好市多 (COST) 2002 Q3 法說會逐字稿

Good morning, my name is Beth and

I will be your conference facilitator. At this time I

would like to welcome everyone to the Costco third

quarter fiscal 2002 earnings conference call. All

lines have been placed on mute to prevent any

background noise. After the speakers' remark, there

will be a question and answer period. If you would

like to ask a question during this time, simply press

star, then the number 1 on your telephone key pad. If

you would like to withdraw your question, press the

pound key. Thank you. Mr. Richard Galanti. You may

begin your conference

Thank you, Beth and

good morning to everyone. As usually, I would like to

review with you several items related to the third

quarter results this morning. To begin with our third

quarter operating results, week ending may 12, came in

at 28 cents a share earnings, up 5 cents or 22% over

last year, a penny a share better and at the high end

of our prior guidance of 26 to 28 cents. I know we

brought our guidance down a penny from the 28 to the

27 cents on our March 5 conference call for the second

quarter. Frankly that was the appropriate guidance at

that time as earnings growth was better in the latter

part of the third quarter than it had been in the

first part, so we showed acceleration there. Comp

sales for the quarter, 6% and I'll go into some detail

in a moment.

the usual topics of interest I'll review with you,

include recent openings, coming expansion plans,

ancillary business results, new initiatives, Costco on

line results, second at this membership results, and

of course the balance sheet for the third quarter.

Lastly, I'll walk you through all of you through

current guidance for Q-4, fiscal 2002, which frankly

remains the same as the prior guidance of 48 to 50

cents range previously given to you and I will give

you a preliminary look at fiscal 2003.

Over all, progressing this fiscal year with the

guidance given to you at the beginning of the year

with earning per share growth flat in the first

quarter year over over year. Up 28% in the third

quarter. Let me start by stating the discussions we

are having will include forward looking statements

within the meaning of the private securities

litigation reform act of 1991, and that these

statements involving risks and uncertainties that may

cause actual events, and or performance to differ from

those indicated by such statements. The risks and

uncertainty include not litted to those outlined in

today's press releases as well as other risk

identified in the company's statements and reports

filed with the SEC. With that stayed, we'll get

started.

Sales again for the quarter were up 11.6%, 8.4 billion

from 7.6 billion a year ago, with same store same or

comps of 6% up. Up 6% for the 12 week third quarter.

Overall, good sales showing compared to retail overall

and in line with many of the other strong value

discounters. For the quarter, comp sales results

weren't affected that much by weaker foreign

currencies, only about one-third negative effect hit

to that. Some of the foreign currencies which had be

weak are showing strength to the dollar. Average

transaction in Q-3, up 2% year over year, average

frequency was essentially up 3% in each of the months

of February, March, and April, and the first part of

May, so again, a combination of a frequency increase

of 3% and a transaction, average transaction size

increase of 2%, reasons for the 6% comp for the

quarter. Terms of sales comparison by geographic

regions, northwest was 5% compared to 5 and 8%

respectively for the first and second quarter,

California was 7, at the high end of the 6 in Q1 and

the 7 in Q-2, so it remained at 7 in Q-3, northeast

was 8 compared to a 7.5 in que 1 and 10 in Q-2. South

east picked up, 9, compared to a 7 and 6 in the prior

two quarters. Midwest remained strong at 17 compared

to an 11 and an 18 in Q1 and 2, so for the year - for

the U.S. overall, Q1 was a 6, Q-2, 8, Q-3 was a 7

In Canada in U.S. dollars, we actually showed our

first positive number, up 1 in U.S. dollars and up 3

in local currency. That was our first U.S. dollar

positive comp in Canada in over a year. Other than

international was up 5 in third quarter and on a local

currency basis up 7

for the total therefore, for Q-3 of a 6 compared to a

5 in Q1 and a 7 in Q-2. Mexico, which of course we do

not incorporate in our numbers, Mexico comps on the

dollar basis were up 13% and on a peso basis up 9% in

line with what it had done for most of the year so far

In terms of merchandise categories, food and sundries,

we have four - five major categories. Food and

sundries was up 5% in the quarter, compares to 6% up

in Q.1 and 5% up in Q-2, so fairly consistent. Hard

lines was up 6% in the third quarter compared to a 3

and 11 in the first and second quarterters. The 6 by

the way in Q-3 was helped by hardware and lawn and

garden and toys. With a little less, I think majors

- I'm sorry, it was a 7. But with majors being about

5 for the quarter. That being electronics. Soft

lines was also - was up 6% in the quarter compared to

a minus 3 in Q1 and a plus 6 in Q-2, so eastbound

again at the high end its perspective range. Again,

soft lines up 6 was helped by a apparel, domestics and

jewelry, which were the stronger departments in that

category.

Fresh foods remained strong at 10 compared to 8 and 10

in the first two quarters of this fiscal year. That

continues strong and actually has for over a couple of

years

Ancillary businesses were up 9%, without gas, it was

actually up 14%, so the base business is besides gas

were up stronger, with gas of course gallonage is up

industry strong, but the average price per gallon is

down about 20, 25% year over year, so again, total

company was 6% for the year.

Continuing down the numbers, to membership fees, we

reported in Q-3 membership fees of $179.9 million or

2.13%. That's up 16% in dollars and up eight basis

points from the last year or $24.5 million increase

year over year. So strong showing in membership fees.

By the way, on a cash basis, we reported on a deferred

accounting basis, on a cash basis, the dollars were up

almost similar amount, up $23.7 million.

These continue to be very good membership numbers and

actually slightly better than average budget on a cash

basis.

Remember in terms of reported book membership fee

income, still benefiting on a small amount from the

September, October of $20,005 fee increase, again with

deferred accounting, it takes about two years for that

to flush all the way through since the fee increase

occurred months 1 through 12, it's actually month 24,

which would be this August/september when we'll see

the tailend of that benefitting book earnings. That

incremental benefit has slowed, we'll be completely

out of of the figures after August. Cash basis,

continued to be helped by the first year membership

sign ups that we did in markets a year ago. As well

as the fact that we are also benefiting from members

converting to our $100 per year executive membership

from the normal $45 per year membership.

This is growing at a level greater than actual

original budget this year, in part because of some of

the activities we've done to push it and market it to

our members.

At third quarter end, close store members in terms of

total members, gold star members totalled

14.1 million, up from the beginning of the year at

12.7 million and up about 100,000 from Q-2 end.

Primary business was 4.4 million, pretty much in line

with where it's been. Recognizing some of those

people have converted to the executive member, which

is typically - which is put into the gold star.

Business add ons, 3.6 million. Total membership is

22.1 million, up 100,000 from Q-2 end, and up 8.3% on

an annualized basis. In fact, in Q-3, our paid sign

ups, excluding all the free beast were do. So

including free spouse cards, we have just under

40 million card holders out there. At third quarter

end, in terms of paid executive memberships, which are

part of these numbers, we ended up with 1.475 million

paid executive members, an increase of 168,000 in the

fourth quarter or about 14,000 a week new paid

executive members.

That a compares to 13,000 a week increase in Q-2 and

11,000 a week in Q1.

In Q-3, executive membership sales in the U.S. where

they're offered, so this is a percent of U.S. sales,

were total 23% of total sales versus 15% of such

sales in last year's Q-3, so you can see that program

continues to grow.

Keep in mind, in the first year when executive member

converts, we see a big bump in the average sales,

something in light of the mid teens and then we see it

stay at that level, not at that level of growth, but

at the higher level, getting back to regular growth

there after.

Membership renewal rates, as I expected and discussed

with you on the March conference call for Q-2, our

rates did trend back up to our all time high of 86%.

Again, as we've anniversaried through the $5 increase,

we went from an 86% all time high renewal rate down to

85, as we would have expected and now that we've

anniversaried that for more than a year is 86. 86 is

split between business members and gold star members,

at 83%. Recall that our - oh, and this is despite

the fact that Costco's annual membership fee is 5 to

$15 higher than our main competitors. We think it's a

combination of what we do in the warehouse, the

constant innovation and new products an services that

we offer, an we feel that frankly that our membership

fee is still a very good value out there, and I think

that's evidenced by the renewal rates.

