Gap's 1Q net income falls 23 percent as costs soar

AP News
Posted: May 19, 2011 7:23 PM
Gap's 1Q net income falls 23 percent as costs soar

Faster cost increases than Gap Inc. expected _ especially for its lower-priced products _ sank the company's first-quarter profit, and the clothing company dramatically cut its forecast for full-year earnings late Thursday.

Escalating costs are only compounding challenges at the company, which is aiming to revive sales at its namesake brand. In fact, the company, which also operates the Banana Republic and Old Navy brands, acknowledged it also did more discounting than expected at the Gap chain in the latest quarter.

Gap's shares fell $3.47, or 14.9 percent, to $19.82 after hours. They had ended regular trading at $23.29, up 21 cents.

The company said it is spending about 20 percent more than a year ago on each item it plans to sell in the second half of the year, particularly for the holidays, it biggest season. And its price increases won't be able to keep pace.

"I will be quite honest with you. I don't feel good about having to come here today and re-guide," Gap CEO and Chairman Glenn Murphy said Thursday, referring during a call with investors to the company's new earnings guidance. "But the 20 percent increase in our average unit costs in the back-half is real."

Murphy said the cost pressure was a "near-term" challenge, not a structural issue, and noted that cotton prices already are retreating. He also reiterated that the company is moving forward with long-term initiatives, especially online and in other countries.

Gap said its net income fell 23 percent to $233 million, or 40 cents per share, for the quarter that ended April 30. That compares with $302 million, or 45 cents per share, a year earlier.

Its revenue fell 1 percent to $3.29 billion. Revenue fell most, nearly 4 percent, at its low-price Old Navy chain, which produces about 40 percent of the company's revenue.

Analysts were expecting even worse performance _ earnings of 39 cents and revenue of $3.27 billion, according to FactSet.

Many clothing companies' costs for raw materials like cotton and for labor in China are rising. But Gap's profit warning shows it hasn't been able to navigate the challenges as well as rivals like J.C. Penney Co. or Abercrombie & Fitch.

Gap and other clothing sellers plan to raise prices this fall to make up for higher costs, but there will be limits to how much shoppers will tolerate in a still challenging economy, particular for low-price chains. In fact, cost pressures are hitting the company's outlets and Old Navy stores hardest because shoppers there resist paying even a couple dollars more for a shirt, so the company has to absorb more costs.

Stifel Nicolaus analyst Richard Jaffe said he was puzzled that Gap is facing bigger cost increases than rivals, which are reporting cost increases of 10 percent to 15 percent.

"This could be unique to them," Jaffe said.

Sabrina Simmons, Gap's chief financial officer, told investors Thursday that it had ordered only spring and summer goods by February, when it made the sunnier full-year forecast, and it assumed costs would ease after it ordered fall goods.

But that didn't happen. When the chain started negotiating with suppliers in March and April for holiday orders, it found costs had soared. Murphy said Gap is still hoping for lower costs as it finishes its holiday buying.

Gap Inc. has made a series of management and organizational changes recently. In February, Art Peck became the brand's president, its fifth in nine years. The San Francisco-based company also established a Global Creative Center and consolidated its marketing in New York. And, earlier this month, it ousted Patrick Robinson, design director for the Gap chain. Murphy has said the Old Navy and Banana Republic brands also need work.

The key indicator of revenue at stores open at least a year fell 3 percent for Gap Inc. as a whole. At Gap North America, the figure was down 3 percent, while it fell 1 percent at Banana Republic and 2 percent at Old Navy North America. The company's international division saw a 6 percent decline. The figure is important because it isn't skewed by stores that recently opened or closed.

Gap is continuing to remodel Old Navy stores and added its first stores in China and Italy last year. The company now sells its wares online in more than 90 countries, and recently announced plans to introduce the Gap brand to Serbia and Ukraine and in a store on China's largest e-commerce website, called Taobao Mall.

Gap Inc.'s total online revenue rose 18 percent to $348 million, compared with $295 million in last year's first quarter.

The company said the March earthquake and tsunami in Japan, where it operates a cluster of stores, cut into its revenue, and said it will take a while for the business to recover.

Gap now expects to earn $1.40 to $1.50 per share for the year, down from its February forecast for $1.88 to $1.93 per share. Before Thursday's earnings report, analysts expected $1.84 per share, according to FactSet.