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 a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. 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 to today's conference call to review our third quarter fiscal year 2022 operating results. Before we begin, a couple of housekeeping items to take care of. First, as you may 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 our 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 2022, the 12 weeks ended this past May 8th. Net income for the quarter was $1.353 billion, $3.04 per diluted share. The reported $3.04 included a one-time $77 million pre-tax charge, $0.13 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, $2.75 per diluted share, which included $57 million pre-tax or $0.09 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, effective 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 are reflected in SG&A and margin for this quarter and will be in for subsequent quarters. Net income for the first 36 weeks of fiscal 2022 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 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 US 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-commerce 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 US came in at up 10.7%, Canada better by 12.8%, other international up $9.1 million, and on a total company basis, ex gas inflation and FX headwinds better by 10.8%, and e-commerce just below 8% at 7.9% for the quarter. In terms of Q3 comp metrics, traffic or shopping frequency increased 6.8% worldwide and up 5.6% in the US. Our average transaction was up 7.6% worldwide and up 10.4% in the US during the quarter. And foreign currencies relative to the US 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 were 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 an all-time high. At Q3 end, our US and Canada renewal rate was 92.3%, up 0.3% 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 0.4% from what we reported at Q2 end. Renewal rates continue to benefit from the increased penetration of both auto renewals and more executive members. In addition to that, higher first-year member renewal rates than we have historically seen. In terms of member counts, number of member households and cardholders at Q3 end, 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 Q3 end, our paid executive memberships were 27.9 million, and that's an increase of just about 800,000 during the 12 weeks since Q2 end. 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 to 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 5.5-year time frame, and our last increase coming in June of 2017. As we approach this 5.5-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 is 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 metrics. 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 merchandised 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 ex-gas, ancillary and other plus six reported and plus 18 ex-gas, 2% rewards plus eight and plus three; LIFO, minus 25 basis points on a reported basis and minus 27% ex 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-com, 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 a $130 million charge in the quarter for LIFO and other was minus 1 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, which related to gross margin. The net result of these two items, again, minus 1 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 ex the impact of gas inflation. And we have five rows: the first row operations, second row central, third row stock compensation expense, fourth through 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 ex the benefit of gas inflation better by 35. Central better by 15 reported, better by 10 ex gas. Stock compensation better by two reported, better by one ex-gas and other minus one and minus two ex gas. Again, all totaled 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, 35 ex 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 14 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 FX. Overall, pre-tax profit – pre-tax income came in for the quarter at 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 26% and 27%. 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 new warehouses for all of fiscal year 2022. The 24 new warehouses by market are 14 in the US, 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 US 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 10 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 2022 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, comm sales in Q3, excluding 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 e-comm merchandise department managers, 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 averaged 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. 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 estimate price inflation was in the 4.5% to 5% range. For Q2, we had estimated 6%-ish, if you will. And for Q3 and talking to our merchants, estimated price inflation was in the 7%-ish 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% year-over-year versus up 19% 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 and 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 e-comm business, primarily in big and bulky categories as mentioned earlier in the call. Food and sundries and fresh is in very good shape. Our weak 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 Minhang, 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 18, 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 Suzhou, which opened last December, has largely avoided the lockdowns and restrictions to this point. We're 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. It would be opening dates in the next two years. These would be our first China openings outside of Shanghai. I believe one of those four is in fiscal 2023 and three are in fiscal 2024. As a reminder, we will announce our May sales results for the four weeks ending Sunday, May 29, on Thursday, June 2, after market close. This is one day later than our usual Wednesday release due to the Memorial Day holiday. I want to take a moment to acknowledge the 300,000 Costco employees worldwide for their outstanding work and proactive efforts in navigating these challenging environments. Our merchants and operators are the best in the business, and their dedication is evident in our strong operating results. Additionally, I want to clarify some misinformation circulating on social media and other media outlets about an increase in the price of our $1.50 hot dog and soda combinations sold in our food courts. The price when we introduced the hot dog/soda combo in the mid-80s was $1.50, and it remains $1.50 today with no plans to increase it. Now, I will turn it back over to Erika and open the floor for Q&A. Thank you.