One operational efficiency that should slight live

help renewal rates and actually speed up collection of

membership dollars is the recent completion really a

major rewrite of our whole membership system. For the

last nine or ten years, we've effectively continued to

a band aid approach to changes in our membership

system. About a year ago, we embarked on a major

rewrite, which took close to 50,000 labor hours, if

you will, to complete. It has a lot of benefits, most

notably, the ability that a member can renew at the

register rather than having to go over to the

membership desk, more importantly, it will - once the

membership card is scanned at the register, the

cashier will be notified when the renewal date is and

can remind the member that even if their membership

renewal is one or two weeks from now or just occurred,

stay would you like to pay right now and save the

means of having to write a check later, and what we

find is it enhances the membership renewal rate

slightly and certainly speeds up by a few weeks if not

more of when the income comes in and can start being

recorded.

We think that's a big positive. There's many other

advantages to the new rewrite, which include the

introduction of the new Costco cash card, how we

process gift cards as well as ultimately, you know,

phone card sales. I'll talk about that in a moment.

In terms of American Express, it continues to grow in

the third quarter. We added 143,000 American express

co-branded cards to be 1.7 million accounts, close to

2.7 million card holders, and American express now

represents just over 20% sales penetration up from 18%

a year ago.

Going down to the gross margin line. In third

quarter, we of course had a very strong gross margin.

In fact, stronger than originally predicted. 36 basis

points up at 10.12% versus 9.76% a year earlier.

Like in the past, if you want to jot down a few

numbers. Wee tie this up to help better explain

membership, and gross margin percentages as we will do

in a minute with SG and A. Look at the components of it.

We break down the 36 basis point improvement into five

categories, core business, the core warehouse, the 2%

executive member award which is an offset to sales,

effectively reduces gross margin as we build that

business. The benefit or detriment related to

ancillary businesses, the fourth category is

international and the fifth category is LIFO, for then

a total for sixth line. Just in terms of a trend,

I'll ask to you jot down three columns. Q-1, Q-2, and

Q-3. And if you go across on the core line, in Q1,

year over year, core gross margin was down 16 basis

points in Q1, up 10 in Q-2 and up 30 in Q-3. I'll

give some more flavor to the 30 in a moment.

the 2% reward was minus 14 basis points in each of the

three quarters. That compares to minus 19 percent

last year.

I'll ancillary, which was plus 16 in Q1, was flat in

Q-2 and up 17 in Q-3. A lot of that has to do with

gas. In Q-2 as an example, that zero had minus 9

related to gas whereas in Q-3, the 17 had plus 7

related to gas. Other things that were strong in gas

- in ancillary in Q-3 were the very strong operating

results in the pharmacy.

International was plus 6 basis points in Q1 and plus 3

in each of Q-2 and 3 and begin, these are the

components. When you add these - LIFO was 0, 0, 0.

In each of the three quarters this year and each of

the three quart trs last fiscal year the lie

photograph charge was $2.5 million. So on the basis

point year over year, it was no change. Keeping in

mind that's an estimate at this point. I'll talk

about that in a moment as well. Total reported gross

margin year over year in Q1, which had been down 7

basis points, in Q-2, down 1 basis point was up a

healthy 36 basis points in Q-3. In terms of the core

improvement, the food and sundries and soft lines were

stronger year over year. Hard lines was about flat

year over year and fresh foods was particularly

strong. we've shown very strong increases in our - in

the efficiencies which is ultimately reflected in our

gross margin as sales continue to be strong there.

the next gross margin component, the 2% executive

member reward, it's pretty straightforward and again

I've tried to share with you some of the components of

that. If you would jot down a little table with four

columns, Q1, 2, 3, and 4, and three line items, fiscal

2000, 2001, and 2002, this matrix would start in Q-3

of 2001 with a minus 1, Q tour would be minus 12, the

four quarters of 2001 going across would be minus 17,

minus 21, minus 23 and minus 17. In 2002, Q1 through

3 would be minus 14, minus 14 and minus 14. What you

see here is we initiated the 2% reward program at the

tailend of Q-3 of fiscal 2000 and the effect of

increasing sales penetration being afforded the 2%

member reward is a reduction reflection in the

reduction of sales by 2% on those sales and therefore

the same costs of sales, you have a hit to gross

margin. On a cumulative basis, if you added these

quarterly columns downward each quarter, you can see

that in Q1, for the two years that we've done it, it

represents 31 basis points, cumulative, Q-2, 35, Q-3,

38, and of course Q-4 for the first two partial

quarters there, two quarters of the first 2 years, 29.

We would expect to see the level of sales penetration

continue to increase, but at a slower rate. Frankly,

it's been at a higher rate than we had planned this

year, which we think is good and we'll talk about that

in a minute.

We think that the strength in the program by the way

is again, increase in our warehouse - in warehouse

signup efforts as well as we believe the

word-of-mouth.

I would guess that in Q-4, it will probably be about

12 basis points detriment, which would give us again

some number in the low 40's, about 40 basis points

cumulative year to date. Next year, while still a

detriment to gross margin, a very small detriment.

I believe that in last year east conference call, I

stated that we would expect the detriment to gross

margin from executive membership to ratchet down a bit

faster than it appears. We think that's great. More

members are selecting the executive membership it

means and frankly with less of them being the initial

adverse selectees, if you will, so we think the

program works. We know it works based on incremental

sales and profitability from the sales, incremental

membership fee income. Here's is where you see the

offset.

with regard to ancillary businesses which were up 17

basis points, again, better pharmacy and optical and

food core profits with pharmacy being particularly

strong. And in a positive reversal from last year's

third quart, our gasoline business, which was quite

frankly abysmal last year was a little less abysmal

this year and a little profitable in Q-3. That added

7 basis points year over year. Whereas it was about

minus 9 basis points last year.

International 3 basis points better, no big surprises

there. And again, I mentioned LIFO. Now I would say

that current reserves so far, we think that exceeds

the year to date level on inflation. In fact, on a

net basis we have seen a slight amount of deef flags,

although again we won't know until the end of the

year. To the extent that continued and there's no

reason to expect it won't, that would help Q-4 in

Q-4's margin, reversal of some of the LIFO charges,

but that would be an of 0 set - that would be an

offset to what most likely will be a very tough year

over year gasoline comparison. Again, going back to

the volume tilt of gasoline P and L where was last year

east Q-3 was abysmal, last year's Q-4 was very, very

good. In fact, I went back to my notes when I

reviewed Q-4 last year, and the gross margin related

just to gasoline profits in Q-4 last year were up 24,

25 basis points. So again, while we are on a

profitable trend in the last several weeks for gas,

we're not at the same level as last year, so I think

those two might offset those. Gross margin outlook in

Q-4 and fiscal - Q-4, again, our budget to start with

is in the high single, low double digits.

the fact that last year's again core was down 21 basis

points will help. The fact again that gasoline was up

quite a bit will be a hard one to compare, so that

could be an offset.

I would also expect in fiscal 2003 and I'll go through

some more of this at the end of the call, we would

expect in fiscal 2003 to get at least 10 basis points

of margin improvement, again while remaining the most

competitive operator out there. There's no - margins

are not our problem as we've shown. The cha eng

continues to be to drive our expenses down.

Before going into SG and A, let me briefly go over some of

our ancillary businesses. As you know, - you don't

know yet, we have 295 pharmacies, having opened one in

the third quarter, and about 23 year to date. Food

service, we added four in the quarter to essentially

be at all locations. One hour photo labs, we added 4

to be at 382, up 43 from fiscal year end. Optical, we

also added four to be up 24 since fiscal year end. We

added one copy center to be at 12. Which was actually

the same number year end and we add one hearing aid

center to be at 105 which is up 24 and gas stations we

add one in the third quarter to be at 160. That would

represent - that represents our 21st since the first

of the year when we had 139. We've opened just in the

last few weeks since the fourth quarter began two

more, including one in Rancho Cucomango [phonetic]

yesterday which was a relocation of a units and we

plan six to eight more to be at fiscal year end to be

right around 16 - I'm sorry, 170 by fiscal year end.

These businesses are doing fine overall. They're

highly profitable, with the exception of the gas

business of course, its profitability is up and down,

which pays many more dividents in terms of the loyalty

factor and driving additional businesses in the

warehouse and over any 12 month period, we've always

seen a modest amount of profit in the gas. These

drive our overall business, have better than average

company comps and again they're yet another reason to

be a member of Costco, which we think helps our

renewal rate.

