Gap Inc. Slashes Profit Outlook

Retail giant warned Thursday that its bottom line in the second half will be “heavily impacted” by rising product costs.

Gap Inc. is dreading the bite that lies ahead from higher costs.

This story first appeared in the May 20, 2011 issue of WWD.  Subscribe Today.

The San Francisco-based apparel retail giant warned Thursday that its bottom line in the second half will be “heavily impacted” by rising product costs as it pulled its full-year earnings guidance down more than 22 percent.

The company reduced full-year earnings guidance to $1.40 to $1.50 a share, down from the $1.88 to $1.93 range provided in February. Gap said Thursday that it now expects product costs per unit to be up about 20 percent in the back half of the year, which will “more than outweigh retail price increases.”

Continuing to struggle with poor sales, Gap reported that net income for the first quarter ended April 30 fell 22.8 percent off a 3 percent decline in comparable-store sales.

Quarterly profits declined to $233 million, or 40 cents a share, 1 cent above analysts’ estimates, compared with $302 million, or 45 cents, for the year-ago quarter, and net sales declined 1 percent to $3.3 billion from $3.33 billion. Gap cited impact from the March earthquake and tsunami in Japan.

“We are disappointed in our quarterly performance, however remain invigorated by the opportunities ahead,” said Glenn Murphy, Gap’s chairman and chief executive officer. “We’re focused on making the necessary adjustments across the business to deliver the kind of sales we should expect from our brands.”

On the company call, Gap chief financial officer, Sabrina Simmons, acknowledged a miscalculation on the company’s part. “We had made the assumption [in February] that our fall buys would be the most expensive, and that we’d get some easing in our holiday buys,” she said. “And it turns out we were just absolutely wrong on that assumption. Holiday got worse, and that costing came in much higher than we expected, and higher than fall.”

Across the industry, retailers are getting increasingly worried about sharp inflation from rising raw material, fuel and shipping costs, how to adjust their own prices on the selling floors and how consumers will react. The recovery from the recession that many have witnessed in recent months appears to be in jeopardy.

At Target Corp., Kathryn A. Tesja, executive vice president of merchandising, on Wednesday said that to offset inflationary pressures, “we’re trying to drive down costs through product design and fabric standardization. Increases for spring have been in the low-to-midsingle digits for apparel. For fall, increases will move to double digits.”

Wal-Mart Stores Inc. and The TJX Cos. Inc. also voiced concerns, with Wal-Mart’s Bill Simon, president and ceo of the U.S. division, indicating the retailer will pay up to offset higher supply costs and TJX ceo Carol Meyrowitz stating, “We see the uncertainty in the marketplace about sourcing and pricing as an opportunity for our business. The key for us is relative value.” She added the company could “maintain the value gap” as prices climb at retail.

Gap’s substantial guidance reduction is the first instance in which a major retailer has recognized the potentially damaging effects of apparel inflation on retailers’ bottom lines.

Murphy said, “While we acknowledge that costing pressure is impacting our business, we’re working hard to navigate this short-term macro challenge to our profitability in the current fiscal year. That said, our strategy remains the same — to deliver consistent, steady growth in North America while investing in our long-term global initiatives, especially in online and international.”

During the quarter, Gap continued to make organizational and operational changes to simplify decision-making; speed the process of getting products sourced, designed and to the stores, and accelerate global store growth. Among the changes, the Gap Global Creative Center in New York started operating; chief designer Patrick Robinson was ousted and a search for his successor was launched, and Art Peck replaced Marka Hansen as president of Gap North America. The international operations were consolidated into one division, based out of London.

The retailer also in the first quarter repurchased about 25 million shares for $548 million; raised $1.65 billion of debt; reported online sales increased 18 percent to $348 million compared with $295 million last year, and signed two new leases to open Athleta stores on Manhattan’s Upper West Side and Upper East Side later this year.

By division, comparable-store sales, including online revenues, for the first quarter were down 3 percent at Gap North America, down 1 percent at Banana Republic North America and down 2 percent at Old Navy North America. International sales were down 6 percent.

Results were reported after the close of the equity markets Thursday. Gap shares closed up 0.9 percent at $23.29 but fell more than 15 percent in the first 90 minutes of after-hours trading.

The results came at the end of a day in which several specialty retailers disappointed investors.

Also reporting after the markets closed, Aéropostale Inc. met first-quarter estimates but offered lower-than-expected second-quarter guidance as the company plans on “aggressively” clearing through spring inventories.

First-quarter profit dropped 63.9 percent to $16.4 million, or 20 cents a diluted share, compared with year-ago income of $45.4 million, or 48 cents a share. Sales improved 1.2 percent to $469.2 million, from $463.6 million in 2010, while quarterly same-store sales fell 7 percent.

Second-quarter earnings per share of between 11 cents and 16 cents are now forecast, below the 27-cent consensus estimate.

Shares of The Buckle Inc. declined $6.71, or 14 percent, Thursday, to $41.19, after the apparel retailer, beset by weakness in women’s denim, missed analysts’ first-quarter expectations.

The Kearney, Neb.-based retailer said net income rose 11.2 percent to $33.5 million, or 71 cents a diluted share, 2 cents below analysts’ estimates, compared with income of $30.1 million, or 64 cents a share, in the year-ago period. Net sales increased 11.8 percent to $240.1 million, from $214.8 million, in 2010.

Same-store sales in the quarter gained 8.1 percent.