Costco Wholesale - Q3 2023
May 25, 2023
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by, and welcome to Costco Wholesale Corporation's fiscal Q3 2023 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Richard Galanti, CFO, you may begin your conference.
Richard Galanti (CFO)
Thank you, Josh, good afternoon to everyone. I will start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results, and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call, as well as other risks identified from time to time in the company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, the company does not undertake to update these statements except as required by law. In today's press release, we reported operating results for the third quarter of fiscal 2023, the 12 weeks ended this past May seventh.
Reported net income for the quarter was $1.30 billion or $2.93 per diluted share. This compared to $1.35 billion or $3.04 per diluted share a year ago in the third quarter. This year's results included a nonrecurring charge to merchandise costs of $298 million pre-tax or $0.50 per share, primarily for the discontinuation of our charter shipping activities. Last year's results included a nonrecurring $77 million pre-tax charge, or $0.13 per share for incremental employee benefits. As many of you know, 2 years ago, we initially leased 3 ships and thousands of containers to help mitigate some of the significant overseas freight challenges that were, we were experiencing.
Later, we added 4 additional vessels and several thousand additional containers with commitments made for up to then 3 additional years. Procuring these ships and containers was integral to us being able to stay in stock for our members during those challenging times. It also allowed us to do so initially at a lower cost than the market rates at that time. Shipping and freight markets have improved dramatically since that time, which led us to reevaluate our position. As you recall, in fiscal 2, fiscal 1, in the fiscal first quarter of this fiscal year, we took a charge to downsize by 2 vessels our charter shipping activities. Since then, shipping and container rates have continued to fall, in the third quarter, this third quarter, we concluded that it would be appropriate to completely discontinue the remainder of our charter shipping activities.
As a result of this decision, we recorded an impairment charge for all remaining charter assets. This decision allows our merchandising teams to take full advantage of the current shipping market rates, as opposed to much higher contracted charter rates. In turn, this allows us to do what we do best and lower prices for our members. In terms of sales, net sales for the third quarter increased 1.9% to $52.6 billion versus $51.61 billion reported last year in the third quarter. Comparable sales for the quarter were as follows: In the U.S., on a reported basis, -0.1% and excluding gas deflation and FX, +1.8%.
Canada, reported minus 1.0%, reported ex gas and FX, plus 7.4%, other international, reported plus 4.1% and ex gas and FX, plus 8.4%. Total company, reported basis, 0.3% comp sales and ex gas deflation and FX at +3.5%. E-commerce on a reported basis was minus 10.0 and - nine.0, excluding FX. In terms of third quarter comp sales metrics, traffic or shopping frequency remains pretty good, increasing 4.8% worldwide and 3.5% in the U.S. during the quarter. Our average daily transaction or ticket was down 4.2% worldwide and down 3.5% in the U.S., impacted in large part from weakness in bigger ticket non-foods, discretionary items.
Foreign currencies relative to the US dollar negatively impacted sales by approximately 1.5%, and gasoline price deflation negatively impacted sales by approximately 1.7%. Next on the income statement is membership fee income. For the quarter, we reported $1,044 million of membership fee income, or 1.98% of sales, compared to $984 million or 1.91% a year ago in the third quarter, a $60 million or 6.1% increase in membership fees. Excluding the headwinds in FX, the $60 million increase would have been higher by $17 million or up year-over-year, 8% adjusted for FX.
In terms of renewal rates, at third quarter end, our U.S. and Canada renewal rate was 92.6%, and our worldwide rate came in at 90.5%. These figures are the same all-time high renewal rates that were achieved in the second quarter, just 12 weeks earlier. Membership growth continues. We ended Q3 with 69.1 paid household members and 124.7 million cardholders, both up approximately 7% versus a year ago. At third quarter end, we had 31.3 million paid Executive Members, an increase of 681,000 or 57,000 per week during the 12-week fiscal third quarter. Executive Members now represent a little over 45% of our paid members and approximately 73% of worldwide sales.
Moving down the income statement, next is our gross margin. Our reported gross margin in the third quarter was higher year-over-year on a reported basis by 13 bps, coming in at 10.32 as compared to a 10.19% number a year earlier. The 13 bps positive ex gas deflation was minus three bps. Both of these numbers, of course, includes the little more than 50 bps impairment charge to margin mentioned in today's earnings release. As I normally do, I'll ask you to jot down a few numbers, two columns, a reported column, and then the columns excluding gas deflation. The first item would be for the third quarter of 2023, core merchandise margin.
On a reported basis, it was up year-over-year, 39 bps, and ex gas deflation, up 24. Ancillary and other, +13 and +9. 2% Reward, -11 and -9. LIFO, +25 and +25, and other, -53 and -52. If you add up the two columns, again, you get to the reported number of, on a reported basis, gross margin year-over-year in the quarter was up 13 bps and ex gas deflation, down 3 bps. Starting with the core, again, core was up, on a reported basis, 39 bps year-over-year and 24 ex gas deflation.
In terms of core margins on their own core sales or core and core margins, they were higher by 17 bps, with food and sundries and non-foods being up and fresh foods being down a little. Ancillary and other businesses, gross margin was higher by 13 and again, higher by 9 ex gas deflation. Within the ancillary businesses, gas, lean business centers, food court and travel were better year-over-year, offset in part by e-com. 2% Reward, again, higher by 11 bps and higher by 9 ex gas deflation. Higher sales penetration coming from our Executive members is certainly part of that. LIFO, a +25 bps year-over-year, both with and without gas deflation. As you recall, a year ago, in the third quarter, we had a $130 million charge for LIFO.
In this fiscal year, we had no LIFO charge, a $130 billion year-over-year improvement on that line item. Note also that in the fourth quarter, a year ago, we had a $223 million LIFO charge, we'll see how that goes in the fourth quarter this year. Other was lower by 53 bps reported and 52 ex-gas deflation. This was net of items from both years. This year, there was a 57 bps negative impact from the $298 million pre-tax charge, again, primarily related to terminating our charter shipping activities. This was partially offset by lapping last year's $77 million charge for incremental employee benefits, of which $20 million or 4 bps related to gross margin. The remaining $57 million, I'll talk about it in a minute under SG&A.
