Q2 2026 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco Wholesale Corporation Fiscal Second Quarter 2026 Conference Call. [Operator Instructions] I would now like to turn the conference over to Gary Millerchip, Chief Financial Officer. You may begin.

Good afternoon, everyone, and thank you for joining us for Costco's Second Quarter 2026 Earnings Call. In addition to covering our second quarter financial results today, we will also review our February sales results. I'd like to start by reminding you 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 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. Comparable sales and comparable sales excluding impacts from changes in gasoline prices and foreign exchange are intended as supplemental information and are not a substitute for net sales presented in accordance with GAAP. Before we dive into our results, I'm delighted to say that Ron Vachris is once again joining me for today's call. I'll now hand over to Ron for some opening comments.

Thank you, Gary. Good afternoon, everyone, and thank you for joining us today. I'll make a few brief comments about some key business priorities before turning it back over to Gary. Let me start by addressing tariffs, as I know this topic is of great interest to our members and our shareholders.

The future impact of tariffs remains extremely fluid as the recently eliminated IEEPA tariffs have now been replaced with new global tariffs for at least the next 150 days. Our buyers continue to act with great agility and urgency, always with the goal of reducing the impact of tariff on prices for our members. We believe our expertise in buying and our limited SKU count model puts us in a position to manage this as well as anyone. Our strategies include moving the country of production when that makes sense, consolidating buying efforts globally to lower the cost of goods, leaning in on Kirkland Signature, where we have the most control of the supply chain and sourcing more items domestically.

Let's move to regarding IEEPA tariff refunds. It is not yet clear what the process will be, what refunds, if any, will be received and when this will happen. Throughout the past year, we've taken action to reduce the impact of tariffs. In many cases, we didn't pass the full cost on to our members.

The complexity of the tariffs implemented over the past year, including layering of different tariffs on top of each other and multiple changes in rates throughout the year, also made it challenging to track the exact impact to an individual item sold. As we've done in the past, when legal challenges have recovered charges passed on in some form to our members, our commitment will be to find the best way to return this value to our members through lower prices and better values. We'll be transparent in how we plan to do this, if and when we receive any refunds. At Costco, we always want to be the first to lower prices and the last to raise them.

During the second quarter, we lowered prices on key items such as eggs, cheese, coffee and some paper products as we saw lower inflation in these commodities. We will continue to be a pricing authority and as some tariffs have been reduced, we are lowering prices on affected items such as certain textiles, bedding and cookware SKUs. Turning to our growth priorities. As I shared last quarter, our real estate and operations teams are focused on increasing our pipeline of new warehouses, both domestically and internationally.

Since our last call, we opened 4 warehouses, including 1 relocation in the U.S., 1 net new U.S. location and 2 additional Canadian business centers. This brings our total warehouse count to 924 warehouses worldwide. We currently expect to have 28 net new openings in fiscal year '26 and are targeting 30-plus new openings per year in the coming years. In digital, we continue to make strides with our road map to deliver a more seamless experience for members in warehouse and online.

In the warehouses, we're achieving meaningful improvements in the speed of checkout, employee productivity, both as a result of our mobile wallet enhancements, pharmacy pay ahead and the rollout of employee pre-scan technology. We're also piloting automated pay stations that will allow members to pay for their pre-scanned orders seamlessly with an average transaction time of around 8 seconds. Early results show this is improving the flow of traffic, and we've received great member feedback. On our digital sites, we continue to roll out new personalization capabilities, which are resonating well with our members and are starting to have measurable impact on e-commerce sales growth.

As consumers embrace AI and their shopping habits, we believe our commitments to providing the best value on great quality items can make Costco a beneficiary of these shifts. We're working closely with the leading AI companies to ensure our values will be visible to existing and potential future Costco members as they engage with these tools. With that, I'll turn it back over to Gary to discuss the results for the quarter, and I'll jump back on during Q&A to field some questions.

Thanks, Ron. In today's press release, we reported operating results for the second quarter of fiscal year 2026 for 12 weeks ending February 15. As usual, we published a slide deck under Events and Presentations on our investor website with supplemental information to support today's press release. Net income for the second quarter came in at $2.035 billion or $4.58 per diluted share, up nearly 14% from $1.788 billion or $4.02 per diluted share in the second quarter last year. Net sales for the second quarter were $68.24 billion, an increase of 9.1% from $62.53 billion in Q2 2025. Comparable sales were up 7.4% or 6.7% adjusted for gas price deflation and FX.

Excluding gas sales entirely and adjusting for the impact of foreign exchange, comparable sales were up 7.4%. Digitally-enabled comparable sales were up 22.6% or 21.7% adjusted for FX. Our segment breakout of comparable sales is disclosed in both our earnings release and the supplemental slide deck. In terms of Q2 comp sales metrics, FX positively impacted sales by approximately 1.4%, while gas price deflation negatively impacted sales by approximately 0.7%.

Traffic or shopping frequency increased 3.1% worldwide. Our average transaction or ticket was up 4.2% worldwide and 3.5% excluding gas price deflation and changes in FX. Moving down the income statement to membership fee income. We reported membership fee income of $1.355 billion, an increase of $162 million or 13.6% year-over-year.

Adjusting for FX, the increase was 12.2%. The September 2024 U.S. and Canada membership fee increase accounted for about 1/3 of our membership income growth. Excluding the membership fee increase and FX, membership income grew 7.5% year-over-year. This was driven by continued growth in our membership base and upgrades to executive memberships.

