Costco Wholesale Corporation

Good afternoon and thank you for standing by. Welcome to the Q2 earnings call and February sales results. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to the speaker today, Richard Galanti, Chief Financial Officer. Please go ahead.

Thank you, Jerome, and good afternoon to everyone. I will start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results, and or performance to differ materially from those indicated by such statements. The risks and uncertainties include but are not limited to those outlined in today's call, as well as other risks identified from time to time in the company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and the company does not undertake to update these statements except as required by law. In today's press release, we reported operating results for the second quarter of fiscal 22. The 12 weeks ended this past February 13th, as well as February retail results for the four weeks ended this past Sunday, February 27th. Net income for the quarter came in at $1,299,000,000, or $2.92 per diluted share. Last year's second quarter net income came in at $951 million, or $2.14 per diluted share. That latter number included a $246 million pre-tax, or 41 cents per share, cost incurred primarily from COVID-19 premium wages. Net income for the 24 weeks was $2.62 billion, or $5.90 per share, compared to $2.12 billion, or $4.76 per diluted share last year in the first half. Net sales for the quarter increased 16.1% to $50.94 billion, up from $43.89 billion last year in the second quarter. Comparable sales in the second quarter for fiscal 22. On a reported basis, U.S. sales increased during the 12-week period was 15.8%, excluding gas inflation, 11.3%, 11.3%. Canada, 16% reported, 12.4% ex-gas inflation and FX. Other international, 6.2%, and plus 9% ex-gas inflation and FX. For the total company, a reported number of 14.4% on a same-store comparable basis, and up 11.1%, excluding gas inflation and FX. E-commerce, on a reported basis, up 12.5%. and FX up 12.6%. In terms of our second quarter comp sales metrics, traffic or shopping frequency increased 9.3% worldwide and up 8.3% year-over-year in the quarter in the United States. Our average transaction or ticket was up 4.6% worldwide and up 6.9% in the U.S. during the second quarter. Foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 60 basis points, while gasoline price inflation positively impacted sales by approximately 390 basis points. I will review our February sales results later in the call. Going down our second quarter fiscal 2022 income statement. Membership fee income reported came in at $967 million, up $86 million or up 9.8% from a year earlier, $881 million. There was about a $6.5 million negative impact due to FX. So on an FX basis, if you will, the $86 million increase would have been up $92 million or 10.4%. In terms of renewal rates, they continue to increase. At second quarter end, our U.S. and Canada renewal rate stood at 92.0%, up four-tenths of a percentage point from the 12 weeks earlier Q1 end. And worldwide rate, it came in at 89.6%, up six-tenths of a percent from where it stood 12 weeks earlier Q1 end. Renewal rates are continuing to benefit from more members auto-renewing, as well as increased penetration of executive members, who on average renew at a higher rate than non-executive members, and higher first-year renewal rates for our new members. In terms of the number of members at second quarter end, member households, and total cardholders, total households was 63.4 million, up 900,000 from the 62.5 million just 12 weeks earlier. And total cardholders at Q2 end, 114.8 million, up 1.7 million from the 113.1 million figure 12 weeks ago. At second quarter end, paid executive memberships stood at 27.1 million, an increase of 644,000 during the 12-week period since Q1 end. Executive members, by the way, represent now 42.7% of our total membership base. and 70.9% of our total sales. Moving down to the gross margin line, our reported gross margin in the second quarter was lower year over year by 32 basis points, but up five basis points, excluding gas inflation. As I always do, I'll ask you to jot down a few numbers, two columns. The first column is reported, and the second column would be excluding gas inflation. First line item, merchandise, core merchandise. on a reported basis was down 75 basis points year-over-year and ex-gas inflation down 43. Ancillary and other businesses reported plus 40 basis points and ex-gas inflation plus 49 basis points. 2% reward plus 3 and minus 1 basis points. LIFO minus 14 and minus 14 basis points. Other plus 14 and plus 14 basis points. So, totally, on a reported basis, again, year-over-year, minus 32 basis points, and excluding gas inflation, plus 5 basis points. Now, in terms of the core merchandise component, being lowered by 75 year-over-year reported and minus 43 basis points, ex-gas inflation, recall last year in Q2 that the core reported was plus 71 basis points and ex-gas plus 63. So, still improved to where we were two years ago, pre-pandemic and ex-gas. In terms of the core margin on its own sales, in Q2, our core-on-core margin, if you will, was lower by 28 basis points year-over-year, approximately two-thirds of this coming from fresh foods and a little from foods and sundries and non-foods as well. Fresh continues to lap exceptional labor productivity and low product spoilage that occurred from the outside sales a year ago in the second quarter. Ancillary and other business gross margin was higher by 40 basis points and by 49x gas in the quarter. Gas, travel, business centers, and pharmacy were all better year over year, offset by e-comm and optical. LIFO, we had a 14 basis point hit year over year to LIFO, or a $71 million LIFO charge during the quarter, both with and without gas inflation. Recall that our Q1 LIFO charge year over year was $14 million, or in the first quarter was $14 million, or a three basis point delta versus the prior year. It's been the last three fiscal quarters that we've actually pointed out LIFO, as we saw a little bit of inflation going back to the summer or Q4 of fiscal 21, a little more in Q1 of this fiscal year, and as with everything you read in the news, quite a bit more in