By and  on February 26, 2009

Two of the nation’s largest apparel specialty chains, Gap Inc. and Limited Brands Inc., on Thursday reported fourth-quarter income declines, providing further evidence of the worsening economy and the tough road ahead.

The results, the uncertainties and some higher expectations pushed both stocks down, with Limited losing 13 percent to close at $7.74 from $8.92, while Gap slipped 2 percent to close at $11.35 from $11.80.

But despite sales declines and markdowns, both companies maintained healthy balance sheets with plenty of cash, thanks to aggressive cost-cutting involving staff and square-footage reductions and efforts to keep margins under control.

As Glenn Murphy, Gap’s chairman and chief executive officer, said on a conference call, “I’m pleased with our results,” adding he was “very proud” of Gap’s 150,000 employees. “It was a good year in a tough economic environment.”

Still, he said traffic in the stores has been the corporation’s “Achilles’ heel” for a number of years.

Adding to uncertainties, Murphy said 2009 “looks a little foggy” and that the company has no expectations to see improvement in the business climate in the next 12 months.

Clearly, conditions are worsening, with the 3,149-unit Gap posting an 8.3 percent drop in fourth-quarter net earnings to $243 million, or 34 cents a share on a diluted basis, from $265 million, or 35 cents, for the same period last year. Same-store sales dropped 14 percent for the quarter. Sales in the three months fell to $4.1 billion from $4.7 billion.

The year overall was better, with net earnings increasing 16 percent to $967 million, or $1.34 a share, compared with $833 million, or $1.05. Comp-store sales for the year fell 12 percent, while total sales declined to $14.5 billion from $15.8 billion.

“Our ability to drive healthy margins and achieve significant cost savings helped us deliver earnings growth of 16 percent over the course of a very challenging year,” said Murphy. “With nearly $2 billion in cash on hand and virtually no debt, we have a strong foundation that will allow our globally recognized brands to compete effectively this year as we navigate the current environment.”

In a snapshot review of each Gap division, he said he felt “pretty good about the Gap brand” and he commended the two-year-old team there for bringing the product back closer to the aesthetic for which Gap is known. He said GapKids continues to perform well, gapbody was completely redone in the last six months under the direction of Patrick Robinson, and, at Old Navy, “there’s some light at the end of the tunnel, despite horrific January [sales.]” Old Navy, he said, has a better balance between seasonal basics and fashion, and its value message is coming out much clearer. “It’s positioned as fun fashion for all. It is starting to get better, but still has a very long way to go.”

Mark Breitbard will join as chief merchandising and creative officer, a new position, next month and is expected to take the chain in a new direction. Todd Oldham left last Friday. He served as consultant-creative director.

Old Navy, showing that it’s starting to feel comfortable enough with its products, launched an integrated, multimedia marketing campaign that attempts to recapture the chain’s original quirkiness. (For more on the campaign, see page 17.)

Murphy characterized Banana Republic as disappointing, affected by the pullback in the luxury market, though it’s positioned as affordable luxury. There are 450 Banana Republic stores in the U.S., some of which Murphy acknowledged could close after an evaluation.

In terms of coping with the recession, Murphy said, “In some ways, we are a little more battle-tested than most. We have more to do, but I think we are ahead of the pack.”

The company has been working hard at lowering average unit costs, which is helping maintain margins in the face of markdowns, and also working to keep SG&A, distribution and logistic costs, and rents and occupancy costs, down. “Third-party vendors had to find a way to tighten their belts in order for us to get the best value from them. We expect the same from our landlord community.”

With a stronger financial foundation, “we are in a position to make some investment in our company,” Murphy said, citing plans to build and test new store models in each division by the third quarter, continuing to open franchised stores overseas, make investments in online business, and grow Athleta, which was purchased last year.

At Limited Brands, lower sales and a write-down of its La Senza acquisition drove down fourth-quarter profits, and expectations of a first-quarter loss led to a sell-off of its shares Thursday.

In the quarter ended Jan. 31, the Columbus, Ohio-based owner of Victoria’s Secret and Bath & Body Works recorded a 95.9 percent drop in profits to $16.1 million, or 5 cents a diluted share, from $388.6 million, or $1.10 a share, in the year-ago period. Sales in the three months fell 8.7 percent to $2.99 billion from $3.28 billion last year and were off 10 percent on a same-store basis. Gross margin fell to 34.3 percent of sales from 39.6 percent a year ago.

Excluding 63 cents in charges related to impairment of the Canadian La Senza operation, acquired in January 2007, and other special items, fourth-quarter earnings per share was 68 cents versus 94 cents last year. Analysts polled by Yahoo Finance were looking for EPS of 64 cents.

The company will be cutting 400 jobs, or about 10 percent of the staff at its home office, suspending pay increases for salaried employees and reducing other controllable expenses.

Martyn Redgrave, executive vice president and chief administrative officer, said on an earnings call with analysts, “In this unprecedented environment, we are choosing to take aggressive actions while remaining confident, disciplined and also looking forward to the opportunities that will come.”

Limited, which ended 2008 with $1.2 billion in cash, will reduce capital expenditures to about $200 million this year from the 2008 level of $479 million. Fifty new stores are planned for the year, versus 145 openings in 2008.

For the year, Limited Brands posted a 69.3 percent drop in net income to $220.1 million, or 65 cents a share, from $718 million, or $1.89 a share, in 2007. Sales fell 10.8 percent to $9.04 billion from $10.13 billion in 2007.

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