Costco Wholesale Corporation

Good day and thank you for standing by. Welcome to the Costco Wholesale Corporation Third Quarter Earnings Conference Call. At this time, all participants are in the 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. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker for today. Thank you. Please go ahead.

Thank you, Erica, and good afternoon to everyone. This is Bob Nelson, Senior VP of Finance and Investor Relations here at Costco. Thank you for dialing in today into today's conference call to review our third quarter fiscal year 22 operating results. Before we begin, a couple of housekeeping items to take care of. First, as you now have surmised, Richard is not with us today. He is doing great and wishes he could be on the call. He is in Italy with his family on a rescheduled vacation that was canceled early in the pandemic. He wanted me to pass along his best to everyone, and in his absence, I will be filling in for him today. Secondly, and before we get into the details of today's earnings results, I need to read our safe harbor disclosure. Let's begin. 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. Okay, with that out of the way, let's get to it. In today's press release, we reported operating results for the third quarter of fiscal 22. The 12 weeks ended this past May 8th. Net income for the quarter was $1.353 billion, $3.04 per diluted share. The reported 304 included a one-time 77 million pre-tax charge, 13 cents per diluted share, for incremental benefits awarded under the new employee agreement effective this past March 14th. Last year's third quarter net income was 1.22 billion, 275 per diluted share, which included 57 million pre-tax, or 9 cents per diluted share, for costs incurred primarily from COVID-19 premium wages. In terms of this year's $77 million pre-tax charge, this was in conjunction with our new employee agreement, again affected this past March 14th, and was primarily to adjust our benefit accrual to account for one additional day of vacation, which is awarded to each employee immediately. The continuing impacts of the wage and benefit enhancements reflected in SG&A and margin for this quarter and will be in as well as for subsequent quarters. Net income for the first 36 weeks of fiscal 22 was $3.98 billion, $8.94 per diluted share, and that compares to $3.34 billion or $7.51 per diluted share last year. Now, let's now review the metrics of our P&L. As always, starting with sales, net sales for the third quarter increased 16.3% to $51.61 billion, and that compares to $44.38 billion reported last year in Q3. In terms of comparable sales for the third quarter, for the 12 weeks on a reported basis, the U.S. was better or up by 16.6%. Canada, better by 15.2%. Other international, up 5.7%. And total company, again, up 14.9%. Our e-com business in the third quarter reported better by 7.4% versus a year ago. For the 12 weeks excluding the benefit of gas inflation and the headwinds of FX, the U.S. came in at up 10.7%. Canada, better by 12.8%. Other international, up 9.1%. And on a total company basis, X gas inflation and FX headwinds, better by 10.8%. And e-commerce, just below 8% at 7.9% of the quarter. In terms of Q3 comp metrics, traffic or shopping frequency increased 6.8% worldwide and up 5.6% in the U.S., Our average transaction was up 7.6% worldwide and up 10.4% in the U.S. during the quarter, and foreign currencies relative to the U.S. dollar negatively impacted sales by just a little over 1%, and our gasoline price inflation positively impacted sales in the quarter just a little bit more than 5%. The best-performing categories in Q3 were candy, sundries, tires, toys, jewelry, kiosks, home furnishings, apparel, bakery, and deli. Underperforming departments were liquor, office, sporting goods, and hardware, all of which were quite strong a year ago. In terms of other business sales, the best performers came in from gasoline, travel, food courts, and our business centers. So overall, our sales grew nicely in the quarter. And for the most part, we're pretty broad-based. Moving down, the income statement to membership fee income reported in Q3 984 million or 1.91 as a percentage of sales compared to last year's 901 million or 2.03 as a percentage of sales. That's up 83 million year-over-year or a 9.2% increase. And excluding headwinds from FX of about 10.6 million, membership was up 10.4% in the quarter. In terms of renewal rates, we hit all-time highs at Q3 end. Our U.S. and Canada renewal rate was 92.3%, up three-tenths of a percent from the 12 weeks earlier at Q2 end, and the worldwide rate came in at 90% for the first time in company history, and that's up four-tenths of a percent from what we reported at Q2 end. Renewal rates continue to benefit from the increased penetration of both auto renewals and more executive members. And in addition to that, higher first-year member renewal rates than what we've historically seen. In terms of member counts, number of member households and cardholders at Q3N, we ended Q3 with 64.4 million paid households and 116.6 million cardholders, both of those up over 6% compared to a year ago. At Q3N, our paid executive memberships were 27.9 million, and that's an increase of just about 800,000 during the 12 weeks since Q2N. Executive members now represent over 43% of our member base and over 71% of our worldwide sales. Now, before I move on, I want to take just a minute and address the question that we've been getting a lot recently regarding the timing of the potential membership fee increase. Historically, we've raised fees every five to six years, with the last three increases coming on average at about the five-and-a-half-year timeframe, and our last increase coming in June of 2017. As we approach this five-and-a-half-year mark, there will be more discussions with Craig, Ron, and the executive team. But for today, we have nothing more specific to report in terms of timing. In addition, given the current macro environment, the historically high inflation, And the burden it's having on our members and all consumers in general, we think increasing our membership fee today ahead of our typical timing is not the right time. We will let you know, however, when that changes. Okay, moving on along the P&L, let's