Senior Vice President, Financial Planning & Investor Relations at Costco Wholesale
Thank you, Erica, and good afternoon to everyone.
This is Bob Nelson, Senior VP of Finance and Investor Relations here at Costco. Thank you for dialing into today's conference call to review our third quarter fiscal year '22 operating results.
Before we begin, a couple of housekeeping items to take care of. First, as you now have surmised, Richard is not with us today. He is doing great and wishes he could be on the call. He is in Italy with this family on a rescheduled vacation that was canceled early in the pandemic. He wanted me to pass along his best to everyone. And in his absence, I will be filling in for him today.
Secondly, and before we get into the details of today's earnings results, I need to read our Safe Harbor disclosure. Let's begin. These discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call, as well as other risks identified from time to time in the company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made and the company does not undertake to update these statements, except as required by law.
Okay. With that out of the way, let's get to it in. In today's press release, we reported operating results for the third quarter of fiscal '22, the 12 weeks ended this past May 8.
Net income for the quarter was $1.353 billion, $3.04 per diluted share. The reported $3.04 included a one-time $77 million pre-tax charge, $0.13 per diluted share, for incremental benefits awarded under the new employee agreement effective this past March 14. Last year's third quarter net income was $1.22 billion, $2.75 per diluted share, which included $57 million pre-tax, or $0.09 per diluted share for costs incurred primarily from COVID-19 premium wages.
In terms of this year's $77 million pre-tax charge, this was in conjunction with our new employee agreement, again effective this past March 14, and was primarily to adjust our benefit accrual to account for one additional day of vacation, which was awarded to each employee immediately. The continuing impacts of the wage and benefit enhancements reflected in SG&A and margin for this quarter and will be in force, as well as for subsequent quarters. Net income for the first 36 weeks of fiscal '22 was $3.98 billion, $8.94 per diluted share and that compares to the $3.34 billion, or $7.51 per diluted share last year.
Now -- let's now review the metrics of our P&L. As always, starting with sales. Net sales for the third quarter increased 16.3% to $51.61 billion, and that compares to $44.38 billion reported last year in Q3. In terms of comparable sales for the third quarter, for the 12 weeks on a reported basis, the U.S. was better or up by 16.6%, Canada better by 15.2%, other international up 5.7%, and total company again up 14.9%. Our e-com business in the third quarter reported better by 7.4% versus year ago.
For the 12-weeks excluding the benefit of gas inflation and the headwinds of FX, the U.S. came in at up 10.7%, Canada better by 12.8%, other international up 9.1%. And on a total company reported basis, ex gas inflation and FX headwinds, better by 10.8%. And ecommerce just below 8% at 7.9% for the quarter.
In terms of Q3 comp metrics, traffic or shopping frequency increased 6.8% worldwide, and up 5.6% in the U.S. Our average transaction was up 7.6% worldwide and up 10.4% in the U.S. during the quarter. And foreign currencies relative to the U.S. dollar negatively impacted sales by just a little over 1%. And our gasoline price inflation positively impacted sales in the quarter, just a little bit more than 5%.
The best-performing categories in Q3 were candy, sundries, tires, toys, jewelry, kiosks, home furnishings, apparel, bakery and deli. Underperforming departments were liquor, office, sporting goods and hardware, all of which were quite strong a year ago. In terms of other business sales, the best performers came in from gasoline, travel, food courts and our business centers. So overall, our sales grew nicely in the quarter and for the most part were pretty broad based.
Moving down the income statement to membership fee income, reported in Q3 $984 million, or 1.91% as a percentage of sales, compared to last year's $901 million or 2.03% as a percentage of sales. That's up $83 million year-over-year or a 9.2% increase. And excluding headwinds from FX of about $10.6 million, membership was up 10.4% in the quarter.
