By  on February 29, 2008

Fashion, store traffic and real estate problems persist, but Gap Inc. pulled off a good fourth quarter in a tough economy, thanks to expense reductions and inventory controls.

And the retailer plans to stick to that agenda this year. In presenting his plan to Wall Street, Glenn Murphy, who joined Gap Inc. as chairman and chief executive officer in August, said the chain will sharply cut back on its North American store-opening program this year and downsize many existing units.

On Thursday, the San Francisco-based specialty retailer said net earnings for the quarter ended Feb. 2 rose 21 percent to $265 million, or 35 cents a share, from $219 million, or 27 cents, in the same period last year. The earnings gain came amid continuing issues over consumer response to merchandise and getting traffic back in the stores, as total sales dropped 5 percent to $4.68 billion from $4.91 billion. Same-store sales dropped 3 percent.

For 2007 overall, net earnings gained 7.1 percent to $833 million, or $1.05 a share, from $778 million, or 93 cents, in the prior year on sales that fell 1 percent to $15.76 billion from $15.92 billion.

In a conference call after the stock market closed, Murphy stated that the company has "an unwavering commitment to developing great product. But more work needs to be done. We need to deliver to stores products that are truly reflective of what each brand stands for."

However, in detailing the top priorities for 2008, Murphy stressed that the company will "improve our earnings with a focus on growing margin dollars. We understand the importance of top-line growth and store comps, but in this environment it is the prudent approach to focus on growth on margin dollars."

He said Gap was "embracing a culture of cost-saving management."

Added Sabrina Simmons, chief financial officer: "Top-line growth and comp-store sales are important, but our primary objective for 2008 is to drive bottom-line earnings. Tightly held inventory levels should reduce margin pressures."

Murphy added that, since he took the helm of the beleaguered business, he has visited more than 350 Gap Inc. stores — and that he sees plenty of room for alterations. "With over 40 million square feet of leased space, the real opportunity is reducing square footage per point of distribution and less so in reducing location," he stated.

He cited a "renewed focus on return on invested capital" involving "right sizing, remodeling and repositioning the stores....The only real growth in square footage will be in franchising international markets. We will open new stores in North America only in very select situations. This is an important change in our real estate strategy."

In terms of lowering costs: "Our biggest area is on cost of goods sold. Our current [cost] base inside the business is nowhere as low as it should be."

He also cited labor management as another area earmarked for cost control. The company is investing in a new system to manage labor that will be in place by the end of the third quarter.

Last year, he said, Gap successfully "restructured" to be "brand-centric, serious about managing inventory, driving better margins and refining the target customer." In addition, a "complicated bureaucracy was simplified" and the company reduced payroll by about $100 million.

At Old Navy, the largest and most troubled division, "I do believe in many of the strategic initiatives," including creating a faster pipeline, and integrating the marketing with the merchandising, as introduced by former president Dawn Robertson. "Dawn and I simply disagreed on how to make this happen," Murphy said. Robertson left the division two weeks ago.

At Old Navy, "there is a fashion component and there is a family component, and the most important part is a value component," Murphy explained. "Perhaps we pursued a strategy more devoted to one of the three at some times. I am pretty confident that the imbalance can be rectified for back-to-school. We're still out of balance for the first half, but it will be improved for fourth quarter."

Gap named Tom Wyatt as interim president, but there has been wide speculation he could move into the position on a permanent basis.

"I've been here for over seven months. I feel even better about the business than when I joined on that fateful day in August," Murphy said. "We have great brands and a very diversified business."

The company is forecasting 2008 net earnings per share in the range of $1.20 to $1.27 and operating margin from 8.5 to 9.5 percent.
Also, Gap will decrease capital spending by $200 million, to $500 million, and only open 65 stores in North America and 35 in Europe. There will be about 85 closings in North America, most of which will be the Gap brand.

By division, Banana Republic is the least troubled, posting a fourth-quarter comp-stores sales gain of 2 percent and total sales of $764 million versus $766 million. Gap North America was down 5 percent on a comp basis, with sales of $1.3 billion from $1.5 billion, while Old Navy North America fell 5 percent on a comp-store basis, with total sales of $1.8 billion compared with $1.9 billion.

The international division fell 1 percent on a comp basis, with total sales of $510 million, up from $497 million, while Gap Direct posted $289 million in sales, which rose from $252 million.

For the year, comparable-store sales dropped 5 percent at Gap North America, 7 percent at Old Navy, 1 percent in international and rose 1 percent at Banana Republic. Gap's total sales fell to $4.5 billion from $4.9 billion; Old Navy fell to $6.2 billion from $6.5 billion; international rose to $1.6 billion from $1.5 billion, and sales were up 1 percent at Banana Republic to $2.5 billion from $2.4 billion. Gap Direct hit $903 million in sales last year.

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