take a look at gross margins. Our reported gross margins in the third quarter were lower year over year by 99 basis points. This year coming in at 10.19 as a percentage of sales. and that compares to last year's 11.18 that we reported a year ago. So, the 99 basis points down year over year, and excluding the negative impact of gas inflation, we would have been down 53 basis points. So, if you would, for me, and as normal, please jot down the following for our gross margin matrix. And again, as usual, two columns, the first column being reported gross margin, the second column being gross margin without the impact of gas inflation. There are six rows, the first row being merchandise core, second, ancillary and other business, the third row, 2% rewards, followed by LIFO, other, and then total. So in terms of our core merchandise margins, on a reported basis, they were down 87 basis points versus last year, down 46 basis points, X gas, ancillary and other, plus six reported, and plus 18x gas, 2% rewards plus eight and plus three, LIFO minus 25 basis points on a reported basis and minus 27x gas inflation, and finally other minus one with and without gas. So again, in total, down 99 reported, down 53, excluding the impact of gas inflation. A little color, more color on gross margins, starting with core merchandise. The core merchandise contribution to gross margin was lower by 46 basis points, ex-gas inflation in the quarter. Sales mix negatively impacted the core, primarily from the lower sales penetration of total core sales relative to our gasoline sales, which were very strong in the quarter. In terms of the core margins on their own sales in Q3, our core on core margins were lower by 39 basis points. Approximately two-thirds of this coming from fresh foods. Fresh experienced a very difficult compare versus last year when the extraordinary volumes produced lower D&D and higher labor productivity a year ago. Also contributing to the fresh decline this quarter were higher raw material costs and higher labor costs due to our new wages. Ancillary and other business gross margin, again, higher by six reported, higher by 18 basis points, ex-gas inflation. Gas, travel, and business centers were better year over year, offset somewhat by e-comm, pharmacy, and optical. Again, 2% rewards, higher by eight reported, higher by three ex-gas. LIFO, minus 25 and minus 27 ex-gas as we recorded $130 million charge in the quarter for LIFO. and other was minus one basis point, both with and ex-gas inflation. This included items from both years. Last year, we had 14 million of COVID expenses, primarily premium wages within gross margin. This year, we had a one-time charge discussed at the beginning of the call, 20 million of the 77 million of which related to gross margin. The net result of these two items, again, minus one basis point. And while we continue to mitigate the impact of price increases as best as we can, we remain comfortable in our ability to pass through higher costs while providing great value to our members. Moving to SG&A, we showed good results. Our reported SG&A in the third quarter was lower or better year over year by 84 basis points, coming in at 8.62%. And that compares to last year's reported 9.46%. SG&A figure. That's, again, 84 basis points lower or better and 44 basis points excluding the impact of gas inflation. Again, if you jot down the following for our SG&A matrix, again, two columns. The first column being reported SG&A. The second column SG&A X the impact of gas inflation. And we have five rows. The first row, operations. Second row, central. Third row, stock compensation expense. Third, our fourth row, other, and then total is the fifth row. In terms of our operations on a reported basis, SG&A was better by 68 basis points. And X, the benefit of gas inflation, better by 35. Central, better by 15 reported, better by 10 X gas. Stock compensation, better by two reported, better by one X gas. And other, minus one and minus two X gas. Again, all total, for 84 basis points lower or better. and 44 excluding the benefit of gas inflation. In Q3, year over year, the core operations component of SG&A was better by 68, again, 35x gas. Keep in mind, this result includes the starting wage increase we instituted this past October, as well as eight weeks of the new wage and benefit increases just implemented during Q3 on October 14th of this year. Central was better by 15 and better by 10 without gas. Stock comp plus two, plus one without gas. And again, other minus one basis point, minus two without gas inflation. Similar to gross margin, this included items from both years. Last year, we had 44 million of COVID expenses. And this year, we had a one-time charge, again discussed at the beginning of the call, 57 million of the 77 million which related to SG&A. The net result of these two items, again, minus one reported, minus two ex-gas inflation. So, all told, reported operating income in Q3 of this year increased 8%, coming in at $1.791 billion. Below the operating income line, interest expense was $35 million this year versus $40 million last year. And interest income and other for the quarter was higher by 44 basis points year over year, primarily due to favorable effects. Overall pre-tax profit, pre-tax income came in for the quarter up 11%, coming in at $1.827 billion, and that compares to $1.65 billion, which we reported a year ago. In terms of income taxes, our tax rate in Q3 was 24.9%. That compares to 25.2% in Q3 last year. Overall, for the year, our effective tax rate is currently projected to be between $0.26 A few other items of note, warehouse expansion. In Q3, we opened one net new warehouse plus two relocations. Q3 year-to-date, we have opened 17 warehouses, including three relocations, for a net of 14 new warehouses so far this fiscal year. For the remainder of the fiscal year and in Q4, we expect to open an additional 10 new warehouses. which will put us at 27 for the year, including three relocations, and for a net of 24 net new warehouses for all of fiscal year 22. The 24 new warehouses by market are 14 in the U.S., two in Canada, and one each in Korea, Japan, Australia, Mexico, Spain, France, China, and our first opening in New Zealand, which will occur in August of this year. In terms of the