(Adds comment from the CFO)

By Michael Carolan

Of DOW JONES NEWSWIRES

LONDON -(Dow Jones)- Home Retail Group PLC (LSE:HOME) (HOME.LN) said Thursday its expectations for its fiscal year are unchanged despite a sharp drop in comparable sales at its Homebase division in the first quarter and a decline in margins at Argos.

The U.K. home and general merchandise retailer said that while sales at its Argos catalogue retail division were in line with its expectations in the 13 weeks to March 2, sales at Homebase - its furniture and home improvement chain - were weaker than anticipated.

"While the consumer outlook remains challenging, we approach it from a position of both financial and operational strength, and at this early stage our expectations for the full year are unchanged," said Chief Executive Terry Duddy in a statement.

Sales at Homebase declined by 5% to GBP440 million in the first 13 weeks of the year, it said. Stripping out new store openings, sales dropped 12%.

The company cited poor weather conditions in March and April for the sales drop. "Seasonal-related categories account for around 40% of first quarter sales, and these experienced a like-for-like decline of approximately 20%," it said.

Sales at Homebase were actually slightly worse than 12% down in March and April, said Finance Director Richard Ashton on a conference call with reporters, with a slightly positive sales result in May once the weather improved.

At Argos, the company's catalogue retail chain, sales grew 4% to GBP929 million, with same-store sales flat. Gross margin at the division declined by 125 basis points as the unit sold more lower-margin consumer electronics goods and fewer higher-margin furniture and homewares products.

While the sales at Argos were slightly better than expected, the gross margin drop and Homebase's weak sales disappointed the market. By 0730 GMT, the shares were down 13 pence, or 5.7%, at 211 pence in a higher London market. Ashton said he wasn't expecting analysts to change their full-year forecasts for the company, with the higher-than-expected sales at Argos offset by the margin news.

Ashton said the flat like-for-like, or LFL, sales performance at Argos was better than expected given the negative sales for the U.K. retail sector over the period.

Ashton estimated that sector-wide sales of nonfood, non-clothing products were down between 3% and 4% during the period. "A flat LFL is a relatively good performance in that market," he said.

Argos sells general merchandise and products for the home from more than 700 stores throughout the U.K. and Republic of Ireland, as well as online and over the telephone.

Argos benefitted from "exceptional" sales of video game machines and software during the period. Percentage sales of such products - which include Nintendo's Wii Fit and Sony's PS3 - were "up very strong double digits - approaching triple," said Ashton.

Ashton said he would be surprised if same-store sales at Argos "got much better than flat" for the year. He said they were more likely to fall back to a slight negative and if they did improve it would be at the expense of gross margin. Gross margin at Homebase grew 125 basis points - driven by sourcing and supply chain savings.

The company said in April that a more difficult consumer environment would result in a negative like-for-like sales performance in both Argos and Homebase in the short term.

Home Retail, along with other house and electrical-goods retailers, as well as clothing companies are hurting due to a slowdown in consumer spending in the U.K. Negative sentiment has intensified recently, with the weakening housing market threatening to further hit spending. Home Retail's share price has more than halved in the last year. Ashton was downbeat on the outlook for consumer spending. "There's been no news that's come out recently to give us a more positive outlook opinion on the consumer," he said. "Our view is probably more pessimistic than it was."

Ashton said that with inflation where it is, flat interest rates for the year "could be a best case scenario." The company had previously expected them to fall.

Company Web site: http://www.homeretailgroup.com

-By Michael Carolan, Dow Jones Newswires; 44-20-7842-9278; michael.carolan@ dowjones.com

    (END) Dow Jones Newswires   06-12-08 0402   Copyright (c) 2008 Dow Jones & Company, Inc.