By  on May 25, 2007

As Gap Inc. continues to work to right its business, the specialty retailer reported a 26 percent decline in net profits for the first quarter ended May 5.

Net income for the quarter fell to $178 million from $242 million in the same period last year as sales gained 3.5 percent to $3.56 billion from $3.44 billion. Same-store sales showed a decline of 4 percent. The gross margin rate dropped 2.1 points to 38.1 percent.

Earnings per diluted share dropped 21.4 percent to 22 cents from 28 cents in the prior year. Excluding a $45 million loss related to the closing of its Forth & Towne flag, announced in February, the EPS was 25 cents — one cent above analysts' consensus, according to Reuters Estimates.

Despite the increase in sales, the gross margin rate lost more than 200 basis points. The good news is that Gap's cash position is strong, and the company plans on paring down its debt load.

"We are actively working to fix our core business, retain and recruit talent and streamline operations so that our organization can be more nimble and efficient," said Robert Fisher, interim president and chief executive officer, in a statement. "We took important steps in the first quarter by strengthening leadership teams and refining strategies at Gap and Old Navy."

By division, first-quarter same-store sales at Gap North America fell 4 percent, while sales at Banana Republic North America lost 2 percent and Old Navy North America declined 5 percent. International same-store sales shed 3 percent.

On a conference call with analysts, Fisher said, "There's more work to be done" at Gap Inc., but he feels "good about the progress we're making."

Fisher added that, as the company searches for a ceo, the board will be "focusing on candidates with deep retailing experience coupled with financing acumen. We're looking for candidates who also understand how to build and develop strong, creative senior talent. We know this type of search can take time, and it remains a top priority for the board."

Byron Pollitt, chief financial officer, said on the call that the quarter was "challenging, and while we were pleased with the success of several trend-right categories such as dresses and shorts, overall response to spring product was mixed."As reported, the Gap brand on Wednesday appointed Patrick Robinson, former designer at Perry Ellis and Paco Rabanne, as executive vice president of design for the Gap Adult and GapBody brands in North America.

Pollitt said full-year capital expenditures will be about $700 million. "This includes about $235 million for new stores, about $310 million for existing stores, about $110 million for IT and about $45 million for headquarters and distribution centers," he said.

The retailer reaffirmed its EPS guidance for this year of between 76 cents and 86 cents, which includes a 4 cents-per-share loss relating to the Forth & Towne closures.

On the balance sheet, the retailer said it closed the quarter with $2.8 billion in cash and investments. "This represents $2.3 billion more in cash and investments than debt," Gap said in a statement. For 2007, free cash flow is expected to reach $500 million, the retailer said, adding that it expects to pay down $325 million worth of debt.

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