In terms of renewal rates, we hit an all time -- we hit all-time highs. At Q3 end, our U.S. and Canada renewal rate was 92.3%, up 0.3% of a percent from the 12 weeks earlier at Q2 end and the worldwide rate came in at 90% for the first time in company history, and that's up 0.4% of a percent from what we reported at q2 end. Renewal rates continue to benefit from the increased penetration of both auto renewals and more executive members. And in addition to that, higher first year member renewal rates than what we've historically seen.
In terms of member counts, number of member households and cardholders at Q3 end, we ended Q3 with 64.4 million paid households, and 116.6 million cardholders. Both of those up over 6% compared to a year ago. At Q3 end, our paid executive memberships were 27.9 million. And that's an increase of just about $800,000 during the 12 weeks since Q2 end. Executive members now represent over 43% of our member base, and over 71% of our worldwide sales.
Now before I move on, I want to take just a minute and address the question that we've been getting a lot recently regarding the timing of a potential membership fee increase. Historically, we've raised fees every five years to six years, with the last three increases coming on average at about the five and a half year timeframe. And our last increase coming in June of 2017. As we approach this five and a half year mark, there will be more discussions with Craig, Ron and the executive team. But for today, we have nothing more specific to report in terms of timing.
In addition, given the current macroenvironment, the historically high inflation and the burden it's having on our members and all consumers in general, we think increasing our membership fee today ahead of our typical timing is not the right time. We will let you know, however, when that changes.
Okay. Moving on along the P&L. Let's take a look at gross margins. Our reported gross margins in the third quarter were lower year-over-year by 99 basis points. This year coming in at 10.19% as a percentage of sales, and that compares to last year's 11.18% that we reported a year ago. So the 99 basis points down year-over-year. And excluding the negative input tax of gas inflation, we would have been down 53 basis points. So if you would, for me, and as normal, please jot down the following for our gross margin metrics. And again, as usual two columns. The first column being reported gross margin. The second column being gross margin, without the impact of gas inflation.
There are six rows. The first row being merchandise core; second, ancillary and other business. The third row, 2% rewards, followed by LIFO, other and then total. So in terms of our core merchandise margins on a reported basis, they were down 87 basis points versus last year, down 46 basis points ex gas. Ancillary, another plus 6 reported and plus 18 ex gas. 2% rewards plus 8 and plus 3. LIFO, minus 25 basis points on a reported basis and minus 27 ex-gas inflation. And finally, other, minus 1 with and without gas. So again in total, down 99 reported, down 53, excluding the impact of gas inflation.
A little color -- more color on gross margins. Starting with core merchandise, the core merchandise contribution to gross margin was lower by 46 basis points ex gas inflation in the quarter. Sales mix negatively impacted the core, primarily from the lower sales penetration of total core sales relative to our gasoline sales, which were very strong in the quarter. In terms of the core margins on their own sales, in q3, our core margins were lower by 39 basis points. Approximately, two-thirds of this are coming from fresh foods.
Fresh experienced a very difficult compare versus last year, when the extraordinary volumes produced -- extraordinary volumes produced lower D&D and higher labor productivity a year ago. Also contributing to the fresh decline this quarter were higher raw material costs and higher labor costs due to our new wages. Ancillary and other business gross margin again higher by 6 reported, higher by 18 basis points ex gas inflation. Gas, travel and business centers were better year-over-year, offset somewhat by e-com, pharmacy and optical. Again, 2% rewards higher by 8 reported, higher by 3 ex-gas. LIFO, minus 25 and minus 27 ex-gas as we recorded a $130 million charge in the quarter for LIFO. And other was minus 1 basis point, both with and ex-gas inflation. This included items from both years.
Last year, we had $14 million of COVID expenses, primarily premium wages within gross margin. This year, we had a one-time charge discussed at the beginning of the call, $20 million of the $77 million, of which related to gross margin. The net result of these two items, again, minus 1 basis point. And while we continue to mitigate the impact of price increases as best as we can, we remain comfortable in our ability to pass through higher costs, while providing great value to our members.