new openings this year, this is four fewer than what we projected in Q2. Two of the four were impacted by supply chain issues related to electrical equipment, and the other two have been delayed due to third-party site development issues. All four of these buildings are now scheduled to open by the end of calendar November this fall. Incidentally, there are three in the U.S. and one in Australia that were delayed. The one net new opening in Q3 was a business center located in San Marcos, California, and the first of the ten scheduled to open in Q4 opened this past week in Riverton, Utah, bringing our worldwide total to 830 Costco's as of today and around the world. Regarding CapEx, the Q3 F22 spend was approximately $854 million. Our full-year CapEx spend is estimated for the year to be just shy of about $4 billion. In terms of our e-comm business, e-comm sales in Q3 FX increased 7.9%. This is on top of the 38% increase a year ago. Stronger departments in the quarter were special order, patio and garden jewelry, and home furnishings. Our largest econ merchandise department majors, which includes consumer electronics, appliances, TVs, was up a little bit better than mid-single digits on a very strong sales increase a year earlier. And Costco grocery, including our third-party delivery, two-day dry, fresh, and frozen, continues to grow up low double digits in the quarter. An update on Costco logistics. Costco logistics continues to drive big and bulky sales for us. We average more than 58,000 stops a week in the third quarter. For the full year, we estimate total deliveries will be up 23% and will exceed 3 million. With logistics, we continue to transition from vendor drop ship to direct ship from our own inventory. particularly in big and bulky items. Overall, this lowers the cost of merchandise and improves delivery times and service levels for our members. Okay, now a few comments regarding inflation. First of all, it continues. Pressures from higher commodity prices, higher wages, higher transportation costs, and supply chain disruptions, all still in play. For Q1, we estimated price inflation was in the four and a half to five percent range. For Q2, we had estimated six-ish, if you will. And for Q3, in talking to our merchants, estimated price inflation was in the seven-ish percent range. However, we did see inflation in fresh foods come in slightly lower in Q3 versus Q2 a year ago as we began cycling high meat prices. We believe our solid sales increases and relatively consistent margins show that we have continued to strike the right balance in passing on higher costs. Switching over to inventory for a minute, our total inventory in Q3 was up 26 percent year-over-year versus up 19 percent in Q2. A couple of high-level comments regarding inventory. A material component of the increase year-over-year is inflation rather than unit growth. We continue to expand open new locations, 20 new in the last 12 months. We are lapping some low stocks in certain departments as a result of last year's high demand. And we are purposely building inventory in our econ business, primarily in big and bulky categories, as mentioned earlier in the call. Food and sundries and fresh is in very good shape. Our week supply is comparable year over year. Non-food inventories are up in certain categories. This is in part a result of being light in certain departments last year, specifically seasonal, lawn and garden, TVs, appliances, and sporting goods. Otherwise, we are a little heavy in small appliances and domestics, primarily due to late arriving merchandise this year. In addition, we have a few hundred million dollars of extra inventory in both late arriving holiday merchandise from last season, which we're storing until this fall, and some buy-in merchandise to ensure proper inventory levels in the face of these ongoing supply chain issues. Speaking with Craig, Ron, and Claudine Adamo, our new head of merchandising, we feel good about our current inventory levels. The additional inventory we're carrying is in the right departments, and they feel good about our ability to move it. A quick update on China. Our first opening in China, located in Menghong, Shanghai, was closed for the last six weeks of the third quarter. That closure had a negative impact in the quarter of approximately $35 million in sales. As of May 18th, we're happy to report that building is back open, but operating under restrictions on the number of people that can be in the building at one time, among other cleaning and operating restrictions. Our second building in Shuzhou, which opened in December, this last December, has largely avoided the lockdowns and restrictions to this point. We are currently targeting an opening date of this December for our third Shanghai building in Pudong. The timing, although, will somewhat depend on the area remaining open for the next several months and not being more negatively impacted by lockdowns. Four additional China buildings are currently underway and planned. With opening dates in the next two years, these would be our first China openings outside of Shanghai. I believe we have, of those four, one is in fiscal 23 and three in fiscal 24. As a reminder, in terms of upcoming releases, we will announce our May sales results for the four weeks ended Sunday, May 29th. This next week on Thursday, June 2nd, after market close, This is a day later than our traditional Wednesday release due to the Memorial Day holiday. Before wrapping up, a quick shout out to the 300,000 worldwide Costco employees around the globe and the excellent work and proactive effort they give each day to navigate during these most challenging environment. Our merchants and operators are the best in the business and their hard work is reflected in our strong operating results. Finally, I want to address some incorrect information floating around on social media and a few other media outlets claiming that we have increased the price of our $1.50 hot dog and soda combination sold in our food courts. Let me just say, the price when we introduced the hot dog soda combo in the mid-'80s was $1.50. The price today is $1.50, and we have no plans to increase the price at this time. With that, I will turn it back over to Erica and open it up. for Q&A. Thank you.