In total for Q-3, ancillary businesses comps again I

mentioned were up 9% and without gas were up 14%. So

many of the, if you will, mature ancillary businesses

like pharmacy, optical, food court, have continued to

show good comps and good growth.

Before moving on to SG and A, I will like to mention one

change at the gasoline pumps, which it says it will

become effective June 1, although there's kind of a

one month grace period where even though we say we

won't accept certain cards, the individual out there

will have the ability to override that. Effective

again in June, Costco will no longer accept Visa,

MasterCard and discover at the gas pumps. As I'm sure

you he know, we do not accept those cards in store.

Initially we chose to accept them out there because we

don't accept cash and checks out there since typically

there is not an employee out there doing that. We

will have continued of course to continue to accept

American express as well as our private label card

offered by household, and debit cards as well.

with traditional credit cards of course the merchant

fees already high by our standards and recognize we

have some if a national particular standards out there

giving given our low gross margin to start with, are

even higher in a transaction where there's not an

employee present to be able to check your card, so

we've run relatively high merchant fees out at the gas

station, in what has proven to be a low margin

business, with of course debit cards, their lower fees

than credit cards overall and with American express,

while I cannot discuss pricing, this is a partnership,

it goes well beyond simple credit card acceptance at

the gas pumps. We have tested it, and we do believe

that it that will help our profitability. All things

being equal, we estimate that this card could help

gasoline P and L by 10 million to $20 million, while

allowing the same credit card and debit card

alternatives as we have in the warehouse.

Also, the timing coincides with a roll out of the

Costco cash card, which essentially is a stored value

card. We haven't been the pioneer in this. I've

gotten the store value card at some other retail

merchants when I've returned merchandise item or two,

but it has many opportunities and benefits for us.

This is being rolled out now as we have - just this

week as we've completed the major membership rewrite,

which included a lot of rewrite in the point of sale

system allowing us to do this. The Costco cash card

has many opportunities, not only for people to buy

goes but to give out as gifts, for parents to give to

kids, going off to college, it will replace gift

certificates in the warehouse, which we had, if you

recall, stacked up on pallets, which was actual value

on the gift certificate and in a corrugated plastic

container. Now it will simply be a card on a peg

board rack with no value on it. The net value can be

added in any increments up to $1,000 at the register

by initializing the card through the scanning and card

swipe system.

We also think it has merit out at the refund desk,

although will still give members the opportunity to

take cash or to take the credit against their credit

card or debit card.

That again is being rolled out as we speak.

Moving on to SG and A, it came in year over year as a% of

says higher than planned. Due mostly to the new

locations we've opened in the last 12 months, 29 new

locations. In Q-3 SG and A higher or worse by 23 basis

points coming in at 9.56% of sales and this years

through Q-3, versus 9.33% of sales in last year.

Again, this will be the last chart I ask you to write

down, but again, if you look at the first three

quarters, and there's again five line items, the core

warehouse, central, which is our administration

offices, ancillary businesses, international, and

other. In the first quarter, the core in terms of the

basis points of detriment are benefit to SG and A overall

and again a negative number means SG and A was worse or

higher. Core business was minus 21 in Q1, minus 20 in

Q-2 and minus 19 in Q-3. Central was plus 5, plus 7,

and plus 4, so plus 4 in Q-3. Again, that would be

lower by 4. Or better by 4. Ancillary, minus 7,

minus 4 and minus 7 fnlt international, minus 3, plus

2, plus 2 and other, 0, 0, and minus 3. For a total

year over year SG and A being higher by 25 basis points if

Q1, 15 in Q-2 and 23 in Q-3. Now in terms of the core

warehouse SG and A year over year, are higher by 19 basis

points. Analyzing components of this, nearly all of

it again relates to the many new market warehouses we

opened. If you take out the - if you separate our

company in to one year or older warehouses an one year

or newer warehouses, basically, that's 18 of the 19

basis points, similar explanation that we had in the

second quarter. The other thing that you know, I've

been asked a lot of questions'last you few months, and

particularly I think since Wal-Mart had talked a

little bit about, particularly at Sam's some of the

health care and related costs, I did look at that and

in the quarter that represented year over year about

four basis points. We think that's manageable. I

might have add that even though it's up year over year

4 basis points on a decent comp, that's not

withstanding the fact that our virtually all of our

ratios of claims and incidences per labor hour

continue to improve based on safety programs in place.

We'll continue to monitor that and share that with

you. But year over year, that was 4 basis points

the only other thing that I'll note is in terms of

other being minus 3, that relates to again a year over

year delta in terms of what we call site location

costs. These are not closing costs which go on the

closing cost line, but whenever we spend money in

initial stages of identifying a site, whether it's

legal, any development work, ultimately that site does

not go forward, we write those off, and again, with

the ramp up in expansion, we had about $2.5 million

year over year higher than that. I generally won't

speak about that number, but again, just trying to

show you where that was, that was three basis points.

Next on the income state is it preopening expense.

Preopening improved by 6.7 million or it was lower by

6.7 million year over year. 12.8 million last year

and 6.1 million this year. Nothing unusual about

that. While it's lower than budgeted because of some

of the pushing out or delaying of some of the

locations, just as things have happened here, in last

year's third quarter, we had nine openings, no

relocations actually, and this year we only had four

openings, again with no relocation, so again, a

slightly more than doubling of openings a year ago

versus now and a year ago preopening was slightly

important double as well.

In terms of revision for impaired assets and closing

costs, this year it total 4.5 million pretax, last

year it was zero. I believe in last year's conference

call I shared with you that the zero was actually

reflected 2 million of actual closing costs, 3 million

of Canada restructuring charges and 5 million of real

estate gains for a sum total of zero. But again, that

is again our numbers overall this year include a year

over year $4.5 million reduction related to higher

closing costs net. So all tolled, operating income in

the third quarter 41.7 million up, up last year

23.8 percent. Not a lot of change reflected below the

operating income line. Net income expense was - I'm

sorry, total interest expense was slightly lower year

over year by about $400,000, essentially flat, and

interest income and other was actual better by - was

actually slighter lower by a couple hundred thousand

dollars. So the net of those two means that we had an

improvement in net interest expense year over year in

the third quarter by $200,000, whereas operating

income was up 41.7 million, pretax income up

41.9 million, also 23.9% year over year on a pretax

basis.

We're pleased with the showing giving our ramped up

expansion program in the last 23 months and including

nearly 75% of the openings over the last 20 months

were in new markets.

One other point I wanted to make on SG and A I wanted to

make while it is a little higher than we had expected,

you know, we probably are our own toughest critic of

SG and A. We are concerned about expenses, we run a very

tight ship out there, although we do things to drive

our business and to enhance customer service. In

reviewing these numbers over the last couple of

Mondays with Jim and others at the budget meetings, we

have continued to place a big emphasis on customer

service as we feel that we focus on that more than

anybody as we drive our business.

That being said, I do believe and I'll share with you

when we go through some direction for next year, we do

believe that we'll be able to show a small

improvements in SG and A over the next year.

Now for a quick run down of our balance sheet. As of

may 12, cash and equivalents, 841 million. Keep in

mind, well over half of that is not - are the

equivalents like debit card and credit card

receivables receipted to the weekend sales since we

closed our fiscal periods on a Sunday night, you have

some Friday and all of Saturday and Sundays related

receivables related to that. Inventories of

3.025 billion. Other current assets of 520 million,

total current assets of 4 billion 386, net P.P.E. of

6.339, other assets of 423, total asset of 11 billion

148 million. On the right-hand side of the balance

sheet, short term net I have, Accounts payable,

2.841 billion. Other current liabilities,

1.433 billion, total current liabilities

4.329 billion, total long term debt, 1 billion,

167 million, deferred and other, 125 million for a

total liabilities of 5 billion, 621. Minority

interests of 119, stockholders equity of 5 billion 408

million, for a total of 11.148. As well, during the

quarter by the way, we did $300 million public debt

deal, and a couple of you had asked why did we do

that, it didn't seem like we had all the cash. As I

mentioned to you, bulk of that cash is really cash

equivalents as it relates to various receivables on

the credit and debit card side. We actually - we had

about 180 million of short term borrowings under a

commercial paper program. What we did effectively

taking advantage of good rate out there, we borrowed

300 million, we - a 5 year fixed rate money, we

swapped it into overnight, and the effect of that as

the effect of essentially lowering our previously

LIBOR based pry sighing to LIBOR minus 27 basis

points.

