Margins Help Wal-Mart Squeeze Out 14% Growth

It matches expectations on strong international results, stronger gross margins and lower interest.
By Troy Wolverton ,

Updated from 8:07 a.m. EDT

Wal-Mart's

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first-quarter profits rose faster than its sales, as the company benefited from margin improvement and decreased interest expenses.

The retail behemoth earned $1.86 billion, or 42 cents a share, in its quarter ended April 30. Wal-Mart's earnings per share were up 13.5% from the year-ago period, when it posted profits of $1.63 billion, or 37 cents a share.

Compared with its first quarter a year ago, Wal-Mart's revenue increased 9.8% to $57.22 billion. That revenue figure does not include sales from McLane, the grocery distributor that Wal-Mart recently agreed to sell to

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.

Analysts had been expecting the Bentonville, Ark.-based retailer to earn 42 cents a share on $60.69 billion in revenue, according to Thomson First Call.

On a prerecorded conference call, Wal-Mart officials acknowledged that the company's sales were "below plan," but praised the company's performance in the face of the sales problems.

"The just-completed quarter was one of the most interesting and, in some ways, confusing quarter in recent Wal-Mart history," said CEO Lee Scott, on the call. "All that said, we had a good quarter from an operating perspective."

Saying that the company was expecting that sales will not improve in the second quarter, company officials warned analysts that their earnings expectations may be optimistic. Officials projected that Wal-Mart will earn between 49 cents to 51 cents in the current quarter; Wall Street expects the company to earn 51 cents a share, according to Thomson First Call.

The company's sales were below plan across all of its divisions in the first quarter, company officials said. Overall, Wal-Mart posted same-store sales growth in its U.S. stores of 2.2%, at the low end of its projection of 2% to 4% growth. Still, not everything was disappointing on the revenue side.

Wal-Mart's international sales jumped 14.3% to $10.3 billion. The company's operations in the U.K. posted particularly strong results, reporting comparable-store sales growth in the high single digits percentage-wise, excluding volatile gasoline sales. Same-store sales compare results at like outlets open for more than one year. Store traffic and customers' average tickets were both up in the Wal-Mart's U.K. stores.

Sam's Club, the company's wholesale club division, posted disappointing sales growth of 7.2% in the quarter. But the division's membership income grew 11.5% in the quarter, showing the results of its focus on signing up business members.

An improvement in gross margin helped the company shore up its bottom line. As a percentage of sales, Wal-Mart's gross margin, which is the difference between what a company charges for its goods and what it pays for them, increased 19 basis points to 22.57% of sales.

An improved mix of products and better sourcing helped Wal-Mart lower its cost of goods and improve its margin, company officials said on the call. Gross margin improved by 55 basis points at Wal-Mart's core namesake division, helping outweigh no margin change at Sam's and deteriorating margin at some of the company's international operations.

While Wal-Mart was able to keep a lid on its product costs, the company lost ground on its operating costs in the quarter. Sales, general and administrative expenses increased 21 basis points to 18.01% of sales in the quarter. Sales growth was not able to keep pace with increases in wage, health care and accident costs, particularly at the company's Wal-Mart division, company officials said.

With the margin improvement and operating expense deterioration largely canceling each other out, the company's bottom line benefited from an improvement on interest expenses. As a portion of sales, interest charges fell 12 basis points to 0.37%, or $212 million. The company attributed the decline to a drop in interest rates.

While Wal-Mart officials expect business to pick up in the second half of the year, they will have to contend with some issues in the short term. The company's inventory increased faster than sales in the first quarter, rising 13.4%. Company officials blamed the rise on slower-than-planned sales and high inventory levels at the beginning of the quarter.

The increase in inventory could lead to markdowns and a decrease in second-quarter margins, company officials acknowledged. However, they said the possible markdowns were built into their earnings guidance.

"I think it's fair to say this performance is not acceptable and we are taking steps to bring inventory in line," said Tom Schoewe, the company's CFO, on the call.

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