As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Simeon Goodman with Morgan Stanley.

Hey, Bob. How are you doing?

Good.

Who's going to whisper the answers if you're the one doing all this? I got help. Okay, I hear it. Can you tell me, on the core-on-core margin, X gas, it looks like underlying run rate got a little worse, which I don't think is a big surprise given what we're hearing out there. You mentioned in the core-on-core, the perishable year-over-year margin. But is it safe that – is it transport or is it there's some markdowns on erratic inventory coming in? Can you talk a little about what's happening there? Thanks.

Yeah, on the fresh side, we literally had no D&D last year. And we had, you know, we had very high labor productivity because of the pounds that we were going – you know, that we were processing, if you will. So I think we've kept a lot of that leverage, actually. We're way above pre-pandemic levels. It's just it was extraordinary last year. And I think we'll keep some of that, but it's not all that. And then a little bit of it is, like I said, raw material costs this year. I mean, those eventually make their way into the price of our goods. But as you know, we're not the first one to go up when we have higher costs. I think just recently, it may have been after the end of the quarter, reluctantly, but we took up the price of our muffins and our croissants, I think a dollar, as the price of a lot of those raw materials have continued to escalate to two and three and four times what they were last year. So that's essentially what's going on there.

Got it. Maybe my follow-up, is anything happening on trip consolidation, items per trip rising, anything that, you know, I'm sure, you know, this is a question you're ready for.

Yeah, you know, honestly, we're not seeing a lot of change in our throughput in the buildings. I mean, we're seeing a lot of traffic. We're not seeing a lot of, you know, we're not seeing trade down, really. We're seeing a little bit of shift in where people are spending their money. You know, last year there was more stuff for the home and that, and this year it's more sales and tickets and restaurants and travel and tires and gas and things of that nature. But we're still holding our own in areas like apparel and furniture and jewelry, TVs, appliances. All those departments are showing good, you know, decent sales growth on top of pretty good numbers a year ago. I would say overall, there might be a very small amount in terms of the number of items in a basket this year, a little less than last year because there was more trip consolidation going on a year ago, I think, during COVID. But overall, I think we feel pretty good about what we're seeing and how our members are shopping.

Okay. Thanks, Bob. Take care.

Your next question comes from the line of Chuck Grom with Gordon Hassett.

Okay, thanks a lot. Good job, Bob. Today. I just curious, Craig's view on balancing the desire to show value quickly lately, as the macro backdrop continues to get more uncertain, while also passing on some price increases, you know, like you articulated, you know, inflation up anywhere between five to 7%. But we know in some cases, the pressures are much higher. So just curious where where Craig is on that balance.

Well, look, I think we always want to be the best value in the marketplace. And to the extent that we continue to show that, I think it's easier for us to pass on higher pricing or higher freight costs or raw material costs, assuming that we show that value in the marketplace. And that's what it's all about, really. And I think we feel good about it. I mean, our most recent shops against who we watch most closely have not changed. And we're every bit as competitive as we've been, notwithstanding the fact we have taken some prices up in certain areas, in food and sundries and in fresh foods.

Okay, great. And then on the core-on-core, you talked about two-thirds being fresh. Just wanted to just give us some color on some of the discretionary categories.

Well, I think that the balance was slightly more in non-foods than in foods in terms of the remaining third of the lower I'm not sure I have specifics right now on certain specific categories. I mean, again, it's not really a category. We're an item business, and so it's all about certain items where we might move or not move.

Okay, cool. Thanks, Bob.

Thanks, Chuck.

Your next question comes from the line of Christopher Horvers with JP Morgan.

Hi, thanks very much. This is Megan Alexander on for Chris. Maybe a follow-up to Simeon's question. Are you seeing any pressure from rising fuel and diesel with regards to transportation in that core-on-core? And if so, it seems like they accelerated pretty quickly at the end of April. Are you holding back any of the price increases on those costs such that it's impacting core-on-core maybe more than normal?

No, I don't believe so, Megan. I mean, I think overall there's higher transportation costs across the whole supply chain, whether it's ocean freight or trucking or the price of fuel, et cetera, et cetera. I think eventually those costs make their way into your sell price. Again, it's not like anything else. We tend to drag a little bit compared to others, but I don't think there's a material change since the end of April in terms of how we're managing that.

Got it. Okay, that's helpful. And then maybe just a quick follow-up on LIFO. You know, since price increases have continued, it seems, you know, does that pressure continue to accelerate going forward? And then do we ever, you know, kind of get that back as we lap, or does it depend, you know, on what the cost environment looks like?

