Costco Wholesale Surges Ahead

Issaquah, Wash. — Helped by rising same-store sales, lower borrowing costs and interest it earned on money it put in the bank, first fiscal quarter profits at Costco Wholesale Corp. climbed by 9.8%, to $236.9 million from $215.8 million last year.

But going forward, the retailer said, second-quarter profits will be throttled down as the company gets hit with a $70 million pre-tax charge to cover costs tied to back-dated stock options.

Merchandise sales at the nation’s dominant warehouse player advanced by 9.3%, to $13.9 billion from $12.7 billion a year ago. Same-store sales improved by 5.0%. In a further boost to the top line, membership fees jumped up by 14.0%, to $299.3 million from $262.6 million last year.

Earnings in the opening quarter came in slightly ahead of Wall Street expectations, rising to $0.51 per fully diluted share, compared with a consensus forecast of a $0.50 gain.

But earnings for the current second quarter will take that $70 million pre-tax hit, about $45 million after taxes, to deal with issues stemming from back-dating stock option grants. Costco said it will increase the exercise price on some options granted between 2000 and 2003, resulting in a greater tax liability for those who received them.

But so employees won’t have to dig into their own pockets when the IRS comes calling, Costco said it will reimburse workers any extra income taxes they will now have to pay because of the options re-pricing. The program is expected to cover about 1,000 U.S. workers, the retailer said, at a cost of about $45 million. “We do not intend for our options-holding employees to be penalized for historical issues with some of our stock-option grants,” said Jim Sinegal, president and ceo.

The extra taxes workers will have to pay as the options are re-priced can be considerable, with Costco paying some workers hundreds of thousands of dollars to make up the difference.

Following an earlier review of options practices, the company said it found no evidence of fraud, but did find “imprecisions” related to some grants. Taking the blame, Sinegal and Richard Galanti, cfo, will not receive 2006 bonuses because of their responsibility for the options problems.