Moving on to SG&A. Our reported SG&A this year was 9.11% compared to 8.62% a year ago. On a reported basis, higher by 49 bps and ex gas deflation, higher 34 bps. as with gross margin, I'll ask you to jot down two columns of numbers, both reported and one with excluding gas deflation. Our first item is operations, -48 bps or higher by 48 bps and -35 bps. Central, 11 bps and nine bps. stock compensation, 0 in both columns. Pre-opening, 1 bps and one bps. other, 11 bps and 11 bps. if you add all those up, again on a basis, 49 bp higher year-over-year, and ex gas deflation, 34 bps.
The core operations, this negative included, of course, the impact of slower sales growth, as well as the impact of a few of the wage increases that we did that are typically out of the normal cycle over the last year, over a year. That included the impact of four weeks of wage and benefits increases implemented last March, the additional top of scale increase that went into effect July 4th, and eight weeks of this March is higher than normal top of scale increase. Despite, again, despite the slowing sales growth, we've continued to invest in our employees over the past year, and that's always been a priority for us. Central, higher by 11 and higher by nine, ex-gas deflation. Again, sales growth is, was the...
No, no big single item was an outlier there, but sales growth overall, in my view, was the impact. Comp sales flat, both with and without gas inflations, no impact there. Pre-opening, again, higher by one bps. We had five openings this year in the quarter and three in last year, but again, one bps delta year-over-year. Other, the 11 bps positive, both with and without gas deflation. This is a result of lapping that $77 million charge, but it within SG&A, lapping 57 of that $77 million charge for the incremental employee benefits, again, discussed earlier in the release. Below the operating income line, interest expense, came in at $36 million, $1 million over last year's $35 million number.
Interest income and other for the quarter was higher by $57 million year-over-year. This was driven by an increase in interest income due to higher interest rates and cash balances, increase in interest income was partially offset by less favorable FX versus last year. In terms of income taxes, our tax rate in the third quarter came in at 26.5%. That compared to 24.9% in 2023 last year. The fiscal 2023 effective rate, excluding discrete items, is currently projected to be in the 26%-27% range. Overall, reported net income was down year-over-year by four percentage points. Net of the 2 non-recurring items in both years, third quarter net income would have been up 8% even with being reflected with that higher income tax rate.
In terms of warehouse expansion, to date, we've opened 17 locations in the first three quarters and also including three relocations, so net of that, 14 net new locations. In Q4, we have nine new openings with no reloads, so a net of nine. That'll put us at 23, 26 openings, less the three reloads, to be a 23 net new for this year. In the quarter, again, we opened five with one, with four being net new. In addition to the relocation in Canada, we had two new buildings in the U.S. open and 1 additional building opened in Japan, in each of Japan and China.
We have, again, of the 9 new buildings planned for our fiscal fourth quarter, I think that includes our North Tulsa, Oklahoma, opening that opened this morning and our fourth and fifth buildings in China, planned for June and August. These Q4 planned openings will bring our full year to count to 26, less the three or a net of 23, and that is made up of 13 in the U.S. and 10 outside of the U.S. Regarding capital expenditures in Q3 of the quarter, of the fiscal year, we spent approximately $819 million. Our estimate for all of fiscal 2023 CapEx is approximately $4 billion.
Moving on to e-commerce, you saw in the release that e-commerce was at -10% sales decline, and ex on a comp basis, and ex gas, ex FX, a -9%. E-comm sales, more of the same story in terms of the sales as I discussed on our second quarter call and in our monthly sales recordings. In Q3, big-ticket discretionary departments, notably majors, home and furnishings, small electrics, jewelry, and hardware, were down about 20% in E-comm and made up 55% of E-comm sales. These same departments were down about 17% in warehouse, but they only make up 8% of warehouse sales. A few comments on inflation. Inflation continues to abate somewhat.
You go back a year ago to the fourth quarter of 2022 last summer, we had estimated the time that year-over-year inflation at the time was up 8%, and by Q1 and Q2, it was down to 6%-7%, and then 5%-6%. This quarter, we're estimating that year-over-year inflation in the 3%-4% range. We continued to see improvements in many items, notably food items like nuts, eggs, and meat, as well as items that include, as part of their components, commodities like steel and resins on the non-food side. Switching over to inventory levels, inventories overall are in pretty good shape. As of quarter end, our inventories year-over-year, as of the end of the third quarter, were down 7%.
Recall that they had been up during some of the supply chain challenges of last year. Finally, in terms of upcoming releases, we will announce our May sales results for the four weeks ending Sunday, this Sunday, May 28th, next Thursday on June 1st after market close. Also remember that our fiscal fourth quarter has an extra week this year, so our quarter ending September 3rd of 2023, we'll have 17 weeks versus 16 weeks in the fiscal fourth quarter. With that, we'll open it up for questions and answers and turn it back over to Josh. Thank you.
Operator (participant)
Reminder, if you would like to ask a question at this time, please press star, followed by 1 on your telephone keypad. Your first question comes from the line of Michael Lasser with UBS. Your line is open.
Michael Lasser (Managing Director and Senior Equity Research Analyst)
Good morning, or good afternoon, Richard. How broadly and widely is Costco willing to roll back prices in order to drive traffic and sustain a mid-single-digit comp growth? How are you thinking about the prospect of deflation across your entire portfolio? Thank you.
Richard Galanti (CFO)
Well, look, that's something that our merchants work on literally every day and every week. I remember when inflation was peaking at 8% and 9%, some out there would say, we're known for, you know, trying to hold the line, work with our suppliers. How much will they eat of that? How much will we eat of that? At the end of the day, if margins year-over-year were down 50 or 100 bps back then, that implies that some portion of it, you know, maybe instead of an 8% or 9% increase, our members were seeing a 6% or 7% or 8% increase.