Q2. Our 2% reward was higher on a reported basis by three and minus one, excluding gas inflation, a reflection of increased penetration of the 2% reward executive members. And other was plus 14 basis points year over year. This is related to the COVID related costs from a year ago, about $60 million. That's the portion of COVID related wages that go into costs of sales that like related to manufacturing businesses, as well as their meat and bakery departments. Overall, pretty good showing on the gross margin, given the ongoing and increasing inflationary pressures. Moving to expenses, to SG&A, I reported SG&A in the second quarter was lower or better year-over-year by 94 basis points, and better by 63 basis points, excluding gas inflation. Again, jotting down two columns of numbers reported, and the second one, X gas inflation, Operations, plus 36 basis points and plus 9. Here a plus is good. It means it's lower year over year. Central, plus 13 and plus 10. Stock compensation, plus 3 and plus 2. Other, plus 42 and plus 42 for a total of plus 94 and plus 63. So better or lower by 94 basis points reported and better or lower by 63 basis points ex-gas inflation. Now, again, looking at the first line item operations, the core operations component better, again, by 36, but as well better by nine or lower by nine basis points, excluding the impact of gas inflation. Keep in mind that this improvement occurred despite both the permanent dollar an hour wage increase that began in March of 2021, is now anniversary, and the additional starting wage increases in from our two basic hourly scale service assistant and service clerk by an additional 50 cents an hour. That occurred in October of 2021. On a central, better by 13 basis points or 10x gas inflation. It's pretty straightforward. Operating leverage on strong sales figures. Stock comp, plus 2 and plus 2. Again, reflection of good sales. And other, this plus 42 basis points. This was the $2 COVID wages of $186 million that goes into SG&A in Q2 a year ago. So, again, on a year-over-year basis, that was that improvement. In terms of pre-opening expenses, in past conference calls, really since we went public, I think, We've covered that pre-opening expenses next on this discussion. Starting this fiscal year and going forward, pre-opening is now included in SG&A. The year-over-year change in SG&A related to pre-opening was flat year-over-year, no basis point delta year-over-year in the second quarter. All told, reported operating income in Q2 increased 35% on a reported basis. coming in at $1,812,000,000 this year compared to $1,340,000,000 a year ago in the second quarter. Below the operating income line, interest expense was $36,000,000 this year versus $40,000,000 last year. Interest income and other for the quarter was higher by $6,000,000 year over year, $25,000,000 this year versus $19,000,000 last year, primarily due to favorable FX. Overall reported pre-tax income in the quarter was up 37%, coming in at $1.8 billion compared to $1.3 billion a year earlier. In terms of income taxes, our tax rate in Q2 was slightly higher than it was in Q2 a year ago. It came in at 26.7% compared to 26.4% a year ago in the second quarter. Our effective tax rate currently continues to be projected to be in the 26% to 27% range for the fiscal year. A few other items of note. Warehouse expansion. For the year, we now plan to have 32 new units and 32 units, including four relocations. So replacing existing units to larger and better located facilities. So net total of 28. I think a quarter ago, we actually said it was a net total of 27. So one more than that. However, remember, several of these are slotted to opening Q4 or fiscal Q4. 15 of them, or 14 net new. So there's always a potential for one of those to shift into the next fiscal year. The five openings in Q2 that we had, one each in Mexico, our 40th in Mexico, our second in France, our second in China, our fourth in Spain, and one additional unit in Florida, where we now have 29 locations. Regarding capital expenditures, our Q2 spend for CapEx was approximately $723 million. and our full-year capex spend is still estimated to be approximately $4.0 billion. Moving on to e-commerce, e-commerce sales in Q2FXFX, as I mentioned earlier, increased 12.6% year-over-year, and that's, of course, on top of a second quarter fiscal 21 increase of 75% increase last year, benefiting, of course, from COVID. Stronger departments in e-commerce in terms of year-over-year percentage increases, jewelry, tires, special order kiosk items, patio and garden, and home furnishings. Our largest online merchandise department, Majors, which consists of consumer electronics, appliances, TVs, et cetera, was up in the high single digits on very strong sales increases a year earlier. In terms of an update on Costco logistics, this continues to drive big and bulky sales. For the quarter, deliveries were up year over year 22%. And now about 85% of our U.S. e-com less than truckload shipments from Costco logistics we're doing ourselves. During the quarter, we average more than 65,000 stops per week with Costco logistics, which translates into a little over $3 million planned drops in Costco logistics for the fiscal year. In terms of e-com and mobile apps, it continues to improve, much improved layout, the ability to view warehouse receipts online, the ability to reschedule e-com deliveries in the U.S. and Canada, as well as reschedule returns pickups. Later this month, we'll have our warehouse inventory, along with the Instacart inventory, online and be able to see all the detail of our in-store merchandise as well. In terms of our e-commerce platform, Costco Next, we added a few additional suppliers, so we now have 37 suppliers online and growing. Again, Costco Next has about 1,000 items on it, curated items at Costco values. Please check it out. From a supply chain perspective, similar issues that we outlined both 12 and 24 weeks ago on the past quarterly earnings calls. The factors pressuring supply chains and inflation include port delays, container shortages, COVID disruptions, shortages of various components and raw materials and ingredients and supplies, labor cost pressures, of course, as well as truck and driver shortages. Overall, we've