Yeah, well, I certainly can't be predictive and tell you exactly where it's going, but We've obviously seen more inflation as the years progressed. If we stay at this level, there will continue to be some impacts to our P&L. If we start to see deflation, if we were in a deflationary environment next year, yeah, we would get some of that back. But we've got a ways to go. I think everybody thinks we're still in a cycle of more inflation versus it stopping. To be fair, this is the first time when we get into Q4 that we'll actually start cycling some of the beginning of this last year. And I think we had a small LIFO charge in Q4 a year ago. So I'm not predicting, but we saw a little bit of decline in our fresh food inflation in this past quarter. Will we see some of it in other areas as we enter Q4? Maybe, but that could be offset by higher costs in other areas in the supply chain. And then, of course, that higher level of inflation started hitting us in Q1 and Q2 at the beginning of this year. So, you know, I really can't predict where it's going to go, but assuming we get more inflation, we'll have more LIFO charges. To the extent that reverses at some point, we'll get some credits.

Got it. Thank you very much.

Sure.

Our next question comes from the line of Scott Ciccarelli with Truist Securities.

Hey, Bob. How are you?

Good.

I guess more of a business strategy question, if you will. You had some pretty good S&A leverage, which helped offset the merchant margin compression that you saw. I guess the question is, would you have tried to pass on more price increases to protect your gross margin if you didn't think you'd have as much SG&A leverage as you were able to generate?

That's a hard one to answer. Look, we would never raise prices if we could get SG&A leverage in every single quarter from now until eternity. I mean, our goal would be to lower prices indefinitely and lower SG&A. It's all a balancing act, sure. You know, the same can be said on gross margins. I mean, everybody's read what's going on out there in the industry. Our sales in gas were very strong. Our gross margins were strong. And to the extent we're able to lever that into other areas of the business by holding prices, that's what we do. That's retail. Got it. Okay. Thank you.

Your next question comes from the line of John Hindenbuckle with Guggenheim.

Hey, Bob. I want to start with, because we're in uncharted territory here with inflation in recent times. To what degree do you guys, and I don't think you do much of this, but test, you know, we're going to take pricing up in certain places, see what the consumer reaction is, and then go more broadly. And have you seen any item by item you know, any elasticity where you'd say, okay, we're either not going to roll it out or not roll out the price increase or roll it back?

Yeah, John, you know, honestly, we don't really test markets or we won't take a market like Seattle and test taking a price up beyond our comfort level. It all comes down to value proposition. And if we feel like we can take a price up and pass on some of the costs that we're incurring in our goods, and the value proposition is still there, we'll go there. We're not testing all these items across the space. It is unprecedented times. I will tell you that because of our limited SKU counts and the small number of SKUs that each buyer actually manages, they have a pretty good understanding of where their competitive situation is in the marketplace. And they have a pretty good feel about what kind of business they can do at what price. And I think that helps us in terms of managing that.

Okay. And then maybe secondly, gas gallons, right? So, you know, what has that been up? And I guess historically, right, higher gas prices have translated into share gains for you. Are you starting to see that accelerate and drive incremental traffic to clubs?

Well, that's a good question. Obviously, our value proposition in the marketplace is best in class, and it's actually accelerated versus where it was a year ago. I think the industry demand in gallons for gas is in the 1% to 2% range. And what I can tell you is we are much better than that in the high teens to the low 20s in terms of where we've been trending. I will say we're certainly getting a lot of shops in the building when people buy gas. But given the extraordinarily high level, we're also getting a lot more members come by and top off their tank just because the value proposition in some cases is over a dollar a gallon. And those members will come by and, you know, buy five or six gallons and then be on their way. So it's difficult to measure because of the just the huge amount of volume we're getting through our stations right now.

Okay. Thank you.

Yep.

Your next question comes from the line of Karen short with Barclays.

Hi, thanks very much. So two questions, you know, Bob obviously addressed the membership component that everyone has on their mind, but I guess what, what I'm curious to hear from you is, I think you've wavered, you know, in one direction and another direction, like based on the last four months. And so I'm curious to hear why you are kind of steadfast now that you would not raise membership fee. Not that I necessarily think you should, but obviously you've taken a stance. So that's my first question.

Well, I don't think we've really wavered. I think once we get a year out, or a year and a half out from that five and a half year cycle, we frankly just start to get a lot of questions about it. And the commentary in the prepared remarks is really more about just saying at this time, we don't think it's right for us. We're not saying that we're not going to do it. We're just saying it's not right for us right now. And I think that's the same answer we had three months ago when we talked about it on the second quarter call. So I don't think anything's really changed, other than we're just not at the five-and-a-half-year cycle yet. Does that make sense?

Okay, that makes sense. Yeah, that makes sense. And then, you know, you made two comments just in terms of I think you said you were a little heavy in small clients. and holiday inventory, but you feel good about your ability to clear the inventory. So I just wanted to clarify what exactly you mean on that in terms of preparing potentially for a slowdown with the consumer and or if you're thinking there may be or if you're not thinking there is and where you're at on that broadly.

