LITTLE ROCK, Ark. (AP) - Wal-Mart Stores Inc. on Tuesday said first-quarter profits rose 6.9 percent, but issued a cautious outlook for the current quarter and warned that the economy will be a "critical factor" in 2008.

The world's largest retailer beat Wall Street's expectations and cited improved inventory management and better customer service. How well those changes, part of a strategy begun two years ago, will continue to offset a sustained downturn in the economy is far from clear.

"There are still uncertainties during the rest of the year," President and CEO Lee Scott said in a recorded call for investors. "The economy is playing a critical factor in 2008."

Wal-Mart shares fell more than 2 percent, or $1.22, to $56.80 in afternoon trading.

Wal-Mart earned $3.02 billion, or 76 cents per share, in the three months ended April 30, up from $2.83 billion, or 68 cents per share, a year earlier.

Analysts polled by Thomson Financial had projected earnings of 75 cents per share.

Wal-Mart Chief Financial Officer Tom Schoewe said the company expects second-quarter sales in stores open at least a year to be between flat and up 2 percent. He said the company expects to earn between 78 cents per share and 81 cents per share, perhaps falling short of analyst expections for 81 cents a share.

"Higher transportation costs will remain a potential headwind for us the rest of the year," Schoewe said.

The company had overall revenue of $95.30 billion, up 10.3 percent from $86.41 billion in the prior year. Net sales excluding membership fees rose to $94.1 billion from $85.4 billion a year ago.

Analysts projected revenue of $93.47 billion for the quarter.

Without fuel, same-store sales for the first quarter were up 2.9 percent at Wal-Mart's domestic properties, rising 2.7 percent in the Wal-Mart Stores division and 3.6 percent at Sam's Clubs.

Eduardo Castro-Wright, CEO of Wal-Mart's U.S. division, said that credit as a form of payment has declined since the third quarter of last year.

"The paycheck cycle is more pronounced as things get tighter for the customer at the end of the month," Castro-Wright said.

But he said that once customers have their basic needs covered, they are still making discretionary purchases, especially on entertainment items for the home.

"Customers do shop for things they want, not just what they need," he said.

Burt P. Flickinger III, managing director of the consumer industry consulting firm Strategic Resource Group, said Wal-Mart's emphasis on lower prices has stimulated sales as the company intended.

Wal-mart has been able to drive demand and customer count, Flickinger said, and having those customers return in the second half of the year would help Wal-Mart during fall and holiday season.

Company research shows customers buy in larger quantities at the start of the month, then in smaller quantities toward the end of the month when money is tighter, Schoewe said. Wal-Mart has been able to adjust its inventory accordingly, he said.

The company, while favoring brand-name products, has seen increased demand for store brands or generics, Schoewe said.

"Our job is to retain as many people as you can," he said.

In a research note, analyst Adrianne Shapira of Goldman Sachs said Wal-Mart's first-quarter numbers "demonstrated that it is best positioned to weather today's challenging environment," considering increases in customer visits and how much shoppers are spending each trip.

Shapira said Wal-Mart's conservative projection for the second quarter could change because the company has not factored in potential benefits from government economic stimulus plan checks arriving in the mail now.

"We believe setting an achievable and potentially beatable bar in today's tough environment is the prudent way to provide guidance," Shapira wrote.

Wal-Mart's results came as the Commerce Department reported that retail sales fell 0.2 percent in April, with consumers hurt by high gasoline prices and a down economy.