At Q2 end, we had 40.4 million paid executive memberships, up 9.5% versus last year. We ended the quarter with 82.1 million total paid members, up 4.8% versus last year and 147.2 million cardholders, up 4.7% year-over-year. In terms of renewal rates, at Q2 end, our U.S. and Canada renewal rate was 92.1%, down 10 basis points from last quarter; and the worldwide rate came in at 89.7%, unchanged from last quarter. The slight decline in the U.S. and Canada renewal rate was due to the factors we have discussed in prior quarters and reflects new online members growing as a percentage of our total base and renewing at a slightly lower rate than warehouse sign-ups.

We continue to focus on increasing the renewal rate of these new online members through targeted digital communications and retention strategies. And those efforts partially offset the negative effect of the increased penetration of online sign-ups. Turning to gross margin. Our reported rate was higher year-over-year by 17 basis points and higher 11 basis points without gas deflation, coming in at 11.02% compared to 10.85% last year.

Core was lower by 3 basis points and lower by 7 basis points excluding gas deflation. In terms of core margins on their own sales, our core-on-core margins were higher by 22 basis points. The increase in core-on-core margins was broad-based with nonfood, food and sundries and fresh all higher year-over-year. The difference between reported core margins and core-on-core margins was driven by mix changes as well as higher 2% executive rewards and lower income from our co-brand credit card program compared to last year.

Ancillary and other businesses gross margin was higher by 19 basis points or 17 basis points excluding gas deflation. This was driven by higher gas profitability and strong growth in pharmacy. LIFO negatively impacted the gross margin rate by 4 basis points. We had a $12 million LIFO charge in Q2 this year compared to a $12 million credit in Q2 last year.

This quarter's gross margin rate also included a nonrecurring legal settlement, which had a positive impact of 5 basis points. Moving on to SG&A. Our reported SG&A rate was higher or worse year-over-year by 13 basis points and higher or worse by 8 basis points without gas deflation, coming in at 9.19% compared to last year's 9.06%. The operations component of SG&A was higher or worse by 2 basis points, but better or lower by 2 basis points excluding the impact of gas deflation.

Our operators once again did a great job improving productivity and capturing efficiency benefits from the technology investments we've recently implemented. These productivity improvements fully offset last year's wage investments and any impact of extended operating hours. Central was higher or worse by 4 basis points and higher by 3 basis points excluding the impact of gas deflation. This quarter's SG&A also included an increase in general liability reserves to reflect higher expected future costs for prior year claims not yet settled.

This negatively impacted the rate by 6 basis points. Below the operating income line, interest expense was $33 million versus $36 million last year. Interest income was $140 million versus $109 million last year, driven by higher cash balances; and FX and other was an $8 million benefit this year versus a $33 million benefit last year, largely due to changes in FX. In terms of income taxes, our tax rate in Q2 was 25.2% compared to 26.2% in Q2 last year.

Turning now to some key items of note in the quarter. Capital expenditure in Q2 was $1.29 billion. We estimate CapEx for the full year will be approximately $6.5 billion as we continue to invest in building a larger pipeline of new warehouses, remodeling our existing warehouses to drive continued growth in high-volume buildings, expanding our depot network to support operations and enhancing the member digital experience. In terms of merchandising highlights, the Lunar New Year celebration this year showcased our merchants global buying expertise.

We were able to introduce many exciting new items for our members that help drive growth across fresh, foods and sundries and nonfood categories in the U.S. and our international markets. Some of the best sellers included items ranging from duck and quail eggs, Year of the Horse-inspired gold jewelry and bullion and Shine Muscat grapes. We also had a very successful Valentine's Day. In fact, laid out stem-to-stem, the roses we sold in the U.S. for Valentine's Day this year would have stretched all the way from Seattle to New York City and back again.

Fresh comparable sales were up low double digits in the quarter, led by meat and bakery. In meat, we saw strong growth in both premium cuts of beef and lower-cost proteins such as ground beef and poultry. In bakery, we continue to see success with the launch of exciting new items like the chocolate hazelnut mini beignets and a variety of seasonal pastries and cookies. Nonfood comp sales were up high single digits in Q2. Top-performing departments were gold and jewelry, tires, majors, health and beauty and small electrics.

Unique items continue to play an important role in creating excitement for our members in nonfoods. And our second quarter sales included a $150,000 emerald-cut 5.8 carat diamond ring, a $20,000 Babe Ruth autograph baseball and nearly 200 luxury Whisper golf carts at an average price of approximately $9,000. In food and sundries, comps grew mid-single digits, led by candy and packaged foods. While egg price deflation is expected to continue to be a headwind to sales in food and sundries for the foreseeable future, we're seeing significant unit and market share growth in eggs because of our strong value proposition.

Overall inflation decreased slightly in Q2 as we saw lower inflation in foods and sundries and fresh, led by deflation in produce, eggs and dairy. This was partially offset by slightly higher inflation in nonfoods. The supply chain was also relatively stable in Q2, and our merchants feel good about our current inventory position heading into the spring. That said, as we look at the rest of the fiscal year, the situation in the Middle East could impact fuel costs and shipping schedules if there is instability in the region for a sustained period of time.

