Costco Wholesale Corp (COST) — Q2 2022 Earnings Call Transcript

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 13, as well as February retail results for the four weeks ended this past Sunday, February 27. Net income for the quarter came in at $1,299 million 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 pretax or $0.41 per share costs, 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 increase during the 12-week period was 15.8%, excluding gas inflation, 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 reported number of 14.4% on a same-store comparable basis and up 11.1%, excluding gas inflation effects. 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 ex-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 0.4 percentage point from the 12-week earlier Q1 end. And worldwide rate, it came in at 89.6%, up 0.6% from where it stood 12 weeks earlier at Q1 end. Our 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, 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 5 basis points, excluding gas inflation. As I always do, I'll ask you to judge on a few numbers, two columns. The first column is reported, 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 basis points. 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 lower by 75% year-over-year reported and 43% minus 43 basis points ex gas inflation. Recall last year in Q2 that the core reported was plus 71 basis points in ex gas plus 63, so still improved to where we were two years ago, prepandemic 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 2/3 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 49 ex 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 $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 3 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 December 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 3% and minus 1%, 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 cost of sales related to manufacturing businesses as well as their meat and bakery departments. Overall, a pretty good showing on the gross margin, given the ongoing and increasing inflationary pressures. Moving to expenses, to SG&A. Our 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, ex 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, 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 was better again by 36, but as well better by 9 or lower by 9 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 and the additional starting wage increases from our two basic hourly scale service assisted and services by an additional $0.50 an hour that occurred in October of 2021. Central, better by 13 basis points or 10 ex gas inflation. It's pretty straightforward operating leverage on strong sales figures. Stock comp, plus 2 and plus 2, again, a reflection of good sales. And other, this plus 42 basis points, 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, 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 million this year compared to $1,340 million a year ago in the second quarter. Below the operating income line, interest expense was $36 million this year versus $40 million last year. Interest income and other for the quarter was higher by $6 million year-over-year, $25 million this year versus $19 million last year, primarily due to favorable FX. Overall, reported pretax income in the quarter was up 37%, coming in at $1.801 billion compared to $1.319 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 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 including 4 relocations. So replacing existing units with larger and better-located facilities, 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 open in Q4, our fiscal Q4, one of them or 14 net new. 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 or 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 estimated to be approximately $4.0 billion. Moving on to e-commerce. E-commerce sales in Q2 ex FX, 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%, benefiting, of course, from COVID. Stronger departments in e-commerce in terms of year-over-year percentage increases include jewelry, tires, special or kiosk items, patio and garden and home furnishings. Our largest online merchandise department majors, which consists of consumer electronics, appliances, TVs, etc., was up in the high single digits on very strong sales increases a year earlier. In terms of an update on Costco Logistics, that 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-comm less than truckload shipments from Costco Logistics, we're doing ourselves. Average during the quarter, we averaged 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-comm 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-line 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 curated items at Costco Values. Please give it a check. 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, as well as truck and driver shortages. Overall, we've done a pretty good job of managing the supply chain challenges. I think that's evidenced in our sales strength. They continue to be delayed for 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. Chip shortages are still one of the things that are impacting many items, some more than others. But again, we're managing the temporal and driving sales. One of the things that we've done that I mentioned 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. And these are for the transport of containers between Asia and the U.S. and Canada. We've also leased containers for use in these ships. With these additions, about one-fourth 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. From 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 their place. And again, some things are seeming to get a little better. Moving to inflation. Inflation, of course, continues, as evidenced by our LIFO 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 shortages and port delays that I just mentioned. Increased demand in certain product categories, various shortages of everything from computer chips to oil chemicals to resins. Higher commodity prices from foodservice 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, and 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 to keep - in order to keep the products that we need pivot when and where necessary, keep our warehouses full like keeping prices as low as we can for our members and continue to show great value versus our competitors. Now turning to our February sales results, the four weeks ended this past Sunday, February 27, 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 1. That's 11 days earlier this past year than last. This shift negatively impacted February's Other International by about 4 percentage points and total company by about 0.5 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 ex gas and FX, a 1.3% to the positive. Total company, 14% and 10.6%, and e-comm within that number is 10.2% reported and 10.4% ex 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 0.2%, Other International by approximately 4.5% and total company by approximately 0.7%. 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 and sundries came in at a positive high single digits, fresh foods in the mid-single digits and nonfoods a deposit of high single digits. Ancillary businesses sales were up mid-40s and with gas being certainly a driver of that as well as food courts 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 Vachris became President of Costco. Ron started his career 39 years ago at Price Company and 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. Since that time, in 2016, he has been in merchandising with certainly responsibility, not only for in-line merchandising but online merchandising as well as being 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, she came into buying and has been buying ever since and most recently was Senior VP of non-foods merchandising. And again, she'll be taking over, looking overall at merchandising. Finally, in terms of upcoming releases, we will announce our March sales results for the five weeks ending April 3 on Sunday, April 3, on Wednesday, April 6 after the markets close. With that, I will open it up to Q&A and turn it back to Jerome. Thank you very much.

