettes which just had a price increase, beef and pork, butter and some of the nuts; deflationary electronics, coffee, apparel items, and vitamins and some of the nuts, and cashews instead of peanuts and walnuts. So overall I am not allowed to tell you there, historically we have tended to record a $2.5 million LIFO charge in the first 3 quarters each quarter, or 2.5 to 3 million, and than in Q4 we tend to recover some, if not all of that. At this point, we will expect to recover, probably recover some of that, half of that, but we will wait and see. Overall the outlook for gross margin, again we are not concerned with what we saw here, again gases coming back, the other things that really don't concern us, it should turn better over the next several quarters. Before going into SG&A, I'll briefly review our ancillary businesses. We ended the quarter with 267 pharmacies, we are up 7 from the prior quarter, 343 food courts, up 9, 340 mini labs, up 9, by the way we opened 9 warehouses during the quarter, 315 optical shops, up 8, 16 fruit and coffee centers, up 1, 79 hearing aid centers, up 4, and 131 gas stations, up 9. In terms of gas stations, we will probably work on another 9 or 10 prior to fiscal year to be about 140 year-end, and I think 3 months ago I said that our goal was to get to about 150 by fiscal year-end, that was an aggressive goal and some permitting delays, and we still plan to open several more. Overall, these businesses too have slowed. The third quarter comps for example for the food court, one-hour mini lab, and the optical were in the 1% to 5% range. Hearing aid is very strong, but also very new. Pharmacy

actually, which is one of the old [_______________] numbers here, big business 1+ billion dollar business, we had it around for a number of years, it still came in strong in the third quarter, up 10%. All told, ancillary business sales last year in fiscal 2000 were $2.5 billion and our current estimate for this year is right at $3 billion. We are up 19% year-over-year and up 11% without gasoline. So, almost $500 million gain to sales this year related to ancillary business sales. Again, these are businesses that not only drive those businesses but help drive people [_______________] on a more frequent basis. Regarding SG&A, we actually did a little better than planned in Q3; partly, I think a little better focus on expenses and partly better comps. As you may recall in Q1, SG&A year-over-year was up higher by 48 basis points; in Q2, higher by 60 basis points; and of course here higher by 39. So, again an improving trend there, and I think this is the last chart I will ask you to jot down, again, if you would, two columns, Q2 and Q3. The first line item would be the core warehouse business, it was worse or negative, I will use negative signs for being worse or higher, negative 33 basis points in Q2, negative 24 in Q3. That by the way, the negative 24 is not the same; in fact, the utility costs overall are higher by 7 basis points year-over-year, so again a little better showing there relative to Q1 and Q2. Centrally, we also saw some good improvement relative to Q1 and Q2; in Q2, central expense is higher or negative 9 basis points; in Q3, higher by only one basis point and that -1, part of that is that the infrastructure is now in place relative to our ramp up and expansion [_______________] the 2 buying offices that we opened in Atlanta and Dallas last year essentially [anniversaried], and hopefully, a little more focus on that as well. Ancillary businesses, -13 basis points in Q2 and -11 in Q3,

nothing unexpected there, international -5 and -3, and others 0 and 0. So, again 60 basis points higher in Q2, 39 in Q3. In terms of Q4 SG&A outlook, if sales continue a little better level, we might see that 39 basis points detriment lessen a little bit. We also have going for us that in Q4 on June 5, 2001, we anniversary our $2 year-over-year wage increase. That should help us a little bit. The one thing that doesn't help us, that hurts us a little bit would be the fact that last year was a 17-week fiscal fourth quarter and with that there are certain annual expense accruals that you didn't have as much in that second quarter that helped Q4 a little bit last year. But we have got our fingers crossed and if sales continue then we should be fine there. Next, on the income statement line is preopening expenses, a big increase dollar wise. Last year in Q3, $6.7 million, up $6 million, just $12.8 million in Q3 this year. The math is pretty straightforward. Last year in Q3, we had two openings recognizing that some of that preopening last year to $6.7 million related to openings that were getting ready to happen in Q4, but this year in Q3, we had 9 openings; so, again nothing untoward there. The next line, provision for impaired assets and closing costs. You noticed that we took out the word "warehouse" before closing costs because this also includes the consolidation efforts we have going on in Canada, and again for both Q3, Q4, and Q1 of next year, we will segment those out to share with you where we are coming in on that. But all told, last year in Q3, we had a provision of $1.5 million on this line. This year, it's flat at 0. The three main line items that sum up to 0 are closing costs, such as upcoming relocations where we close on existing warehouse, gains on sales of real estate, and then the Canadian consolidation. We had about $5

million of closing costs in the quarter, and again that's partly in planning related to the upcoming planned 4-5 relocations we have got between September and calendar year-end, and again once we have committed to do something we have to impair what we know. We had $8.2 million of gains on properties. The big one there was one of the two Manhattan sites that we are selling. Again, this is where we went into Chelsea and also in the West 50s in Manhattan, and both instances we met with great opposition from everybody, residents, city people, and it was clear as well just the difficulty of operating there that it didn't make sense, and as dumb luck would have it, we picked up a nice gain on one of those, and we will pick up some more nice gain on the other one in the fourth quarter. Again, though I think that as we know more about the 4-5 relocations that we are doing that will just help offset that. In terms of Canada within this number, as you can tell from the $5 million closing costs to $8 million gains, we [_______________] 0. We have roughly 3 million of Canadian consolidation costs. The original budget was about 4 million, but that doesn't change our expectation for the whole. Looking forward to Q4 next year, there are no relocations planned in Q4. Again, there are 4-5 planned between September 1, 2001, and calendar year-end, first 4 months of fiscal 2002, and as I mentioned the good news is that between now and calendar year-end, we have a couple of planned gains on sales of properties and when I say planned, we know what the gains are that should help offset that. It's simply that the deals haven't closed yet there in contract and you can't book it until you close it. Again, nothing unusual there, the good news, I think we have managed that process pretty well. With respect to Canada reorganization costs of $3 million again was compared to, I think, our budget was about $4 million occurring in this quarter, about half a penny a share. We pretty much still expect the total Canadian reorganization cost about $26 million pretax, as we had stated in our press