Your first question comes from the line of Simeon Gutman with Morgan Stanley.

Hey, Bob. How are you doing?

Good.

Who's going to whisper the answers, if you're the one doing all of the...

I got help.

I understand. Can you clarify the core margin excluding gas? It seems like the underlying run rate has deteriorated slightly, which isn't entirely unexpected given the current feedback we're receiving. You mentioned the year-over-year performance, but can you explain if this pertains to transportation issues or if there are some markdowns due to fluctuating inventory? I would appreciate any insight you can provide on this matter. Thank you.

Yes. On the fresh side, we literally had no D&D last year. And we had very high labor productivity because of the pounds 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 that was extraordinary last year. So – 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 our – 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, we reluctantly, but we took up the price of our muffins and our croissants, I think $1 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, I'm sure this is a question you're ready for.

Yeah. 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 – we're not seeing trade down really. We're seeing a little bit of shift in where people are spending their money. Last year, there was more stuff for the home and that – and this year, it's more sales in 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 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 the 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 Haskett.

Okay. Thanks a lot. Good job, Bob, today. Just curious, Craig's view on balancing the desire to show value, particularly lately as the macro backdrop continues to get more uncertain, while also passing on some price increases like you articulated, inflation up anywhere between 5% to 7%. But we know, in some cases, the pressures are much higher. So, just curious 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, in sundries, and in fresh foods.

Okay. Great. And then on the core on core, you talked about two-thirds being fresh. Just wonder if you could just give us some color on some of the discretionary categories?

Well, I think the balance was slightly more in nonfoods than in foods in terms of the remaining third of the lower margins. 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. That’s helpful. Thanks a lot Bob.

Thanks Chuck.

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

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 sale 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. Since price increases have continued, it seems. Does that pressure continue to accelerate going forward? And then do we ever get that back as we lap, or does it depend on what the cost environment looks like?

I can’t predict exactly where things are headed. We've seen increased inflation over the years, and if we maintain this level, it will impact our profit and loss. If we experience deflation or inflation next year, we might recover some of that. However, there’s still a long way to go, and I think most agree we are still in a period of rising inflation rather than stabilizing. As we enter Q4, we'll begin to compare against the same time last year, where we had a minor LIFO charge. While we did see a slight decrease in fresh food inflation recently, it’s uncertain whether other areas will follow suit in Q4, especially considering that higher costs in the supply chain might offset any improvements. The elevated inflation began affecting us in the first half of this year, making it difficult to forecast future trends. If inflation continues, we’ll incur more LIFO charges, but if that trend reverses, we may see some credits.

Got it. Thank you very much.

Sure.

Your next question comes from the line of Scot Ciccarelli with Truist Securities.

Hey, Bob, how are you?

Hi. Good.

Good. I guess, more of a business strategy question, if you will. You guys had some pretty good SG&A leverage, which helped offset the merch margin compression that you saw. I guess the question is, would you 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 difficult question to address. We would never increase prices if we could achieve SG&A leverage consistently in every quarter forever. Our objective is to lower prices over time while also reducing SG&A. It's all about finding the right balance. The same applies to gross margins. Everyone is aware of the current industry situation. Our gas sales were very strong, and our gross margins performed well. If we can leverage that success into other areas of the business by maintaining our prices, that's what we aim to do. That's how retail works.

Got it. Okay. Thank you.

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

Hey, Bob, I want to start by discussing how we're navigating the recent inflation. To what extent are you testing price increases in certain areas to gauge consumer response before a wider rollout? Have you noticed any specific items where you would decide against implementing or rolling back a price increase?

Yes. John, 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. I mean, 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.

I mean 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 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 some 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, 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 $1 a gallon. And those members will come by and buy five or six gallons and then be on their way. So it's difficult to measure because of the huge amount of volume we're getting through our stations right now.