Good afternoon. Richard, thanks a lot for taking my question. First one is on the fee increase for the potential for a fee increase. If there is no increase this year, should the market interpret that as some reflection of how Costco is positioning itself either? I think power, especially in light of companies like Amazon and Netflix raising their fees this year? Or should we interpret a sign as the interval with Costco potentially staying flat?

Well, I don't think you should read too much into our timing or reasoning. We always assess whether we believe we are enhancing the value of our membership. We definitely monitor renewal rates and pay less attention to what others are doing, although we are aware of their actions. I noticed that in the past 15 years, our fee increases have typically occurred approximately every 5.5 years, or specifically every five years and seven months. Given that five years from the anniversary of June 2017 would be this coming June, the question will remain until we make a decision. However, we feel very positive about our member loyalty and our success in encouraging members to upgrade to executive membership, which reflects our most loyal customers. You will be informed when we decide, and it will happen at some point, so stay tuned.

My follow-up question is on the core-on-core gross margin. Over the last couple of quarters, you've given back about 1/3 of the core-on-core gross margin gains at Costco during the hardest times like over probably the last couple of years. Is this the right way to think about what's sustainable from here? You may give back 1/3.

Yes. I wish it were that simple to plan and achieve. Sometimes, we reach our goals, but various factors can lead us in unexpected directions. There are many moving parts involved. However, we are confident in our competitive position and our ability to maintain some margin as we move forward. Our gross margins, particularly on a core-on-core basis, are still higher than they were two years ago. Two years ago, we experienced exceptionally high margins, especially in fresh products, where increases reached 20% to 30%. We nearly eliminated spoilage and significantly improved labor productivity in that area. Some of those improvements might not be sustainable, but even after accounting for some declines, we continue to show higher year-over-year numbers on a core-on-core basis. As we've mentioned, we don't boast about this, but despite inflationary pressures, we've made efforts to hold the line where possible. While we can't fully absorb all costs, we've likely been slower than others to increase prices. We've collaborated with our suppliers to share some of the burden. We believe these margins, combined with strong sales and operational efficiency, position us to be even more competitive and drive our business forward. When asked who our biggest competitor is, it's ourselves. We remain competitive, constantly evaluating our competition, and we believe our position in the market is as strong as ever.

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 are 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 efficiencies. 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.

Yes, certainly. With increased sales levels, we can achieve higher labor productivity and hopefully reduce spoilage. While I appreciate your perspective, the future remains uncertain. Over the past 35 years, we've always found a way to return some benefits when conditions improve. Currently, amid rising inflation, our priority is to ensure that products are available on the shelves while also trying to manage various cost factors as effectively as possible, which can be challenging. Nevertheless, we hope to remain competitive, if not more so than others.

I'd like to address the price gaps in the market. It seems that every company we look at in the mass and supermarket sectors is satisfied with these gaps. However, I'm uncertain if that's justified, as we're observing some increases in gross margins. It appears that competitors are raising their prices, which would suggest that the gaps should be expanding and enhancing your value. I'm interested to hear your perspective on this, especially since you have people frequently visiting stores.

We appreciate when customers feel more at ease. Our main competitor is Sam's, and we conduct competitive price checks weekly at almost all locations. We are confident about where we stand in comparison. While our competitive landscape remains challenging, our gas business has shown some strength. Reports indicate that gross margins in retail gas among supermarkets and others are improving, which provides us with some flexibility. However, we always strive to enhance our competitiveness.

Richard. 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.

Not no, and we haven't. I think certainly, the more inflation creates some demand pressure. I'd like to think some of that inflation or wanting to shop across and save more frankly. But we haven't seen that.