release back in January or February, with $16 million pretax or 2 cents a share after tax in Q4 and roughly a penny a share or $6 to $8 million pretax in Q1. The reorganization is going well. A good number of our associates in both Burnaby, British Columbia, and Laval, Quebec near Montreal have decided to move to Nepean, which is in Ottawa, through our Central Canadian headquarters there. Of course, we will have some people still remaining in Burnaby and Laval, and basically, our plan is for consolidating these operations to be effective day one of our new fiscal year in early September. All told, operating income came in down about 11% at $174.6 million this year versus $197 million last year. Again, in line with our April 24th revised earnings estimate that we gave in our press release. Below the operating income line, we lost a little; reported interest expense was actually a little better or lower by $600,000 coming at $9 million in Q3 versus $9.6 million a year ago in Q3. The actual cash interest expense is about the same. What's happened is with the ramp up in expansion, we have an increase in capitalized interest to a tune of about $600,000 [_______________], so that's essentially the difference there. Interest expense in Q4, of course, it's 4 more weeks; it's 16 weeks instead of a 12-week quarter, and again I would take the account of precapitalized interest number and multiply by four-thirds, we would expect something in the $12 million to $12.5 million range for interest expense, which then will be reduced a little bit by again an increasing amount of capitalized interest as we go into again an additional ramp up in expansion in Q1 and early Q2 of fiscal 2002. The interest income and other in Q3 last

year was $12.9 million. It was lower by $3.1 million to $9.8 million this year in the third quarter. This reflects a combination of three things; increased cash usage, of course, lower return on this cash given that interest rates will come down, as well as higher Mexico earnings, which help that line because that's where we put the equity accounting for earnings for Mexico. Again in Q4, this number two will come down year-over-year because of capital expenditures, reduced cash balances, and lower interest rates. So, I expect to see another reduction there. So, with interest expense and interest income together lowering pretax earnings by $2.5 million pretax, reported pretax income was down about 12.5% year-over-year or about $25 million to $175 million versus $200 million in last year's third quarter and commensurately earnings per share coming in at 23 cents versus 26 cents a year ago. In terms of the balance sheet, which is one of about 6 or 7 final topics of interest here, we give you a brief of balance sheet at May 13, 2001. Cash and short term investments $564 million, inventories $2.675 billion, other current assets $454 million, total current assets $3.693 billion, net PP&E $5.515 billion, other assets $368, total assets $9.576 billion. On the right hand side of the balance sheet short-term debt $16 million, accounts payable $2.662 billion, other current liabilities $1.210 billion, for total current liabilities of $3.888 billion, long-term debt of $828 million, deferred and other $95 million, for total liabilities of $4.811 billion, minority interest

of $110 million, stockholders' equity of $4.655 billion, for total right side of the balance sheet also of $9.576 billion, and from a balance sheet health standpoint, certainly we are very strong, that the GAAP ratio is now at 15%. I will mention one thing on the cash balance of $564 million, about $285 million of that is short-term investments and highly marketable stuff that we can get out quickly with no risk. About $205 million is credit and debit card receivables. Keep in mind that we always end our quarters on a Sunday, and so it's the weekend in the banking business, and so given that we're doing close to $100 million a day in sales and debit and credit cards represent probably half of that, that's essentially what that is. In terms of merchandize AP, as you can see here on the balance sheet, accounts payable to inventories is almost 100% financed. Actual merchandize AP to merchandize inventories is about 78% to 80%, little less than last year, but in line with what we see at this kind of seasonal profit at percentage at the end of third quarter, which is a seasonally slow time for us. Additional free flow, if you will, that we get is the fact that we mail our checks everyday and that takes time to get cashed which is not just normal management of our business here. At quarter end, that was about $320 million, and again that's just as we get bigger, every company benefits from that, but again including that, we are almost fully financed in our inventories. In terms of capex, our original budget for fiscal 2001 was right around $1.03 billion with about $650 million to $700 million being new warehouse construction, close to $200 million being in remodel activities, close to $200 million being international, and $200 million to $250 million being in other with close to 200 of that number

being our Depot expansion which we've talked about in the past. Through third quarter year-to-date, our capital expenditures have actually come in right at $979 million which is about a $100 million under our original cash budget with international being most of that, and again it's just timing delays. For the full year, we'll still be very close to that $1.3 billion capex number. Next topic of interest Costco Online. I think our original budget was about $170 million and to make a very small profit like less than a million dollars, and that of course, assume two critical things, that the free ISP services that we'd launched with Yahoo back in August or September of last year would be a big success, and of course, the world of free ISP changed very quickly and that was eliminated back in the fall. Although, we left on good terms with Yahoo and they were a good partner to have and came through with what they had promised. The other thing was that we anticipated our business-to-business site to be up and running by November, and that just got up and running about a month ago and of course, again no free ISP service. More likely, we'll do about $80 million in the Internet, and as I mentioned in the last quarterly conference call, probably it was half a penny share, nothing big relative to the company but continuing to grow. Next topic, Canada reorganization, I pretty much talked about that. We're in line with what we expected. Again the big thing there in our view is the people. Between the two offices, prior to the consolidation, we had 607 people, after the moves between the new office in Ottawa as well as the regional buying offices that we'll maintain in Laval and Burnaby, we would expect to have about 330 to 350 people. We've been fortunate that probably two-thirds of the staffing in Ottawa has come from existing employees at Burnaby and Laval. Certainly some of our employees will opt for severance as well, and some are going to be going into the local warehouses as well as I think we've got a handful 10 or 20 that are actually moving down to the