Well, I can't tell you whether I think there's going to be more pullback in, you know, a month or two months or three months. I mean, again, we feel really good about our ability to drive traffic and drive our members in and, frankly, the ability to drive the top line. When I spoke to Ron yesterday about this, look, he thinks that, you know, we got a couple extra weeks to apply in a couple areas, and he thinks we can move through the inventory quickly. without really a lot of heartburn or problem. On the seasonal stuff, a lot of that is just Christmas stuff that came in late. We've got it in deep freeze, and we're going to put it out this fall, and we're probably going to put it out at pretty good values because the price of all that stuff has gone up. So we feel pretty good about being able to move that. And then the other comment I made is just more – more inventory that we think makes sense to have like masks and things like that, where if there's some kind of hiccup in COVID, we're well prepared. So I don't want to say strategic, but it's, you know, it's a little bit more inventory than we might typically carry in a kind of non-environment like we're in now.

Okay. Sorry. Just to sneak one last one in, in terms of the fuel, obviously that's a huge draw for you to your stores. Is there any update on the conversion into the store during your open hours in terms of people filling up the tanks and then actually going into the store conversion? Because I think that's historically been 70-ish percent during open hours.

No, no, no. That number has been like 50 percent. I'm not sure where 70 percent came from. That number has come down slightly. And again, because what I mentioned earlier, we have a lot more members coming by and topping off their tank. But the overall number of shops from people buying gas is probably up. It's just the percentage is down because we have way more people going through the stations. So the penetration is down a little bit, but the number of relative shops is up probably. Okay.

Okay, I thought it was 70% during open hours and 50 overall, but maybe I was wrong on that, so thank you. Yep.

Your next question comes from the line of Edward Kelly with Wells Fargo.

Hi, guys. Good afternoon. I was hoping that maybe you could share some thoughts on the outlook for the gross margin in fiscal Q4. As we sort of think about some of the pieces, year over year the core compare kind of looks easier, but it's not really on a two-year basis. It seems like you're probably still going to have LIFO. I don't think fuel margins are off to a very good start at all, but maybe that's just because gas prices are rising and obviously it's a long quarter. I'm just kind of curious is that the expectation that we should have around the current quarter

Yeah, and I wish I could be more transparent about what our budgets are and everything, but we really don't guide in terms of where gross margins are going to be. I think it continues to be a challenging environment. I think we feel good about our ability to pass through certain costs. In other areas, we don't feel as good about it, and we want to hold prices. So I think it's – I can't tell you, you know, where exactly it's going to be. I think it's – if I had to kind of – it'll be – it'll look much like what you're looking at this quarter, you know, maybe a little less, maybe a little more. But other than that, we really just don't – we don't guide, you know.

Yeah.

Yeah. Okay.

That's helpful. Yeah. Yeah. All right. Well, the other thing that I wanted to ask about, and you kind of touched on it, is just – you know, how you're navigating product cost inflation and pass through, you know, the customers. And I know historically, you know, you would lag competition. I think maybe those, like the length of that lag has maybe been, you know, reduced to some extent. I don't know if that's true. Just sort of call it there. And then, you know, what have you been able to do from a, you know, a vendor standpoint? Because, you know, you don't sell a lot of SKUs, right? So, you know, you do have you know, some real scale advantage, you know, within those products. So I'm just kind of curious as to how, you know, those negotiations are going as well.

Well, look, like we've always said, our first goal is to mitigate any price increase. And our first goal is to partner with our vendor and figure out if there's a way to mitigate it for both of us. And that's the strategy. It's certainly more difficult times because there's more pressures coming from different areas. It's not just raw material costs. It's labor. There's more factors involved in it. But look, as you alluded to, we do a lot of volume in a relatively small number of BISCUs. We're very important to our suppliers in terms of the volume we do in some of these, and so they work with us. And I think at the end of the day, again, it's about showing the best value proposition in every item that we have on the shelf. And to the extent we're able to pass on some of those costs and we still show a great value in that item, then that's great. In some instances, maybe we're not able to do that as effectively. But overall, I feel pretty good about our merchants being able to navigate through this. We've had a lot to navigate through the last couple quarters, and And I think I feel good about our ability to continue to do it as we look out into Q4 and then into the next fiscal year.

Okay, great. Thank you.

Your next question comes from the line of Peter Benedict with Baird.

Oh, hey, guys. Thanks for taking the question, Bob. Nice job. Question on private label Kirkland Penetration, just maybe where that sits relative to maybe a year ago. And are you seeing any – Any particular areas where you're getting stronger traction or growth rates are picking up there? Just curious how the consumer is behaving around private label.

Yeah, we actually took a look at that, and we were up a little bit in terms of penetration, probably 30 or 40 basis points. We're still doing a lot of business there, but again, we're not, as I mentioned earlier when I was talking about the consumer, we're not seeing, I don't think, a lot of trade down or trade out from branded into our private label. So we continue to grow it, but I think in a way that makes sense for our business, and our consumers really aren't changing how they're shopping with us. I think we're up four-tenths, I think, somewhere around the 26th. 26 and change a number in terms of penetration on a global basis.

Got it. Okay, that's helpful. And then just, I think you mentioned the higher year one renewal rates. I'm just curious maybe how long you've been seeing that. Is that a U.S. dynamic? Is it an international dynamic? Is it happening everywhere? And maybe frame the numbers a little bit just to how much better it's been. Thank you.