Okay. Okay. Great. And then just another near-term question. Historically, I'm wondering if with gas prices where they are and where they're likely to go. I heard today, California is close to $5. Historically, has there really been a tipping point? And 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, $5, Alan, and like then and now, we see our gallons improve relatively speaking because we're still the cheapest game. At some point, if it goes to $5, people stop driving a little bit, it's hard to state. I'd like to think that the hybrid models of working have helped a little bit there.

This is Brandon Cheatham on for Paul. 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?

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 increases 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 in big-ticket furniture items and the like. And more conversions to executive membership, which, again, adds more value long term to that customer, but also adds $60 to their fee.

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

It has not moderated. It continues to go up. Now it's increasing, but perhaps at a slower pace. The significant rise was likely around 4 to 2 months ago, and it has continued to increase since then. If I remember correctly, there was a slight dip in discussions with buyers during the last couple of months of the year. However, many suppliers are already in talks from 2 months prior, and by January, we will be back in touch with you.

So Richard, you guys are running with nearly double the cash balance that you historically would have run with kind of prepandemic. Obviously, there's still a lot of uncertainty in the market. I guess the question is because we've seen this pattern for probably 8-plus quarters now to continue to run with much higher cash levels than what you historically have. Or 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. And mind you, our Q2 balance sheet, Q 2 and 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 Christmas time, not a lot, but some. And frankly, knock on wood, our operating cash flow has certainly exceeded what we had expected 2 years ago. So yes, there is a little more. At some point, certainly, one of the arrows in our quiver is a special dividend along with the regular dividend increase that we've done every year, as well as some stock buybacks. But first and foremost is CapEx. CapEx this year of $4-ish million is up from the $3 million to $3.5 million over the last couple of years and up from numbers lower than that, the 2 to 4 years prior to that. So that's, first and foremost, what we want to spend money on. But we've done 4 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 the quiver, but we haven't made any decision at this point.

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 consumer is going to continue to feel a little 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 in membership at Amazon.

I think it’s not a negative factor, but ultimately, the most important points are our strong sales and our record-high renewal rates and customer loyalty. These are all positives. Additionally, we use this strength to become more competitive. Some might suggest that inflation could help us offset costs, which we are already managing without increasing fees. We've raised our fees only seven times in 35 years, and while it's possible we might consider it in the next six to nine months, we’ll have to see how things unfold. We also don’t feel concerned about the membership fees of our competitors, like Amazon or other warehouse clubs, which haven’t changed their fees in several years. Our focus is on how our actions benefit our members and how we’ve enhanced the value of our membership in the Americas. We believe we’ve done this significantly during past increases, which we use to further enhance our competitiveness. Therefore, while I can’t provide specifics, we feel confident that when we decide to act, we will be ready.

Okay. And then my second question is just on the net income margin, or I guess you could talk about pretax margin. 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 volume and leverage on strong comps, but just wondering how you would frame that?

In this quarter, we saw an improvement in our bottom line margin, driven by significant cost reductions and some margin pressures, excluding any anomalies. Our goal has always been to lower prices while increasing margins. We aim to enhance our bottom line without raising prices, and I'm not specifically addressing inflation at the moment. Some of you may recall when we held our all-hands meeting with about 300 people, we had a 2.8% pretax return on sales at that time. Our founder emphasized that as a great company, we deserve to earn good profits. Over the years, we aspire to move from that 2.8% to a higher figure, which ultimately has shown improvement despite fluctuations. We are committed to doing well for our shareholders, all while remaining competitive in pricing and value for our members.

I guess my first question is, do you look at the U.S. sort of core comp on a 2- and 3-year basis? Really, since the summer, there's been a bit more volatility to the 2 and 3 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 an all-inclusive yes. It's all of the above. I recall that we had particularly strong performance during the early Christmas holiday season, including Thanksgiving. Part of that strength came from bringing in some items early, and part was due to the increased demand generated by COVID for home goods along with shortages of those goods. Once they were available, they sold quickly. Toward the end of the calendar year, the trend was still positive but not as robust. Without further investigation, that appeared to be the reason. Additionally, we faced challenges like storms and shifts caused by the Chinese and Lunar New Year. We don't spend much time analyzing those factors; we focus on understanding why overall sales levels fluctuate. We don’t prioritize those considerations because, as we've always emphasized, we are a top-line company focused on driving sales and value. We aim to optimize our performance and don't read too deeply 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 1. It seems like there's more coming in September. I could think of Jim sort of being paranoid and worried about do we just push too far, and do we not want to risk that and invest more in price before even seeing any deterioration in the sales trends?

