Updated from 12:56 p.m. EDT

Williams-Sonoma ( WSM) piled up inventory in the first quarter with the expectation that sales will improve in later quarters after a sub-par performance.

Inventory at the home products retailer jumped 47.5% over the prior year quarter to $372.5 million. The inventory gain far exceeded both the company's same-store sales and its increase in square footage.

"It's a risky strategy," said Rob Wilson, who covers the company for Tiburon Research Group. "If the economy worsens, they have a lot of inventory risk."

Williams-Sonoma allowed its inventory levels to decline after the Sept. 11 terrorist attacks and then saw them drop further after experiencing strong sales in the first quarter a year ago, company officials said. The build-up is an effort to get inventory back up to levels seen in 2001, they said. In the company's namesake stores, where inventory increased most dramatically in the first quarter, the build-up resulted in strong sales, they said.

"We're feeling good about the progress we're making in reinstating inventory," said Sharon McCollam, the company's chief financial officer, during a conference call.

Retailers' inventory levels have been a growing concern in recent weeks, as companies including Wal-Mart ( WMT), Target ( TGT) and Kohl's ( KSS) have warned that inventory increases could force them to take substantial markdowns in the second quarter. Williams-Sonoma officials did not issue a similar warning, but noted during the call that the company sold fewer goods during the first quarter at full price, indicating that the company is already facing markdown pressure.

In the first quarter, profits slipped at Williams-Sonoma on declining comparable-store sales and increasing operating expenses.

The San Francisco-based company posted a profit of $13.4 million, or 11 cents a share, in its first quarter, which ended May 4. In its year-ago quarter, Williams-Sonoma earned $15.4 million, or 13 cents a share.

Overall revenue at the retailer increased 12% over the first quarter last year to $536.84 million. But on a same-store basis, which compares results of like retailers open more than one year, sales fell 0.8% after a 6.2% increase in the year-ago period.

Earnings and revenue beat analysts' expectations. Analysts surveyed by Thomson First Call were projecting that the company would earn 8 cents a share on $536.17 million in revenue.

While reporting its fourth-quarter results in March, Williams-Sonoma had sought to temper analysts' expectations, saying it expected to earn between 7 cents and 8 cents a share on comparable-store sales ranging from a 2% decline to 1% growth.

For the second quarter, Williams-Sonoma projects that it will earn between 12 cents and 14 cents a share on sales ranging from $557 million to $575 million. Meanwhile, the company increased its full-year estimates. For the full year, the company now expects to earn $1.23 to $1.27 per share on revenue ranging from $2.646 billion to $2.718 billion.

Wall Street had been expecting the company to earn a $1.21 a share on $2.68 billion in sales. Williams-Sonoma previously projected it would earn between $1.20 to $1.24 a share on sales of $2.638 billion to $2.728 billion.

Although the company's overall comparable-store sales fell in the first quarter, its performance varied by division. At its eponymous stores, comparable-store sales grew 5.4% over the first quarter last year. Company officials attributed that growth in part to higher in-stock levels of products due to the inventory increase.

But same-store sales fell 4.4% at the company's Pottery Barn division and 9.7% at its new Pottery Barn Kids stores. Company officials blamed the steep fall-off in comparable-store sales at Pottery Barn Kids on the fact that it has located most of its newer stores in the same markets as older stores.

"We are confident in our strategy going forward," said Laura Alber, Pottery Barn's president, on the call. The decline in same-store sales at Pottery Barn Kids is "consistent with Pottery Barn's growth."

But Wilson called the decline "disturbing," saying that he didn't buy the company's cannibalization explanation. Pottery Barn Kids has held much of the company's growth potential going forward, he noted.

"When you start to see sharply negative comparable-store sales , you start to get concerned," he said.

During the quarter, Williams-Sonoma increased its gross profit margin, which is the difference between what a retailer charges for its products and what it pays for them, by 10 basis points as a portion of sales, to 38.1%. The company's gross margin was helped by a decrease in returns, an increase in merchandise margins and a decrease in "shrink," or lost inventory, McCollam said. The decline in full-price sales, higher occupancy costs and increased freight costs related to the inventory build-up prevented the company's gross margins from increasing more, she said.

While the company increased its gross margin, it lost some ground with its operating expenses. Wiliams-Sonoma's sales, general and administrative expenses jumped 16.7% in the quarter to $182.8 million. As a portion of revenue, such costs increased 1.3 percentage points to 34.1%.

McCollam blamed the increase in operating expenses on rising catalog and employment costs. Williams-Sonoma increased its circulation in the quarter of its Pottery Barn, Hold Everything and West Elm Catalogs, she said. Meanwhile, the company faced higher worker's compensation and other employment-related costs.

Wilson and other analysts noted that the company's catalog circulation increased faster than catalog sales, indicating a decline in productivity. Last year, the company touted an investment in some new technology that was supposed to help it be more effective in choosing whom to send catalogs to, Wilson said.

"I'd like to ask them what happened to that initiative," Wilson said. "You reach a point at which more catalogs are not going to return the level of productivity that you're used to. I think they've reached that point."

But company officials blamed the decline in productivity on new catalogs such as Pottery Barn Teen and West Elm for which the company is still trying to establish a customer base.

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