Okay. Thank you.

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

Hi. Thanks very much. So two questions. Bob, obviously, you addressed the membership component that everyone has on their mind. But I guess what I'm curious to hear from you is I think you've wavered in one 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 the 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 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?

Yeah, that makes sense. And then you made two comments just in terms of – I think you said that you were a little heavy in small clients 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 or maybe if you're not thinking there is? And where are you at on that broadly?

Well, I can't tell you whether I think there's going to be more pull back in 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. What I spoke to Ron yesterday about this, look, he thinks that we got a couple of extra weeks of supply in a couple of areas, and he thinks we can move through the inventory without really a lot of harbor 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 is going up. So we feel pretty good about being able to move that. And then the other comment I made is just more inventory that we think makes sense to have like masks and things like that, but where if there's some kind of hiccup in – in COD, we’re well prepared. So I don’t want to say strategic, but its – its a little bit more inventory than we might typically carry in a kind of non-environment like we're in now.

Okay. Sorry 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%. I'm not sure where 70% came from. That number has come down slightly. And again, because of 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. I thought it was 70% during open hours and 50 overall, but maybe I was wrong. So, thank you.

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

Hi everyone, good afternoon. Could you share your thoughts on the outlook for gross margin in fiscal Q4? Considering some factors, the year-over-year comparison looks easier, but it’s not as favorable over a two-year period. It appears that LIFO will still be a factor. I’m concerned that fuel margins aren't performing well, possibly due to rising gas prices, and it's still a long quarter. What should we expect for this current quarter?

I wish I could provide more clarity, but we're uncertain about our budgets across the board and we don't typically give guidance on where we expect gross margins to be. It's still a tough environment, but we are confident in our ability to pass on some costs. However, there are areas where we aren't as confident and we want to maintain our prices. I can't specify exactly where it will end up; it may look similar to what you're seeing this quarter, possibly slightly lower or higher. Beyond that, we really don't provide guidance.

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

Our primary objective has always been to manage any potential price increases. We aim to collaborate with our vendors to find solutions that benefit both parties. The current environment is challenging due to various pressures, not just from raw material costs but also labor and other factors. However, as you've mentioned, we handle a substantial volume for a limited number of SKUs that are crucial for our suppliers, which encourages them to work with us. Ultimately, our focus is on delivering the best value for every item we offer. If we can pass on some of those costs while still providing great value, that's ideal. In some cases, we might not be able to do that as effectively, but overall, I’m confident in our team's ability to manage these challenges. We've navigated a lot in the past few quarters, and I feel optimistic about our prospects as we approach Q4 and the next fiscal year.

Okay, great. Thank you.

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

Hey guys, thanks for taking the question. Bob, nice job. A question on private label. Kirkland penetration, just maybe where that sits relative to maybe a year ago? And are you seeing 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.

Yes, we examined that and saw a slight increase in penetration, likely around 30 or 40 basis points. We're still doing a significant amount of business there. However, as I mentioned earlier regarding consumer behavior, I don't believe we're experiencing much movement from branded products to our private label. We're continuing to grow our private label in a way that aligns with our business strategy. Our consumers aren't changing their shopping habits with us significantly. I think we're up by 0.4, somewhere around a 26 and change number in terms of global penetration.

Got it. That's helpful. I think you mentioned the higher year one renewal rate. I'm curious about how long you've been seeing that. Is it a US trend or international? Is it happening everywhere? It would be great if you could provide some numbers to illustrate how much improvement there has been.

Sure. Historically, we have been in the low 50s to high 50s in various countries, reaching maybe low 60s. Now, those numbers are in the high 60s to low 70s depending on the country. Over the past two years since the pandemic began, we've experienced about a 10% increase in our first-year member renewals, which we find very positive. Many new members who hadn't tried us before the pandemic have now joined, had good experiences, and we are observing better retention rates among them.