Whatever that was, we felt that we were doing as good a job as anyone out there in term, given the item nature of our business, to lower prices for our members and hopefully drive sales. Certainly right now, we've always been a little bit compared to others, over indexed in bigger ticket discretionary items. That's getting hit arguably more than others. If you look at our fresh foods and food and sundries, they're, you know, in the mid to mid-high singles. You look at the non-foods and some of the answer is notably gasoline, which is, you know, 11% year-over-year deflation in gas prices, that's in the mid-single negative. It all adds up to where it is. Every day, we look to drive sales.
What will it take to get to whatever X is? Who the heck knows? I just know that our merchants and Greg and Ron are, and Claudine, our head of merchandising, are pushing the buyers each day to do that and figuring out how can we take the monies that we get, any types of monies from the vendors that can usually you know, use to drive business. One of the reasons that it made sense for us to discontinue the containers and the shipping, the vessels, is to reduce the cost that our buyers are seeing relative to these higher, much higher contract rates now.
You know, we were smart for a year, and now looking back, it was good to get out of it, and that allow us to be more competitive as well. I feel we're doing a great job of being very competitive. When we do comp shops against our direct warehouse club competitors, as well as different components, whether it's retail food or general merchandise on the buildings, you know, home improvement side, we feel very good about our competitive position and what we're doing to do that.
Michael Lasser (Managing Director and Senior Equity Research Analyst)
Are you not expecting broad-based deflation, Richard? My follow-up question is gonna be: given the amount of value you give to your members, wouldn't it make sense to raise your fees right now?
... because your renewal rates have been so high, and you would be providing even more value on the fiscal economic chart.
Richard Galanti (CFO)
Well, first of all, on the question of deflation, let's hope that there is. Well, you'll be the first to see it at Costco, in my view. As it relates to membership fees, nice try, Michael, but, you know, at the end of the day, with the headline being inflation, we feel very good about if we want to do it, can we do it without impacting in any meaningful way, renewal rates or sign-ups or anything? At some point, we will. Our view right now is that we've got enough levers out there to drive business, and we feel that it's incumbent upon us to be that, you know, that beacon of light to our members in terms of holding them for right now.
It's not a matter of a big time, but, you know, we'll let you know as soon as we know.
Michael Lasser (Managing Director and Senior Equity Research Analyst)
Thank you.
Operator (participant)
Your next question comes from the line of Simeon Gutman with Morgan Stanley. Your line is open.
Simeon Gutman (Senior Equity Analyst)
Hey, Richard. My first question is on the comps and the stacks. It's obviously been slowing, and you probably took more than your fair share over the last three years. Curious, when you sit around, how you're diagnosing it, macro, I don't know if it's gas attachment, merchandising, weather, any of those options. How do you diagnose what's happening?
Richard Galanti (CFO)
Well, first of all, we look at traffic, and we're getting people in the door, and we know what they're buying. They're buying, you know, non-discretionary items. They're buying fresh foods, they're buying food and sundries. They're buying apparel in a big way. They're buying patio furniture now that the weather's turned in a big way. Indoor furniture, not as much. We all know what's going on with consumer electronics out there. While all the numbers industry-wide are down, ours are down a little less, but they're down. Overall, you know, we, you know, when we look at, you know, what else can we do to drive more non-food business, but at the same time, can we bring in a few more items on the food and sundry side?
We know traffic is good there. simple impulse items that sell for, you know, $15-$25. That's what we do every day, and that's what, you know, Claudine and her staff and her merchants are doing.
Simeon Gutman (Senior Equity Analyst)
My follow-up, can you give us some information or color on gasoline gross profit year-over-year? How that profit pool is trending, obviously inclusive of both gallons and the penny profit.
Richard Galanti (CFO)
Well, yeah, gallons are close to flat. The average price per gallon during the quarter was down 11%. You know, that's 12% or 13% of our sales, which was, you know, the average price point per cell unit, if you will, was down 11%. Year-over-year, gasoline was profitable in both quarters, nicely. As I've said, I think, I'm sure I said last year in Q3, and this year, it helped a little year-over-year, but not a lot. Last year in Q4, it was a strong number, and you got an extra week. We'll see how it goes this year.
you know, right now, gasoline continues to be quite profitable for us.
Simeon Gutman (Senior Equity Analyst)
Okay. Thanks, Richard.
Operator (participant)
Your next question comes from the line of Christopher Horvers with J.P. Morgan. Your line is open.
Christopher Horvers (Senior Analyst)
Thanks very much, and good morning. I just want to jump back to the, to the pricing question. From a strategy perspective, you know, typically, if you see things that are disinflating or deflating on more the commodity side, you'll take price ahead of that. I guess, is that what you're doing currently? You know, we've heard a lot of talk in the, in the market about the vendors funding more promotions. How are you thinking about the balance between the retailer funding the promotion or the price investment versus the vendors?
Richard Galanti (CFO)
Well, first, look, we work with our suppliers every day, and it's got to be a partnership there. Again, I think it's easier for us, on the one hand, that we do a lot of volume on a fewer items. You know, we have buyers that literally are managing a couple of dozen items, not 200 items. I remember when certain commodity prices, like resins and steel, were going up in our monthly budget meeting, hearing from the merchants how, you know, while we're committing out 5, 6 months for seasonal items like patio furniture and barbecue grills, this is a couple of years ago. We want to know when the vendor was increasing the price on whatever it was, whether it was a major consumer products company or some manufacturer of non-food items like that.
Why? Exactly why? You know, how much of it's labor? How much of it's the commodity cost? How much is the transportation cost? As prices work and wage pressure, whatever. As we saw commodities coming down, I think, I'd like to think that we were the first on the phone with those suppliers, getting, wanting to know when the price is going to drop. Understandably, in some cases, the supplier had committed to a season of three or four months, and so there was some delay, and we worked with them in there. In addition, as we said, we're going to invest a little in price. How much are you willing to invest in price? It's a partnership.