Moving to SG&A. We showed good results. Our reported SG&A in the third quarter was lower or better year-over-year by 84 basis points, coming in at 8.62%. And that compares to last year's reported 9.46% SG&A figure. That's again 84 basis points lower or better, and 44 basis points excluding the impact of gas inflation. Again, if you jot down the following for SG&A metrics. Again, two columns. The first column being reported SG&A. The second column SG&A ex the impact of gas inflation. And we have five rows. The first row operations; second row, central; third row, stock compensation expense; third -- or fourth row, other, and then total is the fifth row.
In terms of our operations on a reported basis, SG&A was better by 68 basis points. And next, the benefit of gas inflation better by 35, central better by 15 reported, better by 10 ex-gas, stock compensation better by 2 reported, better by 1 ex-gas and other minus 1 and minus 2 ex-gas. Again, all totaled, 84 basis points lower or better and 44 excluding the benefit of gas inflation.
In Q3, year-over-year, the core operations component of SG&A was better by 68, again 35 ex-gas. Keep in mind, this result includes the starting wage increase we instituted this past October, as well as eight weeks of the new wage and benefit increases just implemented during Q3 on October 14 of this year. Central was better by 15 and better by 10 without gas. Stock comp plus 2, plus 1 without gas, and again, other, minus 1 basis point, minus 2 without gas inflation.
Similar to gross margin, this included items from both years. Last year, we had $44 million of COVID expenses and this year, we had a one-time charge, again, discussed at the beginning of the call, $57 million of the $77 million, which related to SG&A. The net result of these two items, again, minus 1 reported, minus 2 ex-gas inflation. So all told, reported operating income in Q3 of this year increased 8%, coming in at $1.791 billion. Below the operating income line, interest expense was $35 million this year versus $40 million last year and interest income and other for the quarter was higher by 44 basis points year-over-year, primarily due to favorable FX.
Overall, pre-tax profit -- pre-tax income came in for the quarter, up 11%, coming in at $1.827 billion and that compares to $1.65 billion, which we reported a year ago. In terms of income taxes, our tax rate in Q3 was 24.9%. That compares to 25.2% in Q3 last year. Overall, for the year, our effective tax rate is currently projected to be between 26% and 27%.
A few other items of note. Warehouse expansion, in Q3, we opened one net new warehouse, plus two relocations. Q3 year-to-date, we have opened 17 warehouses, including three relocations for a net of 14 new warehouses so far this fiscal year. For the remainder of the fiscal year and in Q4, we expect to open an additional 10 new warehouses, which will put us at 27 for the year, including three relocations, and for a net of 24 net new warehouses for all of fiscal year '22.
The 24 new warehouses by market are 14 in the U.S., two in Canada, and one each in Korea, Japan, Australia, Mexico, Spain, France, China, and our first opening in New Zealand, which will occur in August of this year. In terms of the new openings this year, this is four fewer than what we projected in Q2. Two of the four were impacted by supply chain issues related to electrical equipment, and the other two have been delayed due to third-party site development issues. All four of these buildings are now scheduled to open by the end of calendar November this fall. Incidentally, there are three in U.S. and one in Australia that were delayed. The one net new opening in Q3 was a business center located in San Marcos, California. And the first of the 10 scheduled to open in Q4 opened this past week in Riverton, Utah, bringing our worldwide total to 830 Costcos as of today and around the world.
Regarding capex, the Q3 '22 spend was approximately $854 million. Our full-year capex spend is estimated for the year to be just shy of about $4 billion. In terms of our e-com business, e-com sales in Q3 ex-FX increased 7.9% This is on top of the 38% increase a year ago. Stronger departments in the quarter were special order patio and garden, jewelry and home furnishings. Our largest e-com merchandise department, majors, which includes consumer electronics, appliances, TVs, was up a little bit better than mid single digits on a very strong sales increase a year earlier, and Costco grocery, including our third-party delivery, 2-day dry, fresh and frozen continues to grow up low double digits in the quarter.
