Concerns About Gap, Nation's Largest Clothing Chain

NEW YORK (AP) - Deep discounting and escalating production costs pushed Gap Inc.'s second-quarter profit down 19 percent, raising concern about how the nation's largest clothing chain will fare during the critical fall and holiday shopping seasons.

Gap, which operates Gap, Old Navy and Banana Republic chains, on Thursday posted much weaker results than many of its peers. Several major merchants reported profit increases this week and said they've been able to push through price hikes to shoppers as they try to offset their higher costs for labor and raw materials.

The San Francisco-based retailer, which has been struggling for several years, has been particularly hard hit by the down economy. Its Gap chain, in particular, has posted an annual sales drop in last six years at stores in North America open at least a year, a key measure of a retailer's health. Recent stock market turmoil and fears of another recession only compound the retailer's troubles at a time when it's trying to revive its brands.

"We've been very clear internally and externally," Glenn Murphy, chairman and chief executive, said during a conference call with investors. "Our goal is to have moderate, steady growth in our domestic business and we've not achieved that."

In the second quarter, the chain's overall revenue at stores opened at least a year fell 2 percent during the quarter. By division, Gap's domestic business was down 3 percent, while Banana Republic posted a 2 percent decline. Old Navy's domestic business was flat. The company's international division posted a 4 percent drop from a year ago.

The company marked down its merchandise to draw customers into stores, which hurt profit. The company earned $189 million, or 35 cents per share, in the three months ended July 30. That compares with $234 million, or 36 cents per share, a year ago. Revenue rose 2 percent to $3.38 billion. Analysts had expected 33 cents per share on revenue of $3.39 billion in the quarter.

Murphy said shoppers' confidence will probably be more negative in the second half than in the first half. The company reiterated its full-year forecast of per-share earnings of between $1.88 and $1.93. The company also reaffirmed that it's spending about 20 percent more than a year ago on each item because of higher material costs. Gap said its price increases won't be able to keep pace.

Still, Murphy reassured investors that "we have far greater opportunities than challenges ahead of us."

"Every brand, division, and geography is focused on what matters most - delivering consistent, great product and more effective marketing in order to drive higher levels of performance," said Murphy, adding that the company's biggest priorities are to increase marketing and turnaround its women's business.

Gap, once known for turning basics like T shirts and khakis into must-have fashions, has made a number of changes recently to reinvigorate its brands.

The company has closed or shrank the size of stores to boost profit. It had a management shake-up in February that ended with a new brand president, chief marketing offer and ad agency. It also established a Global Creative Center and consolidated its marketing in New York. And in early May, the company ousted Patrick Robinson, design director for the Gap chain.

Old Navy, which has been remodeling its fleet of stores, had been on the mend but it has hit a rough patch in recent months, faced with increasing competition from stores like Target. Banana Republic has had a more stable business, with the chain focusing on dressy casual for work.

But Gap so far hasn't been able to solve its biggest issue: shoppers aren't buying clothes at its namesake chain. Poor fit and lack of exciting fashions have hurt the Gap brand for most of the decade as shoppers flock to cheap chic retailers like H&M and Forever 21 or higher-priced merchants like Abercrombie & Fitch.

Gap had some sales success with its 1969 jeans launched for the fall of 2009. That was followed by a focus on black pants last fall. But the sales momentum did not extend throughout the store. Glenn told investors that the company wants to focus on recreating American class styling for the Gap brand, and he believes that shoppers will notice a difference by the spring.

Gap's shares rose 48 cents to $16 in after markets trading. The results were released after the markets closed.