Cost-U-Less, Inc.

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Cost-U-Less, Inc.

8160 304th Avenue SE, Building 3, Suite A
Preston, Washington 98050
U.S.A.
Telephone: (425) 222-5022
Fax:(425) 222-0044
Web site: http://www.costuless.com

Public Company
Incorporated: 1989
Employees: 500
Sales: $186.3 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: CULS
NAIC: 452910 Warehouse Clubs and Superstores

Cost-U-Less, Inc., owns and operates warehouse-style retail stores in remote island locations on Pacific islands, in Hawaii, Guam, American Samoa, and Fiji, and in the Caribbean, in the U.S. Virgin Islands and the Netherlands Antilles. Cost-U-Less stores, including one mainland store, average 31,000 square feet and offer merchandise in a plain, no-frills environment, with goods being displayed in their cases, on shipping pallets, or on steel shelves. The stores offer groceries, housewares, consumer electronics, lawn and garden supplies, and other merchandise at discount or bulk rate prices. Although Cost-U-Less operates as a mid-sized warehouse club, the company does not charge membership fees.

Origins

At the time that he conceived of the Cost-U-Less warehouse store, Jim Rose owned and operated Rose-Chamberlin, the in-house buyer for Costco Wholesale stores. That experience gave Rose the idea for a smaller version of the warehouse store located in markets considered insufficient for the large format warehouse clubs, such as Costco and Sam’s Club, as well as discount retailers, such as Kmart and Wal-Mart. Rose designed the Cost-U-Less concept for remote, island locations where such competition did not exist. Locating stores on resort islands insured a ready market for bulk purchases from hotels and restaurants serving tourists; thus, Cost-U-Less did not depend solely on the local population for its consumer base. While the large format stores carried inventory for over 100,000 square feet of space, Rose planned Cost-U-Less stores to be 20,000 to 40,000 square feet. Rose reduced the size of the stores by avoiding products and services generally available in warehouse clubs. Products included apparel, automotive tires, and fresh baked goods; services included a photo finishing center, a pharmacy, and an optical service. Initially, Cost-U-Less did not offer produce or meats. By selling brands and merchandise with proven success at Costco stores, Rose lowered operating overhead by minimizing the need for buyers.

Rose formed Cost-U-Less with funds from a group of 35 investors and opened the first Cost-U-Less store on the island of Maui, Hawaii, in July 1989. The 22,000-square-foot store stocked $500,000 in inventory, 90 percent of which Rose purchased from the Costco in Honolulu. Though Cost-U-Less paid retail prices, the merchandise still sold at prices lower than that available on the island and yielded a profit margin of 17 to 18 percent. The Maui store began to earn a profit six months after it opened. In 1991, its second full year in operation, the store sold $13.5 million in goods.

Early Expansion of Company

In 1992, Rose sold his interest in the wholesale brokerage firm and prepared to open new Cost-U-Less stores. The company opened two stores on Pacific islands in 1992, a 31,000-square-foot store in Dededo, Guam, and a 22,000-square-foot store in Hilo, on the big island of Hawaii. In Guam, the low priced merchandise actually decreased the cost of living, causing the government to halt consumer price index measurements. Also, Cost-U-Less began to experiment with the mid-sized warehouse concept in small towns on the mainland, seeking markets un-derserved by mass merchandisers. The first mainland store opened in Walla Walla, Washington, in late 1992. Cost-U-Less supplied most of the merchandise in the stores in the Pacific islands through the Costco in Honolulu, while most of the merchandise at the Walla Walla store came from Costco in Kennewick, Washington. Other mainland stores followed, but closed rather quickly due to unsatisfactory performance.

Cost-U-Less opened four stores in 1993 and 1994. In 1993, the company opened a store in Hawaii; in Kapaa, Kauai; and its first store in the Caribbean, on St. Thomas in the U.S. Virgin Islands. In 1994, the company opened another store in the U.S. Virgin Islands on St. Croix. The company also opened several new stores on the mainland, including a 23,000-square-foot unit in Sonora, California, but closed two of them. At the end of 1994, Cost-U-less recorded $117.2 million in revenues and $1.2 million in profit from eight units.