U.S. So we're pleased with that. In terms of merchandizing initiatives, two things I forgot to mention before, the special order kiosk program and then this summer's upcoming passport program. Again, not to beat a dead horse here, the kiosk program is working fine, we are learning from it. Our goal was to have this in at least 200 warehouses this year. We actually have it in 270 warehouses. This is where we've taken out [_______________] and dedicated those 20 power positions to items that you can't buy on site, you can see them on display, you fill an order form, you pay for it today, and then its typically shipped or installed as the case may be or delivered it to your house like a refrigerator or carpeting. That over 900 items now are on those 20 power displays. Everything from tires, wheels, to home furnishings, to bathroom fixtures like Grohe faucets, and core bathroom fixtures. Our goal here was to add to a typical $100 million warehouse and a million dollars of incremental business. We think we're probably accomplishing about 70% of that, so again we're off to a good start there. What I can assure you is that whatever we're selling today, not all will be existing six months from now as we are testing the things, but hopefully over time that thing will continue to expand. The passport program, this is our summer [_______________] mailing of a booklet of coupons in the form of a, that looks like a passport, with a variety of coupons. Each coupon being date sensitive, in other words, the first coupon is good for this 2-week period and the next several coupons are good for kind of a rolling 2-week period every week. This is an effort to get people in the door over the seasonally slow summertime, which is a little slower than, of course, the fall. We've been doing this for 4 or 5 years now, it works. This year's distribution has been upped to 19 million mailings versus 17.3 million mailings a year ago. The 19 million, by the way, includes about 4 million mailings to non-members, which is a combination of non-renewals over the last year as well as some cross-marketing efforts with our partners such as American Express. We

think this will help sales this summer, as it did last summer, and add members as well. Next topic, I'm almost done here, I think, I have got two more, after this is energy costs. I went into a lot of detail regarding energy costs and the increases anticipated when we had our earnings revision on April 24th conference call. It suffices to say that rising energy cost is fairly a big factor going forward, and we think that in Q4 alone it will represent 1 cent to 1.5 cents a share, which again is in our numbers that we had stated before on April 24, 2001. We basically said at that time that assuming no energy usage conservation our best guess going forward over the next 12 months would be a $60 million to $70 million pretax increase in costs or about 7 cents to 9 cents after tax per share over the course of the year. With energy conservation, of course, which is happening throughout the organization, we would come down to perhaps $40 million pretax or about 5 cents a year. This is through a combination of conservation efforts, increased cooling set points is an example during the hot summer, reduced lighting, great benefit that we have is we've been putting a lot of sky lights for several years now. Actually the maximum allowable to keep the roof up, to still have the roof up. Again, I think we'll do a shade better than that, and so far we'll see where it goes, but again it's a little bit of a crapshoot, in the sense that we don't know what energy costs, what the various utilities are going to do, not only in California, but in the Northwest and elsewhere. The other thing that we've done from an operational standpoint is, we now have in all locations battery backup power for all California locations that is, to run our registers, given that there is the risk of rolling blackouts, starting now pretty much. We also have, I think, in about 20 locations in the LA region where we were subject to some other very inflationary potential price increases, we actually have

onsite generators for job rate refrigeration and cooling as well. Next, last topic, new openings overall in line within a couple of million dollars of our original budget and estimated P&L. Getting good response in those two markets overall, very quickly for the first three quarters year-to-date, we've opened 27 new warehouses and 5 relocations. So a total of 32 locations and that's where we consolidate and down in Mexico one additional location there as well this fiscal year-to-date. In the fourth quarter, we planned 5 new warehouses, as I mentioned no new relocations and a second unit in Mexico this year. So for the year, we would have 32 new, 5 relocations, for a total of 37 in the US, Canada, Europe, and Asia, plus and consolidated 2 more in Mexico. This 32 number, by the way, is I think 2 or 3 less then we said three months ago in our second quarter conference call. That is simply timing which will make for a busier fall back in the first quarter in the first half, first part of Q2 of 2002, all told, for 2001 again 32 new units. One thing I want to point out that was, one of the things that has affected our P&L this year and that we've known all along, and we've talked about as late as a year ago, was the fact that not only we're opening more units, we're opening more units both internationally and in new markets domestically. These tend to lose money more often than not in the first and second years. So, only six of the 32 units were in existing US and Canadian markets, and again that was one of the implications of the P&L detriment this year that we had budgeted into our numbers and that we talked to you about in the past. Looking forward to the first half of fiscal 2002, we are going to have, again we expect roughly 35 new units for the year, but about 24 to 25 of those in the first half of the fiscal year. So again kind of slated towards the beginning of the year. Of

those 24, we will call 24 new locations, 10 are in existing markets or 40% of them versus less than 20% of them last year. What that means is that we still plan to open lot of units, but this should improve the relative P&L, or the relative L if you will, of the class of 2002 openings in 2002 versus the class of 2001 openings in 2001. We will have to see, again we are just going through our budgeting process now. And the very last topic before I turn it back to [_______________] for Q&A, our outlook for Q4 in 2002. In our April 24, 2001, press release we brought expectations down to a range of 39 to 41 cents, this fiscal year, first fourth quarter versus last year's 43 cents or about an average around 10% reduction. Yes, our outlook on sales has improved, but we are only 21/2 weeks into the quarter, and yes, our gasoline P&L has also improved and what we hear in the news is that may be gas prices this summer won't increase as much as people feared, but again we are only 21/2 weeks into the quarter, and yes, energy costs are starting to increase, and to consumers in California, and we don't know what the effect of the consumer spending will be, but we will have to see. So, given the range of that 39 to 41 and if you did a range of a weak 39 to a strong 41, you are talking nearly 3 cents or $20 million pretax. Given that and despite the fact that we are starting the quarter well in the first few weeks, we will keep that range intact for now and hopefully at the higher end rather than the lower end but we will just have to see. In terms of the outlook for 2002 as I stated in our April 24, 2001, conference call, I was hoping to give some preliminary guidance today, but I am going to have to wait. We just started, as I mentioned, our Q2 budgeting process, and we are of course more then 3 months away from the beginning of 2002, and this will be an important summer with energy and gas prices. Qualitatively however, I do feel better today about 2002 than I did 5 weeks ago. As I mentioned, comps are a little better but the gasoline P&L, it's a P instead of