In terms of the balance sheet, let me point out a

couple things. The cap ex ratio continues low an

strong at 18%, that is never a concern of any of

yours, the financial strength of the company. On

terms of managing our inventories and payables, again,

we take every term and discount and pay as quickly as

possible to earn those terms of discount, because of

our high inventory turnover, we show good accounts

receivable ratios. Our third quarter ratio of account

payable to inventories was 94%. Down from a year ago,

98%. Keep in mind, this is not just merchandise

inventories, it also includes payables related to

construction in progress with contractors. If you

just look at merchandise papers - of course a year

ago we had a lot more going on than we do now,

although we have a lot more going on now, we had a lot

more going on a year ago. If you take out those types

of payables shs merchandise payables as a percent of

inventories is up 2% at 80% versus 78% a year ago.

This is seseasonally low period of time in the third

quarter.

Average inventories per warehouse, tweaked up slightly

year over year, coming in at 8.2 million per warehouse

or up about 330,000 year over year. Most of that

increase is in three categories, tobacco, as we build

up for pending price increases, which occurred

already, toys, which is principally a reflection of

all the electronic game stuff with X box and play

station, and pharmacy, an again, pharmacy has been -

our pharmacy sales growth has been particularly strong

both on the R.X. side as well as the over the counter

side.

In terms of LIFO, I note nothing new to say there. In

terms of cap ex, our original budget for this year,

1.3 billion, down from about 1.45 billion a year ago.

You know, again our original budget was 35 planned

openings and 7 relocations, it looks like the 35 will

be 29 and the 7 will be 6. Most of that relates to

simply timing where things have been pushed into the

early part of next year. But we do - with that,

we'll see a slight reduction in cap ex. I would guess

our cap ex this year would be about 100, maybe even

more than 100 million lower than our original budget.

Our original budget on a net free cash flow basis was

to be down 200, 250 million, so that would I am employ

you're net free cash flow would be down about

100 million negative.

Next topic, Costco on line, it has been profitable for

the last several months. Recall last year east sales

of 73 or 76 million, I think it was 73. First quarter

sales increased this year was up 35%, second quarter

sales increased up 109%, some of that was helped by -

a couple of coupons in the Costco wallet program which

is the equivalent of our passport coupon

program'summer. Third quarter sales increase without

any wallet items up 73%. And we would expect fiscal

2002 sales to be in excess of 130 million and most

importantly to be profitable on a fully allocated and

spendsed bay expensed basis.

Expansion, year to date through may 25, we opened 24

new units and relocated three, between now and

September - the end of the fiscal year in early

September, we'll open five new units and three

relocations. So again for the total year, 29 new

locations, six relocations, and total of 35 openings.

In terms of the eight that we have planned between

this past weekend and the end of the fiscal year,

again, we just yesterday relocated Rancho Cucomungo,

California, we'll open on June 6 in Laguna [Phonetic]

we'll relocate our original Honolulu site in Hawaii to

[inaudible] on June 12, we'll open our second

Pittsburgh area site, Pennsylvania, on July 9. We'll

open a site Fredriksburg, Virginia, on July 10. We'll

open our tenth Texas site on July 11, San Antonio.

Sometime later in July, we'll open Port Chester, New

York, and on August 8, we plan our last relocation of

a year in Bakersfield, California. So with 29 net new

openings this year on the basis of 345, that would

total 8.4% unit growth, and about 9.5% square footage

growth, recognizing these units are a little bigger

than the company average, coming in around 148,000 and

we do relocation activities and other remodel

activities, which expand a little bit on a year end

base.

In terms of 2003, through the end of the calendar year

this year, on September 5, we'll open our third Japan

location in Tommasaki [phonetic], a sub burr of Tokyo,

that's on September 5. In September, we'll also open

in St. Louis, Missouri, may field heights, Ohio,

Tracey, California, Indianapolis, Indiana, as well as

a relocation in Boca Raton, Florida, and about ten

more unit that I haven't announced, since they haven't

actually started construction by calendar year end, so

a total of about 16 new units between September 1 and

Christmas.

Finally, before I turn it back to Beth for questions

and answers, let me briefly go through some things for

Q-4 and some very preliminary direction for 2003,

recognizing we have yet to start - we have just

started the formal budgeting process, but as bob and I

and others sat down to walk through the numbers, to

try to come up with some expected assumptions there.

In terms of the fourth quart, again, our guidance

remains from the 41 cents last year to be in the 48 to

50 sent range this year. I know some of you are going

to call me and say you brought us down from 28 to 27

and came in at 28. I promise you that the 48 to 50 is

a good range and hope we would get to the top there,

but we could be in the middle or lower end and we'll

be just fine. That 48 to 50 sent range by the way is

a 17 to 22% increase year over year and that would

imply a 10 to 13% increase for the year which again

has been a transition year when we're comparing to

when we were flat, down 4% earnings in fiscal 2001

overall and flat in the first quarter of this year,

fiscal 2002. In terms of where we get, you know,

assuming we get to that range, you would - I would

expect to see some still year over year increase in

SG and A, but a better showing than we did in Q-3.

Gross margins showing some strength, not as much as we

saw in Q-4 recognizing the thing I mentioned about

gasoline.

and membership still up, you know, 3 to 5 basis point.

Again, the rate of increase still increasing, but not

the same effect given the $5 increase.

In terms of in a very preliminary outlook for 2003,

our bay assumption is going to be about 30 new

locations and maybe a couple more, but if we just did

the 30, that would be 8% unit growth and 9% square

footage growth. More importantly, the mix of those

units as we mentioned, I think I mentioned on the

third quarter, will be rather than again about 75% of

the unit that we've opened in the last year and three

quarters, being in new market, this would be more of

about a 40/60 mix new market to existing market the

that is again a conscious effort on our part and

bodies well for our bottom line. Decent gross margins

and good membership fee income. SG and A, the assumptions

there are - include the benefit of or the less

detriment of a mix shift in terms of where we open our

locations.

the anniversarying of these older locations in these

new market which I think continue to show help.

Continued leverage of central expenses to a small

amount. I mentioned the improved merchant fees at the

gas station are expected, and offset a little bit by

slightly higher health costs as I indicated in Q-3,

you saw that about four basis point higher.

with that, with the assumption of comp in the 5 to 6%

range, we would expect to see, you know, sales growth

in the 11 plus range, and we would expect that based

on that, and again, you can do your own analysis, and

this is purely, you know, back to the envelope

expectations now, I would expect gross margin

improvement to be in the 10 plus basis point range to

have SG and A improvement in the 0 to 10 range, to have

membership fees at least flat, maybe a little better

as a percent of sales, but again that would be good

given the fact that we don't raise our fees every

year. In fact, I was asked recently what's - with

what's going on with our competition and membership

fees, where we haven't seen, not only haven't we seen

the types of increases that we've shown there, but

we've actually seen many promotional activities

related to membership fees, I can assure you that as

it relates to promotional activity, we have limited it

to doing the free check mailer and new markets and we

have every confidence that at some point we will do

that, although I don't expect to see that in the next

few months.

the other - we'll get a little basis point

improvement also from preopening and closing costs as

a percent of sale.

So all tolled, we could see - we haven't an exact

goal yet, but we think it's pretty easy to do the back

of the envelope to see how 11, twem,% sales growth and

at least 10, if not 15 plus basis points of total

improvement on the various lines, if not even a little

more, we could get at least 15, frankly if not a

little bit more, we could get in excess of 15 percent

growth, but we'll share more with you as we go along.

This is back of the envelope outlook at this point.

With that I'll turn it over to Beth for Q. and A. D

I would like to remind everyone,

to ask a question, press star then the number 1 on

your telephone key pad. We'll pause for a moment to

compile the Q and As roster.

Your first question comes from

Daniel Ferry [phonetic] of Merrill Lynch.

Good morning, Richard.

Congratulations on a great quarter. A question about

your - the expansion program. You fell short of the

number you originally indicated at the beginning of

the year. Was any of that deliberately cut being

back, slowing down to help the margins or was there

just delays? Since you did delay some units, it would

appear you should be pushing more units in the first

half of next year, but your rate next year is actually

less than in the first half than for the year as a

whole?