I think we are in a better position to do that simply because if you take our $230 billion or $240 billion in sales and divide it by 3,800 SKUs, it's a lot more pricing power per SKU and a lot more focus on a item-by-item basis. That's what we do. You know, as there are promotional monies out there from the suppliers, this goes back to the beginning of time around here. I remember with the old traditional co-op advertising dollars, a supplier wanted you to spend $0.05 of our own money and add it to $0.05 of theirs to do $0.10 of advertising of their product. We said: Just give us the $0.05, and we'll base it on a $0.95 cost, not a $1 cost. That's what we still do.
So I think We have to be smart about knowing what every bucket of money is out there, whether it's promotional monies or ad monies or ad monies online now, and work with our suppliers to do that. In our case also, we do what we call the MVM, the Multi-Vendor Mailers, the coupon booklets that we send out 11 times a year. Not only that, but hot buys in store and what we call temporary price discounts, and what could drive sales? The other part of that is, when we get monies, in some cases, how much elasticity is there in driving business by lowering their price? In some categories, particularly some of the bigger ticket categories right now, there's not an appetite by the consumer necessarily for that.
How do we add value to the item or do more things to it to drive business? It's all of the above.
Christopher Horvers (Senior Analyst)
As you look forward, you know, you said, I think 3%-4% inflation in the quarter. You know, if you look at the Nielsen data, that was sort of low double-digit, right? I mean, Walmart talked about that. Two-part question. One is the difference just mix, that you have more fresh commodity exposure? Then, you know, if you project forward that you'll have sort of no inflation, potentially six, eight months out, how do you think about your ability to continue to comp overall?
Richard Galanti (CFO)
Well, you know, when there was low inflation and not an overarching concern about a recession, when the world was seen to be comping 3, 4, 5, and 6 years ago at 2%-4%, we were 5%-7%. Our view is because we got great members buying more, with great loyalty and the best prices by a major difference and quality. We've succeeded under those. I think right now, in my view, more of it relates to the fact that we're not only dealing with big ticket discretionary items weakness, which again, when we look at like MVD and everything, we're doing better in most of those categories. Our negative is not as negative as others out there.
In addition, we're comparing against 2 years of outsized growth in some of those things as people were buying things from their home. We saw outsized sales in indoor and outdoor furniture and electronics and TVs and exercise equipment. We're not only comparing against this, quote-unquote, "recession," concerns about big ticket items, but comparing against uber strength over the last 2 years prior to that. I think we'll come out of this fine. We're pretty good at figuring out new items and new things to do. You know, we're not just focused on how do we drive sales another 1% or 2%, but how can we drive sales with bringing in new and exciting stuff? We continue to do that.
You know, this is anecdotal, but over the last year and a half, we've always been very good at taking what I'll call big American Costco products, including a lot of KS, and having huge success overseas. We're now, on a conscious basis, figuring out what unique, exciting overseas items can we bring elsewhere in the world, including the U.S. and Canada. We're having, you know, good experience with some of those things. These are all small things, but there's lots of little small things around here that add up.
Christopher Horvers (Senior Analyst)
Got it. Thank you so much.
Operator (participant)
Your next question comes from the line of Scot Ciccarelli with Truist. Your line is open.
Scot Ciccarelli (Managing Director and Senior Equity Research Analyst)
Good afternoon, guys. Scot Ciccarelli. Richard, I think you mentioned fresh foods were a bit on the softer side. You know, when you kind of look at the data, is that a function of your members moving to less expensive packaged goods, or is that more just due to the COVID-driven comparisons like you were just talking about on the discretionary side?
Richard Galanti (CFO)
Yeah, by the way, when I was talking earlier about down, the margins were a little weaker on fresh. Sales have been fine. In the quarter, again, when you look at a reported total company sales number of 0.3% or 3.5% ex gas and FX, but within that, 0.3% reported, you know, fresh was mid-singles, food and sundries is mid to high singles, non-foods was a little over mid-single negative.
Scot Ciccarelli (Managing Director and Senior Equity Research Analyst)
Got it. All right. I understood that. The second question related to that, though, is are you seeing any other kind of trade, let's call it trade down type activity, whether it's more private label sales, et cetera, that you can identify from your members? Thanks.
Richard Galanti (CFO)
Yeah. You know, By the way, not just in this current, quote-unquote, "recession" or concern for recession, historically, we've always seen some like within fresh protein, we've always seen when there's a recession, whether it was 1999, 2000 or 2009, you know, 2008, 2009, 2010, we would see some sales penetration shift from beef to poultry to, and pork. We've seen some of that now. I think anecdotally, I heard a few months ago from our head of food and sundries buyer, that we saw some switch even to some canned products, on like canned chicken and canned tuna and things like that. On the KS side, we've also seen that. I think last quarter I mentioned that a year-over-year basis was a 150 bps increase in private label, sales penetration.
This year, at the end of the quarter, is 120 bps. Still, over a full percentage point delta in sales penetration. If you go back over the last 10 years, my guess is that on a year-over-year basis, maybe we've gone from, I'm guessing, 22 or 3 to 25 or 6%. Call it 300 bps over 10 years or 8 years. You know, 30 to 50 bps versus 120 and 150 in the last couple of quarters. Yeah, that would again, at least anecdotally, suggest that we've seen people looking for better bargains.
We try to correct people when they said it was a, you know, a downgrading, because our view was an upgrade when they went to Kirkland Signature.
Scot Ciccarelli (Managing Director and Senior Equity Research Analyst)
Got it. Thank you very much.
Operator (participant)
Your next question comes from the line of Karen Short with Credit Suisse. Your line is open.
Karen Short (Managing Director)
Hey, thanks very much. Good to talk to you. two questions. One is, your pre-tax margin is one of the highest that I think I've seen in the model. Like, I'm not even sure I could go back to when it was as high as it was. I'm curious if you could just make some color or commentary on that. The second question I had was, not that we're necessarily going into a deflationary environment in food, but if we were to go into deflationary environment in food, what would be the deleverage you would see on the EBIT line on that front?