an L, all those things are good. Other qualitative factors, the $5 fee increase that we did last September-October. The one nice thing about deferred membership accounting is that you get a 2-year benefit instead of a 1-year benefit on a reported basis. Whereas that represented probably 10 or 11 basis points of improvement this fiscal year, we will have an incremental probably 10 to 12 basis point or 11 to 12 basis points next year. The other thing, next year, we will have an easier comp comparison. Of course this year we are comparing against last years comps of 13, 14, 10, and 9 respectively in last years first and fourth quarters. This year so far we have got a 5, 2, and 5 in the first quarter, second quarter, and third quarter. So as we get into next year, the comparisons there will be easier. We are also [anniversarying] some of the things that related to the build up of infrastructure related to the ramp up in our expansion. As I mentioned to many of you over the past year, we are seeing our earnings in our Depot operations come down as we open new Depot operations and also affected by the lower comps this year. That is [_______________] of the anniversary and also noted in the regional offices that has just anniversaried and a little or no preopening increase, whereas this year versus last year, we probably will again have $12 million to $14 million preopening increase as we go to 30 plus units this year versus 21 last year. I think and I am hopeful there is nothing we haven't talked to any currency experts, but given that the UK and Canadian currency as relative to the dollar have weakened over the past year, we typically see that flattening out if not improving a little bit next year. Also, as I mentioned, slightly less cannibalization, and as I mentioned, the mix of the 35 warehouses gets a little better vis-a-vis existing versus new markets, but still with emphasis on new markets and again the gasoline P&L should improve a little bit, but the hurdles of course are energy costs and gasoline prices and sales levels related to energy costs and continued expansion. We have got a lot of units coming up and even

though the class of 2001 will show some improvement in 2002, they are open for a whole year instead of half year. So again that should be a flat or slight negative there. But again I am hopeful here given what we have seen lately. With that I will turn it back to [_______________] for Q&A.

Thank-you. The floor is open for questions. If you have a question or a comment please press the number '1' followed by '4' on you touch-tone phone. If at any point your question is answered, you may remove yourself from queue by pressing the '#' key. Questions will be taken in the order they are received. We do ask that while posing your question that you pick up your handsets to provide excellent sound quality. Please hold while I poll for questions. Our first question comes from Jonathan Ziegler. Please state your affiliation.

Deutsche Banc Alex Brown. Good morning Richard. I have really two questions. Could you review again the kiosk program. Did you say that they would contribute, your estimate was a about a million dollars per club, and are you disappointed with that 70% run rate, and I was wondering did I hear correctly that this is a kind of a free cash flow generator for you as you pick up the cash before you have to deliver the product and then secondly looking at your mature markets and opening existing clubs in existing markets, are you finding sites available here in California in the Northwest where you have very high productive clubs where you can do some purposeful self-cannibalization?

Okay, first of all in terms of the kiosk, as you have known us for 10 or more years Jonathan, we always set the bar very high. We are pleased with the results. Still using that 70% of a million dollars on 200, not 270 on an annualized basis that is still $140 million of incremental business. We are learning from it. It is a nice cash flow business from the standpoint that we get the money today and pay for it later. But it is still small. Again you call it $200 million that's a rough number, 20 million a month, so may be there is 20 million or 30 million of cash flow this time, month or month and a half of payables. But that will grow and more importantly we can save an individual $200 on a Grohe faucet that normally retails for $500. We can save an individual a $1000 on a pool table or $300 on a set of chrome wheel covers. They are our members, and in terms of enhancing that customer loyalty is great because these are items that they no longer get a discount on. So, we think it is good and we will keep working on it. We think that again within our industry we have the potential to benefit most from it because it is selling upscale merchandize to arguably, we have the most upscale membership base. In terms of sites available, yes I mean, one of our focus is of course hopefully letting you know that it is not all [_______________] the torpedoes around here and just let whatever happens, happens. As we recognize that we have to increase if not even just a little bit, the percentage of new units that are in the existing markets versus new markets and we have focused on that. It is harder because we have already entered these markets and now we are getting ready, just the last budget meeting, we have been talking about it for 4 years internally, we finally found our 5th important site that's a no-brainer. It will cannibalize but it will be hugely successful in that market typically when we have added a new

unit in LA or the Bay area or Seattle, we will open up doing a 100 plus million dollars, in some instances in Southern California 150 plus million dollars, and cannibalize 25 or 30 million from nearby locations, if they offered a good. It is harder, there is still a lot of competition among other warehouse clubs, among other power discounters, among home improvement centers for sites. We think we are getting our share, we washed out a few but we have got a few coming as well.

Thanks very much.

Our next question comes from [_______________]. Please set your affiliation.

[_______________]. I am curious regarding the stores you mentioned around LA where you bought generators. I have talked to a number of businesses that have been told by the AQMD that they will only be able to run it 24 [hours] a month due to smog regulations. How are you affected by that?

I am not aware of that aspect of that. But generally speaking when there is a blackout it is a rolling blackout for an hour to an hour and half, and it is not everyday, and so I guess that if it was an hour, you can do it for 24 days under that scenario. What we will do, that being said, and I don't know the exact answer, but what we will do there is that we would just as we would do in the rest of California with the rolling blackout. We do have battery operation packs for our register system. We have skylights that in fact in many Southern California locations that between about 11 a.m. and 4 p.m. have no lights at all on inside because of the multitude of skylights and there's plenty light in there. What we do is, we just rope off the refrigerators and freezers and put blankets, I think, not blankets but some type of covering over the open [_______________] coffins, the [_______________] and basically let people shop and check out. So, we restrict them through that 10% of our merchandize areas, 10 or 15% of our merchandize areas, but we still operate and again the battery packs are something we haven't done until the last few months.

Okay, thanks.

The next question comes from David Schick. Please state your affiliations.

Hi Robinson-Humphrey, good morning. I am going to ask, I guess, 3 questions. Could you update us on any developments in the private label business just from a percentage standpoint or significant new products? The second would be international markets, if you could just update us on, we talked about sales for the 2001 profitability. And third, just a little more color on the wage comment, with the anniversary coming up in the fourth quarter, how do you see that playing out through the P&L? Thanks.

In terms of private label, I didn't get an exact percentage now, but I think as of the second quarter private label I'd say it is just 12 to 13, so I assume by now it's 13, maybe 13 plus a little. Recent new items that we just rolled out, would be in the baby area, Kirkland Signature baby wipes, significant savings over the leading national brands, good quality product, we expect annual sales of that to be in the mid-double digits. Also Kirkland Signature baby formula, again a very good savings over the 2 leading national brands, and a very high quality item, and that's the kind of stuff that once somebody tries it, and again some parents will not try the formula, but many others will, and once they try it, they'll keep to it because of the savings. There is also some additional private label, Health and Beauty aid items, I know in the vitamin area, which has been a big success for us in that area, small relative to the whole company. In terms of international, I'm not sure what was the question on international?

