COSTCO REPORTS 3RD-QUARTER SALES INCREASE, SOFT EARNINGS

JON SPRINGER

ISSAQUAH, Wash. - Costco here said its third-quarter sales increased by 11% but high gas prices and higher taxes contributed to lower-than-expected profits.

Overall sales for the 12-week period, which ended May 7, increased by 11% to $13 billion, with comparable-store sales gains of 7%, compared with year-ago results. Quarterly earnings of $236.5 million, or 49 cents per share, increased by 12.3% but were at the low end of the retailer's expectations and a penny below analyst estimates of 50 cents per share.

In a conference call discussing results, Richard Galanti, vice president and chief financial officer, said inflation during the quarter was flat overall but varied wildly among product categories. Increases in costs for items such as gasoline, tuna, walnuts, coffee and olive oil were balanced by sharp price decreases for electronics.

Gasoline at Costco "is a great business in terms of bringing in the customer," but higher sales of gasoline amid rapidly rising prices contributed to an 11-basis-point reduction in quarterly gross margins, and 2 cents per share in earnings, Galanti explained. Increased executive club membership penetration, which offers rewards to frequent customers, also contributed to the decline in gross margins, he added. The income tax rate increased 1% to 38.9% as compared to the same period a year ago, which also hampered earnings.

Costco opened seven new clubs during the quarter, including one relocation. Building in existing markets increased cannibalization rates, Galanti said - a trend the company expects will continue as it looks to open 26 new stores during the fiscal year and more than 30 in fiscal 2007.

"I hate to sound like I have blinders on but we're focused on our own growth and feel we have a lot of market potential still," Galanti said.