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

Thanks. Thanks, Peter.

Your next question comes from the line of Paul Lejuez with Citi.

Hey. This is Brandon Cheatham on for Paul. I just wanted to ask about supply chain bottlenecks. Any particular categories that have improved or any that have gotten worse? I think some of your competitors have mentioned general merge and furniture as some categories that have been challenging. Just wondering, if you all are seeing that as well.

Yes. I'm here with Ron, and he is indicating that we are seeing slight improvements across the board from our previous position. It's not specific to any one category. Part of the reason is that there are around 40 to 50 ships in LA now, compared to 100 or 120 before, and we've been able to use our own ships to facilitate product arrival. Overall, everything we're purchasing has seen a slight improvement.

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 has improved?

We can pivot more easily because we focus on individual items rather than entire categories. When we face challenges with a specific item or struggle to demonstrate its value, we can transition to other options and store them in the warehouse. This flexibility is inherent to our operations, whether in the current environment or under normal circumstances. It provides us with a competitive advantage due to our business structure.

Yeah. Appreciate it. Thanks. And good luck.

Yeah. Great. Thanks.

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

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

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

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

Not really. I mean, some of the areas I mentioned like sporting goods, well, all the gyms are opening up again and a lot of – within sporting goods, it's really exercise equipment that – 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 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 are 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.

Well, 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 consumables 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 in terms of our – we're certainly seeing higher inflation in certain non-food areas, although mix is bringing that down. 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. And I think, again, I need to keep using this term, but it's all about the value proposition. And 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?

We're focused on a product-driven business, and currently, we're seeing strong demand in furniture and patio items. Last year, we faced inventory shortages, but we have improved our stock levels, allowing us to sell more products. Some categories, like exercise equipment and barbecues, are experiencing lower sales this year compared to last, as many people purchased barbecues when they were staying home. However, we have a diverse range of merchandise, which helps balance things out. Appliances, for instance, are performing well this year, despite last year's supply constraints related to chips. Although the situation isn't fully resolved, we have better inventory now and are selling more appliances than we did a year ago, which are considered higher-ticket items. Additionally, the travel sector has rebounded significantly as people are eager to travel after being cooped up for two years. While there are discussions about a potential recession, our observations in stores and airports suggest that the impact may not be as pronounced.

Perfect. Thank you.

Yeah.

Your next question comes from the line of Laura Champine 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, 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 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, 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 June 18th 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 can use for a specific date that's important to them. 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 Melich with Evercore ISI.

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

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

And so the penny profit and gas should be accepted as it was actually up year-over-year.

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

The margin, yes.

Yes, yes.

Got it. Regarding the vacation charge of $77 million, is that an accrual for the year, or is it now part of the base, meaning we should expect to see it each of the next four quarters?

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

Got it. So that...

The costs for Q3, specifically for the eight weeks in that quarter, are included in the regular SG&A numbers.

Got it. Okay. That's great. Thanks a lot.

Yes, thanks, Greg.

Your next question comes from the line of Stephanie Wissink with Jefferies.

It's Blake on for Steph. Thanks for squeezing us in. I wanted to see if you could give any color on new member growth. I know you talked about gas being a benefit to attracting members, and you didn't see a lot of trade down for existing members, but I 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 that hit – particularly in say, grocery. If you don't live within 10 or 15 miles of a club. But in the pandemic, you tried this, you moved a little bit further away, you had a good experience and you signed up digitally and you stay digitally and you might use this half digitally and half in the warehouse. So 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. Just wondering how that was versus your expectations and also the MFI growth versus your expectations as well? Thank you.

My team has informed me that our results aligned closely with our expectations. We continue to see an increase in the conversion of base members to the executive member program, which typically shows higher renewal rates and greater loyalty. This trend is evident every week and will positively impact our renewal rates. Moreover, the improvement in first-year renewal rates and the addition of more members are also contributing to these positive metrics.

Thanks, Bob. That's helpful.

In 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 I will be 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.