Just the profitability as you are adding UK clubs, etc., or Mexico you talked about a little bit.

So Mexico has been very profitable this year. I think it's up 50 plus percent in profitability. UK is up a little bit in profitability this year, but that includes the preopening related to the new units there, so we're doing fine there. Japan of course in terms of dollars is the big loser, but we planned that. We just opened our second unit, our first big city unit, right outside of Tokyo. That unit is doing substantially better than the unit that was opened a year earlier, but in the southern part of Japan. And we've got a full compliment of central office there, costing us 5 plus million dollars. Taiwan actually, I think was profitable last month, for the first time as a company. And Korea, given that we've just opened 2 units in the last 6 months, both of which severely cannibalized our strongest unit by a long shot there in Seoul, is unprofitable this year, but should be profitable next year. So again we're growing it, UK, relatively speaking UK, Mexico is best, UK is probably the biggest potential given that we are just starting to add 3 to 4 units a year to a small base, and Japan's a longer term issue, in terms of we have got to see where it goes. Last thing is your wage increase, if you recall, last year effective June 5, 2001, we took the [_______________] scale wage through out our company everywhere, but I was talking about the dollars in US here, up $2 from $8 to $10 an hour, and a commensurate increase up in Canada, in Canadian dollars, best in Canadian dollars. Companywide, that was about $30 million to $32 million hit to us. Recognizing that we do something every year to our wage structure, so we estimated that probably two-thirds of that or $20

million was additional first year [_______________] in the program. That's what we're [anniversarying]. Offsetting that a little bit is, is that every 3 years, we review our whole wage structure at top of scale, we just put it into effect the upcoming three years every 3rd March, if you will. That's a much smaller and that again, we've had that every year, even if in the last three years, that represents about a 2.5% to 3.5% wage increase each year going forward. But again, that's nothing new; we've done that in each of the last three years as well. So overall, again I think more of it relates to the $2 increase, call it $20 million of paying annualized on anniversary June 5, 2001, or about one-fourth delay into Q4.

Thanks a lot.

Our next question comes from John [_______________], please state your affiliation. Mr. [_______________] your line is live. Our next question comes from Daniel Barry, please state your affiliation.

Merrill Lynch. Good morning Richard. Could you give us some more color on the California, I see it improved a little bit. Do you see any particular weakness in areas where you have had a few rolling blackouts that have started. And also is there any difference in the business-individual mix, has that changed any in California versus rest of the country?

In terms of the latter question Dan no, the mix seems like week-in and week-out other than holiday times or holiday weekend, it's about 57% to 58% business members in the US and about 42% Gold Star.

I was asking if there is any change in California.

No, but in California, we don't see a big change there either. We really haven't seen any big, we haven't had that many, in terms of, I know in the Bay area let's say where we have 30 locations, and let's say over a 30-day period, that will be 900 potential blackout days. You're talking about less than 10 or 15 blackout days. When we have a blackout, I know what happens. Even when the registers weren't running, most people just leave their car and leave and we got to spend time in putting it up for that hour and a half, and some of them come back, and some of them don't later in the day. With the battery tax on the registers, I think that would be greatly reduced, and so it's more of an inconvenience, if I had a guess you pick up 90% of it, so it's an hour and a half a day, 90% of that you can pick up later, that's a guess on my part.

And you say there are 900 blackout days?

No, I'm saying in a given month and let's say just look at Northern California, you have got 30 warehouses, over a given month of 30 days, that'll be 900 potential blackout days.

Okay

And we have maybe 10 or 15.

I understand.

It's not a big issue yet, we'll have to wait and see this summer.

Thanks Richard.

Our next question comes from Jeff Feiner, please state your affiliation.

Jeff Feiner from Lehman Brothers. Richard, a couple of brief questions, could you talk a little bit about pricing in food versus non-food, may be talk briefly but elaborate a little bit more, and where you see those trends going, and why you don't want to give any guidance for the fiscal year 2000 outlook beyond? Do you expect an improvement in the overall macro environment, at least talk to that point as it relates to Costco's business mix.

Okay, in terms of pricing in food versus non-food, the improved margin again we're talking basis points here, 10 and 20 basis points, which is how we manage our business. But relatively speaking, that's not a whole lot of change. The strong fresh foods business and the fresh food comps dramatically helps your gross margins there. I think we're finding them on a global basis, we are able to find some better deals and again as has been our case over the last year, year and a half, when we save money by better buying, we keep some of it, not all of it, we pass on a good chunk of it to the member in the form of lower pricing, but we've been able to keep a little of that. And I think there's probably been a few more global deals on the food and sundry side versus the hardline side to date. But we're working on that hard, we think there are some big opportunities over the next several years, not only from the Canadian consolidation, where we think we can get some significant benefits up there, but overall global pricing. Just in the last 6 months, we hired a gentleman who worked for one of the leading consumer products companies, and actually worked on our account for 10 plus years, who has a great expertise in understanding the global buying practices of not only his company which we don't see, there's nothing extra there, but every global manufacturer out there. So we think that will help us a little bit. On the non-food side, the mark downs are not big, maybe there was an extra basis point or two but nothing that meaningful. Just overall, you've got electronics sales and computer sales were down 10%, instead of up 20% and you work on a couple of less percentage points. In terms of no guidance, yes, I think we've come back from our nadir of expectations here, up a little bit, but again we'll have to see. I do feel a little better about it. Clearly, we expect to see an improvement in P&L next year, but we also know, as I mentioned, we have got 24 new openings and 28 or 29 total openings just in the first 4 months. So that will hurt us a little bit. I think what'll help us a little bit is the fact that we're not going into the year, again hindsight is a great perspective here, but we know we're not going to be 4 and 5 percentage points below budget on comps. I think we feel a little more confident about that given that we'll be comparing as weaker comps and we're seeing some improvement. That sounds like a weatherman reporting the weather; it's indefinite maybe, but we're positively inclined right now.