Kirkland Signature remains a top focus to deliver great value for our members with KS items typically offering 15% to 20% value compared to the national brand alternative with equal or better quality. In Q2, we launched approximately 30 new KS items, including crispy wings, blackened salmon and various apparel items. As Ron mentioned earlier, our goal is to be the first to lower prices where we see opportunities to do so. And a few examples this quarter included KS Butter from $13.89 at the end of Q1 to $8.49 at the end of Q2, 12-count KS Organic Coconut Water from $12.79 to $10.99, KS Organic Seaweed from $10.99 to $9.99, and 2-liter KS Italian extra virgin olive oil from $29.99 to $24.99. Within ancillary businesses, pharmacy and food court experienced double-digit comparable sales growth, and optical and hearing had high single-digit growth.

Gas comps were negative mid-single digits, driven by mid- to high single digit price deflation, partially offset by gallon growth. Turning to digital. Site traffic in the quarter was up 32% and app traffic was up 45%. Sales of pharmacy, gold and jewelry, toys, tires, small electrics, special events and housewares, all grew double digits year-over-year.

And our same-day delivery service offered through Instacart, Uber Eats and DoorDash continue to grow at a faster pace than our overall digital sales. The enhancements we are making to deliver a more personalized digital experience for our members are starting to create measurable impacts. In Q2, our personalized product recommendation carousels drove over $470 million of e-commerce sales, and our newly modernized product display pages are driving incremental sales on our dot-com site as well as increased traffic to our same-day sites. We have a clear road map for future digital enhancements and believe these will allow us to continue to grow digitally-enabled sales at a faster pace than overall sales.

Finally, a brief update on our February sales results for the 4 weeks ended this past Sunday, March 1. Net sales for the month came in at $21.69 billion, an increase of 9.5% from $19.81 billion last year. Comparable sales were as follows: the U.S. was up 5.2% or 6% adjusted for gas deflation and FX; Canada was up 12.8% or 9.3% adjusted for gas deflation and FX; Other International was up 17.9% or 10.9% adjusted for gas deflation and FX. And this resulted in total company comp sales of plus 7.9% or plus 7% adjusted for gas deflation and FX. Digitally-enabled sales were up 21.8% or 20.8% adjusted for FX.

Total company comparable sales for the month, excluding all gas sales and the impact of foreign exchange, was 7.8%. As a reminder, Lunar and Chinese New Year occurred on February 17, 19 days later this year. This shift positively impacted February Other International and total company sales by approximately 4% and 0.5%, respectively. Our comp traffic or frequency for February was up 3% worldwide and 1.5% in the U.S.

Foreign currencies year-over-year relative to the U.S. dollar positively impacted total and comparable sales as follows: Canada by approximately 5%, Other International by approximately 8% and total company by approximately 1.7%. Gas price deflation negatively impacted total reported comp sales by approximately 85 basis points. The average worldwide selling price per gallon was down 7.5% versus last year. Worldwide, the average transaction was up 4.8%, which includes the impacts from gas deflation and FX.

Excluding gas deflation and FX, average transaction was up 3.9%. In terms of regional and merchandising categories, the general highlights were as follows: U.S. regions with the strongest comparable sales were the Midwest, Northwest and Southeast. Other International in local currencies, we saw the strongest results in China, Taiwan and Korea. The negative impact of cannibalization was approximately 60 basis points for the total company.

Moving to merchandise highlights. The following comparable sales results by category for the month excludes the positive impact of foreign exchange. Food and sundries were positive mid-single digits. Better performing departments included candy, food and frozen foods.

Fresh foods were positive low double digits. Better performing departments included meat and bakery. Nonfoods were positive mid-single digits. Better performing departments included jewelry, majors and small appliances.

Ancillary business sales were up mid- to high single digits. Pharmacy, food court and optical were the top performers. Gas was down low to mid-single digits, driven by price per gallon changes year-over-year. In terms of upcoming releases, we will announce our March sales results for the 5 weeks ending Sunday, April 5; on Wednesday, April 8, after market close.

That concludes our prepared remarks, and we'll now open the line up for questions.

[Operator Instructions] And our first question comes from the line of Chris Horvers with JPMorgan.

So a bit of a near-term question here. There's been a lot of noise in January and February on the weather, whether there was a net benefit to January. One of your competitors talked about a headwind into February because of the weather. Could you reconcile how the weather dynamics affected the first 2 months of the year?

And then similarly, gold has been very spiked into the beginning of January, has pulled back a little bit here in February. So how are you thinking about how that impacted the business in those 2 months? And how do you think about that, how that could play out for the rest of the year?

Chris, thanks for the questions. Maybe on the first part of the question, on the weather, I think, our general view is that it certainly created some volatility during the first 2 months of the year, but we wouldn't really call anything out. I don't think that we would say we think there's a major sort of impact when you look at the total sales results that we posted in January and February. I think the one thing that I probably would mention is that our traffic visits were a little bit lighter in the U.S. in February.

The thing that we think may have caused that to look a little bit lighter was because of the weather we had in the Northeast, in particular, we have 55 warehouses that were closed for a full day and then took a couple of days for the local communities to get back up to sort of speed. So I don't know that we call out when you look at the actual total sales that there was anything there that we'd want to call out, but I do think there might have been some impact on visits when you look at the sort of year-over-year growth there in the February results. But beyond that, I don't think there's anything that we would say that you should -- we'd look at in our results and say it was a major impact that should be adjusted for.

