AP
Gap 3Q Profit Rises 26 Pct on Cost Cuts
Wednesday November 21, 4:58 pm ET
By Rachel Konrad, AP Business Writer
Gap 3rd-Quarter Earnings Jump 26 Percent but Executives Brace for "Tough" Holiday


SAN FRANCISCO (AP) -- Gap Inc. said Wednesday its third-quarter profit rose 26 percent as marketing costs fell.

But the company's cost-cutting campaign couldn't compensate for a slowdown in sales at its Gap and Old Navy chains. Companywide revenue was flat, and same-store sales -- a key measure of retail health -- fell 5 percent.

"We feel this is going to be a tough economic environment this upcoming holiday season," Chairman and Chief Executive Glenn Murphy said in a conference call.

Its shares sank more than 6 percent Wednesday.

The San Francisco-based company, which named Murphy as CEO during the summer, said net income for the quarter ended Nov. 3 rose to $238 million, or 30 cents per share, from $189 million, or 23 cents per share, in the year-ago period.

Sales were flat at $3.85 billion.

Analysts surveyed by Thomson Financial, on average, anticipated earnings per share of 29 cents on sales of $3.86 billion.

Its shares dropped $1.24, or 6.1 percent, to close at $18.96 Wednesday.

Despite an increased outlook for the full fiscal year, executives sounded notes of caution about the upcoming holiday season.

"The consumer will ultimately be the judge, but we feel we're well positioned -- but we're also very aware this is going to be a tougher environment than we faced last year," Murphy told analysts.

Gap increased fiscal 2007 guidance to a range of 92 cents to 98 cents per share. Executives previously expected a range of 83 cents to 88 cents per share.

But Sabrina Simmons, executive vice president of Gap Inc. finance, acknowledged that fourth-quarter sales estimates were difficult: "The macroeconomic environment warrants caution," she said.

The company is betting heavily on fashions with bold color and patterns -- particularly its "crazy stripes" campaign at Gap stores, which will run through the end of the year. Stores are visibly brighter and zanier than previous quarters, when critics said Gap had become staid and dark.

The company is betting heavily on fashions with bold color and patterns -- particularly its "crazy stripes" campaign at Gap stores, which will run through the end of the year. Stores are visibly brighter and zanier than previous quarters, when critics said Gap had become staid and dark.

But it's unclear if bold colors will be remembered among Gap's other successes, such as cargo pants and down vests.

"I don't know if 'crazy stripes' cuts it, but Gap badly needs a product that inspires people to buy," said Stifel Nicolaus & Co. analyst Richard Jaffe. "No one needs new clothes -- you have to want them. There's no formula to figuring out what the consumer wants next. It's an art form."

The company is also hoping to spur holiday sales with "doorbuster" promotions on Friday and weekly sales until Christmas. About 90 percent of Old Navy stores will open at 5 a.m. on the day after Thanksgiving, traditionally the busiest shopping day of the year, and 170 Gap Outlets will open at midnight on Thursday.

In the third quarter, same-store sales fell 5 percent compared with the period ended Nov. 4 a year ago, with Gap North America recording a 6 percent drop and Old Navy same-store sales falling 8 percent.

Same-store sales, or sales at stores open at least a year, is a key measure of retailer performance, because it gauges growth at existing stores rather than from newly opened ones.

Gap, which also operates Banana Republic stores, said it cut marketing expenses by about $75 million in the quarter, as planned.

On the sales side, one of the few bright spots came from online sales, which surged 36 percent to $247 million, from $182 million in the third quarter of last year. Gap operates online shoe store Piperlime, gap.com and other e-commerce sites.

The company ended the quarter with $1.7 billion in cash and investments. It repurchased 48 million shares during the quarter for $887 million -- part of a $1.5 billion share repurchase program announced in August.

Aggressive cost-cutting has reduced in 1,500 job cuts this year, and the company is reorganizing its North American real-estate holdings -- selling underperforming, older stores in aging markets and buying property in hot growth suburbs and urban retail centers.

The company opened 187 new stores this year and closed 127 stores, including closure or conversion of all Old Navy outlet stores, and the closure of all Forth & Towne stores, which targeted older women. Overall, the company increased store square footage by 2 percent.

Analysts peppered executives about the seemingly slow pace of the turnaround. Reorganizing the company's retail holdings could take years, but Murphy emphasized that the turnaround has already begun.

"Round one is just identifying what we're going to do, and then we focus on executing," he said.