done a pretty good job of giving these supply chains challenges. I think that's evidenced in our sales strength. They continue to be delayed container arrivals, so we continue to advance order in many cases as we are able to. Virtually all departments are impacted. Less product and packaging challenges, but still a few. Still some limitations on key items, but again, that's improving a little. Ship shortages are still one of the things that are impacting many items, some more than others, but again, we're managing to have our shelves full and driving sales. One of the things that we've done that I mentioned last quarter, last quarter I mentioned we had chartered three small container vessels to help provide us with additional flexibility on shipping. We have now chartered a total of seven ocean vessels, up from those three for the next three years. These are transport containers between Asia and the US and Canada. We've also leased containers for use in these ships. With these additions, about a quarter of our annual Trans-Pacific containers and shipment needs are being accommodated this way, which gives us additional supply chain flexibility. Despite all the supply chain issues, we're staying in stock and continue to work to mitigate cost and price increases as best we can. Every day and every week, you're going to see in different items in different departments certain things on allocation or short, but other things are filling its place. And again, some things are seeming to get a little better. Moving to inflation, inflation, of course, continues as evidenced by our life-out charge. The inflationary pressures that we and others continue to see include higher labor costs, higher freight costs, as well as higher transportation demand, along with the container shortage and port delays that I just mentioned. Increased demand in certain product categories. Various shortages of everything from computer chips to oils and chemicals to resins. Higher commodity prices from food service oils to additives and motor oils to plastics to detergents to paper products as well. On the fresh side, proteins and butter and eggs and things like that. Not very different than what you hear and read and see from others, but again, we think we've done a pretty good job of corralling it as best we can. For the first quarter, a quarter ago, I mentioned that we estimated at that time overall price inflation to have been in the 4.5% to 5% range. For the second quarter, in talking with senior merchants, estimated overall price inflation was in the 6% range. All of this said, again, I want to give another shout out to the job that our merchants and our traffic department and operators have all been able to do in order to keep the products that we need, pivot when and where necessary, and keep our warehouses full by keeping prices as low as we can for our members and continuing to show great value versus our competitors. Now turning to our February sales results. The four weeks ended this past Sunday, February 27th, compared to the same four-week period a year ago. As reported in our release, net sales for the month of February came in at $16.29 billion, an increase of 15.9% from $14.05 billion a year earlier. Recall from January sales results that Lunar New Year, Chinese New Year, occurred on February 1st. That's 11 days earlier this year than last. This shift negatively impacted February's other international by about four percentage points and total company by about a half a percentage point. Comparable sales for the four weeks on a reported basis, U.S. was 17.4. Ex-gas and FX, 12.9. Canada reported 11.7. Ex-gas and FX, 8.8. Other international, minus 0.9. and X gas and FX at 1.3 to the positive. Total company, 14.0 and 10.6. And e-com within that number is 10.2 reported and 10.4 X gas and FX. Our comp traffic and frequency for February was up 8% worldwide and 8.2% in the United States. Foreign currencies year over year relative to the dollar negatively impacted total and comp sales as follows. Canada by approximately two-tenths of a percent, Other international by approximately 4.5%, and total company by approximately 7 tenths of a percent. Gas price inflation positively impacted total reported comps by about 4%, and average worldwide selling price per gallon was up year over year by 37%. Worldwide, the average transaction for February was up 5.5%. Our U.S. regions with the strongest sales were Texas, the Southeast, and the Northeast. Other international and local currencies saw the strongest results in Australia, Mexico, and the U.K. Moving to merchandise highlights for the month of February, food incendiaries came in at a positive high single digits, fresh foods in the mid-single digits, and non-foods in the positive high single digits. Ancillary businesses' sales were up mid-40s. with gas being certainly a driver of that, as well as food court and hearing aids were the top performers. With that, I want to mention just a couple of recent executive changes. A month ago, we reported that Ron Vakris became president of Costco. Ron started his career 39 years ago at Price Company, at Price Club, at the young age of 17. Most of his career was in operations through 2015. Then he spent a little over a year in real estate traveling the world and working on both worldwide and domestic expansion. And since that time in 2016 has been in merchandising with certainly responsibly not only for inline merchandising but online merchandising as well as very involved with logistics and transportation. As well, just this week internally we reported that taking Ron's previous spot as head of merchandising is Claudine Adamo. Claudine has been with us for 30 years. She began in an hourly position in our Kirkland warehouse in 1992, 30 years ago. But a year later, came into buying and has been in buying ever since. And most recently was senior VP of non-foods sales, of non-foods merchandising. And again, she'll be taking over, looking over all of merchandising. Finally, in terms of upcoming releases, we will announce our March sales results for the five weeks ending April 3rd, on a Sunday, April 3rd, on Wednesday, April 6th, after the markets close. With that, we'll open it up to Q&A and turn it back to Jerome. Thank you very much.

Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from the line of Michael Lusser from UBS. Your line is now open.

Good afternoon, Richard. Thanks a lot for taking my question. First one's on a fee increase or the potential for a fee increase. If there is no fee increase this year, should the market interpret that as some reflection of how cost will be either based on pricing power, especially in light of companies like Amazon and Netflix raising their fees this year, or should we interpret a sign as the interval by which Costco will raise its fees over time?

Well, certainly, I don't think you should interpret anything related to why or when. You know, historically, we always look at things like, you know, do we feel we can, we look ourselves in the mirror and do we feel that we've continued to increase the value of the membership? Certainly we look at renewal rates. Uh, we look less at what others do, frankly, uh, but certainly is out there what others are doing. And, uh, what I do note is, is that I've looked at the last, uh, three increases over the last 15 years. And on average, they were done about every five and a half, a little over every five and a half years, about five years and seven months. And, um, Five years from the anniversary of the June of 17 would be this June. So I think the question will continue to be asked until we do or don't do something. But at the end of the day, we certainly feel very good about our member loyalty, our success in getting members to move to executive member, which are the most loyal. And so you guys will know when we tell you, and at some point it will happen, but stay tuned.

Thank you. My final question is on the core-on-core gross margin. Over the last couple of quarters, you've given back about a third of the core-on-core gross margin gains that cost during the hardest times that go to heart over the last couple of years. Is this the right way to think about what's sustainable from here? You may give back a third of it and keep the third. Alternatively, would you expect... Yeah.

Yeah, look, recognizing, I'd like to think it was that easy that we could plan it and get there. Sometimes we get there, but 10 different variables go in 10 different directions than we had planned. There's lots of moving parts to it. The fact of the matter is we certainly have confidence in our competitive position and our confidence to get some margin as we go forth. The fact of the matter is our gross margins are still, even on core and core, higher than they were two years ago. We had outsized margins two years ago, most particularly in fresh. When you had 20% and 30% increases in fresh, you darn near eliminated spoilage and you improved dramatically labor productivity in fresh, and you darn near eliminated all your spoilage. some of that's not sustainable. But even with some of the giveback, if you will, on a two-year stack, if you will, we're still showing higher year-over-year numbers on core-on-core. The other thing is, as we've said, and we don't sit around and just pound our chest on it, despite these inflationary pressures, we've tried to to hold where we can. Now, needless to say, you can't do that near in its entirety, but we've probably been a little later than others in terms of raising some things in our view. We've worked with our suppliers to eat a little of it, and we eat a little of it. And I think that these margins, particularly given the sales strength and the operating leverage, allow us to be ever more competitive and drive our business. So when asked the question, as many of you know over the years, who's our toughest competitor? It's us. And I don't really look at this as being a reflection of what's going on out there. We're ever competitive. We're always checking our competition. And we feel that our competitive position is as strong as ever.

Thank you. Your next question comes from the line of Simon Gattman. from Oregon Stanley. Your line is now open.

Hey, everyone. Good afternoon. Richard, I'd like to follow up on the core on core question just asked differently. About, I could say, a year ago, supply chain costs were rising, input costs were rising, and it felt like you were not ahead of it. And in the last two quarters, it seems like you're now more ahead of it. You feel better. You called out the two-year trend in the core on core. So does it feel like we are past the worst and that you're able to either move pricing or have some visibility on supply chain? And then related to the perishable piece, it sounds like you're going to keep some efficiency. So there is a reason to believe that some of this you will keep going forward. I don't know if that's fair or not.

Yeah, well, certainly on the fresh and the fact that we're at higher sales levels, that allows for higher labor productivity. and hopefully a little lower D&D or spoilage. I don't disagree with what you say, but never know what's going to happen tomorrow. I know that for 35 years when things get better, we figure out how to give a little more of it back. And certainly right now with all the inflation, first and foremost is getting merchandise on the shelves and then mitigating those various cost components as much as you can, which is not a lot. And, again, but hopefully being as, if not a little more competitive than others.

And maybe a follow-up. I'd love your take on the price gaps out there. It feels like every company we cover in the mass space, supermarket space, they're all pleased with price gaps. And yet I don't know if that's right or wrong, and we're seeing gross margins actually start to go up in some places. So it seems like companies, your competition, they're taking price, That would imply that the gaps actually should be widening and making you more valuable. Curious, I know you guys have folks running around stores a lot. Curious, what's your take on it?

Well, we like when they feel more comfortable, frankly. Look, our most direct competitor is Sam's. And I'm sure they do, too, do comp shops every week at nearly every location. We feel good about those gaps. It's not that they've widened or shrunk. Overall, they're a tough competitor, and so are we. As it relates to other traditional, yes, you've seen – I think we've called out strength in gas business. I think overall what I read externally about gross margins in retail gas by the supermarkets and others is up. And there's a little bit more that gives us breathing room as well. But we want to be ever more competitive.

Great, thank you.

Your next question comes from the line of Jack Grom from Gordon Haskett. Your line is open.

Hey, thanks a lot, Richard. You know, over the past few months, you guys have had success raising retails, and I'm wondering if that trend has continued or if you're starting to see some limits or demand destruction in any parts of the club.

No, we haven't. I think, you know, certainly the more inflation creates some demand pressure. I'd like to think some of that inflation wanting to shop at Costco to save more, frankly. But we haven't seen that.

Okay. Okay, great. And then just another near-term question. You know, historically, I'm wondering if with gas prices, you know, where they are and where they're likely to go. I heard today California is close to five bucks. Historically, has there really been a tipping point in how it impacts traffic for you guys? I understand how it impacts the margin structure of your business, but historically, is there a tipping point for you?

We haven't seen that. The only time in my recollection is a number of years ago when prices got to $4 or $5 a gallon. And like then and now, we see our gallons improve, relatively speaking, because we're still the cheapest game right now. So, you know, at some point, if it goes to five, seven, who knows? People stop driving a little bit. It's hard to say. I'd like to think that the hybrid models of working from home has helped Dave a little bit there.

Okay, great. Thank you.

Your next question comes from the line of Paul Lages from Citi. Your line is now open.

Hi, everyone. This is Brandon Peterman for Paul. Thanks for taking our question. I was wondering, are you seeing any change in consumer behavior, such as trade down or maybe trade to private label brands, anything of that nature?