As Cost-U-Less opened and prepared to open new stores, the company began to buy all of its merchandise direct from manufacturers. Since Cost-U-Less no longer needed to purchase goods at retail prices, the company diverted the savings on inventory to hiring buyers. The company began to tailor its product mix to accommodate local tastes and preferences and to market higher margin goods and more of the popular U.S. brands.

In February 1995, Cost-U-Less opened a distribution center in Union City, California, serving stores in the Pacific islands and mainland stores in the Pacific Northwest. Shipments across the sea involved consolidation of merchandise from various vendors at a cross-dock facility in Union City. Each store was designated a lane where goods were loaded into a freight container until it was full; then the container was shipped to the designated store. The logistics of shipping perishable goods, such as frozen foods and fresh meats and produce, proved to be more complicated, as shipping took from seven to fourteen days. In order to avoid excess inventory, the company gave its vendors an estimate of goods required. When the final order was determined, goods were drawn from the suppliers’ consignment depot near the cross-dock. The goods were considered purchased at the time of delivery to the cross-dock for shipment. A distribution facility in Port Everglades served the Caribbean stores in a similar manner, but an independent company operated that facility. Cost-U-Less paid fees for the service on a volume, per pallet basis.

The distribution facilities supported expansion as Cost-U-Less opened four new stores in 1995. New operations in the Pacific islands involved a 32,000-square-foot store in Pago Pago, American Samoa, and a 35,000-square-foot store in Tamanig, Guam. A recession and new competition in Maui prompted the company to close that store in December 1995 when the lease expired. Cost-U-Less opened two more stores on the mainland, including a store in San Jose, California, its first in a major metropolitan location. The 31,000-square-foot store operated in an area where warehouse clubs had not saturated the market; Cost-U-Less hoped to attract customers interested in bulk rate goods without the additional cost of a membership fee. Some mainland stores did not meet expectations, resulting in closing and lease buy-out expenses. At the end of 1995, Cost-U-Less recorded revenues of $139.7 million and profits of $250,000 from 11 units.

Cost-U-Less Returns Focus to Island Markets in 1995

The company’s experiment in mainland markets failed for several reasons, including a low volume of merchandise turnover, low profit margins, at 14 to 15 percent, and the entry of major discount retailers into these markets at this time. Also, Cost-U-Less underestimated the competition from warehouse clubs that required customers to drive some distance. By June 1997, Cost-U-Less closed five of the six mainland stores, keeping the profitable Sonora unit open to test new merchandising and operating methods. In 1997, revenues dropped to $124.9 million, from $134.8 million in 1996, while net earnings remained steady at $363,000 from eight units.

Cost-U-Less decided to return its focus of business to remote, island markets. Rose determined that to operate successfully a store locale required a minimum population of 40,000 people and Gross Domestic Product of $125 million. Before continuing expansion, Cost-U-Less sought to improve operations, applying specially designed management information systems to inventory control and the logistics of delivery. Communication by electronic mail, facsimile, and the Internet helped to link management in distant places to headquarters in Bellevue, Washington. Also, Cost-U-Less began to develop a prototype store easily replicated at low cost. A new store required an investment of $2.5 million to $3 million for construction of a 28,000- to 48,000-square-foot facility, plus $2 million for inventory and fixtures.

One aspect of operating businesses in exotic, island locations involved the risks and unpredictable economic consequences due to tropical storms. Facilities must be built to withstand hurricanes in the Caribbean and typhoons in the Pacific Ocean to minimize the cost of insurance deductibles to pay for damage. In summer 1998, Cost-U-Less relocated its St. Thomas operations to a larger store, the first prototype unit, because the original store had been damaged during a hurricane in 1995 and the landlord had not repaired the building properly. Another unpredictable consequence of tropical storms was the possibility of store closures. In September 1998, Hurricane Georges instigated very high sales before and after the storm, but required stores to close. The St. Thomas store closed one day, while the harder hit island of St. Croix required that Cost-U-Less store to close for four days. Despite losses related to minor property damage, demand for goods nearly tripled normal sales and resulted in an overall profit; however, this has not always been the case with other storms.

Company Perspectives:

We are an innovative, growing, international retailer, committed to providing: preferred brands, quality products, exceptional value, and a unique shopping experience. Our actions are driven by honest respect for our customers, employees, business partners, and communities.