None of it was

deliberate. I can think of one or two units that

we've postponed indefinitely and I won't tell you

where, but in markets where we've opened, where we've

fallen a little short of expectations and we've sad

let's not add insult to injury, let's get the ones

working first, and that's I think one, maybe two.

Aside from that, the answer, it's more of just a

timing delay, recognizing when we put or original

budget together, on the 35 units, there's always, you

know, 10 or 12 in the last, you know, inevitably,

there's 10 or 12 in the last couple of months, because

we, you know, we're working on them, we believe with a

very high probability that it will occur, but when

push comes to shove and we're going through the

permitting process and Port Chester is a good example

in New York, that was in our original budget to open

in the first half of the fiscal year, and it's now

going to finally open in July. Now it's still in the

same fiscal year, but we've run into a lot of probably

an extra million dollars of site costs. This will be

capitalized as part of the construction project,

related to Blassing of rock on the site where we found

more rock than dirt frankly, and it's taking a little

longer. So those things happen.

Now, I guess, you know, usually I start off the year

by saying we're going to do about 35 to 38 and we end

up doing 32. This year we started by saying we will

do 35, we're going to do 29. My guess is, when I say

we're going to do about 30 next year, it assumes we

will have a budget that probably has about 35, with

five or six of those frankly being the ones that are

carry over from this year, but inevitably, same thing

will happen next July and August, a few will fall out.

So I don't see a big delta year over year. Maybe

there's one or two net reduction, not for any reason

other than that's what's on the list right now. I

think the bigger change is a conscious effort to have

our real estate people really starting about six or

nine months ago to start focusing on tougher sites.

In other words, the no brainer sites and the L.A.s,

and the bay areas and Seattles and the Portland and

long islands and the Virginias, where we are very

successful and we should find more locations and even

though we've been looking for a long time, we need to

double up those efforts

Again, a related question, you once

said you were looking for a 10% growth rate in units

over let's say the next five years. You've done eight

this year and you forecasted eight for the next year,

so should we lower our forecast to 8% unit growth

rather than 10

I would say it's fair

to lower it to a 9. I don't see - I basically see,

you know, as you know, with all this growth, with

little less, you know, little tougher economy over the

last year, we had minus 4% earnings last year, we'll

be up this year, but again, that it's that transition

year. I'm pretty much convinced if we follow through

like we think we can next year and we've got the

momentum that carries in, not just in 2003 but in 2004

with some of the things we have going oranges I could

see that bumping up a little more, so I would say 9 is

a good number.

and the 9 would give you 10 square

footage

Yes.

Thanks.

Your next question comes from

Charles Lee most of Deutsche Banc

Good morning. Congratulations on a

solid quarter and on great press in the "New York

Times" yesterday. I guess my question, I've got a

couple hodgepodge questions. Can we touch on the

special order kiosk, how that's growing in the last

year, you did about 3.1 in sales, how is that doing,

how many do you have?

Okay. We have -

especially kiosk program is essentially in the U.S.,

although we plan to roll it out over the next six or

eight months in Canada. When we first started it, our

original guess and goal, and it was probably more

guess than goal, was that in a typical $100 million

warehouse, could we add incrementally, above and

beyond that what square footage did, could we add a

million dollars to the each building and in in the

first year we did about 70 percent of that, added

about roughly 130 million. Of I don't have the exact

numbers, the current estimate is to do close to

300 million order in special order kiosk. And the

important thing there is that, you know, it's a test

to figure out what sells and what doesn't. We're

trying new things, we're learning - we've had some

surprising winners and surprising losers. Things we

thought were going to do well, things that we thought

weren't do well, we thought try it and it did well.

We will continue to do that. You should consider it

very much part of the warehouse now and we're going to

continue to do it.

On the margin improvement in the

ancillaries is some of that being driven by a shift to

generic in pharmacy?

Well, we definitely

have strong margins in pharmacy. Some of that is a

shift to generics, recognizing we've set our own - we

set caps in our business. Companywide, we have a

markup limit, if you will, of 14% on branded goods and

15% on private label. Clearly, though, the pharmacy

gross margins are closetory the high ends than other

departments in the company. And, frankly, even though

I said the high ends, we probably percentagewise are

saving customers more money in the pharmacy than

anywhere else.

My last question, which is private

label, have you seen shifts into private label sales

away from branded and is that one of the explanations

for improvement in gross margin?

That's an ongoing

reason over the last few years for some small

improvements in gross margin. I don't think that's

the bulk of - you know, that's a small piece of Q-3,

if that. You know, private label sales for us are in

the 13 to 14% range, so it's ratchetted up a another

point in the last year. I - I must say, I think

there is probably an added benefit of private label.

There have been instances where even when word was out

that we were looking at a private label alternative,

lo and be hold, we found extra money from the vendor,

and so it is - and that doesn't necessarily stop us

from doing the private label, but no some instances,

that branded good has to compete with the private

label. I'll give you an example, just in terms of our

savings, we just in the last few months began

introducing a flavored sports drink called Kirkland

signature sports drink or whatever, something pretty

basic name, it's a 29% savings to our price that we

sell the branded sport aide drinks at, and it has

taken market share and with that we can see, you know,

greater pricing power on the branded goods, and I'm

not - I didn't mean to pick that one out. On

virtually every item, whether it was spies a few years

ago or chicken or you name it, we have the ability -

or you know, cranberry juice, we have the ability to

not only improve as we improve our margins saving the

customer money on private label, but I am professor

our buying power an keeping some of the savings on the

branded goods as well.

Thanks a lot.

Your next question comes from Amy

cost love [Phonetic] of Sanford Bernstein

I have a couple of questions on the

gas business. The first one is Richard, can you just

go over what the basis point swing in sales is

required to move earnings a penny? Second, what are

you embedding in your Q-4 guidance with respect to

gas. Timely, will there be any positive impact from

changing the card acceptance rules at the pump or is

it just way too early and we won't see that until

2003?

Let me do the last one

first. I think there will be a little bit this

quarter, but it will be more in the first quarter,

you'll start to see that 10 to 12 million I talked

about on an annual baicy. As it relates to the gas

business, let me try to quickly do this on my

calculator. You know, gas is a 1.3 billion for us, so

call it 100 million for us, rough numbers, we can have

a P and L link in a month of as much as $3 million.

Recognizing you never have a 3 million-dollar swing in

the same direction every month. Most times, it's a

lot less than 3 municipal. But you know, you could

make 1 million in one week and lose a half a million

the next week or vice versa, so - but on $100 million

in sales, could you have a three quarters of a penny

swing, which would be $6 million on an extreme basis?

6 million on 100 million is 6%. So - I'm talking

about as a percent of gas sales, not as a percent of

total sales and we have seen that. We've seen our

gross margin on gasoline range from 13 to 14% frankly.

Whereas we might have need, you know, 5 or 6 cents a

gallon to break even. 5 or 6 September a gallon would

be 4%.

Okay. And what are you embedding in

Q-4 guidance with respect to gas?

In our Q-4 guidance

I'm embedding a small level of profitability compared

to a very high level of profitability a year ago. The

leather off the ball last year.

Okay. Great. Thanks.

So it is a decline

year other year. Go ahead.

Your next question comes from

Sherry Eberts [phonetic]of J. P. Morgan

Good morning. Richard, I just

wanted to talk to you a little more about the 2003

guidance that you gave. You mentioned that the SG and A

would be down slightly for the year. I think that was

sort of similar to the guidance you gave for 2002. I

was hoping you could talk a little more about the

timing of this and exactly when those new store losses

should start to anniversary more favorably

Well, it's - even

with all the knowledge that we have, which is more

knowledge on our business than you have, it's still a

little bit of a guessing game. What I can say is is

that, you know, the you know, in 2001, we had 80% new

market openings. In 2002, while they improved year

over year, the aggregate lo was greater because they

were open for a whole year, not a of half a year, so

in 2003, we're finally now on a full year to full year

comparison, they'll be helped. In 2002, the year that

we're currently in, we've opened up again a large

number of new openings, but it wasn't 80% new markets,

it was 65%, so that delta should still hurt us next

year because again it will be a full year comparison

versus a partial year comparison on those, but not

hurt us as much as the 2001 hurt us and 2002. In

2003, we again are going to improve that analysis a

little bit by opening up about the same number of

units, but again a focus on units that are profitable.