I would say we're more aggressive when conditions are favorable, and we maintain that aggressiveness regardless of the situation. I recall someone asking about a period of weak sales for a month or two, suggesting that was a reason to strengthen our pricing approach. This was particularly relevant due to a pending membership fee increase marking our over five-year anniversary. The perspective was that our members are loyal, and we would leverage that loyalty to boost sales. So, I don’t think our approach has changed; we inherently strive to deliver more value and remain focused on that objective. If we continue to prioritize this, no one will be able to catch up to us. It's harder to catch us at least.

And just one quick question, could you please repeat that?

Okay. I guess I'll stay on the inflation question, but ask 2 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 comp prices, in other words, not to come down and then to gain some margin in that sense?

Well, in theory, you don't get it back. If inflation continues, you should see some additional LIFO charges, maybe not as significant, but it's uncertain. At the beginning of a new fiscal year, you'll have the LIFO charge from the past year, which sets a new baseline for costs for each item. If there's more inflation compared to that starting point, you will incur additional LIFO next year. If prices decrease, for instance, if they increased by 20% one year and then fell by 10% the next year, you would have a substantial LIFO charge this year and then possibly a LIFO credit in the following year.

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 what your comfort is with your wage levels in the marketplace, just given we continue to see others raise their wages?

We continue to increase our wages just like others in the industry, and we will keep doing so. One of the main challenges we face is being headquartered in Seattle, which is becoming increasingly expensive. Additionally, we are competing against major tech companies in the area, each employing between 10,000 and 20,000 people. As a result, we've had to continuously raise wages over the past couple of years, not just in the last two weeks. We may lose some employees because we are not fully remote; we believe we have a fair hybrid work model, but some prefer to work from home. However, if you consider our overall compensation and benefits, 90% of our workforce is hourly and works in the warehouse. While there may be a few locations where we start at slightly above the entry-level wage, we have consistently raised our wages and plan to do so again.

Okay. Great. And then maybe one additional question. Just on the ancillary front, if you can just remind us where you are with your recovery versus pre-pandemic and some of the more challenged categories travel, food core, etc.?

Yes. The main issue is gas, which has been consistently rising. As I mentioned earlier, retail competitive price pressure has likely decreased over the past couple of years. Travel, as you pointed out, has experienced significant fluctuations. During the mid-2020 lockdowns due to COVID, we saw negative impacts on the business with cancellations outnumbering new orders, resulting in losses and negative revenues. However, it has rebounded somewhat, dipping slightly due to Delta, and then again due to Omicron, but now it appears to be on an upward trend. While it's not as profitable as it was two years ago, it is moving in that direction. The travel sector remains substantial, particularly in vacation packages and rental cars. Additionally, businesses such as our hearing aid and optical shops, which require in-person interaction, were closed for several weeks in mid-2020, but they have since returned. Food courts have also seen a recovery as we've reopened seating and expanded our menu. In summary, while many of these ancillary businesses haven't fully returned to pre-pandemic levels, they are making progress, and gas remains the dominant business in terms of size and profitability. Overall, ancillary operations are performing well, and those most affected are starting to bounce back.

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 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 of years and it's less volatile than it was 5 and 10 years ago in terms of a big margin fluctuation. But I don't have the detail like 2 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 of 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.

Certainly. If you had asked me five years ago what things would look like now, we were opening about 25 locations a year, let's say 26 to simplify the math. The distribution was roughly 70% in the U.S. and Canada, which are our most mature markets. Looking ahead over the next five to ten years, I would have anticipated that this would change to around 60% outside of the U.S. and Canada. Fast forward five years and we're currently seeing a 65-35 split in favor of the U.S. and Canada. This shift is due in part to our rising expectations for performance in these regions and the longer timelines we face internationally, though we're making progress with more presence and initiatives abroad. If you ask me for the next five years, I expect to see that split move closer to 50-50. The positive takeaway is that we still have many opportunities in the U.S. and Canada, and we are increasing our efforts in other successful countries. Over the next ten years, we plan to open about 16 of our 28 locations this year in the U.S., give or take one or two. We believe there’s no reason we can’t maintain an opening pace of about 15 locations per year in the U.S. Some of these may be our business centers, which now number 22 in the U.S. and five in Canada, proving to be a valuable addition. For example, in San Jose, four or five years ago, we opened our fourth location in the Greater San Jose area, and while the previous three locations were each averaging about 250 members, the four current locations are averaging around 300 members each. Although the number of members per location has decreased slightly since existing members are traveling shorter distances, there’s a blend of infilling happening. We’re now present in 46 states, so the potential for new states is limited. However, we are less penetrated compared to our competitors in certain areas, particularly in the Midwest, Texas, the South, and parts of the Southeast, and we will continue to expand there. Overall, we are far from saturating our most established markets, and we are bolstering our presence on the ground to support more openings in our pipeline.