And then I think more broadly -- I'll maybe just answer it in general terms. You mentioned the question around gold. I think as we look at the overall state of the consumer and our members and how they're shopping, I think it really is, generally big picture, a continuation of the trends that we've seen over the last few quarters where, for sure, members are very focused on quality and value and newness and exciting new items are very important. But when you deliver on those things, we're seeing members are willing to and have the capacity to spend.

And I think the fact that our buyers continue to find new and exciting items have resulted in our overall sales results each month when you strip out the noise around calendar shifts and strip out the noise around sort of short-term blips when there's questions around port strikes and tariffs. Overall, our results have been very consistent in that 6% to 7%. So I really wouldn't say there's anything, certainly, changes in different items because as we've adjusted assortment to reflect whether it's tariffs or different member preferences, but overall, very consistent in terms of the results that we've seen.

And our next question comes from the line of Michael Lasser with UBS.

Ron, you highlighted several innovations that you are currently implementing or testing to improve the member experience as well as increasing the efficiency of the business. Did you size the potential savings from things like prepaying your card or line breaking from your associates? And then as part of that, to what degree will you take those savings, reinvest it back in areas like the store wages, store labor and/or price? And are you starting to see any diminishing returns on the investments that historically Costco has been making and have proven to be quite fruitful?

You're very welcome. The digital enhancements we're making both online and in the warehouse have all been very beneficial for us. In the warehouse, as you use the example of the pharmacy, our pharmacy business is very strong. Traffic has been significantly up, and the adoption of the new digital enhancements have really allowed us to maintain the staffing we have in place and then handle this new growth of volume we're seeing.

It's improving the member experience and it's making the throughput much better, be it the pharmacy app that we've developed or the pay ahead that we have in our warehouses. So it is really -- it's very accretive to us handling this new volume and being efficient as we do that. So we do see some good tailwinds behind that as that moves forward. As far as investing in the business, seeing the same values in that, no, we feel that we still get the same return from our members as we continue to invest in the business out there.

And the members are responding very nicely to it, both with traffic and with sales that we see as well. So we feel good that we will continue to reinvest. That's what we do, both in employees and in pricing and in the business overall and expansion, as Gary mentioned and I mentioned in the earlier talk that we just had. And we're not only expanding buildings, we're relocating and we're also upgrading the insides of a lot of our older warehouses too.

So we continue to put the money back into the company to drive top line sales and grow our business globally.

And our next question comes from the line of Chuck Grom with Gordon Haskett.

Inventory levels continue to be very well managed. Curious as you look ahead to the spring and summer, are you making any notable changes to the assortment akin to some of the changes you made last fall? And then with rising gas prices in the near term, can you just remind us historically the crossover traffic that you typically see into the club on like-for-like hours?

Sure. As far as mix goes, going into the spring and summer, we feel we're going back a little more traditional than we've seen last year. The supply chain has balanced out a little bit more. We feel good about the sourcing moves that we've made.

So we feel, as far as timing goes, selection, SKU counts, we're back on track again with where we were at the year prior. So I feel good about the lineup that we have. We feel good about production. Shipments until the most recent undertakings have really been -- everything has been on time and moving through very well.

So we haven't seen any disruptions from the Middle East in our regular merchandise flow, but we're watching that very cautiously, and we're staying on top of that. So we feel good about the spring and summer. And then as we forecast out into the fall, we feel we're in a good place. As far as gas, I'll let Gary answer that.

Yes. Thanks, Ron. Chuck, on gas, generally speaking, we see about half of members that will shop at the gas station will also cross shop at the warehouse. And obviously, as Ron mentioned, early days to know what the impact longer term might be from events in the Middle East at the moment.

But generally speaking, if gas prices start to increase, then we tend to see our value position resonates better with members just because, obviously, we want to be the pricing authority on gas. And so when prices are higher, that will tend to cause members to maybe take the extra mile that it might be involved to get to the gas station because of the incremental value they see there. But obviously, we'll have to see what happens with gas prices over the coming months there.

And our next question comes from the line of Simeon Gutman with Morgan Stanley.

I have 2 unrelated questions. First, the competitive openings are stepping up this year. I imagine there's maybe some membership impact in nearby openings from competitors. Is there anything above and beyond? And then the second part is if a customer speaks to an LLM, how do you show up or how do you want to show up? And are you seeing any opportunities to convert members?

You're welcome. As far as the new openings coming up, it won't have a negative effect on our membership. We won't see those big swells of new markets that we would see when you go into an existing building. So it balances that out.

It really drives our sales with frequency and visits. As we relieve a high-volume warehouse, those tend to build back very quickly. And so we may not see the traditional number of new members, but frequency of members and those type of things start really ramping up in those markets as we see. So we don't see a negative effect, but we don't see the big tailwind we saw with new sign-ups as we would in the new market as well.

And for the LLM, I'll take a shot at that. The biggest thing we feel with our quality and our value is we want to show up everywhere we can and everywhere we can. And we want to make sure that Costco is surfacing with all these partners that we feel very confident with our values and our prices. If we're coming up on all these searches, we're going to [ fare ] very well with those.

So I don't know if you want to add anything to that, Gary.

Well, the only thing, Ron, maybe just to come back to your first answer, I didn't know if, Simeon, your question was when competitors are opening warehouses too. And I guess I would say that really, we don't see any meaningful impact on our membership base or membership growth when we feel we operate today very effectively across the U.S., competing against very different operators. And we tend to focus on being our own toughest competitor, finding ways of how can we lower prices and continue to deliver more value. And so generally speaking, there's nothing I would call out that we see an impact to our membership base when we're competing against different operators in each market.