I can tell you and I don't have the exact numbers in

front of me, but if I had to look at, you know, the

last five years of new market units versus existing

market units, what do they do in the first 12 months,

recognizing those first 12 months generally will

overlap the fiscal year? Because they don't all open

on day one of the year. That on a pretax P and L at the

warehouse level, we could make as much as 2 million in

a unit but let's say make 1 million to 1.5 million in

an existing market and we could lose the same in a new

market unit, so if we switched, you know, eight to ten

units from new market to existing market in a given

year, let's say eight, that's eight over the next 12

months, recognizing these are partial years though,

but in the next 12 months, you might have eight units

that instead of losing call it 1.5 million say

2 million each even, so you're safe that 16 million

and then you have 8 units making a million each or a

little more than a million each, so you have about 20,

$25 million swing there. Again, that's how I can best

explain it off the top of my head.

Okay. And then secondly just on the

gross margin improvement for 2003, is most of that

just the executive membership improvement or what else

is factoring into that?

The executive member

will still be a negative year over year, but a whereas

in 2001 year over year it was like 15 or 18 basis

points, in 2002, it's about 14 trending down hopefully

in the quarter a little bit next quarter, you know,

let's say it's 5 to 7 next year, so it's less - we'll

have less to pick up there. I would assume, since

that - for the year this year it hasn't been a great

gas year, I don't think it could be any worse next

year, but I've been proven wrong before, but let's

assume we get a little bit there, I sthil think you're

going to find the bulk of our improvement on the core

business and you know, it's funnily, when I'm asked

over the years why can't you guys get a little more

margin, then we get a little more, everybody says, are

going to hurt your competitive situation? I can

assure you we will do nothing to hurt our competitive

situation. If anything, our toughest competitor is

Jim 16 that goal [Phonetic] even with the kind of

improvements we've shown, recognizing there are a

little extra benefits in Q-3 relating to gas year over

year and things like that but the fact of the matter

is, I have no worry and personally I have no worry

that we can't achieve and remain very competitive with

the buying power that we have, with the global

sourcing that we're doing, with a lot things we're

doing.

Okay. Good. My last question, I

was wondering if you could talk about renewal trends

in last year's new markets and just any comment on the

broader offering that you did for the new memberships,

if you viewed that as a success and is that part of

the operating plan going forward? I am

I'm sorry. I missed

that part of that it was breaking up on me.

In terms of the renewal trends in

last year's new markets and then, if I remember

correctly, you extended new membership to a broader

geography, and I was wondering how you felt that went

and if you would use that going forward.

I think in terms of a

broader geography beings I think in some of the new

market we went out geographically, 20 miles instead of

10 to get to a trade area. I don't think there's been

a big change there, partly just depends on how big

that trade area and how far people have to travel in.

What we've seen historically is about a 30% renewal

rate on the first year free beast, and it's

interesting, sometimes, if I use as a bench market the

average number of free beast we do in a new warehouse

let's say over the 10 weeks prior to opening and 8 to

10 weeks post opening, I would sale the average is

probably 60,000 free beast, so a year later, 30% times

60,000 is 18 or 20,000. It's interesting, when we

signed up 100,000 free beast, as we have, we find the

renewal rate slower and with we sign up 45 or 50,000,

we find the renewal rate slight live higher, some

range of paid sign ups a year hence, while there's a

range, it's a smaller range than that 50 to 100,000

free beast. It's really not been a lot of change in

that that we've seen over the last couple of years.

the free membership, when we go into somebody else's

market, the free check mailer does work and we'll

continue to do that. I think the other pro mowingal

thing that we - promotional thing we do as you know,

relates to the summer passport program that was just

sent out. If any of you didn't get it, feel free to

call or e-mail me and we'll get you 1 and the winter

wallet which is essentially the same thing although

over a shorter number of weeks. Between the two, I

think we cover about 18 or 20 weeks, 12 in the summer

and eight in the winter, and that's been pa very

successful program for us. It's a way to take the

monies at that vendors are willing to give us to

reflect directly in 100% in the price of their goods

and to drive their business and our business at the

same time. And increase frequency, so I think you

will see - continue to see us do those things as

well.

Okay. Great. Thanks very much.

Your next question comes from may

yen [PHONETIC] Salomon Brothers

I have two questions on foreign

exchange. The first one is in terms Q-4, what sort of

aassumptions do you have in terms of the Canadian

dollar and I would expect you would see some sort of

benefit if the currency remains where it is, and if

you talk about the impact to comps and also

profitability.

Well, you know,

frankly, on Canada, even though it has historically

trended down, ten years ago the Canadian dollar was 85

or 86 cents, it troughed about at 62 cents a year ago

and it's now in the mid 60's, sick 6 I at this 4 lish,

63, 60 four-ish, so it's come up a little from its

low, we frankly assume whatever it was last month it's

going to be this month and change it accordingly.

Let's assume it improves a little bit. Canada, we

probably had a bigger poor economy than we have had in

the U.S. frankly and we've seen - so we've seen

relatively slow growth up there. It has picked up a

little bit. Our budgets assume a continued slight

pickup income ps up there from its current low, you

know, 3 or 4 percent. But not a lot.

Okay. So the fourth quarter

guidance that you have already assumed some sort of

benefit

Our fourth quarter

guidance assumes very little benefit, if any, from

that.

kay. Thank you.

Your next question comes from

Todd slater of Losard[Phonetic]

Thank you. Richard, you talked

about the expectation of lower gas profitability in

the fourth quarter I guess versus last year's

comparison. What does this translate to in terms of

your expectation on year over year change in gas

prices, what are you have assuming? I

Todd, frankly, your

guess is as good as mine on that. You know, we - for

whatever reason, last summer was, you know, as bad as

Q-3 was last year, Q-4 was better than it was bad, the

prior quarter. While we're starting off profitable,

we don't expect to be at a million plus a week in gas

profitability. As of today, our current assumption -

bob actually has preliminary numbers from Paul lay

thumb, is that gas prices will come up a little bit

but not a lot, 5, 10 cents is what I'm reading,

whereas right now they're down 20, 25% from last year.

The pricing obviously has impact

on your view of gas profitability, right?

You know, it's

interesting, a year ago, the trends that we had seen,

recognizing, we're now experts'gas business because

we've been doing it for four or fooifs years, what

we're experts in is selling a lot of gas. Early on

what we saw trendwise is because we turned our

inventory so fast in gas, literally every day,

compared to the guy down the street turning it every

five or six days, when prices were rising rapidly,

like 3 or 4 cents a gallon per day for a week or two

in a row, that the guy down the street was pricing off

of cheaper gas than they had bought five or six days

ago. In doing so, when prices were rising, we saved

the customer less and in many instances lost money.

Conversely, when prices were falling, because of our

very fast turn, we saved the customer more and made

more money. So it was either both bad things or both

good things. Pair par that was logical based on what

we saw.

In the last year, that logic hasn't occurred and part

of that is that if anything, we've probably seen a

little less competition out there in gas pricing. I

don't know if it's the pressure and the publicity that

the refiners, you know, the argument that the refiners

are making all the money in the refinery and not

making money at the retail branded gas pumps. What

ultimately our view and certainly Jim's view as

impatient people like me and bob and I have continued

to say to him, we have to do something because we're

losing money this month, his feeling was and he seems

to have been proven right so far is is that, your

know, operators like Costco can weather that storm and

we'll be around. I think what you're finding out

there is that there is a little less competition both

from the majorrings and the independents, which has

helped us even when prices have risen or fallen. But

not helped us as extreme as they had before or hurt as

as extreme as they had before.

Okay. And does your fourth quarter

guidance include a likely positive 1 cent a share or

so LIFO adjustment that you talked about?

My gut tells me yes,

but we'll see that if not a slightly bigger negative,

even with profitable gas not near as profitable as

last year. We could be profitable and 1 to 2 cents

profitable next year in Q-4, but I also have

confidence in our margins overall that we should be

okay, but all that - all the things we just talked

about are baked into that 48 to 50 cents range.

Okay. Do you care to comment at

all about sort of the current comp trends given that

that a lot of retailers seemed to be a little below

plan this month

We're 5 to 6 I would

expect for the month. So no change.

