Net income dropped to $224 million, or 49 cents a share, from $235.6 million, or 49 cents, a year earlier, the Issaquah, Washington-based company said today in a statement. Excluding the return expenses, earnings matched analysts' estimates.

Pretax profit was reduced by $48.1 million after Costco added reserves to account for the possibility of more shoppers bringing back their older digital music players and cameras. The company started limiting returns to 90 days earlier this year after customers abused the previous open-ended policy, hurting profit.

"Now that that's adjusted, they'll be OK moving forward," said Howard Davidowitz, chairman of New York-based retail consulting firm Davidowitz & Associates. "When you compare to the 30 days of other competitors, I think they still have a generous returns policy. I think the returns policy they had was way overboard."

Fourth-quarter profit will rise as much as 83 cents a share, Chief Financial Officer Richard Galanti said on a conference call today with analysts. Profit for the year will be as much as $2.56, he said.

Analysts surveyed by Bloomberg estimated average profit of 84 cents for the quarter and $2.56 for the year.

The shares fell 6 cents to $56.47 at 4:01 p.m. in composite trading on the Nasdaq Stock Market. They have gained 6.8 percent this year.

Sales Gain

Sales rose 10 percent to $14.3 billion, Costco said. Revenue, including membership fees, climbed 10 percent to $14.7 billion.

Excluding costs associated with the returns policy, profit would have been 56 cents a share, Costco said, in line with the average estimate of 21 analysts surveyed by Bloomberg.

Sales at stores open at least a year rose 7 percent in the U.S. and 10 percent at the retailer's international locations. Same-stores sales are considered a key retail gauge because they measure performance at established locations.

Reported sales were reduced by $228.2 million as a result of an increase in the returns reserve balance, the company said. The new U.S. returns policy for some electronic goods will "favorably impact future returns experience," Costco said.

Operating margin, or the percentage of sales excluding costs of goods sold and selling, general and administrative expenses, fell to 2.4 percent from 2.7 percent.

Policy Abuse

Mitchell Kaiser, an analyst at Piper Jaffray Cos. who rates shares "outperform," said the old policy likely hurt margins by as much 0.15 percentage points annually.

"Basically, you could take a TV back whenever you want," Kaiser said in an interview from Minneapolis. "With the price deflation at that we're experiencing on televisions, people were abusing the policies."

"The real story is the operating margin," Kaiser said. "Can they get the operating margin to expand?"

Membership revenue rose 15 percent from a year earlier to $317.7 million after Costco raised membership fees for individuals and businesses by $5 to $45 in May 2006.

Costco operates 510 warehouses in North America, Asia and the U.K.

BJ's Wholesale Club Inc., the third-largest U.S. warehouse retailer, said May 22 that first-quarter profit fell 11 percent while sales climbed 7.6 percent. Same-store sales climbed 2.3 percent on demand for higher-priced gasoline.