Our next question comes from Teresa Donahue; please state your affiliation.

Hi, Richard, it's Neuberger Berman. Couple of questions, what was the impact on the gross margin of competitive markets first of all, and secondly, the energy conservation initiatives, do they go beyond California, because I was in a couple of your Dallas locations yesterday, and they had the power down signs, and I know it was kind of warm and half the lights were out.

Okay, well first I will ask you, was it still bright in there?

Yeah, the only reason I noticed the lights were out was because it was kind of warm but the lighting was, but you know, the appearance of the store was fine.

In terms of the relative effect of new market openings, when we go into Dallas or 4 years ago when we went to Atlanta, I think Atlanta is probably a better example because we got 3 or 4 years of experience here, when we went into that market, we probably saw our warehouse gross margin, 150 to 200 basis points lower than our company average.

Okay.

In comparison, by definition half of our units in our whole company are always going to be below the average and half are going to be above the average. In a regular competitive market, when we compete with Sam's and BJ's in plenty of markets already, you probably are 50 basis points below average of those markets versus being 50 basis points above average in [_______________] Montana or [_______________] Seattle. So, the 150 to 200 is 100 to 150 higher than that.

Okay.

After 3 or 4 years, we see that come back such that Atlanta is not that dramatically different than being 50 basis points lower.

Okay.

And the first hurt is the hardest, is the biggest hurt, and of course we've got a lot of that right now. In Q3, Bob Nelson did a little analysis that showed that on a year-over-year basis, if we just took out the new market openings from both of those quarters, Q3 last year and Q3 this year, it's about 9 basis points. The gross margin delta would be 9 basis points better.

Excluding new stores and new markets?

Excluding new markets last year and excluding new markets this year.

Okay, thanks.

In Q2 you had some of that also, but a little less, maybe 3 or 4 basis points, maybe or 6 instead of 9.

Okay.

I did not do it for Q2 but I assume it has come up a little bit, and that delta will probably again, maybe it was 9 in Q3, maybe it will be 11 or 12 in Q1 before it starts to improve the other way. The big improvement in deltas and gross margin again will be the [anniversarying] of the big push of our Executive Member reward program when we start showing [anniversarying] over that negative delta.

And when is that Richard?

Well in Q4, it starts in Q4 actually and probably half of Q4 and half of it in Q1.

Okay, thanks and the power down initiative, is that companywide?

I'm sorry yes, that is absolutely companywide, in fact preparing for the conference call last night, I decided with three little kids at home I have decided to stay here and at about 7 I said, man it's hot, I realized that at 5 o'clock the air conditioning goes off in our building.

Okay, thanks.

Our next question comes from Linda Kristiansen; please state your affiliation.

UBS Warburg. Hi Richard, two questions, could you elaborate a little bit more, first of all on why you think the core gross margin will bounce back in the fourth quarter, and then secondly, do you know how much the real estate gain is going to be in the fourth quarter, you said, I guess you are selling another property in the fourth quarter.

The real estate gain in the fourth quarter I think will be, I don't have it in front of me, I think it is 4 million, maybe a little better, but again we will have also some closing, forgetting about Canada, leaving that separately, because that will be a big number, close to 16 million is our estimate for Q4, because that's when everything happens. But leaving that aside, I think we'll also have some increased relocation costs given that the commitments we're just making to relocations, once you have the formal commitment, you know with certainty, if we are demolishing a building, or our real estate department feels that they're going to take a loss on an old site, which doesn't always happen of course, that will be offset, so the best guess is excluding the 16 million budget for Canada reorganization, a wash, to positive or maybe a million or two negative.

Okay, and on the gross margin in the fourth quarter?

I am confident, honestly part of my confidence is, I was taking to Jim about it yesterday and he said, because I was asking him to help me explain what does he see going on, and his view was that Q3 was a little bit of an anomaly and that things were fine, and I think we have a commitment to improve our earnings without cheating, and we're not going to just raise prices, but we're going to get all the margin where we can, and also there are new deals coming all the time, and I guess we've, our merchandising initiatives have placed a greater emphasis on letting Bob and I know where those deals are, and we feel pretty good about Q4 at this juncture. I'd like to add that it would be nice if gross margin was a little better in Q3 year-over-year but none of it, other than the new market stuff that I just talked about, none of it has increased levels of competitive pressure.

Okay in existing markets?

Yeah.

Okay, thank-you Richard.

Our next question comes from Shari Eberts; please state your affiliation.

JP Morgan. Richard given the front end loaded openings for the first half for fiscal 2002, can you talk a little bit about when you might expect to see earnings actually start to grow at a more normalized pace?

Well, the easy answer is it is Q2, Q3, and Q4, you know a little bit of tongue-in-cheek there, but that's the reality of it. I think Q2 will have some improvement, Q1 is the big question mark, and I have to wait and see. Q1 maybe okay with the exception of preopening, but again we're just starting the budgeting process and I don't want to be too optimistic, I'm crossing my fingers though, I mean comp stores are again a little better, gasoline doesn't hurt us, I mean this is the [anniversarying] of the wage, and those are the things that are helping us, but if I were to be a conservative betting person right here, I'd probably say Q1's no, Q2 yes, Q3 and 4 absolutely.

Okay, and can you just talk a little bit more about whether the new clubs for this year are annualizing in terms of sales volumes versus what you would have expected and also just how the profitability or the loss is coming out versus plans on the new clubs for this year, both in new markets and existing markets?

Okay, in terms of new markets, I think I gave a number out in the second quarter conference call which scared everybody, what I did was, I listed all the new market units for the prior 2 weeks to that conference call, so whatever was end of February or early March conference call was the last 2 weeks of February, and I annualized that number and I think it was like $45 million and [_______________], oh my god it's down from $50 million and $55 million and no it's not, one it's mid February which is a crappy time of year saleswise, it's probably the low point of the year and two, it's all new markets, it does include the Norwalk, Connecticuts of the world, or the Burlington and [_______________] Washingtons of the world. I just overlooked that, I don't think there is any big change since that time, maybe a little improvement seasonally. One of the things we did for our board meeting a month ago, is we looked at the first 32 weeks, not the first 36 weeks, but essentially I don't think there has been any big change there. In the first 32 weeks, we had opened a total of 20 new units. These are new market units. Our budgeted P&L, original budget from back in last August and the actual is about $1.8 million higher, so lets say for the year, it's close to $3 million higher loss, so again not a big deal. Sales were essentially in line, and again I think that's indicative of the fact that we aggressively budget sales, we get there, margins we do a little worse because of these many new markets, we are going to [_______________].