Richard, how do you view the possibility of narrowing the gap between the two membership tiers? Are there ways to encourage more conversions to the executive tier? Have you gathered any insights from your current executive members about what features or benefits they would like that are currently not offered, which could potentially justify an increase in the annual fee?

We have been quite satisfied with our success in converting existing members to executive status and attracting new members to sign up as executives. In the past, when we launched this in the U.S., we had a much lower conversion rate, with only about 20 to 25 out of every 100 signing up as executive members. Now, that number has increased to the 50s, approaching 60, simply by demonstrating the value of the executive membership. We've improved our approach, especially when entering new countries. Currently, we are in six of the largest markets, and we typically consider introducing an executive membership after establishing at least 15 locations. While we've considered the idea of offering something even beyond executive, we often revert to the realization that our current model is effective, and there are no immediate plans to change it. Presently, about 72% to 73% of our sales come from executive members, and while we contemplate what happens if that percentage reaches 85 or 90, eliminating lower memberships isn't something we are planning for the near future. We are pleased with our current strategy, as it is functioning well.

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 in does that pick up steam in the next year or so?

I believe we will see progress in the next year or so. When we hired someone for the data analytics team two years ago, they built a strong team. We are starting to see small deliverables, particularly with merchants and to a lesser extent with some operators. These deliverables have genuinely saved our buyers' time and are currently being rolled out. In terms of personalization and targeting, we have improved our targeting, although we still have work to do on personalization, which will develop further. Thank you for your question about the timeline. Let's take two more questions.

I'll make it quick. To follow up on the unit growth questions asked earlier, it seems like you're planning to open more international stores. Should I interpret this to mean that unit growth may increase next fiscal year and beyond, considering it's projected to be around 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 5 or 6 years, we were opening 25-ish, some of the years 21 or 22-ish. The view even then was to get up closer to 30%, certainly 25% to 30%. I think this year is we're finally hitting that with the expectation of 28 in my call this morning and call it, 26 to 30, whatever it comes out to be. 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 succeed in opening the second one. One of the things is it's the biggest cost factor on warehouse P&L is labor and efficiency. When you're running a high-volume unit, it's helpful when you've got more people coming over from a nearby unit. So we are pretty methodical about growing somewhat slowly in new markets. We went from 1 to 5 20 years ago, over a 5-year period in Japan. We've sped up a little in China, thinking that we've opened 2 now in 3 years, and with another several in process and a couple more. So we've increased it a little bit, but we feel pretty good about that. 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, and over year 6 through 10, we're going to be talking about 30% to 35%, but we'll have to wait and see.

So 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 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, 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 year?

We have made some changes, though not extensively. One of the adjustments is a slight increase in our supplier diversification, especially for large SKUs worth between $300 million and $1 billion. We've also introduced some non-traditional items during winter, like bikes, which we were able to source and sell. Additionally, we are exploring new countries of origin. While these changes aren't significant, they contribute to our overall strategy. Our buying power is quite substantial for each item, and having fewer than 4,000 SKUs to generate $200 billion is a significant difference compared to managing 100,000 SKUs for revenues between $150 billion and $500 billion, depending on the retailer. We've become more flexible in our sourcing initiatives, and we're optimistic that the supply chain will improve significantly over the next couple of years. Lastly, the executive membership consists of 43% of the members and accounts for 7% of the sales. Where do these numbers stand, particularly in your more established markets? How under-penetrated is it in some of the newer markets? I'm trying to understand the potential pathway for these newer markets. Yes. Renewal rates start off lower and gradually increase over time, similar to the executive transition we're experiencing. We're performing better today, including in new markets where we added executive membership in Japan and Korea over the last couple of years. The 42% figure remains in the low 50s and climbs higher in more established markets. Although it begins lower in newer markets, it is still an improvement compared to previous new markets a few years back. Thank you very much. I hope everyone has a good afternoon and evening, and I appreciate your participation in the call.