Sure. Yeah, sure. We have historically been, depending on the country and the area, somewhere in the kind of low 50s to low, sorry, high 50s to maybe 60, low 60s. And those numbers now are depending on the country in the high 60s and low 70s. So we've gradually seen over the last two years since the pandemic started about a 10% bump in our first year renewal, our first year members, if you will. which we do is very favorable because we obviously signed up a lot of new members that hadn't tried us before the pandemic. They tried us, had a good experience and we're seeing better retention rates out of those members.

Yep. Well, certainly better than it going to the opposite direction. So, uh, good job. Thanks very much. Thanks. Thanks, Peter.

Your next question comes from the line of Paul as we would city.

Hey, this is Brandon Sheet. I'm on for Paul. Yeah, just wanted to ask about supply chain bottlenecks. Any particular categories that have improved? Any that have gotten worse? I think some of your competitors have mentioned, you know, general merch and furniture as some categories that have been challenging. Just wondering if you all are seeing that as well. All improving previously.

Yeah, I'm sitting here with Ron, and he's indicating to me that we're pretty much across the board improving everywhere slightly from where we were. It's not really in any one particular category. I think part of that is there's 40 or 50 ships in LA now instead of 100 or 120. And the fact that we've been able to utilize our own ships to kind of help get product over here I think it's just improved a little bit across the board in everything that we're purchasing.

Thanks. And I think in the past you've mentioned that if you did have shortages, you would be able to kind of switch out a vendor or utilize an existing vendor for new product. Has that kind of slowed because the supply chain's improved?

Look, we certainly are able to pivot more easily because we have less category business and more item business. So to the extent we're having difficulty in a particular item or have a hard time showing value in a particular item, we are able to pivot over into something else and put it in the warehouse. I think that's just part of our DNA, what we do here every day, whether it's in the environment we're operating in now or in a normal environment. I think it's just a competitive advantage based on our, you know, the structure of our business.

Yeah. Appreciate it. Thanks and good luck.

Great. Thanks.

Your next question comes from the line of Rupesh Parikh with Oppenheimer.

Good afternoon. This is actually Erica Eiler on for PESH. Thanks for taking our questions. So I guess first, you know, you touched on gas prices and, you know, driving traffic to clubs. I was just curious, you know, given the gas price dynamics out there right now, do you think that's driving more memberships at all to clubs, you know, as perhaps consumers, you know, seek out more value in this environment?

Sure. Sure, yeah. Sure. I mean, absolutely. I think every member that signs up, you know, has a different reason, but sure, absolutely. Particularly given the extreme value proposition in gas right now.

Okay. And then, and then just, you know, shifting gears kind of back, back to discretionary, you touched on, you know, seeing consumers, you know, spend in other categories, which is, you know, what we're hearing from, you know, everyone out there right now. And just curious, you know, based on what you're seeing today, has anything surprised you in terms of, you know, the shift by category that you're seeing right now that perhaps you hadn't planned for?

You know, not really. I mean, some of the areas I mentioned, like sporting goods, well, you know, all the gyms are opening up again. And within sporting goods, it's really exercise equipment that, you know, we sold a lot a year ago. And this year, people are back at the gyms. Office is down a little bit. And, again, people were setting up home offices and working from home a year ago. So it's no surprise to us that that department is a little bit softer than a year ago. So, not really. I think the categories that we're seeing be a little bit softer than we expect or categories that we expected to be soft. It's not a big surprise.

Okay, great. Thank you.

Sure.

Your next question comes from the line of Kelly Bania with BMO Capital.

Oh, thanks, and well done, Bob. Just another question. As you think about that 7% inflation that you mentioned, can you maybe give us a little color on how that looks on the food and consumable side versus the discretionary side of the business? And as well, is there any difference in your ability or willingness to pass on some of the inflation on either side of the aisle there?

I would say... I would say in terms of our, we're certainly seeing higher inflation in certain non-food areas, although mix is bringing that down. You know, you're going to sell fewer, say, I'm making this up, but patio sets that are up, say, 10%, than you are, say, a piece of apparel that might be up less so. It's going to be less of an impact on a smaller priced item. I think overall the inflation that we're seeing is relatively the same. Again, we're an item business, so we're certainly seeing it higher than that in some items and lower than that in other areas of the business. I think, again, I hate to keep using this term, but it's all about the value proposition. Our willingness to take pricing along or take pricing up depends on what our position is in the marketplace. And to the extent we continue to show great value, it's a little easier to do that.

Okay. And maybe just to follow up in terms of just big ticket in general, can you just maybe talk about how that's trending? And do you think about maybe planning big ticket just a little bit more conservatively? or just help us understand the internal thought process about just big ticket in the current environment?