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

Ron, 2 maybe international questions, but can you talk about -- so Canada AUVs is now approaching $300 million. Thoughts -- and you're still growing, right? So thoughts on shopability capacity in those clubs, and I know you're opening business centers. So thoughts on that.

And then secondly, I think you're going to open 3 outside of international, outside of Canada this year. What does the pipeline look like in '27 and '28, because I think you do want to ramp that up much higher than it is today?

Okay. Yes. As far as Canada goes, we have 114 buildings now, and we have had some very good success with infilling, and even opened up a couple of new markets in the recent 2 years. Our volume per location is quite high in that market.

We have done several things. The technology that we've done in the U.S., we're using in Canada as well. We've recently expanded operating hours in all of our Canadian buildings to help offset some of the traffic increases. So we feel that we've got a very good path of expansion in Canada over the next 5 years, and we feel good that we'll be able to maintain a good, high average volume per location and continue to infill with some great incremental sales there as well.

Internationally, yes, they take a little bit longer, a little bit longer before we bring these to fruition as opposed to being in North America. But we feel very good about the future from '27 on in our international markets as we continue to see performance both in Asia and Europe to be very strong. And so we look forward to some good growth expansion. We feel a good balance as we've had in the past, with a good portion of our locations being outside North America and an equal amount being here domestically as well.

And our next question comes from the line of Kate McShane with Goldman Sachs.

I wondered if I could tack on to the real estate question and just ask about the fact that you noted some new opportunities in real estate are allowing you to enter into markets that you didn't think you could enter into previously. How should we think about this longer term? And how it will influence maybe the number of units you open in a year domestically?

Okay. Well, we're not changing the model, but we are being a little more creative with the use of things like parking decks. I know it's been announced what we're doing in Los Angeles with the residents above our locations. So we are getting a little more creative.

If we want to get into some of these inner cities, you're not going to find 25 acres available for us to go into. So how can we infill in some of these very strong markets like Los Angeles, New York, different places with a unique model for Costco that is going to allow us to continue to expand? We've done a lot of these things in the past. We've proven out the models in Asia, and we've got some very unique business models, and also in Europe as well, that have served us very well.

So it's not new to the company. It's a little newer to the U.S. But we feel very good about how we can be efficient, we can maintain the Costco experience in all of these warehouses. But being a little bit -- a little more creative than a standard 25-acre site with 800 parks and 1 level of parking decks out there as well.

So that's where we're seeing a lot of the openness to the opportunities to partner with others and get into markets that could have been otherwise tough to get into.

And Kate, I think that's kind of allowing us to be able to have more confidence in that plan to achieve that 30 warehouse a year goal that we talked about in the last couple of earnings calls. And when we talk about 30 a year, we look at sort of generally a 5- to 10-year time horizon for warehouses. And we feel like that, that 30 sort of target a year is there to be achieved for that sort of time horizon. And that's the goal that we're working towards as we look at the plan.

And roughly just over half of those, we think, would be in the U.S. and just under half would be in the rest of the world, if you include Mexico, Canada, Asia, Europe, Australia and New Zealand in that broader Rest of the World category.

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

I was hoping that you could expand on core-on-core margins in the quarter and then maybe how we should be thinking about the back half? The compare seems a little bit tougher there, but just thoughts on how we should be thinking about that would be great.

Yes. Thanks, Ed. I'll take a step back overall on gross margin. We were pleased with the quarter overall in gross margin.

As you heard us say that the overall result was -- if you adjust for gas deflation, was up 11 basis points, but we had a gain for a nonrecurring legal settlement in there for 6 basis points. So overall, we look at it as being up by 5 basis points in the quarter and being able to achieve that growth when we were also lowering prices for members and managing the impact of tariffs. I think the team did a really good job of being able to stay the course in making sure we're delivering more value while also being able to deliver a good financial outcome for our shareholders. On the core-on-core, specifically, side of it, as you heard us say, we were up 22 basis points.

I wouldn't say there's one particular sort of driver of that. It's similar to the themes we shared the last couple of quarters. I think during Q2, in particular, partly would have had some benefit when you look at -- we've said I know in prior discussions that when we see prices coming down, as we saw in some of the deflationary items, often that's a time that's helpful to us because we can lead the sort of the world down with lower prices for our members. But because we turn the inventory so quickly, we also tend to get some financial benefit in there.

And then we're continuing to work on supply chain efficiencies and Kirkland Signature penetration continues to improve. So there's a number of different sort of factors, I would say, that help with that. At the same time, as you heard us say, there were some offsets in core because we paid higher 2% rewards. We were lapping some higher income in the credit card program.

There is some mix shift as well because our pharmacy business is growing and our e-commerce businesses are both growing at a faster pace than our core sales. So they kind of dilute some of the impact when you look at the total core margin growth. And I share all that context because I think from our perspective, when you think about looking forward, the rate is going to fluctuate and the different elements are going to fluctuate quarter-to-quarter, and we tend to not get too fixated on one individual element of the margin. Our goal is to run the business holistically for the long term.

