By  on January 12, 2006

NEW YORK — Memo to Wall Street: Gap Inc. is working on its problems.

The company reiterated its aggressive posture on Wednesday, outlining plans to improve its sagging sales and shareholder value by maximizing its sourcing to get products into stores faster.

But Byron Pollitt, the chief financial officer of the San Francisco-based specialty retailer, admitted to attendees at the S.G. Cowen & Co. investor conference here that the initiatives will take time to win back shoppers.

"We are maniacally focused on delivering [customers] amazing product, executing flawlessly our store experience and driving traffic through strong, competitive marketing campaigns," Pollitt said. "We are confident that, with a steadfast laser focus on these initiatives, we will win back our customers the old-fashioned way, one season at a time."

Investors liked what they heard and sent shares of Gap up 3.8 percent to $18.15 in trading on the New York Stock Exchange. It was the stock's highest close in nearly a month. Gap shares have lost about 16 percent over the last 52 weeks and opened 2005 at around $21.

Pollitt's remarks, however, essentially echoed those of president and chief executive officer Paul Pressler during the company's November earnings conference call. After reporting a 20 percent decline in third-quarter earnings to $212 million from $265 million on sales that dropped 3 percent to $3.86 billion, Pressler said the company was committed to focusing on the three fundamentals of retailing: product, store experience and marketing. Pressler also admitted in November that the company had been so focused on building infrastructure and operating efficiencies over the past two years that it had neglected creating "amazing product and compelling store experience."

Pressler has said he doesn't expect to see positive results from the company's refocus on its "fresh casual American-style" design aesthetic until this spring. And several analysts who follow the company don't expect to see positive results until fall.

Within its focus to improve customer conversion rates, Pollitt said Wednesday that Gap will specifically improve speed-to-market capabilities by working more closely with vendors and adding more sourcing capabilities in North America. The moves are aimed at more effectively reacting to consumers' acceptance of new collections.Pollitt said the company already has shown its commitment to improving product. At Old Navy, for example, design and merchandise operations recently were consolidated to the West Coast. In addition, the division is working to increase customer service levels in stores as well as improve in-store presentations.

"We only sell a lot of basics, that's what pays the bills," Pollitt said of Old Navy. "But what drives the traffic is creative product that we take to fashion on a ‘massify' basis to drive traffic season by season."

Meanwhile, the Gap brand is in the midst of updating adult store designs after testing new designs in stores in Denver, Hartford and San Diego. It has also seen the most executive turnover, and Pollitt defended the moves by saying that "some turnover is healthy." A new executive, Charlotte Neuville, was announced in October to run Gap adult, Gap accessories and Gap women. A new head for Gap kids, baby and maternity, Pamela B. Wallack, was announced in early November, and Cynthia Harriss was appointed president of the Gap brand in May.

At Banana Republic, which launched its first stores in Japan in September, Pollitt said the company plans to franchise in certain other international markets this year. The division also relaunched its Web site with improved usability, which will include a "shop-by-size" feature, to be launched soon. The feature will allow customers to preorder items before they are in stores.

And finally, Gap's newest division, Forth & Towne, has seen positive customer reaction in its New York and Chicago test stores, as well as to its customer loyalty program, Pollitt said.

Fresh from meetings with Gap management earlier this week, equity analyst Dana Telsey of Bear, Stearns & Co. took an optimistic stance on the company in a research report released Wednesday. While noting that Gap "is in the midst of a transformation," the analyst said that "traffic improvement and regular price selling are the two key metrics that should ultimately lead to an improvement in the operating margin." The company has targeted operating margins to increase to the midteens from current 10 percent levels, Telsey said.

Telsey maintained her "outperform" rating on shares of Gap, writing "the company is well positioned to achieve a respectable double-digit growth rate over a long-term investment horizon, as strategic initiatives facilitate same-store sales gains and operating efficiencies."Meanwhile, there's certainly pressure on top management to solve the company's woes. Indeed, some analysts questioned Pressler's leadership late last year as the company's sales performance continued to deteriorate. Pressler, who was formerly a top executive at Disney, came under fire by some analysts, who believed that a ceo with more past merchandising experience would be better able to turn the company around and therefore please Wall Street.

It's clear, however, that the work Gap did prior to December was not enough to beef up customer purchases. Gap announced last week that consolidated same-store sales in December were down 9 percent, which included a 10 percent decline at both Gap and Old Navy and a 5 percent drop at Banana Republic.

Traffic was the main culprit for holiday results. "Our customers are continuing to shop our stores; where we are beginning to fall short is frequency," Pollitt admitted.

Pollitt said that, although the company has seen a top-line growth slump, Gap has maintained "respectable financial results," generating "healthy" cash flow, actively repurchasing shares, doubling its dividend and returning the company to investment grade.

Pollitt backed the same earnings guidance the company issued last week. Earnings per share are expected to reach the high end of $1.12 to $1.17 in the full year, thanks to intact gross margins and successful inventory management. The analyst consensus is for $1.15.

In November, Gap lowered its full-year EPS assumption to the $1.12 to $1.17 range from a prior estimate for $1.30 to $1.34.

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