Richard Galanti (CFO)
I'd be remiss if I even could think of a number off the top of my head here. you know, in our view, first of all, deflation, we'll be the first out there, you know, lowering prices with it, and I'd like to think that we could drive business with it. The other thing is, you know, look at even something like gasoline. I think all retailers out there that have gasoline operations have, in the last few years, reflected higher profitability from gas. In our view, we still have the most extreme savings versus everybody else. We've been able to make a little more per gallon because others have decided to make more than a little more. I think that same thing holds true elsewhere.
When we looked at our competitive price shops against our direct club competitors and against others on key items like fresh with supermarkets, again, those price gaps between us and our competition have not changed. They're still as strong as we feel that they should be. Again, it's hard to say what. You know, your comment about some of the highest pre-tax margins. Let's face it, I remember looking at even like SG&A, which was up year-over-year, of course. If you go back pre-COVID, I think our SG&A, on a reported basis, had a 10 in front of it. It was like 10.1 or 10.0%, and our view is, could it even get below 10?
With COVID and crazy sales for 2 years, we benefited, of course, more than we were detrimented by COVID in many of our categories. We got down below 9. Of course, normalized, it's still better than it was, and margins are still better than they were. I think some of it is sustainable. You know, wages are not gonna go down. The question is, will they continue to go up? Again, we're gonna be ahead of that, too, in terms of wanting to make sure we take care of our employees. Let's assume that a big chunk of that is if overall inflation subsides a little bit, I think we'll see a little less wage pressure.
Look, as you know, Karen, with us, it's top-line sales mostly, and the base thing can affect anything. I think we've shown that even with some lesser top-line sales, we've been able to pull the levers in a way that still allows us to drive bottom line, and we'll continue to be pragmatic about it, but we'll have to wait and see.
Karen Short (Managing Director)
Sorry, just to follow up on that: Is there any way to frame what, ex gas, ex gas margins, ex fuel prices, like, what delta in sales would result in a delta in EBIT? Is there any way to do that?
Richard Galanti (CFO)
Well, it's hard to say. Not really. I mean, we used to, you know, look at almost like the old Y equals MX plus B model, you know, based on incremental sales, what's the variable rate of expenses in a warehouse? In our collective view, this goes back several years, but our collective view was, is you needed somewhere around 4.5, whether it was four or five, but of a comp number to have flat SG&A or flat expenses at the warehouse. You know, certainly taking the weakness right now in big-ticket items, then taking the weakness of gas deflation, those things impact that SG&A % more than anything.
When I look every month at our budget meetings, when the operators report on labor productivity, as an example, in fresh, we're still improving in the 3%-6% labor productivity in pounds of protein, you know, processing pork, poultry, and beef meat through the system. When we look at front-end labor, or, you know, warehouse labor, not the ancillary businesses or the fresh foods or anything, but, you know, labor hours, we've showed labor productivity. Now, in the last year, with slower, little slower sales and with three unusual additional wage increases, that's gonna still show a labor % number higher as a % of sales, which is our single biggest SG&A item, bigger than other things.
Look, at the end of the day, we're still a top-line company. In our view, that will mend all things. I'm sure we'd like to see something pre-inflation back in the 5%-7% or 8% range, but let's get from where we are now to 3% and 4%, and we'll go from there.
Karen Short (Managing Director)
Okay. Understood.
Richard Galanti (CFO)
The good news also is, you know, if I look back, the last. Well, this is the second quarter that we've seen that discussion of, you know, lower sales of big-ticket discretionary items. It started actually, I think, a little bit in the quarter prior to that, not the entire quarter, just a little bit in there. If you will, there's, if all things being equal, we'll be comparing against easier compares, you know, six months from now. But hopefully we can do a little on our own as well.
Karen Short (Managing Director)
No, that makes sense. Thanks so much.
Operator (participant)
Your next question comes from the line of John Heinbockel with Guggenheim Securities. Your line is open.
John Heinbockel (Managing Director)
Richard, core on core, food and sundries and non-food were up, right? It's kind of a two-part on core and core. One, what drove that, right? Was that predominantly mix? Secondly, fresh food was down. You know, where does fresh food versus 2019, and are we kind of getting to the point where that erosion is gonna stop, right? Because we're pretty close to 2019.
Richard Galanti (CFO)
Yeah. Look, fresh foods are still up year-over-year on margins.
Operator (participant)
No, versus 19.
Richard Galanti (CFO)
Versus 19. Right. Fresh foods margins are up versus 19. It went way up. I mean, I think, hold on a minute, I had a little cheat sheet.
Operator (participant)
Take your time.
Richard Galanti (CFO)
If I look back at just fresh foods, if I go back to 2021, we had a couple of quarters where fresh foods margins were up 200-300 bps year over year in the quarter. By the end of 2021, this is near the end of.
Operator (participant)
Lapping.
Richard Galanti (CFO)
This is lapping that craziness, that crazy goodness, we were down 190 bps. For all of 2022, we were down anywhere from 50-120 bps on a year-over-year basis. Some of that compared to those plus 200 and 300 bps numbers. This year, we're down again versus last year, but down versus that giant increase in fiscal 2021. I look at where our food gross margin is today in Q3 versus pre-COVID, we're still up.
John Heinbockel (Managing Director)
Okay. The other categories that were up, right, is that predominantly mix, private brand and less big ticket?
Richard Galanti (CFO)
Yeah, I think it's mixed. Like, some of the non-food strength, as I mentioned, I threw out apparel as one of them. Apparel has a strong margin. Apparel has a strong margin relative to all of our departments anyway.
Operator (participant)
Majors have weak margins.
Richard Galanti (CFO)
Major, majors has a weak margin generally anyway, and then, of course, lower penetration of that.
John Heinbockel (Managing Director)
All right.
Richard Galanti (CFO)
Freight. Freight is, by the way, freight has helped too, particularly on big ticket items, the, you know, the furniture, the white goods, exercise equipment, things like that.
John Heinbockel (Managing Director)
Secondly, you know, where are we on the personalization journey, right? Because I know you've done more data analytics in the last couple of years. Right, you've got the old loyalty program, right? When you think about wallet share and, you know, targeting promotions and emails and so forth, it looks like a huge opportunity. You know, where are we on that?