And my comment earlier about some slight improvement in the gross margin rate while lowering prices and continuing to manage the business effectively is how we tend to think about delivering value for, first of all, our members, and in turn, that resulting in members and shareholders. So when you look at the trajectory, I think, I would focus less on one individual metric. I think where I would come back to is if you look at the quarter overall, we were up about 6 basis points. If you look at the last 12 to 24 months, generally, our gross margin has been stable and has grown slightly, and there's been puts and takes with core-on-core and the other elements that I mentioned, but our focus is really on running the business for the long term and making sure we're delivering value for members.

But we do think through some of the efficiencies that we create, we can -- we are slightly expanding margin, but it's only slightly because, as Ron mentioned, really where we see meaningful benefit. We're reinvesting in the member to make sure that we're driving top line sales.

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

So just going back to membership growth, so it's sub-5% this quarter. So if you could maybe walk through some of the dynamics at play. And then as you look at your same club membership growth rates, just how those are trending versus your expectations?

Yes. Thanks, Rupesh. Yes, maybe again, just taking a step back, big picture. We were pleased with the membership results for the quarter.

We saw -- I think you heard us say in the prepared remarks, 7.5% growth in membership fee income if you adjust out the fee increase in FX, so underlying some really strong member loyalty and member fee income growth during the quarter. The bigger part of that was the 9% growth in upgrades, which I think shows that the impact of the $10 Instacart credit that we're offering each month for online shopping and the extended hours and some of the other benefits that we've added are resonating with our members and increasing the level of upgrades. You mentioned the overall paid membership was a driver of that, too, was up about 4.8% during the quarter.

As you said, Rupesh, it's a little bit lower than it's been over the last year or so. The last couple of quarters have been around that 5% mark. I think there's really 3 things that I would call out there. One is that we have seen over the last year or so, less new warehouse openings in sort of genuinely new markets.

And generally speaking, when we open in Japan or China, there's a dramatic increase and spike in the number of new members. So they certainly help to inflate the overall membership growth. And we really haven't had a meaningful number of those in the last year or so. So that's having an impact on slowing down the rate of growth.

Secondly, I'd say we are cycling some strong new member sign-ups a year ago. So we're having some impact of the -- as we cycle those, and still seeing strong member sign-ups, but certainly, we're sort of lapping some higher growth that we saw this time last year. And then I think, I'd also probably say, if you look at the long-term growth rate, as I mentioned, certainly, we've had growth at a higher rate when there have been times where we've had those large new warehouse openings with inflated new members and we've had peaks at certain times where we've seen higher member sign-ups. If you look at our long-term growth rate, it really is in more of that 5% growth range in terms of new members.

So I think it's kind of maybe resting more closer to where the long-term growth rate has been. And we think there's still plenty of opportunities to keep growing the membership base, whether it's through adding new benefits as we did some of those this year, whether it's existing warehouses continuing to mature and growing their membership base, as I mentioned earlier, improving the renewal rates as we're making good progress in those as well. And then in our international markets, we tend to be -- while we have a large member base per warehouse, the executive membership base tends to be lower penetrated in those areas as well.

So we think there's lots of opportunity for continued growth, but I think those would be the 3 points that I would call out as being the main drivers of us at a slightly lower rate year-over-year than we've been in the quarters prior to the last 2.

And our next question comes from the line of David Bellinger with Mizuho.

Thanks for the questions. It's on renewal rates. The U.S. down about 10 basis points, worldwide flat. So is this the real bottom here?

Given the way you calculate renewal rates, do you have a certain time line or time frame in mind when you can see this data set start to improve and move back up again? And then separately, we've noticed some in-warehouse activity, maybe given out a free item when you sign your membership up for auto renew. Can you talk about the uptake for that program and how that's helping renewal rate as well?

Sure. Yes. As you mentioned, we called out a few quarters ago that we were seeing a slight decline in the overall membership renewal rate and you characterized it very, very well, which is as we've started to see a meaningful increase over recent years in the member -- in the number of digital members signing up, they do generally renew at a slightly lower rate. And so as they've been building as a percentage of the total base, it's been a real positive for us in terms of adding younger new members and helping with total revenue growth and some of the comments I made about the membership growth, responding to Rupesh's question earlier.

But it has had an impact. When you blend those into the total mix of members, it does bring down slightly the overall renewal rate. When we called that out 2 or 3 quarters ago, we said we probably have a few more quarters where we'd expect to see a continuation of a slight decline in the renewal rate because there is that sort of math where those numbers are feeding into the overall renewal calculation. It does bring down the average.

I think we're pleased to see that the global rate actually was flat during this quarter and the U.S. rate was only down 10 basis points, as you mentioned. So I think it shows that we're making some good progress with the impact that we thought would happen through the maturation of those online members coming into the overall number, but also with some of the initiatives that we've been driving around contacting and engaging with those new digital members through digital communications, through retention strategies. And if we'd have just played out the impact we would have expected without any of that activity, it would have been a higher decline just with the math of the number of digital members that we're feeding into the overall renewal rate calculation.

So we are seeing and showing some impact of the benefit of those programs. The auto renewal is something we've been focused on for some time. We believe as more members have grown over time, there's a real benefit in helping the member from a convenience point of view, having auto renew. And of course, it helps us with membership renewal rates as well.

So that's something we've been -- we've had as a program for a while now, and there are certain times where we'll raise the awareness of it in the warehouse for our employees to have a talking point with a promotion of some sort as well. So overall, I think we feel that we're seeing what we expected with the change in the renewal rate. It has slowed down. As we called out before, we may slow a few more quarters where it's kind of reaching that maturation point, but we are very focused on those retention programs and have been pleased with the way that's adjusted the trajectory, and we'll be targeting for that to continue.