You know, it's interesting. On the one hand, the only thing I can think of is in fresh, when there's been big fluctuations in prices or big increase in prices on beef relative to chicken or something, you'll see some trade down within the protein family. Other than that, a couple of anomalies that are perverse in the sense that it's almost just the opposite. We've seen strength in jewelry and big-ticket furniture items and the like, and more conversions to executive membership, which, again, there's more value long-term to that customer, but it's adding $60 to their fee. Got it.

And just a point of clarification on price inflation, has that moderated the past couple months, as I think some of your monthly updates have indicated, or are you still seeing that accelerate?

It is not moderated. It continues to go up. Got it. Thank you. Now, it's going up perhaps at a little less slope. The bigger slope was probably four to two months ago. and it's gone up from there. I think, if I recall, there was a little lull talking to the buyers, a little lull in the last couple of months of the year, but many suppliers are already talking back two months prior to that to come January, we'll be coming back and talking to you again.

Got it. Appreciate it.

Thank you. Your next question comes from the line of Scott Ciccarelli from Truvi Securities. Your line is now open.

Good afternoon, guys. Scott Ciccarelli. So, Richard, you guys are running with nearly double the cash balance that you historically would have run with kind of pre-pandemic. Obviously, there's still a lot of uncertainty in the market. I guess the question is, because we've seen this pattern for, you know, probably eight plus quarters now, to continue to run with much higher cash levels than what you historically have? Or, you know, should we start thinking about the potential return of capital to shareholders like you've done periodically?

Well, at some point we'll figure out what to do with it. Mind you, our Q2 balance sheet, Q2N balance sheet, is probably the highest point from a seasonal standpoint because you've built a lot of sales and you still have some of the bills to pay from the Christmas time. Not a lot, but some. And, frankly, you know, knock on wood, our operating cash flow has – certainly exceeded what we'd expected two years ago. So, yes, there is a little more. At some point, certainly one of the arrows, our quiver, is a special dividend along with the regular dividend increase that we've done every year, as well as some stock buyback. But, you know, first and foremost is CapEx. You know, CapEx this year of four-ish plus million is up from the three, three and a half over the last couple of years and up from numbers lower than that the two to four years prior to that. So that's first and foremost what we want to spend money on. But we've done four specials, and as one of the board members said, we are a little quirky, and it seems to have worked for us. So it's certainly an arrow in a quiver, but we haven't made any decision at this point. Got it. Thank you.

Your next question comes from the line of Karen Short from Barclays. Your line is now open.

Hi. Thanks very much. I just wanted to ask the membership fee question a little differently. So in the past, you've talked about raising the membership fee in the context that you obviously have an inflow of dollars to then reinvest in price. So I guess the question is, maybe with the assumption that the consumer is going to continue to feel a little more and more stretched as the year progresses, how does that factor into your thought process? And then also tying that in with the fact that there was obviously the increase on membership at Amazon.

I think that doesn't hurt, but honestly, at the end of the day, first and foremost, the factors that doesn't give us any concerns is the fact that our sales are strong, our renewal rates and loyalty are at all-time highs, so that's all positive. And yes, when we do it, we use it to be even more competitive. So on the one hand, you might argue that because of inflation, would this allow us to mitigate some of that? We're already doing that, by the way, without a fee increase. But, you know, we've done it seven times in 35 years. And, you know, sometime between summer and six or nine months down the road, is it likely? It's possible, but we'll have to wait and see. But we don't really consider what what Amazon or whatever we were getting, we're asked the question the other way with some of our direct warehouse club competitors that theirs is they have not changed theirs in a number of years. And that does not concern us either. We, we look at what we're doing, how it affects our members. And we look at ourselves in the mirror and says, have we, have we improved the value of the membership? And we've always felt that we've done that in a more dramatic fashion than these increases. And then that we take those increases and use it to become even more competitive. So, uh, You know, I cannot give you an answer other than we feel good about if and when we want to do it, we'll be able to.

Okay. And then my second question is just on the net income margin, or I guess you could talk about pre-tax margin. You know, obviously that has come up quite a bit over the last several years. And I think the question on a lot of people's mind is just, is there more of a willingness to flow through margin on that line? And I know, again, you don't run your business that way. You run it for units and volume and leverage on strong comps. But just wondering how you would frame that.

Well, you know, first of all, certainly in this quarter as well, you know, the bottom line margin improvement was the sum of, a great expense improvement and some margin detriment. I'm taking out all the anomalies of each. And that's the way we want to do it. The old saying is we want to lower prices and raise margins. The same thing is we want to improve the bottom line while not raising prices. And I'm not talking about necessarily specific inflation right now. I think I recall a few of you on the call might have remembered this when we had our made first and last all-hands analyst meeting out here with about 300 people. And at the time, we had a 2.8% pre-tax return on sales, pre-tax. And our founder was up there saying that we're a great company and great companies deserve to make good money. And over the next several years, we wanted to go from 2.8 to a number, I won't get everybody excited, but a bigger number. And at the end of the day, it went up and down, but it has improved. I think that We've got a lot of great things going on. We're not embarrassed to make money for our shareholders as well, but we're going to do it within the confines of being ever more competitive from a pricing and value standpoint to our members.

Okay. Thanks very much.

Our next question comes from the line of Chris Horvath from JPMorgan. Your line is open.

Thanks. Good evening. I guess my first question is, do you look at the U.S. sort of core comp on a two- and three-year basis? Really since the summer, there's been a bit more volatility to the two- and three-year trends, even over the past few months. Do you read into that? How much do you think that was maybe just like a holiday shift, maybe some Omicron impact in January? Curious how you're thinking about that.