Richard Galanti (CFO)
Sure. By the way, one other question that we've gotten a couple of times of late because of some of the companies out there that reported much higher shrink. Our shrink is intact. We haven't seen any major change in shrinkage. You know, it fluctuated a couple of 3 bpss up really before COVID, as we rolled out self-checkout, and since then, it's come back down a little bit. It's, it's been a very tight range, and so we've been fortunate in that regard. In terms of where we are in personalization, for those of you on the call that have known me forever, I was probably four years ago that we talked about sometime soon, we'll do targeting, after that, do personalization.
We're still in the early innings, but I guess what I'd like to tell you, and I think I mentioned this on the last quarter's call. You know, just under a year ago, we hired a new VP of digital transformation, if you will, both in e-commerce and mobile sites and applications. That complemented three other outside VPs we hired, one of which was in the data analytics area. We've really, over the last six to nine months, began a two-year roadmap to improve and replatform our primary e-commerce website, and the same goes for our mobile apps and mobile site.
Working, of course, with, again, with data analytics people, the architect people, as well as the business users, we're currently building and dramatically increasing, you know, the number of engineering capabilities that we have, and we're on our way. I'd say we're in the early innings. First order of business to have, you know, which we now we feel we've gotten to, a much better, you know, clean data site. We're still sending you too many emails a week that don't pertain specifically to what you do, I think you're gonna see incremental changes, and I'll be able to hopefully report more on that at the next quarterly call.
Just in the last 3 months, as an example, we've had 3 small releases to our mobile app that are improvements of it, and we're now on plans to have small improvements in that app each month for the several months going forward. You know, you really, as you know, you've heard me say for the past couple of years that we're in the early innings. I'll repeat that. We are, but we actually got a, I think, a good game plan, and you'll see more to that over the future. A little longer than we had hoped to do some of this stuff, but I think we're on our, on our way in that regard.
John Heinbockel (Managing Director)
Okay, thank you.
Operator (participant)
Your next question comes from the line of Oliver Chen with TD Cowen. Your line is open.
Oliver Chen (Managing Director)
Hi, Richard. When you think about household income, what kind of trends are you seeing in terms of your customers and people trading into Costco at large? The big ticket item question, what are your thoughts on how you're planning inventories there? The compares ease, do you expect improvement and within big ticket, any color in terms of how that may proceed sequentially?
Richard Galanti (CFO)
Sure.
Oliver Chen (Managing Director)
Thanks.
Richard Galanti (CFO)
Our annual household income has actually gone up a little, but I think that's more to do with wage increases than anything. We still over-index to higher-end people, higher-end income people, and so I, that's still there. As it relates to our inventories, you know, again, if you'd asked me 6 months ago, when. In fact, it was, I think it was Q3 and Q1, Q4 and Q1, where year-over-year inventories were up 26%, as was our competitors, everybody else. A lot of that had to do with some people had enough big-ticket items, but also just the terrible supply chain challenges that we all had. Since then, like others, we've shown a reduction in that dramatically, and that's good. We feel pretty good about where we stand right now.
If some of you have noted and called us on, back, again, six, five, four, three months ago, we had a lot of promotional things going on. If you bought $3,000 or more of these 10 items, and they were all like, you know, different patio items or different in-store furniture items, you know, if you did $3,000 or more, you got a $500 cash card on already great pricing. That was a lot of our promotional money, markdown money, to get our inventories back in line, particularly on things where we were over-inventoried because of supply chain delays. Then on some examples, I think air conditioners might be an example, because of supply chains last summer, we did great in selling through fans and air conditioners, but.
These are not exact numbers, but let's say we planned to sell $500 million of it. Easily, 20%-25% of it got here after the summer because of supply chain challenges. There was no need to mark those down to try and get rid of them in September, October. We held them, and we're selling through them now, and that's not an issue at all. In talking to Claudine Adamo, our Head of Merchandising and her non-food people, we feel pretty good about where we are, both on existing inventory levels of what we have in there and as well as what we've committed to going forward for upcoming seasons, notably back to school and Christmas, and things like that.
Oliver Chen (Managing Director)
Okay, Richard, you've made a lot of great strides in Asia and China and other regions. I'd love just some highlights in terms of what's ahead for the back half there. A second question on that connected consumer experience between digital and physical, are there thoughts in terms of BOPUS and curbside and what your members want in delivering, you know, the ultimate convenience? Thanks.
Richard Galanti (CFO)
Sure. Well, first of all, in terms of expansions outside the United States, if you look at just even this year, at 2023, I think it was, what? 13 and 10. 60ish, 60-65% in the U.S., Canada, which I combine as one because it's well saturated, but we're still opening a bunch of units there, and it's our oldest areas. I see that over the next five years, going from 65, 35 or 60, 40, to at least 50-50, if not trending a little bit towards outside the U.S. and Canada. Now, that, again, is the same answer I would have given you 6, 7 years ago for now.
I think that's a function of, one, having more opportunities every day than we thought we had before in the U.S. and Canada, and there's plenty of opportunities going forward elsewhere. You're gonna, but I think you're still gonna see us open in Korea, Taiwan, a unit this year on a base of somewhere in the mid to high teens. In Japan, more than a unit a year on a base in the low 30s. A unit a year in Australia, not exactly a year, each year. Maybe it's one year, none, and then two. In Australia, we've got 14, I believe. In Europe, you know, we're dominantly, most of our units are in the U.K., where we've got in the low 30s.
We're still gonna open one or two a year there, or one a year, probably there. We've opened a few others. We got, we opened our fourth in Spain, and we now have two in France and one each in Iceland and Sweden. A little growth there. Certainly in China, I mean, China, the big story this year for us is, one of the stories is that, you know, we opened our first unit in China 3.5, four years ago, our second, 1.5 years ago, our third, last December, and 3 more this year. We're gonna be at 6 at the end of this year.
Oliver Chen (Managing Director)
This calendar.