And our next question comes from the line of Greg Melich with Evercore ISI.

I wanted to follow up on inflation. You mentioned how, I believe, it was a little bit less this quarter than the prior quarter. And I'm just curious how much less. If we look at that ticket up 3.4% in the U.S., could we say that inflation was maybe 100 bps of it down from 150 or maybe just sort of frame it?

Sure. Yes. Thanks, Greg. On inflation, in general, you heard it exactly right that we did see -- we've been talking about low to mid-single-digit inflation.

It was slower in the second quarter, trending towards sort of low single digits, I guess. Now I'll caveat that with that was Q2. Obviously, the world has changed a little bit since we gave that update, and so we'll have to see how things play out with the situation in the Middle East. But certainly, as we look at what happened during the second quarter for us, fresh and food and sundries really drove the lower inflation overall. Ron mentioned it, but we've seen deflation in produce, eggs, butter, cheese, some of these commodities.

And they have a meaningful impact, as you might imagine, on food and sundries in particular. We do still see some areas of the business that are inflationary. Beef remains fairly inflationary. And candy is still seeing -- I think, still seeing some of the flow-through that we've seen historically and some of the commodity impacts there as well.

But net-net, fresh and food and sundry would have been lower in Q2 than they were in Q1. We saw a little bit of increased inflation in nonfoods, again, modest, I would say, and it wasn't a big impact as you heard us talk about the LIFO impact. So it's still low single-digit inflation in nonfoods, and that would be a little bit of sort of flowing through of tariffs in a couple of areas; and gold, of course, was inflationary during the quarter as well. So overall, sort of tying it to your question about basket, I think it kind of depends on how you define the impact of inflation. We tend to look at it, are there more items in the basket, which would be the units, and they're certainly growing.

And then we break down or we'd look at inflation as being 2 components. One would be the price part that I just mentioned, and the other part will be mix changes, so has the item changed in the basket or has the size of the item changed in the basket? And we really don't kind of necessarily pull those apart. But directionally to your point, the inflation as in the actual price increases would only have been a fraction of the total, and the mix changes and the increasing units would have been a meaningful part of the growth as well.

Got it. Gold bars are helping the mix.

It's broader than gold bars, but I think certainly, gold bars have been a great example for us actually of where -- it's one of those examples where it's certainly been a tailwind to the business, but the amount of interest it drives around the brand and the traffic it drives to our websites and some of the cross-selling it drives there, I think it's been a nice surprise of, yes, it's been a great way to deliver value for members, but it's actually, I think, helped elevate other parts of our business, too, by raising more awareness of the things we have to offer online, for example.

And our next question comes from the line of Oliver Chen with TD Cowen.

On the digital advertising frontier, there's a lot of great opportunity ahead. I'd love your thoughts on what the road map looks like there as well as marketplaces. And then as you zoom out on AI, you're having a lot of great success so far. AI is a technology that involves a lot of different partners, but you've had so much internal excellence.

Like what are your thoughts on balancing that development and innovation around AI? And as you look forward, do you have an idea, will it impact pricing, supply chain, merchandising or membership engagement more or less or probably all of the above? But would love your earlier views on where it might be most impactful.

Yes. Thanks, Oliver. I'll just try and canter through those relatively quickly. On advertising, I think, we've shared before, as I think you know, that we have a meaningful amount of dollars that we generate from sort of media revenue today, and that is growing double digits.

We have over -- I think it's now 1,000 of our suppliers that participate in and engaging with us through placement or sort of being able to provide promotional opportunities for them. From a retail media perspective, we think of that as being somewhat of a new opportunity around how do we get into -- sort of connecting to more of those marketing dollars that our vendors and suppliers are spending. Our first priority is really to build the capabilities internally around delivering more personalized relevant communication to our members. And you heard me mention in the prepared remarks, we're starting to see a few nice examples now where as we build in more of that relevant communication for our members, we're seeing them really respond in a positive way in driving either visits or items in the basket.

So really encouraged by that. I'd say we're still in the early innings with retail media because while we've been doing that, we're definitely testing and doing some programs with our suppliers on things like digital TV and targeted MVM amplifications, but they're really kind of the early learning stages. And I think as we continue to build that personalization capability, we will -- we think we'll see some additional benefit really throwing through in advertising. I will sort of caveat as always with our expectation of ourselves is that we'll reinvest the vast majority of that to really deliver more value for the member and drive more top line sales as we do with everything that we do.

On the marketplace, I think for us, it's really -- it's been a case of where are there places that we can find services and value that offers more value to our members? We've seen, I think, some really good progress on things like installation services and new values that we can offer around, whether it's garden furniture or garden fixtures and windows, and some of these areas where we see opportunities to really bring unique value to our member with great partners who deliver great quality and value. So there's certainly focus there. And then I would broaden it to some of the services that we offer.

As you think about things like Costco Travel and think about some of the additional services that we're offering to members that again, are unique ways in which we can deliver value, and we've been finding a lot of success in really deepening loyalty with members there and growing those elements. That's kind of probably the biggest part of as we think about sort of the marketplace concept of where we think the value can resonate with our members. On AI, I think, for us, it's really we look at it through the lens of -- we think we have a clear view of how we can deliver value for our members and how we support our employees.

