Shifting Brand Mix, Gap Inc. Meets Expectations

Comparable brick-and-mortar store sales fell 8% on average, compared with a 10% decline in the same year-earlier period; the decline widened significantly for Gap and Banana Republic stores in North America while it shrunk significantly for Old Navy stores in North America. Same-store Gap sales declined 10% in the second quarter, compared to a 6% decline in the same year-earlier period. Same-store Banana Republic sales declined 15% in the quarter, compared to a 6% decline in the same year-earlier period. Same-store Old Navy sales declined by 4%, compared to a 16% decline in the same year-earlier period. Online sales (including Athleta) increased 17% to $224 million from $191 million in the same year-earlier period.

The company's gross margin increased 150 basis points to 39.7% from the same year-earlier period on improved merchandise margins. Operating expenses fell by $52 million, and are down by $650 million year-to-date, helping widen the operating margin to 11.6% from 10.7% in the same year-earlier period. The company expects operating expenses in the third quarter to be flat to up about $20 million compared to the same year-earlier period due primarily to an expected $25 million increase in marketing expenses compared to 2008.

The company opened 12 stores and closed 16 stores in the second quarter, which compares to 22 openings and 29 closings in the same year-earlier period. The company ended the second quarter with 3,145 store locations. Year to date, the company has opened 23 store locations and closed 27 store locations; it continues to expect that it will have opened about 50 stores and closed about 100 by the end of the year.

Earlier this year the company said most of the closings in 2009 would be Gap-brand stores in the US, while the openings would mostly be overseas. In the second quarter, the company closed 10 Gap stores and five Old Navy stores, all of them in North America, and closed one Banana Republic in North America. It opened five Banana Republic stores in North America, four Gap stores in Europe, one Gap in North America, one Gap in Asia one Old Navy in North America.

In addition to opening new stores, having received solid performance data and customer feedback from four new Old Navy store models, chief executive Glenn Murphy told analysts Thursday that the company will remodel 50 more Old Navy stores over the next 60 days. "For the most part this is a sampling of the fleet with which we can see how much the top line comp sales trajectory changes against the control group," he said, adding that stores would be shrunk, remodeled and in some cases relocated, either within the mall or within the immediate area depending on negotiations with their existing lessors.

Speaking of renegotiating leases, Murphy reminded analysts this week that the company is one year into a three- to five-year plan to reduce square footage by between 10% and 15. The company expects to shed 2% of its square footage in 2009. "We still believe that in general economic conditions make this a slight net positive environment for someone with 40 million square feet [of leasing power]," he said. "My experience in real estate is that, even though it takes two parties, if you are clear and consistent you can get what you want out of your strategy."

Murphy told analysts in February that the company would be looking for concessions from building owners as part of its plan to lower overall costs while improving its stores, marketing and merchandising in order to recapture store traffic lost to rivals in recent years. "We've had to offer more value to our customers in order to get them inside our stores. Our third party partners, like the vendors who make our clothes, also have had to tighten their belts [to help with that effort], and third party marketing and goods providers also have [done the same] to bring us more value," he said. "We expect the same from the landlord community.""

Murphy added that the owners of the buildings it leases are aware that, in addition to the store closings, the company is trying not only to elevate stores' presence with better locations and combination stores but also to shrink the size of some of its Old Navy stores. "There's no such thing as a perfect time [for this] but landlords understand our strategy; we've been working on this for the last six months and we've been having good two-way dialogues," Murphy said. "But at the end of the day our strategy is our strategy and it needs to be executed."