Richard Galanti (CFO)
This calendar year, I'm sorry, this calendar year. Two more this fiscal year, and then one more in the fall. There's certainly more growth there, but, you know, that's not a lot of growth relative to some companies that have tried to go in and open 20 somewhere or something. We feel good about how we do that, but we think there's plenty on. You know, if you look at the bottom line, if we're opening 23-25 a year, we'd like to be a little 25+ a year for the next five years and somewhere closer to 30 a year in years 6 through 10, that would make us feel quite good. We feel very comfortable that we can do that at this juncture.
In terms of curbside, we're not very thrilled about it or maybe a little stubborn about it. You know, we tried it in a few locations a year ago and successfully proved to ourselves we don't like it, and we want you to come in. Now we do have lockers from big-ticket, non-food items. Interestingly, when people do that, they come in and they over half of them shop while they're back in the location. You know, and one of our challenges, which is a good quality problem to have, is, you know, our average volume per warehouse has continued to grow way more than we had thought a few years ago.
You know, last year, we had over 150 locations doing over $300 million, I think over 27 or 8, doing over $400 million, and, and, or 26. We've had to open more units, we're continuing to look at a lot of places, even in the U.S., and we don't get a lot of ask for it, honestly. Now, we're not asking a lot about it either, but we don't get a lot of ask for it. I don't see that being as a big thing.
One of the things that we will be doing, though, is even online, when you go to look at an online product, if we're selling in the warehouse near you, based on where you've shopped, in the next several months. Cross my fingers, you will be able to say, you can go ahead and get it in store at this, at the, you know, at the Kirkland, at the Issaquah location, which also has it in stock right now. In some cases, yeah. Oh, same-day grocery, you know, of course, we already have with delivery, mostly with Instacart. We partner with a couple of other people as well, but they're the big kahuna there, both in the U.S. and Canada. We do two-day dry. Yeah.
By the way, that, and that number, which is continuing to grow, is not reporting in our income numbers. In that case, their employee or contract employee comes in, shops, rings it up, and takes it to you. That we consider a warehouse sale.
Oliver Chen (Managing Director)
Got it. Very helpful. Thanks, Richard.
Operator (participant)
Your next question comes from the line of Scott Mushkin with R5 Capital. Your line is open.
Scott Mushkin (Founder and CEO)
Hey, thanks, Richard, again, for taking the question. I wanted to talk about competition a little bit. First, shorter term, and then maybe I missed the answer to this or if it was asked. Promotional activities now, are they someone, one of your competitors said they've really kind of ramped up. Is that what you're seeing as well?
Richard Galanti (CFO)
Yes, it's higher than it was.
Scott Mushkin (Founder and CEO)
Okay.
Richard Galanti (CFO)
Now, mind you, it was a lot lower for a couple of years because of supply chain challenges. I mean, every TV we could sell, every whatever we could, not particularly on an odd food day, we could sell, every paper good we could sell. We actually took some items out of, like, the MVM mailers on the, on the, on the sundry side, because one, there were shortages, like paper goods, and, you know, why promote it when, first of all, we've got to limit one per customer? Some of those comparisons, there's more versus a lot less for a couple of years as well. Yes, we are seeing more now.
Scott Mushkin (Founder and CEO)
Is that purely from the vendors, or is that some activities you're seeing from retailers themselves?
Richard Galanti (CFO)
Well, you mean, well, I can speak for us. Yeah, I mean, well, certainly when we see something that other retailers are doing, we want to make sure, you know, we ask our supplier, they can't tell us, but we're putting the pressure on to know that we're seeing some unusual things out there, and lo and behold, sometimes we see better deals the following day to us. We just got to stay on top of that. In terms of, you know, I think, as I said a little earlier, I think we've got a lot of leverage to pull. Certainly, all retailers that have gas right now has continued to be helped with that. You know, unusual things like fresh has been relatively strong, and so we feel good about that.
you know, things like, even like apparel, which is a close to an $8 billion business for us worldwide, $7+ billion business worldwide, that's been strong. That's not promotional, that's just better margins in some cases.
Scott Mushkin (Founder and CEO)
I wanted to talk a little bit more long term about competition. It's been a long time, I think, that we've seen as many openings from non-Costco people. You are gonna see that over the next year or 2, 3. The other competitors also, you know, they tout their omni-channel and their technology about, you know, just scanning it and going it. Just give us an overall, you know, your view of the competitive environment over the next 1 to 3 years, and how Costco fits, and whether you think that some of those technologies and ecoms stuff are competitive advantages for people that are competing against you.
Richard Galanti (CFO)
Well, I think we're fortunate in one way, that, first and foremost, the biggest value attribute or customer attraction attribute is the best quality goods at the lowest price, and we dwarf everybody in that regard. I mean, our average markup on goods is in the low double digits, you know, 12%, 13%. You know what they are at other traditional retailers, anywhere from 25%-35% to 100%. We have that extreme benefit to start with. Arguably, we've been somewhat simple in our own arrogant way over the years. One of the things we've done, as I mentioned earlier, on the question that John, I think, had on, even forget about personalization, even target marketing.
I view it now as some low-hanging fruit that we're finally getting around to do over the next couple of years. That'll be a positive to us relative to others. In terms of the benefit of buying online and picking up in store and things like that, we frankly view that as more costly than it is beneficial. Again, we haven't been asked a lot about it other than by analysts who are responding in fairness to the different retailers that feel they have to do it. Many of them want to do it, but there's a cost to doing that. We feel pretty good about the driving business. We think we can do more. We can certainly do more online.
We don't have some strategic goal to go from 8%, which is still a $20 billion business, but to go from 8% of sales to 16%. But let's go from 8 to 9 to 10 to 11 over a certain period of time. We think that with some of the things we're doing on that side, we can. I think we've also done an incredible job, day in and day out on the merchandising side of bringing in more exciting items. That's something that is focused on, that I hear about at every budget meeting, and every Monday morning meeting with Greg and Ron and a few other senior colleagues, including our merchandising head. I think that's what's gonna keep driving our business.