Thanks a lot.

Your next question comes from

Debra WeinSmith [phonetic] of Salomon Smith Barney

Good morning, Richard, a few quick

questions. You focused on the question of cost

reduck. Are we seeing any improvement in preopening

cost per club especially as you're opening new clubs

in existing markets?

You will see - every

year we - I know Jim's talked about with operators

how can we reduce preopening by 100,000 a warehouse.

The reality is when we go into new markets, it's more

expensive, so to the extent the mix changes, I would

expect that our budget would be a little less next

year per warehouse, recognizing fully a third of the

preopening is not just new warehouses but relocations

and when we do a major remodel activity.

Okay. And then on the pharmacy

area, you talk about that as being particularly strong

with a lot of competitors adding pharmacy counters,

what would you kind of indicate as driving that

business in the Costco clubs

Two things. One

thing, but then I'll break it into two things. It's

pricing. If you look at the - as I understand, just

on first of all the RX, the prescription side of the

business, in the typical chain pharmacy in the

country, fully 90% of their prescriptions are under

negotiated plans with company programs. At Costco,

it's 50/50. What that means is is that anybody that

has to pay their own medicines has to come to Costco

because of the savings. On the pricing - pricing

savings is more extreme on the over the counter. I

remember a year or so ago when there was yet another

wave of political news about the government was going

to focus on driving down the cost of prescriptions and

I was getting calls from people saying, you know, on

Medicare or Medicaid, isn't that going to hurt our

business because everybody will be on the same price

on certain things and that was a goat yes and I asked

Charlie burr net, our senior V.P. of pharmacy

operations, and his first out of the box comment was

over the counter drives our business. Whatever we

save the customer on the pharmacy, we save them

multi-fold on the over the counter. We're so

incredibly low. You can tell you a very anecdotal

personal experience.

I was in a - I won't mention which one, but a chain

pharmacy in town a couple months ago and just needed

- are run out of an antihistamine or allergy pill and

bought collar trim ton, a 24 back for $5.99, let's

say, $6.99, $4.99, whatever it was, I was in Costco

subsequently and bought a 600 count of the signature

generic, two, 300 count bottles, for the same price,

within a dollar. Now that's extreme, but it tells

you, I can assure you that if you saw a 600 count

generic at a chain store, you would find it at two or

three times that $4.99 price.

So on the - on the private label stuff, we're able

to save substantially more because that's where

frankly traditional retailers make a lot of money.

Okay. The last question is you

mentioned that the clubs you're opening are large at

148,000 square feet. What is the extra square footage

going to?

It's really going to

everything. It's going to an expanded fresh foods,

wider aisles frankly, the ancillary businesses,

expanded tire center the I would say all of the above.

And general merchandising. The freezers and

refrigerators are a little bigger, few extra doors.

Thanks so much.

Your next question comes from

David Chick [phonetic] of sun trust Waubanson

[phonetic].

Hi. How are you. Only one remaining

question for me. In the core groups margin, 30 basis

points that you mentioned, was there anything outside

a mix shift that you can talk about? You mentioned

mix shift when you were going through that, but

anything sort of inside each category? Thanks

The glaring big thing

was rather than mix shift, there's a little mix shift

because fresh foods is comeping at this greater number

than the rest of the core warehouse, so there's a

little mix shift, but more important is the strength

in fresh food margins. I think there probably were a

couple examples, David through the quarter. I gave

you have the example a couple years ago on muffins,

$4.99 a dozen muffins was a great price point that we

allowed ourself to go from a 12 to 6 margin on a fully

allocated muffins, simply by maintaining a price for

eight years. We have relooked at a couple things

similarly in fresh foods where we are so below the

market and we've hurt ourselves because we've been so

strict, but those are small examples. The bigger

thing is is that you know, there is great leverage in

- if you could run your produce department at a

higher volume, and we are because of global sourcing

frankly of produce, even a small change in higher

volume translate well to the bottom line in grows

margin, fully allocated gross margin, because you have

less spoilage, less labor in picking through the

spoilage. It's even more extreme in backry, where,

frankly, I think as good as our bakeries are, some of

the items got stale and we saw great pickup in the

last few months in bakery. Go connected out some of

the Danish, they're bigger and better, they have more

sprinkle stuff on top, everything is bigger and

better. On the 12 pack of Danish, we actually raised

the price point but kept or lowered the price per

pound or price per ounce because the stuff is 30%

larger, so it's a better value, better item, all the

stuff we talked about.

Thanks.

Your next question comes from

Robert Tumy [Phonetic] of R.B.C. Dan Rausher

[Phonetic]

Good morning. A couple questions.

Richard, on comps, you talked about geographic

performance of comps. You've seen some strength

recently, it looks like in New England and the

Midwest. How much of that is do you think new stores

or how much of that is market share? Can you comment

on that?

Well, on a comp basis,

of course, it's not new stores. Other than the fact

that I think new stores - I'll give you an example,

Chicago. When we first opened in Chicago, we have

five or six in Chicago, when we opened the first

couple in Chicago, frankly, they start off a little

slower than we planned. Once we got the third and

fourth units and we became a bettory known name in

that market and more importantly, when we opened I

think it was Lincoln park, which we kind of considered

the flagship location for us in that market, a great

awe fluent area, we saw all of them pick up faster, so

there is something to that critical mass, even though

we don't have the types of efficiencies that a

traditional retailer would have because we don't

advertisement we don't have those kind of

efficiencies.

What was the other part of the question?

Well, market share relative to, you

know, -

Clearly it's market

share. I think in the case of the Midwest, it's

probably more the fact that they're immature units

growing and in the northeast it's market share.

Against your traditional competitor

up there?

Against everybody. It

helps, you know, while we probably didn't get as much

benefit as target and wall mortgage did with Kmart's

problems, it can't hurt. I think you know, frankly,

when you see, if any of you caught that date line or

20/20 special a couple - a week ago on the

supermarket industry and the dating of meat products,

meat and poultry products, we think that as bad as

that hour-segment was on the retail supermarket meat

industry, it helps you, and it's one of our signature

areas, and fortunately, we think we do a good job

there and I think that all those things help us. And

it helps us when we get Levis direct and it helps us

when we buy tight list golf balls. Our relationship

with the likes of well known, high quality names like

Levi, versus having selling a limited amount of Levi

when we were diverting is a tremendous boost to our

business and is driving market share.

the other question I have is

long-term store expansion plans. Your talking about

your 2003 projections a little while ago. At one

point you thought you could basically double your

store base. I forget what actually year that was off,

it was 19 or 2000, but are you still on track with

that?

You know, we just went

through that process literally on the back of an

envelope. We took a big - a blackboard and went

through every market with the map of the U.S. and went

through with the operators, and right now I think we

have 289 or 290 locations in the U.S., and the feeling

is is that if we continue to figure out what we do and

evolve and continue to grow and continue to

infiltrate, which is important, we think that Jim just

the other day said the 28, 290 can be 600. Now let's

assume it's 500, for more reasonableness, I think that

- we are optimistic about that. We believe we can

continue the same market share.

What's probably given us a positive feeling

domesticically is that in new markets, we're doing

fine. Saleswise, recognizing you lose money in the

most of them for the first couple, two, three years,

but more surprising and more gratifying I guess short

term is is that we think that we can penetrate and

saturate our existing markets to a higher level than

we ever thought possible. We opened up two units in

the western Washington a year and a half ago,

Pieolo [phonetic]and Burlington, Burlington being

about 50 or 60 miles north of Seattle and Pieolo

[phonetic]being 10 to 15 miles south and east of the

airport in Seattle, and here are two markets where -

and they were 10 to 15 miles away from the nearest

Costco in each direction. In both instances, he they

averaged in their first 12 months, $100 million, with

about 25 million being cannibalized sales, so in a

market where we have strong gross margins, because we

dominate the market, and we did $75 million with lower

preopening because we don't do the free check mailer,

so I think that that - those examples are reason as

extreme if not more extreme in L.A., so those are the

assumptions that are built into that as well as the

assumptions that we'll keep getting vendors to sell to

us before and keep figuring out what's the next

special order kiosk item or what's the next ancillary

business.

Part of that is the faith we have in ourself that

we'll continue to evolve.

