By  on November 17, 2006

The comeback at Gap Inc. remains a work in progress.

As the $16 billion retailer reported a 10.8 percent decline in third-quarter earnings Thursday, due in part to sagging sales at Old Navy, chief executive officer Paul Pressler admitted it still will take some time to rebuild foot traffic in the group's stores.

The company lowered its full-year earnings guidance by 5 to 6 percent, but said on a conference call that it was focused on the turnaround and the retailer's long-term prospects.

"We're creating great buzz in the market with our Gap (Product) Red campaigns, but we know it will take several seasons of compelling messaging and product to rebuild our traffic," Pressler said on the call.

In a statement, Pressler said third-quarter results "reflect that each brand is at a different stage in its turnaround. We are pleased with the solid performance at Banana Republic and continued progress each month of the quarter at Gap brand; however, Old Navy's results were disappointing."

For the three months ended Oct. 28, net income fell to $189 million, or 23 cents a diluted share, from $212 million, or 24 cents, in the year-ago period. Sales were flat at $3.86 billion. Total same-store sales decreased 5 percent, compared with a 7 percent decrease in the same period last year.

By brand, comps were down 7 percent domestically at Gap and Old Navy and up 3 percent at Banana Republic North America. Internationally, comps declined 6 percent.

For the nine-month period, earnings were down 27.9 percent to $559 million, or 66 cents a diluted share, from $775 million, or 86 cents a share, in last year's period. Sales were down slightly to $11.01 billion from $11.2 billion.

"Although we believe we've made improvements in Old Navy's product and store experience over the past several months, traffic trends unexpectedly deteriorated in October, making it difficult to clear fall product," Pressler said on the call.

During a subsequent question-and-answer session with analysts, Cynthia Harris, Gap president, said the retailer is engaged in a long-term strategy. And although the Gap nameplates have "disappointed customers over many seasons, the third quarter showed positive indicators," especially in women's wear.Regarding the retailer's earnings guidance, management originally expected full-year earnings in the range of $1.08 to $1.12 a share, based on the deceleration of sales at Old Navy in October. Since sales have continued to lag at Old Navy into this month, coupled with a slower turnaround pace at Gap brand, the company is revising its guidance to $1.01 to $1.06 a share for the year.

Shares of Gap closed down 1.1 percent on Thursday to $19.80 and continued to fall in after-market activity, shedding 2.2 percent in the hour after the bell rang.

One bright spot on the quarterly report was cash flow. Byron Pollitt, executive vice president and chief financial officer, said on the conference call that, "despite several quarters of challenging top-line results, we have delivered healthy, free cash flow. Because of this, we are now comfortable reducing our minimum cash target to $1.5 billion, and we will continue to revisit this target periodically."

Pollitt said the company expects to "deploy excess cash according to the same three priorities we have previously outlined. First, investment in the business; second, in increasing our dividend, and third, for share repurchases."

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