By and  on January 5, 2007

It's bad news on top of bad news for Gap Inc. — and with no turnaround in plain sight.

The struggling retailer reported Thursday that December sales dropped 8 percent on a comparable-store basis, after a 9 percent decrease in December 2005. Total sales for the five-week period ended Dec. 30 fell 4 percent to $2.34 billion, compared with sales of $2.44 billion for the same period ended Dec. 31, 2005.

Based on the poor holiday performance, the chain lowered its fiscal 2006 guidance to full-year earnings per share of 83 cents to 87 cents versus previous guidance of $1.01 to $1.06. Full-year operating margins are now expected to be about 7 percent, and free cash flow is now expected to be about $650 million for the year.

The holiday news is glaring, considering other specialty retailers were either positive or slightly negative for the month, and because Gap has been working hard to turn itself around. Second-half marketing has been intense, with high-profile campaigns promoting everything from Audrey Hepburn-inspired slim pants to the socially-conscious Gap (RED) campaign. Now the group's emphasis is on clearance, with markdowns up to 75 percent off.

The latest same-store results compound the pressures on Gap Inc. president and chief executive officer Paul Pressler, whose contract expires in the fall, and triggered a dire statement by Sabrina Simmons, the firm's senior vice president of corporate finance. "Given our holiday sales results, the management team along with the active involvement of our board of directors is reexamining our go-forward product and merchandising strategies and tactics," Simmons said. "We expect to provide an updated view of our approach to 2007 no later than our year-end earnings conference call scheduled for March 1."

The company's one bright spot was Banana Republic, where comparable store sales for December were positive 2 percent, versus negative 5 percent last year. However, Gap North America was negative 9 percent versus negative 10 percent last year, and Old Navy North America was negative 10 percent versus negative 10 percent last year. The international division was negative 8 percent versus negative 3 percent last year.

"Although Banana Republic continued to make good progress in its turnaround, we continued to experience negative traffic trends at Gap and Old Navy," said Simmons. "Given the weak traffic trends, we needed to take significant action on promotions and markdowns at these two brands, which drove Gap Inc.'s overall merchandise margins significantly below last year. We expect continued margin pressure into January as we work to clear remaining holiday product at Gap and Old Navy."

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