Yeah, well, again, not to keep using this term, but we're an item business, and I think we're seeing great strength in furniture right now. We're seeing great strength in patio. We didn't have as good inventory supplies a year ago, and we have more inventory now, and so we're able to move that product. Things like exercise equipment isn't as selling as much because... Or barbecues, for example, everybody bought a barbecue last year because everybody was home and cooking from home. Certain items like that are not selling as well this year. I think the good thing for us is we're so broad-based in terms of the merchandise that we sell that I guess we don't really look at it as big ticket. Appliances is another example. Appliances are very strong this year. Now, again, we had a little bit of a supply constraint last year, more issues with chips. That's getting better. It's not solved. But we're in better stock this year, and we're certainly selling more appliances than we did a year ago. And those are the biggest of ticket items. What? What about it? Oh, my guys were saying travel, not really a. a big ticket, but an experience. And, you know, with everybody pent up for two years and not traveling, yeah, that business has taken off like mad. So there's a lot of discussion and talk about a recession coming, but if you look in our buildings and if you've been on an airplane lately, you'd never notice it.

Perfect. Thank you.

Yep.

Your next question comes from the line of Laura Champagne with Loop Capital.

Thanks for taking my question. Can you talk specifically about what you're seeing in renewal rates in China? I know that at first you had such great member growth there, but I'm interested in how well you've retained those customers, just given what they've been through over the past few years.

Yeah. Laura, you know, I don't have those in front of me, actually. If you want to Ping me offline. We can maybe give you a little bit more color. I do know that they're slightly lower than we've seen in some markets because we signed up so many members in those first two warehouses. And so I know the retention rates are a little bit lower as a percentage. But part of that is, you know, when we opened our first building there, it was the only building. And now that we have two buildings with a third coming on the Shanghai market, you know, it's going to change the dynamics a little bit.

Got it. And then just a detail on that one-time charge. Did you add a vacation day just basically because Juneteenth was made a holiday, or is there something else going on there?

No, it was just for each and every employee to use as they fit. It's essentially an additional floating holiday that each employee could use for a specific day that's important to them.

Got it.

Thanks. Why don't we take one or two more, and then David, Josh, and myself will be available for some offline questions.

Okay, and your next question comes from the line of Greg Mellage with Evercore ISI.

Hi, thanks. Bob, could you give us a little more insight into the ancillary businesses margin going up? Is that travel coming back? What's really driving that?

Well, certainly gas was the biggest driver in there. And I think we mentioned that travel was also one of the beneficiaries. What was that one?

And so penny profit and gas, we should accept that that was actually up year over year.

It was up year over year. But keep in mind, the price of gas was up 40% year over year.

The margin, yep.

Yep, yep.

Got it. And then a housekeeping on the day vacation, the charge, the $77 million, is that an accrual for the year or is that now in the base and we should see that each of the next four quarters?

It's both. The $77 million was essentially to get on the books the cost of that vacation for each employee at that time on March 14th, if you will. And then the ongoing cost of that is in our regular SG&A and benefit costs each quarter, correct?

Got it.

And those costs for Q3, or I should say the eight weeks of Q3, were just in the regular SG&A numbers.

Got it. So now, so presumably that was eight weeks of Q3, and we can just look at the weekly and sort of use that running forward.

Well, we didn't give you what it was by week. That's what it was for the year.

Oh, that's what it was for the, so the 77 was for the year.

Correct. There were additional costs per quarter relating to the eight weeks for that benefit.

Got it.

Okay.

All right. That's great. Thanks a lot.

Yeah. Thanks, Greg.

Your next question comes from the line of Stephanie Wissick with Jeffries.

Hi, thanks for squeezing us in wanted to see if you could give any color on new member growth. I know you talked about gas was a benefit to attracting members and you didn't see a lot of trade down for existing members, but didn't know if you could talk about maybe any new members joining the club for savings on food or non food specifically.

Well, we don't really ask each member when they sign up why they're signing up. I'm hoping that there's a different value proposition for each and every member that entices them to be a member and sign up. The one thing I can add on to that is we are getting more strength in terms of the number of members that sign up digitally. And that's really grown throughout the pandemic and become a bigger percentage of our growth as well. And I think some of that has to do with some of our online offerings, particularly in St. Grocery. If you don't live within 10 or 15 miles of a club, but in the pandemic you tried us, you lived a little bit further away, you had a good experience, you signed up digitally and you stayed digitally, and you might use us half digitally and half in the warehouse. I think it's a different reason for everybody, really. It just depends on your preferences.

Okay. And then lastly, on renewal rate, that was strong in the quarter. I was wondering how that was versus your expectations and also the MFI growth versus your expectations as well. Thank you.

My guys are telling me I didn't know, but I think it was pretty much in line with what our expectations were. When you take a look at what's driving that, we continue to convert more base members to the executive member program who tend to renew at a higher rate and have more loyalty with us. That's contributing to that. We see that every week, so we know that's going to help the renewal rates. So I think based on, you know, watch, and of course, the first year renewal rates that are improving, we know that's going to help the number as well. And signing up more members. So all that I think is contributing to those improved metrics, if you will. Thanks, Bob. That's helpful. And auto bill. Yeah. Okay, if there's no more questions, we'll call it a wrap. I appreciate everybody dialing in today. And again, David and Josh and myself are available if you guys have any follow-ups. Have a good day.

This concludes today's conference call. Thank you for participating. You may now disconnect.