It would be the all-inclusive yes. It's all of the above. You know, I remember when we had particularly strong early in the Christmas holidays, Thanksgiving, Christmas holiday season, we had strength. Part of that was bringing in some things early. Part of it was the increased demand that COVID has created for, you know, goods for the home and the shortages of those same goods. And so once they hit the shelves, you sold quickly again. And then, of course, it was still positive, but a little less than that trend at the end of the calendar year. And without doing a lot of work, it seemed like that was the reason. Then you've got storms that affect the things. You've got shifts in things like Chinese and Lunar New Year. We really don't spend a lot of time doing that. We try to understand why overall some level of sales either generally reduced. If it increased, we don't worry about it as much. But I don't think we spend a lot of time thinking about that. As we've been reminded from the day of our founding, we're a top-line company, and it's all about driving sales and value. And it's going to be as good as we can get it. And so we don't read a lot into what you asked.

Got it. It's a good segue. I guess your executive trends, the renewal rates, the comps, the traffic, you're one of the few big retailers with really strong traffic. But at the same time, is there a point where just the culture becomes uncomfortable with passing through price? I mean, the vendors have talked about more price increases that have come starting January 1st. It seems like there's more coming in September. I could think of Jim sort of being paranoid and, you know, worried about, do we just push too far and do we not want to risk that and, and, you know, invest more in price before even seeing any deterioration in the sales trends?

You know, I would say we're more aggressive when things are good than we're aggressive when things are good and bad. I remember somebody years ago asked the question, given that sales for whatever reason had been weak for a month or two, And that was more the reason to be even more strong on pricing. And I think that actually had to do related to a pending membership fee increase based on this kind of five plus year anniversary. And the view was, is no, our members are loyal and we're going to use it to drive more sales. So no, I don't, I think we're still bored of that same DNA of trying to constantly drive more value and not worry about how strong or weak we are today. Just keep driving more value and, And if we keep focusing on that, nobody can catch us. Uh, and then just one quick, sorry, say that again. It's harder to catch us at least. So, yeah.

And then just a quick question on life. Oh, if price increases have continued into this year, does that life Oh number just stay at this level? And, you know, as we lap through it, do we actually get that back?

Uh, well, in theory, you don't get it back. Um, if life, as I said earlier, if inflation is continuing, you should see some additional LIFO charges, maybe not as big, but who knows. And at some point at the beginning, as you start a new fiscal year, you've had whatever LIFO charge you'll have for this past year. And that's kind of the new set point for costs for each item. And then to the extent if there's additional inflation relative to that starting point, you'll have some additional LIFO next year. If things came down a little bit, let's say things, I'm making these numbers up in the extreme, but things were up in one year 20% and the next year they were down 10, you had a big LIFO charge this year and you actually have some LIFO credit in the following year. Got it. Thank you. Best of luck. I gave you an extreme example. That's not the reality. Thank you.

Your next question comes from the line of Mike Baker from TA Davidson. Your line is now open.

Okay, thanks. I guess I'll stay on the inflation question, but ask two different inflation questions. One, if prices do come down, eventually they will, historically what do you see in terms of your ability to maintain the current prices, in other words, not to come down and then to gain some in that sense. And then a second inflation-related question. Historically, when you see outside inflation, now it's been a long time since we've seen inflation like this, but you've been around for a long time. When you see inflation, do you get more customers coming in to Costco to save money? You alluded to that earlier. You said that's what you hope happens, but I guess I'm sure you've looked at it historically. What have you seen?

On the latter question, past history has indicated yes. Not in a big way, but the answer is yes. directionally. As it relates to prices come down, if our costs come down, we want to be the first to lower the price, period.

Okay. That makes sense. One last one, if I could. Similar to that, you know, to get more customers when it's an inflationary environment, do you see more customers wanting to sign up to take advantage of your value in a tougher economic situation? In other No stimulus does appear as if the economy might not be, or at least the consumer economy might not be as strong as last year. How does that impact your memberships or renewal rates?

I think if you asked us two years ago, how would the next two years be in terms of new member signups, we would be positive, but we probably have achieved greater than our own expectations by a little. And so arguably that it was not just the stimulus, but notwithstanding the stimulus, there wasn't a lot of positive feelings out there in terms of a consumer and we did just fine. So, you know, one of the good things that we've been blessed with that we are the extreme value proposition and it generally bodes well for us in good and bad economic times. And so I think we don't pay a lot of attention to it other than, you know, really being focused on driving, you know, price and value of our products and services and taking care of the customer and then the rest seems to work.

Yep, sure does. Thanks for the call.

Yes, sir.

Your next question comes from the line of Rufus from Oppenheimer. Your line is now open.

Good afternoon. Thanks for taking my question. So I had a question just on the labor front. I was just curious what you guys are seeing from a labor availability standpoint and then, you know, what your comfort is with your wage levels in the marketplace, just given we continue to see others raise their wages.

Well, we continue to raise them, as others have, and we will continue to do that. The biggest single area of challenge is, one, we're headquartered in Seattle, which has become an increasingly expensive market, and within that, IT, where you not only have two big tech behemoths, But the next three tech behemoths all have 10,000 to 20,000 employees in this town as well. So we've had to raise wages there, and it didn't happen overnight in the last two weeks, but it's happened continually over the last couple of years. And we will also lose a few people because we're not 100% work from home. We think a good, fair hybrid work model, but for a few, they want that. Overall, though, if you look at – Our total compensation and benefits package, 90% of our employees are hourly in the warehouse. And while maybe there's a city or two where we've got to occasionally start it one step above the entry level, we've continued to raise the wages, as I mentioned in the thing, and we'll do it again.

