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Wal-Mart Stores Inc. on Thursday reported a decline in profits for the first time in a decade.

The world’s largest retailer said second-quarter net income was $2.08 billion, or 50 cents a share, a 26 percent drop compared with $2.8 billion, or 67 cents a share, in the same period the previous year. Sales in the quarter ended July 31 totaled $84.5 billion, an 11 percent increase. But the sales came in lower than the $86.2 billion analysts had estimated.

Factors negatively impacting Wal-Mart’s results in the quarter included the sale of its retail operations in Germany; the company took an $863 million charge related to the deal. Wal-Mart also has sold its business in South Korea, but that is expected to generate a gain for the period in which the sale closes.

Excluding the costs of exiting Germany, Wal-Mart earned 72 cents a share in the second quarter, up from 68 cents a share in the prior-year quarter.

President and chief executive officer H. Lee Scott Jr. said during a conference call that he was “quite honestly disappointed in the sales performance of Wal-Mart U.S. Some of the same issues affecting our customers, such as higher utility costs and gas prices, are impacting corporations like Wal-Mart, as well.”

Sales at U.S. stores rose 6.9 percent in the second quarter. Same-store sales grew only 1.7 percent, the smallest increase in six consecutive periods. Wal-Mart Stores had a 1.5 percent gain, while Sam’s Club’s comp-store sales rose 2.6 percent. Total U.S. comparable-store sales for the six months ended July 31 were up 2.7 percent, with Wal-Mart Stores realizing a 2.6 percent increase and Sam’s Club a 3.4 percent gain.

Net sales for the six months were $163.4 billion, an increase of 11.9 percent over the first six months of fiscal 2006. Income from continuing operations for the six months ended July 31 were $5.64 billion, or $1.35 a share, up from $5.36 billion, or $1.28 a share, in the prior-year period. Earnings per share from continuing operations for the six months ended July 31 were favorably impacted by two items totaling $145 million aftertax, or 3 cents a share, the company said.

As rising energy prices and higher interest rates squeeze core customers, Wal-Mart has sought to appeal to more affluent shoppers by providing luxury items. A store that opened in Plano, Tex., features expensive wines and gourmet foods. The company also has taken aggressive steps toward improving its fashion quotient, for example, by launching Metro 7 for style-conscious women.

This story first appeared in the August 16, 2006 issue of WWD.  Subscribe Today.

“They’re doing a good job with No Boundaries, the junior program that’s greatly improved,” said Robert Buchanan, a retail analyst at A.G. Edwards. “The George assortments look much more ‘with it’ in a fashion sense this fall. They need to do that consistently. They’ve got a lot of work to do in home.”

Wal-Mart fully remodeled 200 stores recently and has said it will make changes to another 1,800 units in the next 18 months, bringing fixtures in the apparel, electronics and home departments more up to date.

The international sector is becoming increasingly important to Wal-Mart as it nears saturation in rural areas of the U.S. and faces opposition in some big cities where it’s trying to expand. Marybrett Whitfield, a senior vice president at Retail Forward, said Wal-Mart ultimately intends for international to account for 25 to 30 percent of sales and profits.

International sales from continuing operations for the second quarter were $18.7 billion, up 31.9 percent compared with the same period last year. The sales increase includes the impact of Wal-Mart’s acquisition in Southern Brazil and the consolidation of Seiyu in Wal-Mart Central America. Sales from these entities contributed 19.2 percentage points of international sales.

Mexico was the star performer, with total sales up 17.3 percent in real terms, which is adjusted for inflation. The real comp-store sales increase during the quarter was 6.9 percent. Declining margins from the competitive environment in the U.K. led to operating income that was moderately below plan for the second quarter. Charles M. Holley Jr., senior vice president of finance, said sales performance and merchandising efforts in the U.K. led to an increase in the market share in the quarter. China’s comps grew in the low-double digits for the quarter. “In Japan, we continued to see progress,” Holley said. “Comp sales in the second quarter were positive.”

In the U.S., Wal-Mart operates 3,918 locations, including 1,146 discount stores, 2,098 SuperCenters, 107 neighborhood stores and 567 Sam’s Clubs, totaling approximately 589 million square feet. The international store count is 2,710.

Thomas M. Schoewe, executive vice president and chief financial officer, discussing the outlook for the third quarter, said U.S. comp-store sales are expected to increase by 2 to 4 percent and EPS from continuing operations between 59 cents and 63 cents a share. Forecasts for EPS from continuing operations remains at $2.88 to $2.95 a share for the year, he said.

Wal-Mart shares on Tuesday closed at $44.55 on the New York Stock Exchange, down 55 cents.