Cost Cuts Boost Gap Profit

Sales come in flat with a year earlier.
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Updated since 11:34 a.m. EST

BUFFALO, N.Y. --

Gap

(GPS) - Get Report

showed the first signs of improvement under the direction of its new chief executive, whose cost cutting helped push the struggling retailer's third-quarter profit up by 26%.

The chain was able to improve its merchandise margins by 100 basis points by moving more of its apparel off the floor at regular price. But it remains hesitant about the upcoming holiday season and will wait to see if customers return to its stores after staying away from them for so long.

Gap earned $238 million, or 30 cents a share, in the quarter ending Nov. 3. That compared with $189 million, or 23 cents a share, in the same period last year. Analysts polled by Thomson Financial had expected earnings of 29 cents a share.

Sales totaled $3.9 billion, which was flat compared to the same quarter a year ago. Same-store sales, or sales at stores open at least a year, fell 5%. Analysts expected sales of $3.86 billion.

The company realized about $75 million in savings from cuts in marketing spending. The company does not expect to make substantial reductions in the fourth quarter vs. last year.

"During the third quarter, we made progress in driving earnings growthby managing our inventory and reducing expenses," said CEO Glenn Murphy, who was appointed to the post in August. "Our brands are focused on the upcoming holiday season and providing customers with a compelling store experience."

Same-store sales at the company's flagship namesake fell by 6% while Old Navy same-store sales fell by 8%. At Banana Republic, same-store sales were up by 1%.

Adrienne Tennant, an analyst for Friedman Billings Ramsey, notes that this is the first full year that Dawn Robertson has served as division president of Old Navy, a brand that has met with fierce competition from mass merchants like

Target

(TGT) - Get Report

.

"She will be judged in the fourth quarter," Tennant says of Robertson.

Tennant points out that Old Navy, the company's worst performing division, is also the largest of the three brands, making it difficult to control unwieldy inventory. But she adds that last year, that distinction went to the Gap brand, which performed the worst and is now finally showing signs of improvement .

Inventory has been a challenge for most retailers in the third quarter, with merchandise backed up from a slow selling season in the fall. For its part, Gap reported an 8% decline in inventory per square foot compared to flat inventory last year. It expects inventory to be down in the mid-single digits at the end of the fourth quarter.

Sabrina Simmons, vice president of investor relations at Gap, said on Wednesday's conference call that the company wants to keep inventory in line with foot traffic, and would rather run out of stock on items at its stores than carry too much and put pressure on margins because of markdowns.

The company increased its full-year earnings guidance to 92 cents to 98 cents a share from its prior guidance of 83 cents to 88 cents a share.

Excluding expenses associated with the cost reduction initiatives and the discontinued operation of Forth & Towne, the company expects earnings of 99 cents to $1.05 a share. On that basis, analysts were expecting $1.05 a share.

Shares of Gap were recently off 75 cents, or 3.7%, to $19.45.