I think we are getting better on the technology side, playing from behind a little bit on that, but I think we've finally got a game plan and some people that are helping build those areas up, both from a marketing and advertising standpoint, taking advantage of the advertising dollars that are out there, that we've done pretty well despite ourselves, but we know we can do a lot better in grabbing some of those dollars. What we'll use it for is to drive sales.
Scott Mushkin (Founder and CEO)
... and the club openings, I don't think you touched on that. Thank you.
Richard Galanti (CFO)
Oh, yeah, the big club opening thing is on target. I think if you the last three years, you know, there's a big down year because of the year, the first year of COVID. Fiscal 2021, 2022, and 2023, I think we averaged around 23 net new units a year. 2022, 2023, we'd like to get above 25 each of the next five years and closer to 30, year 6 through 10. That's kind of the game plan, and that really is a bottom-up approach by each of the 8 U.S. geographic regions, the 2 Canadian regions, and every other country region, working with operations in our real estate department, kind of a, of which ones are likely and what's our priority. We feel pretty comfortable.
We've got a good, you know, a good pipeline of pending openings for sure, over the next 3 or 4 years, and with an equal level of comfort that we feel that we'll continue to have plenty of opportunities to open units.
Scott Mushkin (Founder and CEO)
Thanks.
Operator (participant)
Your next question comes from the line of Paul Lejuez with Citi. Your line is open.
Brandon Cheatham (Equity Analyst)
Hey, Richard, this is Brian Cheatham on for Paul. I wanted to follow up on, you know, what you mentioned about the digital investments that you all are making. You know, it sounds like it's something that eventually you might monetize, partnering with your vendors. You know, how do you balance that with, you know, your view that you really want your members in your warehouse? How do you see that working kind of over the long term?
Richard Galanti (CFO)
First of all, part of that monetizing of digital is in warehouse. You know, we've been very successful of moving the needle, if you will, on a holiday weekend with hot prices on, you know, strip steaks, or at the beginning of a season with the planting season with, you know, green items. I think, it's just we're getting around to doing a better job of it, and we're bringing in people that have done it before, frankly. That's even in Membership Marketing, you know, Sandy Torre, who heads up, you know, Senior VP of Membership Marketing, she's doing more things today than we did even a year ago, trying some things.
Again, I think that our first order of business is to drive business in store, certainly driving it online as well, but not to just replace what's in store. I think, you know, again, I try to stay a little low-key on this subject because I hate to use the word, this new strategic effort, but what we've learned over the last few years is everybody is a technology company today, and there's some things that we have been a little slow to doing, and we know there's a lot of opportunity there to do some of the even basic things. Not have you get five emails a week that none of which relate specifically to you.
If it was an email, even just based on a couple of items you purchased in store, that had a banner of items that you might be interested in, you could literally double the click rate on them. Those are the kind of things that bringing in, you know, of the 4, what we call catalyst VP hires in our IT department over the last few years, one is data analytics, and one is digital. It's not just 2 individuals, it's the teams that they have built in short order. We'll continue to do that and tell you more as we go along.
Brandon Cheatham (Equity Analyst)
Got it. If I could follow up, you know, on the membership side, you mentioned membership marketing. Are you seeing any difference in promotions from your competitors for their memberships? You know, how has that, you know, informed what you all are doing? Is there any major change, on promotions on membership from your competitors?
Richard Galanti (CFO)
Well, for us, there's really no change. I mean, we do a few promotional things each year, but the biggest thing that we don't do is, in any big way, discount our membership. Now, some of the promotional things that you may sign up for a membership, and you get a certain number of coupons related to stuff, but I don't want to go into that, but you can look at our competitors and see what they do. There's a lot more promotional activity going on elsewhere. We're still getting, as I mentioned on the call, a year-over-year, 7% increase in new memberships with about a just under a 3% increase in number of new warehouses. We're still getting people in the door. I think in fairness, that's been helped by COVID.
When we were one of the we being warehouse clubs, was a big cavernous place to come and get a lot of things, and that certainly helped us. I'd like to think we're pretty good at what we do, and that's why more people are signing up, and we're opening new units, and driving more business that way. But really, we have not done, and if anything, we've done a little less on the promotional side and membership. We do a few promotional things each year, but not a lot.
Brandon Cheatham (Equity Analyst)
Got it. Thank you. Good luck.
Richard Galanti (CFO)
I'm gonna take one more question.
Operator (participant)
Your next question comes from the line of Rupesh Parikh with Oppenheimer & Co. Your line is open.
Rupesh Parikh (Managing Director and Senior Analyst)
Good afternoon, thanks for taking my question. On China, I was curious with the reopening there, how those locations are performing versus your expectations?
Richard Galanti (CFO)
They're doing great, end of story. We've been blessed by those first openings that we have over there. Needless to say, we were impacted like everybody over there during the shutdown and what have you. We had some great video clips at our budget meetings here, showing what we did to create care packages, not only for our members, but for the neighborhoods around us. We were told they were the best care packages of any of the big retailers. That made us feel good.
Rupesh Parikh (Managing Director and Senior Analyst)
Great. Maybe just one follow-up question. As you look at your bigger ticket categories, consumer electronics, et cetera, any sense at this point whether trends have bottomed or, you know, just curious if you think trends have bottomed or whether we could see further softening in some of these bigger ticket areas?
Richard Galanti (CFO)
I have one of my colleagues here on the merchandising side, and she was saying to me softly, "The negatives are getting better." Again, as I mentioned earlier, it's about seven or eight months ago, seven-ish months ago, when we started seeing the decline, and so if nothing else, we'll be having an easier compare five months hence. Certainly, we've seen a little bit improvement in the negatives. Thank you, everyone.
Rupesh Parikh (Managing Director and Senior Analyst)
Great. Thank you.
Richard Galanti (CFO)
Dave and Josh and I are around to answer questions if you have any more, which I'm sure you will. Have a good afternoon.
Operator (participant)
This concludes today's conference call. Thank you for your participation. You may now disconnect.