What caused the decrease in net income compared to the prior year?

The decrease in net income was primarily driven by two significant, non-recurring items: a $224.4 million adjustment to increase the reserve for sales returns, which reduced net sales by $224.4 million and gross margin by $48.1 million, and a $46.4 million charge related to employee tax consequences on stock options. Excluding these items, net income and earnings per share showed growth.

How is the company managing its inventory?

The company's inventory management approach emphasizes low prices and high sales volumes with rapid inventory turnover. Inventories are valued using the LIFO method for U.S. operations and FIFO for foreign operations, both at the lower of cost or market. The balance sheet shows merchandise inventories of $4.93 billion, a slight increase from the previous fiscal year-end, and the cash flow statement shows an increase in inventory levels contributing to a decrease in cash from operations.

What is the company's strategy for expansion?

Costco plans to spend approximately $1.4 billion to $1.5 billion in fiscal 2007 for new and remodeled warehouses, both domestically and internationally. In the second quarter of fiscal 2007, 4 new warehouses were opened, and plans for the remainder of the year include opening an additional 14-15 new warehouses in the U.S. and Canada. The company intends to fund these expenditures through cash flow from operations and existing liquid assets.

What is the company's policy on share repurchases and dividends?

Costco actively engages in share repurchases, having spent $480.8 million in the second quarter of fiscal 2007 to repurchase approximately 8.9 million shares. The company has a substantial authorization for future repurchases, with $1.72 billion available at the end of the quarter. The company also continues to pay a quarterly cash dividend, with the current rate at $0.13 per share, or $0.52 annualized.

COST 10-Q Quarterly Report Q2 FY2007 — Revenue, Net Income, EPS

Summary

Costco Wholesale Corporation's Q2 FY2007 filing shows a mixed financial performance with solid revenue growth partially offset by an increase in the sales return reserve. Net sales increased by 7.4% to $14.8 billion, but this was impacted by a $224.4 million adjustment to the sales return reserve. Excluding this item, net sales grew by a healthier 9.0%. Membership fees saw a significant 13.9% increase, driven by new store openings, higher Executive Membership penetration, and a prior year's membership fee increase. Despite revenue growth, net income decreased by 15.8% to $249.5 million from $296.2 million in the prior year's quarter. This decline was primarily due to the aforementioned sales return reserve adjustment and a $46 million charge related to employee tax consequences on stock options. Excluding these non-recurring items, adjusted net income actually increased by 2.3% to $302.9 million, and adjusted diluted EPS grew by 6% to $0.66. The company continued its aggressive share repurchase program, spending $480.8 million in the quarter, and outlined plans for approximately $1.4 to $1.5 billion in capital expenditures for fiscal 2007.

Key Highlights

1Net sales increased by 7.4% to $14.8 billion, but adjusted for a $224.4 million increase in the sales return reserve, the growth was 9.0%.
2Membership fees rose 13.9% due to new stores, Executive Membership growth, and a prior year's price increase.
3Net income decreased by 15.8% to $249.5 million, largely due to a $48.1 million charge to gross margin for sales return adjustments and a $46 million charge related to stock option tax consequences.
4Excluding unusual items, adjusted diluted EPS increased 6% to $0.66 from $0.62 in the prior year.
5The company repurchased approximately $480.8 million of its common stock in the quarter.
6Planned capital expenditures for fiscal 2007 are between $1.4 billion and $1.5 billion, primarily for new and remodeled warehouses.

COSTCO WHOLESALE CORP /NEW Quarterly Report for Q2 Ended Feb 18, 2007

Summary

Key Highlights

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