Gap Shares Flat After Report

The retailer's earnings rise 87% from year-ago levels but sales rise 7.8%.
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Updated from Nov. 20

Gap

(GPS) - Get Report

may have posted a strong quarter on Thursday, but investors weren't impressed.

In recent trading, Gap shares were down 4 cents, or 0.2%, to $20.95. This despite the fact that the company's earnings jumped 87% in the third quarter, surpassing both analysts' estimates and Gap's own projections.

The apparel retailer earned $262.57 million, or 28 cents a share in the quarter, compared with $135.27 million, or 15 cents a share in the year-ago period. Revenues at the company increased 7.8% to $3.93 billion.

Analysts polled by Thomson First Call were expecting the company to earn 27 cents a share on $3.91 billion in sales. Earlier this month, Gap raised its quarterly guidance to a range of 26 cents to 28 cents a share.

"As far as I can see, they seem to be doing a good job with what they have," said Brian Gilmartin, a portfolio manager with Trinity Asset Management, who is long Gap. "The proof in the pudding will be this Christmas."

Gap did not provide earnings or revenue guidance for the fourth quarter. Wall Street has forecast profits of 33 cents a share in the holiday quarter on sales of $4.82 billion.

In the third quarter, Gap benefited from a pickup in sales at its older stores. Same-store sales, which compare like results at outlets open more than a year, increased 6% in the quarter, compared with a 2% gain last year.

Each of the company's four divisions either matched or bettered their same-store sales growth in the quarter. At Banana Republic, for instance, same-store sales grew 11% in the just-completed quarter, compared with 1% growth in the year-ago period.

But Gap posted its biggest gains on the expense side. The company's gross margin, which subtracts product and occupancy costs from the company's sales, increased 2.8 percentage points in the quarter to 38.9% of sales.

The jump in gross margin came largely as the result of better direct-merchandise margins. But the company's sales increase also outpaced the growth in its occupancy, rent and depreciation expenses in the quarter, further boosting Gap's gross margin.

Meanwhile, Gap's operating expenses fell 90 basis points as a portion of sales, to 26.8%. Again, the company's sales grew faster than did its marketing, general and administrative costs. Additionally, the company spent about $174 million on advertising in the quarter, which was below its prior guidance of $200 million.

Gap's sales gains came despite the fact that it slashed inventory in the quarter. The overall value of its merchandise inventory fell 8% to $2.59 billion. On a per-square-foot basis, inventories fell 6.6% to $70.12. The slower decline in per-foot inventory drop came because the company closed about 600,000 square feet, or 1.6%, of its selling space over the last year.

"As far as I can see, they seem to be doing a good job with what they have," said Brian Gilmartin, a portfolio manager with Trinity Asset Management, who is long Gap. "The proof in the pudding will be this Christmas."

The fact that the company was able to post positive comparable-store sales even while cutting inventory shows that Gap is doing a better job of working with what it has to increase productivity, said Gilmartin, a contributor to

Street Insight

.

"That was a good sign," he said.