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Gap Inc. Scores Three-Peat

NEW YORK — Third time’s a charm, but is it a rebound?<br><br>After suffering three quarterly losses, Gap Inc. Thursday completed a trio of consecutive profitable ones as it reported its first earnings improvement in more than two years....

NEW YORK — Third time’s a charm, but is it a rebound?

This story first appeared in the November 15, 2002 issue of WWD.  Subscribe Today.

After suffering three quarterly losses, Gap Inc. Thursday completed a trio of consecutive profitable ones as it reported its first earnings improvement in more than two years. The last time Gap posted an earnings increase was the first quarter of 2000.

The San Francisco-based operator of Gap, Banana Republic and Old Navy stores said for the three months ended Nov. 2, its net income fattened to $135.3 million, or 15 cents a diluted share, beating Wall Street’s raised expectations by a penny and reversing a year-ago loss of $178.8 million, or 21 cents. Last week, Gap said impressive gains in October led it to raise its third-quarter earnings guidance to 12 to 14 cents a share, which was at the time at least 50 percent higher than the consensus estimate of 6 cents.

Net sales for the quarter increased 9.3 percent, to $3.64 billion from $3.33 billion in last year’s quarter, and rose 2 percent on a comp basis versus a 17 percent decrease last year and an 8 percent dip in 2000. The BR and ON divisions comped up 1 percent and 6 percent, respectively, while Gap was down 2 percent.

Looking ahead, Heidi Kunz, Gap’s chief financial officer, said on the call that, while she is pleased with the results, including customer approval of merchandise improvements in all divisions, she said she will remain cautious until the company sees continued improvements.

Gap also indicated that it was putting the brakes on store expansion, with net square footage actually expected to decline from current-year levels. Gap operates 4,294 store concepts out of 3,158 store locations. The company said next year it expects to open 40 to 60 concepts at 30 to 40 locations with about 60 percent of the new square footage going to Old Navy.

In his first conference call as Gap’s president and chief executive, Paul Pressler, who took over the Gap’s reins at the end of September from Millard “Mickey” Drexler, said, “I am certainly pleased with the earnings for the quarter and the progress we are making in each of our divisions. The three are moving in the right direction and at the same time we have many opportunities to evolve.”

While declining to unveil a grand new vision for Gap, he did outline his four immediate focus points: product and product positioning, marketing, sourcing and distribution, and Gap’s employees.

Explaining his reasons for leaving the Walt Disney Co. after 15 years, Pressler said Gap simply was too great an opportunity to turn down. “Gap, Old Navy and Banana Republic are premium brands that enjoy a strong emotional relationship with customers,” he said in a phrase that echoed his predecessor. He added that “the company offers a compelling turnaround challenge.”

Still, although Gap’s 11 percent comp improvement last month was a pleasant surprise, some analysts remain cautious about America’s largest apparel specialty retailer, taking a wait-and-see attitude as a changing company under new management copes with a difficult, promotional retail environment.

Richard Jaffe, a specialty retail analyst at UBS Warburg, said, “Clearly, this is a sign of an improvement, but we are not back to anything near full strength yet.”

Asked if that was possible, Jaffe, said, “Yes, I am very encouraged by what I am seeing.”

Kindra Devaney, a specialty retail analyst at Fulcrum Global Partners, said although Gap’s 11 percent comp improvement last month was great, one month does not make a recovery. “Is the recent improvement due to the low-hanging fruit?” she asked rhetorically, referring to Gap’s dramatic two-year declines in gross margins and comps of 1,430 basis points and 25 percent, respectively. “What drove the gain this year was comps turned positive and margins saw great improvements, but part of the reason that happened was it was so easy,” she said.

She said Gap was targeting a 13 percent operating margin, its historical average, but a big jump — roughly a 700 basis point improvement — from where it is today, averaging 5 to 6 percent.

“Now that they have stabilized and captured the low-hanging fruit, given how negative the trends have been the last two years, the question is can they take this rate of improvement and continue it into 2003 and 2004 or does the rate slow down as they figure out how to operate in this challenging environment?” she asked.

Still, Devaney said she is encouraged they are no longer losing money. “It will take them longer to achieve their historical levels. With a company that large and a new ceo to learn the ropes, it takes longer to implement change.”

Adrienne Tennant, specialty retail analyst with Wedbush Morgan Securities, likened Gap’s turnaround to steering a large steamer: “They are turning, but it could take a while to get the boat moving in the right direction.”

Tennant credits the company for taking steps in the right direction by moving back to core basics and buying more deeply into fewer categories so at the end of the day, it will have fewer markdowns if the bets were wrong. “They are placing their bets, but narrowing down what they are betting on,” she said.

However, Tennant said she was concerned about consumers increasingly buying on the basis of price. For instance, Old Navy — its value-oriented division — drove Gap’s October comps with its 24 percent comp gain. In addition, she said she was worried Gap division’s promotions during the last few years may have trained customers to a “see it now, buy it later” mentality. She pointed to the fact that Gap’s sales and traffic comps improved as the quarter wore on in combination with its promotional strategy, despite the new advertising campaign it rolled out at the beginning of the quarter.

For the first nine months, income soared more than eightfold — 766.6 percent — to $228.7 million, or 26 cents a diluted share, versus year-ago income of $26.4 million, or 3 cents. Sales inched up 0.5 percent to $9.8 billion from $9.76 billion in the comparable 2001 period.