And so our focus with AI in general is where can it make us better at who we are? We're not really trying to chase things that aren't core to Costco. We think that's been key to what allowed us to navigate previous technology and digital sort of evolutions in the marketplace. And we're really focused on where are the places that we think AI can make us better for our members, can deliver more value for our members, can help our employees be more productive so that we can pay them better and we can deliver more value for our members.

So really, that's our overall philosophical approach there. But still early days, but encouraged by the work we've been doing.

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

I know it's only been about 2 years or so, but the last time you had this much cash on the balance sheet, you did pay out a special dividend. So is that something we could see in the next few quarters? And I guess, on a related front, just given how quickly cash is now building for you, could we see payouts on a more frequent basis than maybe what we've seen in the past?

Thanks, Scot. Yes, I wouldn't say our financial strategy has really changed significantly as we think about cash. Our first priority, of course, is always to invest in the business. And as you've seen, we've been investing more capital in the last couple of years to support Ron's priorities that he shared earlier around ensuring we've got the strong pipeline of new warehouses, ensuring that we're investing in our existing warehouses to improve the member experience and support the tremendous growth that we've seen in those warehouses.

We're investing in depots and expanding the network there, not only to support our warehouses, but also support the e-commerce growth that we're seeing. And we're investing in digital. And we think there's plenty of opportunities to continue to invest, and we feel good about the returns we can generate from those investments. I think you're right, we are seeing strong cash flow build up.

The great thing about our model is it generates significant free cash flow. And even with the investments we're making, we're seeing continued growth in that cash. Our general priorities are, subject to Board approval, we want to continue to grow the regular dividend because we think that's a core sort of fundamental part of demonstrating our confidence in the future growth of the company. And we continue to sort of buy back stock to avoid dilution from executive stock grants.

But when we do all those things in the way we have in the past, typically, we still generate excess cash and we're building a stronger cash balance on our balance sheet today. And we do think, with our valuation, the special dividend is probably the most effective way to return excess cash because it keeps flexibility if we want to invest more in capital expenditure in the future as well. What I'd say on special dividend is while our cash balances are back to the levels that they were pre the last special dividend, I think, it's important to remember that to achieve a similar yield to last time when our stock was at $660, the cash would need to be greater.

And so we'll continue to review the question of special dividend with our Board, but there are no plans that we could share at this time around a plan for special dividend.

And our next question comes from the line of Kelly Bania with BMO Capital Markets.

I wanted to ask first, if you could just talk about the pharmacy category. A lot of moving pieces being called out by some of your competitors there with the maximum fair pricing. And just curious how and if that impacts you, it doesn't look like it, but maybe would just want to confirm how you see that going forward. And then just bigger picture, wanted to follow up on the media question and the advertising.

And I was curious if you would maybe size up that more specifically. I think, Gary, you said a meaningful amount. But just curious how that looks today or even if not specific on how it is, just maybe relative to where it could be over time. Any color there?

Sure. Thanks, Kelly. On the pharmacy side of things, yes, we've had tremendous success with our pharmacy business. I think you've heard us say on a couple of the previous earnings calls that the team is really focused on how do we make sure that we're delivering not just the great value that we always promise to our members, but improving the member experience too.

So we've added some new AI tools to improve our in-stock positions on pharmacy, and we've also made some digital enhancements to make it easier for the member to check out at the pharmacy to speed up the experience there as well. So we've seen strong growth in pharmacy. And you may have heard me say in the prepared remarks that the pharmacy business grew at a faster pace than our total sales, which was part of the sort of reason for the disconnect between the core-on-core margin improvement and the core margin overall. I would say we will have a small impact as a result of the change with Medicare and the pricing of the drugs involved there, but nothing that I would call out to think about as a material headwind for us in terms of our top line sales results as we see it today.

And I think on retail media, I think really -- we do think it's a significant opportunity, Kelly. But the reason we don't really size it is that it really comes back to my final point that there's tremendous opportunity for us to capture more value, we think, and to help our suppliers actually improve the return on their ad spend. But our focus will be very much on how do we use those dollars to deliver more value back to the member and drive top line sales. So sizing it for us would be more how much value can we create for the member and drive greater investment in our members in the value that we offer.

And you would see it more in our top line growth as we're able to achieve that growth versus it being sort of a major change in our margin profile, I would say.

And our final question comes from the line of Zhihan Ma with Bernstein.

I wanted to ask about the international expansion side, specifically China, where growth seems to have stalled a bit recently, where I'm sure you're facing some pretty strong local competition and Sam's competition as well. Curious how you think about your business model fitting in a market which is highly e-commerce driven, and what learnings you can gain there that can be applied to the rest of the business as well?

Thank you. I wouldn't say it was stalled. It was more by design. The way we have opened up the first warehouse is very customary to what we've done when we've gone into every other country.

We get in, we open up some warehouses, we learn about the culture, we learn about doing business in that country. And then we're on a good, steady growth pattern from there. We see great opportunities in China as we did before we went into the country. We're very pleased with our business and how we're growing.

We feel we can compete with anybody in the country as we do internationally. So I see good things coming for us in China, but it will be customary to our normal growth as we have done that around the world, as we've built out Japan and Korea and Europe the same customary way that Costco grows in these new countries. So we're happy with China, it's growing nicely, and there's more to come in the future for sure.

And ladies and gentlemen, this concludes our question-and-answer session as well as today's call. We thank you for your participation, and you may now disconnect.