Okay, great. And maybe one additional question. Just on the ants way up front, if you could just remind us where you are with your recovery versus pre-pandemic and some of the more challenged categories, travel, food court, et cetera.

Yeah, well, the biggest one is gas, and that's gone nothing but up. And, again, as I mentioned earlier, the retail competitive price pressure has probably lessened over the last couple of years. Travel, you mentioned, is one that has been extreme recently. ups and downs. You know, there was a period during the mid-2020 year lockouts, COVID lockouts, where we had negative, we had lost money in the business and had negative revenues because you're getting more cancellations and no new orders. And that's fluctuated. It's come back. It fell a little bit with Delta. It came back after that. It fell a little bit with Omicron. although now we seem to be up on the upward trend and it is profitable, not as profitable as it was two years ago, but continuing in that direction. Huge business in both vacation packages as well as auto rental cars and the like. So that's a business that's coming back nicely. You know, it was businesses like where there was face-to-face touch, if you will, in our hearing aid and optical shops. That was actually closed for a number of weeks, in the mid-2020, but just for 10 or 15 weeks, I think. That's come back as well. Food courts have come back because we have chairs and tables back out and we expanded the menu. So overall, a few of those ancillary businesses, they're not back to where they were, but they're getting there. And then, of course, the one business that dwarfs all the other is gas, just in its size and its increased profitability. So overall, ancillary is doing fine and And some of the ones that were hurt the most are picking up.

Great, thank you.

Your next question comes from the line of Kelly Banya from BMO Capital. Your line is now open.

Hi, thanks for taking our questions. Just to follow up real quickly on the gas, Richard, you made the comment about gas margins going up kind of across the space. Can you help us understand a little bit about how Costco's gas margins are relative to 2019? Are they up, maybe just up a little less? And where are we with gallons versus 2019?

I don't have that detail in front of me. Margins are up, prices are up, and it's a huge business. It's a It's a little more than 10% of our sales. It's a $20-plus million business now, recognizing there's been, as I mentioned earlier, a 30-plus percent increase in just the price per gallon. But it's definitely been up the last couple years, and it's less volatile than it was five and ten years ago in terms of a big margin fluctuation. But I don't have the detail related to two years ago.

Okay. I'll just ask another one just on – white space then just in the U.S. Just curious if you can just give us an update on how you're looking at that today over the next couple years. Do you have to at all change your target demographics or target population density in terms of where you'll plan on opening up new clubs in the U.S.? Just the eventual number that you see, just an update there.

Sure. I mean, if you'd asked me five years ago five years hence or now, what would it look like? Five years ago, we were opening about 25 a year. Call it 26 to make the math easy for a second. And maybe 70, 30 U.S. and Canada are most mature markets. And then over the next five or 10 years, the 70, 30 would probably go to 60, 40 outside of the U.S. and Canada. And here we are five years into that incorrect answer. and we're probably 65-35 U.S.-Canada for two reasons. Partly is our expectations of what we can do in the U.S. and Canada has increased, not just in the last five years, but in general over many years, and it's taken a little longer, the timelines internationally, although we've got more feet on the ground and more stuff looking. So if you ask me today, I look five years from now, we'll go from 65-35 or whatever X is today, probably down to 50-50. I think the good news with that answer from that perspective is, is that we feel we still have plenty of opportunities in the U S and Canada, and we've ramped up our, our, our activities to, to do more in these other countries where we've also been quite successful. Um, the, uh, you know, if you said asked over the next 10 years, we're opening, I think this year, 16 of our 28 are in the U S I can be off by one or two. Uh, Our view is there's no reason to think for the next 10 years we can't open 15 or so a year in the U.S. Now, mind you, one or two of those or growing to two or three will be the business centers. We now have 22 business centers in the U.S. and five in Canada. That's been a good adjunct to our business. But we're also in infilling. I gave an example at an internal meeting yesterday. And I've given it before to you guys. In San Jose, about four or five years ago, we opened our fourth in the greater San Jose market. At the time, the three units were doing about 250 each. Now the four units are averaging right at 300 each, averaging. And on fewer members per location because you've got existing members driving less far. So there's a combination of infill. Now, we're in 46 states, so there's not a lot of additional states. We're less penetrated versus our direct competitors in certain locations in the Midwest and Texas and parts of the Southeast, and we're still opening there as well. So it really is a combination of all those things. I think our view is the good news is that we're far from saturating our most saturated markets. And we've upped the ante in terms of feet on the ground, real estate feet on the ground, if you will, in terms of getting some more into the pipeline. Thank you.

Your next question comes from the line of John Haverkamp from Guggenheim. Your line is open.

Hey, Richard. First thing, philosophically, how do you guys think about closing the gap on the two membership tiers maybe encouraging some further conversion to executive. And I don't know if you've done any kind of work with your current executive members. What would they like in the membership that's not there today that perhaps might help you take the annual fee higher?

