Costco Call, Part 6 (Bore Port) October 18, 1999

Boring Portfolio
Costco Call, Part 6
Q&A Concluded

By Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (Oct. 18, 1999) -- This is a continuation from Part 5 of Costco Wholesale's (Nasdaq: COST) Q4 financial results conference call. The following is the conclusion of the Q&A with Richard Galanti, CFO.

Q: With regard to Executive Membership, in order to spur further acceptance of the program, would Costco ever consider lowering the membership fee (now at $100)?

A: We've thought about that and the answer is "no." One of the things we've thought about and recognized, especially on the consumer side, is that certain of these services are really better served by offering them to the entire membership base and then thinking about how to add on something to that for the Executive Member. If we do that, we can drive more volume of the service, therefore driving our pricing down and have more money to play with in terms of really doing it well for the customer. We're looking at a lot of things like that. At this point, we're not prepared to change that fee, we're prepared to figure out how to get more value from the perspective of the member.

Q: With regard to the competitive front, given Wal-Mart's aggressive expansion plans for its supercenters, what, if any, impact do you believe this could have going forward on Costco, particularly in those regions of the country like California and the West Coast where you operate absent a lot of supercenter competition?

A: There's one adage that "traffic begets traffic," but we don't believe that completely. I think the fact is that they'll take some business. They'll have a much bigger effect on other discount stores and other retail food stores. What we have found, and this is kind of a rule of thumb, is that when we've opened another unit near us, we take 20% of that business. When another club like Sam's or BJ's opens near us, they take 10% or 15% perhaps initially before it comes back. When some type of supercenter has come, it's maybe 5%. So it's not as big an effect as another warehouse club or when we cannibalize ourselves.

Ultimately, every time somebody else sells Band-Aids and cleaning detergents along with food items, if you stopped there, you have probably picked up a few things you would have perhaps picked up at Costco next time. I think there's plenty of business to go around. As we have done in the past, our view is of taking little pieces from lots of different types of retail and we will continue to do that. If we can keep adding ways to get customers into our place, that shouldn't be a big concern.

Q: How much are you spending on fighting "anti-big box" bills in California and elsewhere.

A: [Discussion here about two minutes] I can't imagine spending one-half to a million dollars. It's a non-issue in terms of P&L.

Q: On new store openings, net closings, could you run through the total amount of openings and closings over the next four quarters?

A: In Q1, we're going to open eight, including one relocation, excluding Mexico, which isn't consolidated. In Q2, four openings and one relocation. In Q3, probably four or five openings and or two relocations, and 10 openings and two or three relocations in Q4.

Q: What are your capital expenditure plans for the year, what will depreciation and amortization be, and finally, will you be doing any significant investment in the logistics and distribution side of the business?

A: Total cap ex will be a little over $900 million. Within that number, probably $70 million to $100 million will go toward depots, or distribution assets, and that's because of the amount of construction on expansions of refrigerated/frozen depots. There's probably another $30 million of "central stuff," everything from $8 million to $10 million of equipment for warehouses to do the co-branded card with Amex and do some other things, over $100 million in remodels (not relocations). Free cash flow will be about $100 million this year. Depreciation and amortization for fiscal 2000 (these are early estimates) will be about $295 million.

Q: As you expand your online offerings, how does that effect your handling of fulfillment, which I understand has been handled so far by your vendors?

A: It won't really be a big impact. When we started online, fulfillment was around 100% done by vendors. Right now, it's about 90%. Best guess right now is for 80% vendor fulfillment a year from now. The fact of it is, big-ticket items like white goods, mattresses, expensive smaller items like PCs, that's very easy to vendor-fulfill. We fulfill jewelry because we have our own jewelry operation. We have a half-billion [dollar] jewelry operation that buys watches, replaces batteries, tags and tickets them, buys gold chainlink, puts the clasps on, packages them, and sends them out to the 300 warehouses we have. It's not that big a deal yet. Right now we're doing small amounts of fulfillment out of one of our depots and to the extent it gets better, that'll be easier to figure out. Some of business-to-business will be direct through us and some will be through a third party, and we haven't announced that yet.

Q: On e-commerce, do you know what the percentage of transactions is from members?

A: We're over 90% from members right now, something like 95% or 96%.

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