Internationally, I still look at that as over the next

five years a step our toe in the water type of

concept. We will continue to grow the U.K. as fast as

we can. In early May, we opened our 12th, 13th, and

14th locations. I think we have one more before the

calendar year end. But because of restrictions and

planning and zoning over there, we probably won't get

more than four or five openings a year, even though we

would probably like to do five or eight a year. Asia,

is still an unknown. In the case of Korea and Taiwan,

where we have five and three units respectively,

neither market will ever be more than 12 or 15 units

each. Japan is the big question mark.

Original plan was in the first five years to open five

or six units. We're now in the beginning of our

probably about the beginning of our third year, we're

getting ready to open our third unit. We'll lose

money for the first five years. We will see if we can

make it work. We're encouraged by the fact that our

second units, its one in toak Tokyo, started off and

is doing quite a bit better than our first unit, but

we haven't proven anything this. My assumptions from

going to 290 in the U.S. to 580 or whatever, I think

it's probably - I'll call it assertive, not

aggressive. But, what it's not 580, it's 500, I think

that would still be healthy.

Overseas, my guess is you're talking for the next few

years, four to eight units a year total. Hopefully

growing to 10 or 15 units a year in years 6 through

10.

Okay. Great. And just - I think

you answered - last question was new products. I

think you kind of answered that. Do you still feel

confident about your ability to in know elevate

merchandisingwise?

Absolutely. You know,

I remember when the 8 track became a cassette, I never

thought they would have anything beyond a cassette,

how can they ever improve technology? I think that is

anecdotal to our business. Every buyer has a list

that they are measured on every year of getting

vendors that won't sell us, whether it's Godiva

chocolate or Estee Lauder perfumes, whatever it may

be, and recognizing we won't be successful in some of

these, but some of the years we thought five years ago

we wouldn't be successful n we are and every buyer is

thought to in know elevate the, to drive the business,

to go to trade shows, so I don't think that that

mentality with change.

Great. Thanks very much.

Your next question comes from

Adrien Shapiro of Goldman Sachs.

Thanks. I'm just wondering perhaps

with continued gross margin expansion opportunity and

the start of potential SG and A leverage, what do you

think we should be thinking reasonably in the long

term EBIT margin target for Costco

Let me do it instead

of EBIT - or I'll do pit, pretax earnings. You know,

if you look back ot our annual report, I think there

was one year where we peaked at a time 3.3% pretax

margin, a couple years we were at 3.2. Last year we

were 2.9. This year, we'll be around 3. You know, in

reading between the lines here, we feel and Jim has

stated, both privately at budget meetings and

publicly, that we deserve to make more money and we

have created a great franchise, we save customers a

lot of money and shareholders are one of our

stakeholders, but we're going to do it on his time

schedule, which we all understand as well and not to

hurt our competitive advantage.

That being said, he has said that he sees no reason

that over the next five years we can't see a number,

you know, in the closer to a mid 3 number. Whether

it's 3.4, 3.5, or 3.6, I can't say. We have to first

figure out how to get from 3.0 to 3 - or 3.1 plus, we

can do that. But I would say that our own internal,

you know, it doesn't do - we can all do the back of

the envelope to say, on, you know, 11 or 12 percent

sales growth or 10 to 12 percent sales growth, how

many basis points do you need to get, you know, about

16.5% earnings growth, which would translate into 15%

E.P.S. growth. Doing that base case, you need about 9

or 10 basis points a year over the next five years,.

I think we can easily get that based on our own

budgeting, but it's - again, one of our problems is

we're always focused on basis points and I think we

should be, but there can be a volatility that one

quarter versus the next. You've got a couple of basis

points change. I think overall we're going to be good

great. Thank you for.

Next question comes from

Danielle binder of Buckingham research.

It's Dan binder. A couple

questions. You commented a new product store

activity, international, just can you give us a little

more detail year to date where you are on new stores

and also with fewer stores opening up for the total

year, what would you be looking at for preopening and

should that allow us to get to the higher end of

guidance? It seems that would be the case.

You know, our guidance

reflects all our knowledge right now. So I - and

again, I - I know that a couple of you are saying

guidance, they've got us down to 27 so they can come

in at 28. I've got to tell you, earnings during the

quarter, 2, 3, accelerated and on March 5, when we had

our conference call, we were three weeks into the

quarter and frankly I was hopeful to get to 27 and

felt more comfortable about 26, but we - you know, we

performed.

I think that if I - as I look at Q-4, all the things

we're doing are embedded in the - maybe preopening is

a couple million less than I thought on March 5, but

there's also, I hadn't focused as much on the strength

of gas profits. You know, there's 10 things that each

go, five in each direct, so I don't think there's any

change in our expectations right now

On the new store productivity year

to date

The new store

productivity. I'm sorry. We're probably more than a

half - say probably somewhere in the 4 plus million

dollar range, maybe 5 or 6 million worse than our

original budgets for the year. On the stores that

we've opened, recognizing that that will translate

probably into being closer to even given that we've

opened a few less units.

4 to 6 million on a total basis

Pretax P and L worse than

our original budget on the 29 units. And again, many

of these are new market units that are, you know, we

try to be reasonable but reasonably aggressive on our

assumptions and doing a little bet.

Okay 689 the comp plan for Q-4

continues to be 5 to 7.

Comp 4 is still in the

5 to 6 range.

Great, thanks.

your next question comes from

Barbara Miller of federated Kaufman

Thanks. Two questions. One on your

kind of philosophical on the expense structure. If

you look at your expenses over the last few years, on

a variety of reasons on a square footage basis went

off now they're starting to level off. Over the next

couple of years, do you see any major changes in the

business that would ratchet up the expenses from that

standpoint or is it fair to say that you're at a point

that's more level because of the mix of some of the

more labor intensive businesses? And I have another

question as well

I think on that one,

with the exception of health and insurance costs,

which are going up, but again, I think that's a less

- that detriment is smaller one like when we

introduced A.M.X., there's nothing conscious object

our part, the conscious thing or our part is the gas

thing that should help us, kind of an offset to

insurance. No, I would hope and expect to see it go

the other way. Again, we are our own - our toughest

critic when it comes to spends control. At the same

time, I was talking with Jim yesterday, I said, you

know, 1 of the questions that we ask our self and we

get, on per basis comp, why didn't we see - I can go

through all the explanations. Buff he reminds me, he

said this morning, let not forget that, you know, he's

the one that's at the same time he's pushing

warehouses to control labor, he's the one that when he

visits eight warehouses a week around the world, is

yelling at them to say I want more labor up front,

customer service is important because that's how you

drive market share, so I think we do a good job of

controlling things. There's no bottom of the scale

increases that kills you for a year or two. They're

no more big thing like an A.M.X. program, so yes

you're right with the small exception of health care.

the other question is on inventories,

you explained some of the changes. Should we expect

to see turns level with last year going forward into

the fourth quart of next year?

I would - I mean, my

guess is assuming the 5 to 6% comp continuing, I would

guess that's probably level in Q-4 and improves a

little next year, in part because of the mix change in

new warehouses and the fact that 30 warehouses on a

bigger basis, half a point lower.

Okay. Great. Thank you.

Your next question comes from

sally Wallich [Phonetic] of lag mason [phonetic].

Good afternoon. Just one question.

Richard, could you talk a little bit about your

experience when a regular member becomes an executive

member, what happens to spending and so on.

When a regular member

becomes an executive member, first they pay us 55

extra dollars, we can't lose sight of that. In the

first year, assuming they've been a member for a

number of years, in the very first year the comps

improves into the mid teens - I'm sorry in the first

year, it's actually a little higher than that, in the

very high teens or very low 20's and then it levels

back off at a normalized rate of growth but at a

higher base. Now when you do that initially, you get

hammered by your highest, you know, the guy that's

coming in and already going to earn on his current

purchases a $200 rebate, but even at that level, he's

going - that can be unprofitable for a number of

years, but slightly unprofitable. We've now in our

view done the adverse selection and, you know, have

already felt the pain of adverse selection, where it's

the guys already making the full 200 to $500 rebate.

We've now getting people in that are also going to

earn call it a $55 rebate, but we have the money

early. There's some slippage in the fact that not all

rebate checks ever get cashed, although we try to get

them cashed and they spend more. We see a positive

net of it.

Great. Thanks a lot.

At this time there are no further

questions.

Okay. Well thank you

everyone.