Gap Inc. Q1 Profits Slump on Unanticipated Expense Increases

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San Francisco—Citing production costs 20% higher than a year ago, Gap Inc. reported Thursday that its first quarter profit slumped 28% causing the company to revise its full year earnings forecast.

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

Total sales fell 1% to $3.29 billion. Revenue at its Old Navy division, which accounts for about 40% of the company’s sales, fell almost 4%.

‘Short Term Macro Challenge to our Profitability’

Comparable store sales were down 3% even including the 2-percentage-point increase in comparable online sales.

By division, comparable store sales at Gap North America declined 3%, Banana Republic’s comparable sales fell 1% and Old Navy North America reported comparable sales decline of 2%. The international division had a 6% decline in comparable store sales.

A bright spot for the company was online where revenue rose 18% to $348 million, compared with $295 million in last year’s first quarter.

Despite the disappointing results, Gap Inc. actually fared better than analysts’ average estimates expecting an even worse performance of earnings of 39 cents and revenue of $3.27 billion.

While rising costs on raw materials such as cotton and labor have been the bane of most retailers that sell apparel, Gap apparently is having more difficulties adjusting to the costs.

“We’re working hard to navigate this short-term macro challenge to our profitability in the current fiscal year,” Glenn Murphy, chairman and ceo. “That said, our strategy remains the same– to deliver consistent steady growth in North America while investing in our long-term initiatives, especially in online and international.”

In a conference call with analysts, Sabrina Simmons, Gap’s chief financial officer said that company faced a “very difficult cost environment” but that those pressures were temporary.

Nevertheless the company cautioned that it expects product costs per unit to be up about 20% in the second half of the year–increases that “will more than outweigh retail price increases.”

Referring to previous forecasts, Simmons said, “We made the assumption at that time that holiday pricing would ease, because we were buying fall into what we believed at the time was the peak of cotton…And it turns out we were just absolutely wrong on that assumption. Holiday got worse, and that costing came in much higher than we expected — and higher than fall.”

Stifel Nicolaus analyst Richard Jaffe said “this could be unique to them” referring to the 20% cost increase when other retailers had reported increases between 10% and 15%.

Due to the costs, Gap Inc. revised downward its full year forecast expecting earnings now to be $1.40 to $1.50 a share, down from its February forecast for $1.88 to $1.93 per share. Prior to its first quarter report, analysts average estimate expected  $1.84 per share.

Meanwhile the company is restructuring its Gap division, naming Art Peck became as president, the fifth in nine years. Patrick Robinson, design director was ousted last month, too. The company established a Global Creative Center and consolidated its marketing in New York. Murphy has also said Old Navy and Banana Republic brands also need a design boost.

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, Taobao Mall.