Okay, and then just last question, BJ's had talked about entering certain Florida market where both you and Sam's Club already have clubs and that they're going to be building a little bit on sort of the outside of where you are located, closer to where the population is growing, and I was just wondering if you could comment on any impact you would expect in Florida, Florida markets from them and just how you think about relocating your existing units in general to try and make sure you are in the right location?

Sure, first of all we respect BJ's, in fact in some locations we actually compete across the street from them. I'm happy to hear that they're going further out. I think they would acknowledge too that there is a reason why our unit does a 100 million and theirs does 40 to 45 million. We think we have a little bit of different customer, we think that they have found their niche and we have found our niche, and we can profitably coexist. But I'd like nobody to come into any of our markets sure, but we find ourselves that a combination of, we've been good competitors, even though both of us sell Snicker's bars from vending machines and both of us sell Tide detergent, both of us sell soda pop, the fact is that there is probably less overlap of like items with BJ's than there are with Sam's. Keep in mind the average Costco has 4,000 items roughly, the average BJ's has close to 6,000 items, I believe. That means a lot of smaller sized queues, certainly different private label items. The other thing that I think, we all have going for us is as we have seen in many markets as we have opened in other people's markets, the market for warehouse clubs is still expanding and that's the good news.

Okay, and is there any comment on how you think about once you relocate to make sure you are on the right location?

Well, as you know, we have not been shy about relocating. We probably average 5 to 7 units a year for the last 4 or 5 years. We are constantly looking at it. Every operator wants to do it because they get a nice too big shiny location that's going to comp 30% to 50% instead of 0% to 10% and 3 years from now it's going to be great, one year from now it's going to be great. So we are always looking at that and I don't know any detail in there, I know that Jeff Brotman particularly, and Jim as well, but Jeff with his real estate department spent a lot of time looking at relocations and at any given time we probably have 25 or 30 locations that are considered for relocations, and we are looking for a way out though, that's not like we are only doing 5 of them, why aren't we doing all 30. The fact is that we are looking at several of them knowing that Sam's or BJ's is in the market looking around and that 3 years from now we got to think about doing something.

Okay great, thanks a lot.

Our next question comes from Michael Exstein. Please state your affiliation.

Credit Suisse First Boston. Good morning, just quickly Richard, when you get to the third quarter, you think there is a shot that you can start having positive year-over-year comparisons in SG&A percents, thanks.

Yeah, Michael that's a good question. I think so recognizing that you will be a year and half into the class of 2001 units, so that should definitely be positive. We have [anniversaried] all these other things I have talked about, the new units will hurt it. I think the net of that will be a positive, and I am going on the gut here, and I am also going with the fact that Bob was contemplating and also shook his head in the affirmative. So yes.

Perfect.

Our next question comes from Michelle [_______________]. Please state your affiliation.

Hi, this is Michelle [_______________] from Salomon Smith Barney, I was wondering if you could comment on the impact on consumer demand and energy sensitive regions like California specifically on the small business and retail customers?

Well, we really haven't seen a big change yet, again recognize the energy costs are just hitting their [_______________] this month and next for the first time, although, it's been on the news everyday for the last several months. California again has a kind of bucked the trend. California is relatively speaking has improved more than other regions. The one region that has continued to be a little weak relatively speaking is the Northwest, although, there is no competitive issue here and again that sure has improved a little bit but California has actually comeback nicely. So the answer is that I don't have any answers for you yet. We haven't seen anything to suggest that it's going to go down, although, we are just starting to see the way the energy increases.

Okay, thank-you.

Our next question comes from [_______________]. Please state your affiliation.

[_______________]. It's [_______________]. Good morning Richard, looking at some of the new programs you put in place over the past year like the 2% reward, Amex, and not the wage increases review program, but just if you could talk about outside of just [anniversarying] those increases and the easy comparisons, how they contributed? And is that contribution on plan, and if you can give us some evidence, for example, wage increases have you seen a higher retention rate, lower training costs, anything, any kind of evidence that you could point to that these programs are working.

Oh yeah, in terms of wages, we have seen an improvement. Historically, even though nearly half of our employees are part time hourly and the other nearly are full time hourly, despite that, we enjoyed low 20% or 21%, 22%, turnover rates and a year ago that was up to 27% to 28%, I believe, now it's about 23%, and so yes it has come back down probably that is because nobody is leaving their job. A year ago, people were going to dotcoms and now they are calling us to come back. So I think it's a combination of the two, but we also thought that it was a right thing to do. In terms of the Executive Member program, I know we like many of you do these wonderful matrices, about 5 years ago, when we announced the Executive Membership program which had no membership reward aspect, it was just an extra $55 or $60, and boy, this is going to be the do all end all. The fact is that they take time. Basically, we are right on target with our budget, actually maybe a shade better, in terms of what we think we can do, but it's no guarantee. At best even right now and over the next few years we think it will be a positive. It trends towards positive, but it enhances loyalty, and more importantly, if we have a little under a million members now, then we have 3 million members, 5 years from now, and we build these service programs; we make money on these services we give our [vendor]; we are locking those members in for a lot of other reasons. They may move and not even have a Costco near them, but they are going to still be a member because of their auto insurance. So long-term, we think it's a good program but it's by no means a slammed on big positive. Actually, right now it's a booked negative. So again nothing out of the ordinary, they are pretty much in line with what we have stated.

Okay, what about Amex?

Amex again it's hard to remember, it's an up scale member. We have been surprised on the upside by the number of new signups got through the Amex marketing efforts for the cobranded Amex Costco card. We have seen a little bit of an increase in the average spend of these members, although, that fluctuates each month, but net of that has been increase for sure over the last year. I think the biggest positive there is that both sides really feel honestly good about it, and it's going in the right direction for both sides. Again, its not a big giant leap for mankind here, bottom line it's a net positive and it will grow from there.

