Falling gasoline prices, weaker sales of big-ticket discretionary items and price cuts aimed at boosting customer traffic in stores combined to send Costco Wholesale Corp.'s (COST) fiscal second-quarter net income down 27%.

But Chief Financial Officer Richard Galanti said Costco's moves to cut prices, in some cases even before it realized benefits from falling commodity prices, helped bring members into stores more often and improved the discount club retailer's inventory position.

The approach is also improving customer loyalty and contributing to "underlying" sales growth, or sales excluding the impact of foreign currency exchange and falling gasoline prices, Galanti said during a conference call.

"While our members are buying a little less each visit, they're coming in more frequently," he said.

For the quarter ended Feb. 15, Costco posted net income of $239.7 million, or 55 cents a diluted share, down from $327.9 million, or 74 cents a share a year earlier.

Revenue for the second quarter declined to $16.84 billion from $16.96 billion a year earlier as same-store sales fell 3%. Excluding gasoline deflation and foreign currency impacts, same-store sales would have increased about 5%, Galanti said.

When gasoline prices were more than 40% higher a year ago, gasoline sales volumes also increased as motorists filled up more frequently to limit future pain at the pump. Galanti said he and others worried that motorists would fill up less frequently as prices have fallen. "To our pleasant surprise that did not occur" in February, and sales volumes improved, he said.

And membership renewal rates have remained strong, "essentially, at all-time highs," Galanti said. Both trends support his view that Costco is gaining customer loyalty despite sacrificing some margins.

Warehouse and discount retailers like Costco - known for selling big packages of household goods - have held up better in the weak economy as consumers seek to spend less, but they haven't been immune to the global recession. But the ongoing focus by shoppers on basic necessities like groceries and health and beauty aids rather than the more discretionary, expensive items like jewelry and furniture that have been Costco's strength in recent years means the retailer has had to adjust.

Shares of Costco rose 0.8% to $41.02 in recent trading.

"We believe management has clearly signaled that it will sacrifice margin to protect both its membership renewal rates and sales trends," Morgan Stanley said in a note to clients. "While food sales remain strong, comps here could slow as inflation cools, and we see risk to further declines in discretionary categories."

Costco warned last month that earnings would fall "substantially below" analysts' estimates as January same-store sales in the U.S. were flat, and down 9% in foreign stores.

Galanti said Wednesday that sales trends are still a story of "haves and have-nots."

"Food, sundries, health and beauty aids continue to be positive," he said. "Generally, nonfoods - hardlines and softlines - are in the have-nots category." One exception has been televisions, where Costco has seen big unit increases amid falling average selling prices.

Galanti also said Costco did "fairly well controlling expenses given the sales weakness," though some analysts believe the retailer may have room to improve.

Analysts, according to Thomson Reuters, expected earnings of 59 cents a share and $16.9 billion in revenue.

Galanti said he expects weakness during the third quarter in sales of bigger-ticket items such as patio furniture and grills, but the retailer planned accordingly and has worked with suppliers to limit its exposure to markdowns.

In December, Costco - the nation's largest warehouse chain by sales - cut its 2009 capital expenditure target to $1.5 billion to $1.6 billion from $1.6 billion to $1.8 billion.

Costco in February also said it would no longer publicly forecast financial performance for the remainder of its current fiscal year.

-By Mary Ellen Lloyd, Dow Jones Newswires; 704-948-9145; maryellen.lloyd@dowjones.com

(Katherine E. Wegert contributed to this report.)

Order free Annual Report for Costco Wholesale

Visit http://djnewswires.ar.wilink.com/?link=COST or call 1-888-301-0513