Yeah, well, I don't know exactly what we would ask. I need to ask our membership marketing people. I think we've frankly been very pleased of our success of getting more existing members to convert and, frankly, more new members to sign up initially as an executive. Mind you, eight or ten years ago in the U.S. where it started, we've had it for 15 years now probably. you came in and we just signed you up. We asked you what you wanted. We didn't do a lot, and maybe 20 or 25, at most 25 of every 100 signed up as an executive member. Today it's in the 50s, close to 60, and that's with just trying a little bit and showing them the value of it. So I think we've done a better job of doing that. We do a better job when we go into a new country. We're now in, I think, five of our six of our countries, which are the largest ones. You want to have at least 15 or so locations before you're looking at it to put an executive membership in it. So we've toyed with the idea of having, you know, something even higher than executive, but we always go back to the fact that what we have works very well. And so I don't think there's anything currently on our plate to change that. We're always, we've also asked the question, you know, at some point, Right now it's 72% or 3% of our sales are with the executive member. What happens when it gets to 85% or 90%? Do you eliminate the lower membership? At some point we might, but that's, again, not in the cards at any time in the near future. We kind of like what we're doing, and it's working fine.

And secondly, where are you on the personalization journey? I know you hired somebody maybe two years ago to kind of spearhead that. where are we and does that pick up steam in the next year or so?

I think it picks up steam in the next year or so. The first order of business when we brought in people on that data analytics side two years ago, a person, he has built a great team and we're seeing small deliverables first and foremost, not online but with the merchants and to a smaller extent with some of the operators and there's been some real deliverables that have saved our buyers' time, and those are in the process of being rolled out. On the personalization and targeting, I think we've got a little better at targeting and still have a journey on the personalization, but that will be coming. But I thank you for asking when you said a year or two. Okay, thank you. We'll take two more questions.

Okay, not that soon. Your next question comes from the line of Laura Champin. from Loop Capital. Your line is now open.

Thanks for taking my question. I'll make it quick. To follow on to the unit growth questions asked earlier, it sounds like you're positioning the business to launch more international stores. Does it make sense for me to interpret that as unit growth may accelerate next fiscal year and beyond from this looks like it's going to be about 3.5% this year?

Well, look, our goal for the last several years, there was the unique year of COVID where we went down to 13 openings because there were several that construction had stopped for several months in the middle of 2020. But the reality is, if you go back five or six years, we were opening 25-ish, some of the years 21 or two-ish. And the view even then was to get up to closer to 30, certainly 25 to 30. I think this year we're finally hitting that with the expectation of 28 in my call this morning and call it 26 to 30, whatever X is it comes out to be. And we would certainly be comfortable at 30. One of the things that is unique is we try to be relatively methodical about it, particularly in new international markets. Once you open the first one, if it's successful, you're taking some people from that one to help and succeed in opening the second one. One of the things is the biggest cost factor on Warehouse P&L is labor and efficiency, and when you're running a high-volume unit, it's helpful when you've got more people coming over from a nearby unit. We are pretty methodical about growing somewhat slowly in new markets. We went from one to five 20 years ago over a five-year period in Japan. We've sped up a little in China, thinking that we've opened two now in three years and with another several in process. Probably several is more than a couple more. So, yeah, we've increased it a little bit, but we feel pretty good about that. So I would still say our rounded pat answer right now is 25 to 30. And we'd like it to be more to 30 than 25 right now. But we're not necessarily looking at that percentage. As we get bigger, God willing, in years 6 through 10, we're going to be talking about 30 to 35. But we'll have to wait and see.

Got it. Thank you.

Your last question comes from the line of Peter Benedict from Baird. Your line is now open. Peter Benedict, your line is open.

Sorry to take me off mute there. Thank you, Richard. So, like most of my questions have been asked, but just thinking about the supply chain situation and just curious if it's caused you guys to rethink or accelerate any of your your kind of sourcing initiatives. I mean, you talked about the vessels and the containers and that clearly seems to be in reaction to what's going on, but I'm thinking more along the lines of categories, you know, these, these efforts you've been underway for a long time going vertical. Are there any that maybe have jumped to the front of the line because of what you've seen over the last, last year or two?

Well, I think a couple of things we've done, not in a big way, but a couple of things we've done is there's probably a little bit more diversification of suppliers, particularly on huge, you know, 300 million to billion dollar SKUs. You need a little bit more there. We've brought in certain things that are non-traditional to its season. During the winter, bringing in bikes because we could add access to them, and we sold them. Yeah, new countries of origin. So there's a few of those things, but not in a big way. Part of our success is huge buying power per item And having less than 4,000 SKUs to do our $200 billion is quite a bit different than having even 100,000 SKUs doing $150 to $500 billion, depending on who the retailer is. So we've made changes, and we are more open-minded to bringing in some things. But hopefully this thing, the supply chain, works out over the next couple of years in a big way and in a better way.

And then just lastly, I'd study the executive membership, you know, 43% of the members and 71% of the sales. How, where are those numbers in maybe your more established markets where you've had it and maybe how under penetrated is it in some of the newer markets? Just trying to get a sense of what the pathway might be for some of these newer markets. Yeah.

Yeah. Well, it's, it's, it's like renewal rates, real rates, irrespective of what it becomes 10 years, hence in a mark in a location in a market. It starts off at a lower number and builds up to the higher number. Same thing with that executive transition. We're doing better today, and even in first-year new markets. I think in the last couple of years, where have we added executive? Japan and Korea? What? That 42% number is hovering in the low 50s. 50 are a little higher in more mature markets and starts off lower in other markets, but higher than it started in the previous new market a few years ago. It grows over time. Fair enough. Thank you very much. Everyone have a good afternoon and evening and I appreciate you getting on the call.