An update on Costco Logistics. Costco logistics continues to drive big and bulky sales for us. We average more than 58,000 stops a week in the third quarter. For the full year, we estimate total deliveries will be up 23% and will exceed 3 million. Costco -- with logistics, we continue to transition from vendor dropship to direct ship from our own inventory, particularly in big and bulky items. Overall, this lowers the cost of merchandise and improves delivery times and service levels for our members.
Okay. A few -- now a few comments regarding inflation. First of all, a continuous pressures from higher commodity prices, higher wages, higher transportation costs, and supply chain disruptions, all still in play. For Q1, we estimated price inflation was in the 4.5% to 5% range. For Q2, we had estimated 6-ish, if you will, and for Q3 and talking to our merchants, estimated price inflation was in the 7-ish percent range. However, we did see inflation in fresh foods come in slightly lower in Q3 versus Q2 a year ago, as we began cycling high meat prices. We believe our solid sales increases and relatively consistent margins show that we have continued to strike the right balance in passing on higher costs.
Switching over to inventory for a minute. Our total inventory in Q3 was up 26% year-over-year versus up 19% in Q2. A couple of high-level comments regarding inventory. A material component of the increase year-over-year is inflation rather than unit growth. We continue to expand, open new locations, 20 new in the last 12 months. We are lapping some low stocks in certain departments as a result of last year's high demand. And we are purposely building inventory in our e-com business, primarily in big and bulky categories as mentioned earlier in the call.
Food and sundries and fresh is in very good shape. Our week supply is comparable year-over-year. Non-food inventories are up in certain categories. This is in part a result of being light in certain departments last year, specifically seasonal, lawn and garden, TVs, appliances and sporting goods. Otherwise, we are a little heavy in small appliances and domestics, primarily due to late arriving merchandise this year.
In addition, we have a few $100 million of extra inventory in both late arriving holiday merchandise from last season, which we're storing until this fall and some buying merchandise to ensure proper inventory levels in the face of these ongoing supply chain issues. Speaking with Craig, Ron and Claudine Adamo, our new Head of Merchandising, we feel good about our current inventory levels. The additional inventory we are carrying is in the right departments, and they feel good about our ability to move it.
A quick update on China. Our first opening in China located in Minhang, Shanghai, was closed for the last six weeks of the third quarter. That closure had a negative impact in the quarter of approximately $35 million in sales. As of May 18, we're happy to report that building is back open, but operating under restrictions on the number of people that can be in the building at one time, among other cleaning and operating restrictions.
Our second building in Suzhou, which opened in December, this last December, was largely -- has largely avoided the lockdowns and restrictions to this point. We are currently targeting an opening date of this December for our third Shanghai building in Pudong. The timing although will somewhat depend on the area remaining open for the next several months and not being more negatively impacted by lockdowns.
Four additional China buildings are currently underway and planned, with opening dates in the next two years. These would be our first China openings outside of Shanghai. I believe we have, of those four, one in fiscal '23 and three in fiscal '24. As a reminder, in terms of upcoming releases, we will announce our May sales results for the four weeks ending Sunday, May 29th, this next week on Thursday, June 2, after market close. This is a day later than our traditional Wednesday release due to the Memorial Day holiday.
Before wrapping up, a quick shout-out to the 300,000 worldwide Costco employees around the globe and the excellent work and proactive effort they give each day to navigate during these most challenging environment. Our merchants and operators are the best in the business and their hard work is reflected in our strong operating results.
Finally, I want to address some incorrect information floating around on social media and a few other media outlets claiming that we have increased the price of our $1.50 hot dog and soda combinations sold in our food courts. Let me just say the price when we introduced the hot dog-soda combo in the mid-80s was $1.50. The price today is $1.50, and we have no plans to increase the price at this time.
With that, I will turn it back over to Erika and open it up for Q&A. Thank you.