Have you [_______________] numbers to figure out when you might be recoup those investments or the costs associated with it [_______________]?

No, they are all in line with what we expect, again I think the Executive Membership is long-term. The Amex is long-term, I mean, more than recoup the investment. We think the [_______________] program is a net positive, right now first year, it's a small net positive and it will grow from there. As an example of the first year, I think we have got about 300,000 new members and these are people that had already not renewed for more than 6 months from us but were still Amex members, and they came back and when they got a cobranded card, they had to pay us $45 to be a Costco member, that's 12 million bucks and that's people that are going to come in and shop and hopefully a good percentage of those will pay us another 12 million bucks next year. So again, I think those were all net positives, and it's kind of like the old commercial [_______________] these programs are making money the old fashioned way over the long-term.

Great, thank-you.

Our next question comes from [_______________]. Please state your affiliation.

Hi, Dain Rauscher. Richard you mentioned earlier, you talked a little bit about, you made some comments to the effect that the warehouse club market has still a lot of growth left in there, can you talk a little bit about how you size that potential and what the outlook is there and then secondly, I have a question on the long-term trends in gross margin particularly on new stores and how that impacts return on capital, looking at that equation?

Okay, let's see where do I start, first of all, on the return on the capital stuff it hurts return on capital in short-term. We plan to be in Atlanta, I mean again, I will use Atlanta. Atlanta is a good example because it has done well. Those units had a cash-on-cash return on assets, negative in the first year or two, it's now completing its fourth year in the first couple of units, and they are in the low teens, and by next year, it will be in the high teens based on what we see so far. That actually ain't so bad because we are going to be there for a long time.

Are they in line with the long-term trends, Richard, from where you were say 5 years ago?

Oh, I think years ago, there was more low-lying fruit, and it does take a little more time. Have we replaced a little bit greater emphasis on making sure we get some more existing market units? Yes and again that doesn't happen overnight, but as I mentioned I know we have got a couple of more of California units in the existing markets, we have got I think another Phoenix unit, another Maryland unit, another Virginia unit, we just opened Norwalk, Connecticut, we have got another New York unit, and a Port Chester, we have got another Portland unit, so all these things again relatively speaking that will help that a little bit, but the old status we are building for the long-term, we recognize it's a little painful short-term, but we think it's the right thing to do. As it relates to that, we are confident that we can improve the P&L. Some of that improvement comes from an improving gross margin and an improving gross margin each year for the next few years, but that's doing it Jim's way. Jim [_______________] way which means not cheating and again we think we can get there with some of the goals for buying deals of what we are doing with private label, with better buying, and not by just saying let's take something from 649 up to 679.

And when you look at the sizing the long-term market potential?

Long-term market potential, Jim just went through one of his back of [_______________] exercises when we had some people visiting a few weeks ago. I think we have got about 260 locations in the US. He feels that 10 years from now we could have 500. Now the assumption is that there is more infill, which is happening and that we have gone into all these new states, I mean, two years ago, we had just opened our first two units in Atlanta. We are just getting ready to open our fifth unit this summer, and we have got two more planned. A year ago, we had nothing in Dallas; we now have four with a fifth in Dallas, Fort Worth Metroplex by August, and two more units in Houston and Austin. So just two years ago, we had 1 or 2 units in Chicago, we just opened our 5th with 2 or 3 more planned in the short term. So the part of it is that assumption as well. What it means is we got over 23 units a year for 10 more years in the US, and we are going to do everything we can to do that and that's what we think. And certainly a part of it is that our equation is a little different. We are not a fashion statement, and we are not just in retail apparel, we are not just in consumer electronics, we are not just in home improvement, we are not just in toys, and we have got a big draw with fresh foods, and we have got a big draw with saving people's money on every item they buy. So hopefully, that will help and again, I get back to fresh foods, more than anything I believe fresh foods is what keeps people coming because once they tried [_______________] steak or muffins or cake, they come back because they love the size and the quality and the price.

Okay, and do you know what capex would be in the 2002 at this point. Can you comment on that?

Yeah, I think it will be about the same as this year about $1.3 billion.

Okay, and what will that workout to in square footage increases for 2001, Richard.

Well, I think, this year we started the year with, how many units Bob, 313, we started the year with 313 and we'll end with 32 more, so we will end with 345. That would be a unit increase of exactly 10% or 10.2%, rough number you can add a percentage point to that on a square footage basis.

Great.

And next year on a base of 345 to start with, you would add lets say 35, I'll be aggressive there that's maybe a little bit on the high end but 35 should be 380 on 345 is also a 10.1%, so that would be 11% square footage growth.

Great, thanks very much.

Our next question comes from Todd Slater. Please state your affiliation.

Hi, Lazard and my questions have been answered, thank-you.

Why don't we take two more questions since it's now approaching 90 minutes. Go ahead.

Our next question comes from Teresa Donahue. Please state your affiliation.

Neuberger, my question was answered, thanks.

Once again if you have a question or comment please press the number '1' followed by '4' on your touch-tone phone at this time. Our next question comes from Barry [_______________].

Hi it's actually, [_______________] from [_______________] Asset Management. I missed the beginning of the Q&A so excuse me if this has been answered already, but the last conference call you had made some comments on categories that were weak or strong, I was wondering if you could give some color on that as well.

I am sorry could you ask that again.

Categories for like last conference call you had said jewelry was particularly weak, I was wondering if you are seeing the same weakness in the same categories for this past quarter.

Yes, but a little less weakness. The jewelry which I think in April, March or April was [_______________] down 15% to 17% it was down to 4% or 5% of late, computers which have been down as much as 20 plus percent is down a little less, although that has been helped by some really low priced e-machines that we have for 399. Apparel was down 8 or 9, now it's flat to down 2, probably one thing that is stronger than expected in the high single digits was lawn and garden and sporting goods.

Thank-you.

Sir, there appears to be no further questions at this time.

Okay, [_______________] thank you very much to everyone, and Bob and I will be around if you have any further questions.

Thank-you, this does conclude today's teleconference. You may disconnect at this time.