Initial Public Offering Funds Expansion: Late 1990s

In July 1998 Cost-U-Less became a public company in an initial offering of 1.5 million shares of stock at $7.00 per share. Ironically, the share value of the stock closed at $6.875 per share at the end of the first day of trading. Nevertheless, the company raised almost $10 million in capital funds to pay short-term debt and to use for working capital and for expansion. Cost-U-Less hoped to open 26 new stores by the end of 2002, including two in Fiji in 1998 and six stores in 1999. After a two-year hiatus of new store openings, Cost-U-Less commenced operations of two stores in Fiji during 1998, in the resort town of Nadi and the capital city of Suva. With two new stores and a 10 percent increase in sales at existing stores, the company rebounded financially in 1998, recording $134.9 million in revenue and $1.2 million in profit.

Cost-U-Less had determined that 30 Pacific and Caribbean islands met its minimum market requirements, with 90 potential store sites. In the Pacific Cost-U-Less considered Tahiti, Papua New Guinea, and New Zealand as viable possibilities. In the Caribbean Cost-U-Less explored opportunities on Aruba, St. Maarten, Barbados, and Grand Cayman. Cost-U-Less opened a store on Curacao, a Caribbean island in the Netherlands Antilles, in summer 1999. Finding employees on the islands has been difficult, as the local people prefer outdoor work. Hourly pay ranged from $14 per hour in Guam and $8 to $9 per hour in American Samoa to $3 per hour in Fiji.

In June 1999 Cost-U-Less announced its intention to open two stores on the North Island of New Zealand. The company planned a 36,000 square-foot store in Rotorua, a tourist center, and a 30,000 square-foot store in Porirua, suburb of the capital city of Wellington. The stores opened in November and December 1999, respectively. The stores stocked a mix of New Zealand, Australian, and American brands of goods. Buying offices in Aukland, New Zealand, and Sydney, Australia, supported store operations. Also, Cost-U-Less relocated its cross-dock distribution facility from Union City to a larger, 81,000-square-foot facility in San Leandro to ease distribution from the United States.

In September Cost-U-Less installed a new management team led by Jefferey Meder, founder of Western Drug Distributors, owner and operator of 20 Drug Emporium franchises in the Pacific Northwest. Meder had sold the company in 1998 and became CEO and president of Cost-U-Less after the board asked Rose to relinquish involvement in daily operations; the board then elected Rose chairman. Meder restructured the executive management staff and began development of a three-year business plan to open new stores and to improve operations and profits at existing stores. Relocation of company headquarters to Preston, Washington, in June 2000, allowed Cost-U-Less to double its office space and save on overhead expenses.

By May 2000, it became clear that Cost-U-Less could not succeed in New Zealand and the company decided to close the stores there. Company officials had not anticipated the high level of loyalty to local brands among residents of New Zealand or the lack of familiarity with American brands and with the concept of bulk purchase. Also, the environment was more competitive than Cost-U-Less had expected. The company had planned to open 18 stores in New Zealand, but withdrew completely. The company lost $3.4 million in closing costs and $1.5 million from operating and development losses. The failure of the New Zealand experiment, as well as economic decline in Guam and Curacao resulted in a net loss of $4.9 million on revenues of $186.3 million in 2000.

Cost-U-Less opened a store on St. Maarten in July 2000 and encountered the opposite result. In this instance the new business surpassed expectations as the awareness and popularity of brand merchandise from the United States led to a high level of merchandise turnover and high revenues. Company management realized it needed to focus its efforts in areas similar to St. Maarten, where brand awareness and understanding of the warehouse concept attracted customers; they needed to build on the success of this experience. Cost-U-Less sought to improve store operations by sending a management team to all of the stores to examine operations. In early 2001, the company became profitable again. The company was forced to consolidate the two Fiji stores into one, however, as political turmoil hampered tourism. Cost-U-Less closed the store in the resort town of Nadi.

Principal Competitors

Costco Wholesale Corporation; Kmart Corporation; Wal-Mart Stores, Inc.

Key Dates:

1989:: The first Cost-U-Less store opens on the island of Maui, Hawaii.
1992:: Cost-U-Less expands with new stores in Hawaii and Guam.
1993:: The company opens its first store in the Caribbean, on St. Thomas.
1995:: Failure of stores on mainland causes company to refocus on island locations.
1998:: Initial public offering of stock provides funds for expansion.
2000:: After less than one year in operation, Cost-U-Less closes its two stores in New Zealand.