By  on August 19, 2010

While still grappling with traffic and merchandise issues, Gap Inc. showed improved financial results, reporting Thursday that net earnings for the second quarter grew 3 percent to $234 million, from $228 million in the year-ago period.

Earnings per diluted share rose 9 percent to 36 cents from 33 cents.

But it’s the company’s ability to flex costs that keeps earnings up, offsetting insufficient headway in improving certain categories and generating better selling results. “Q2 proved to me that the economic model is flexible. We are able to flex down and take costs out of the business to deliver healthy earnings. We need to grow top line and push even harder to get market share in North America,” Glenn Murphy, Gap Inc. chairman and chief executive officer, stated during a conference call.

Comparable-store sales at Gap North America were down 4 percent; Banana Republic North America was up 3 percent; Old Navy North America was up 2 percent, and International rose 3 percent. Overall, comparable-store sales were up 1 percent in the second quarter ended July 31, while net sales increased 2 percent to $3.32 billion from $3.25 billion in the year-ago period. Online sales for the quarter increased 15 percent to $258 million.

While characterizing the three-month period as “a decent quarter,” Murphy qualified the comment by stating, “We are disappointed by an inability to generate the sales we had expected.” Regarding the Gap brand, the most troubled division in the corporation, he said, “At the end of the day, we expect a lot from the brand….My patience is not indefinite.”

He said tops represented a big missed opportunity, though the Gap division has been doing well with its 1969 premium denim program and black pants. On Aug. 24, the company is launching a new sport pant, Gap Body Fit.

“There were not enough tops in the business and not enough great tops in the business to take advantage of success in bottoms,” Murphy explained. However, tops are beginning to come in “through a faster pipeline to complement the black pant.” There should be a noticeable difference beginning around Oct. 1, with “a step up for holiday and another step up for spring,” Murphy added.

Management conceded that Gap tops have been too basic and androgynous and lacking femininity and emotion.

But across the divisions, recent team meetings have a “heightened level of intensity” discussing traffic concerns, marketing, differentiating the inventory and key item initiatives, Murphy said. He said he left the meetings “invigorated.”

Gross profit grew 2 percent to $1.31 billion compared with $1.29 billion last year, while the operating margin increased 40 basis points to 12 percent compared with 11.6 percent last year. Gap pointed out that this is the highest second-quarter operating margin in a decade.

While still having traffic and merchandise issues domestically, Gap is pushing international expansion to drive better results. Last quarter, Gap grew its e-commerce from one country to 55 through international shipping, making Old Navy available for the first time to customers outside of North America. The company expects to launch e-commerce sites this month in Canada and the U.K. On the brick-and-mortar front, Gap stores should be operating in China, Italy and Australia by the end of the year, which means Gap Inc. brands, via store operations as well as online, will be available in 80 countries.

This year, about 65 stores, mostly overseas, will open, and about 110 stores, weighted toward Gap brand, will close. Net square footage is seen dropping about 3 percent in fiscal 2010. The company also revealed a new $750 million share repurchase program. This brings the company’s total share repurchase authorizations in fiscal year 2010 to $1.75 billion.

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