Gap Inc. (GPS) has reported relatively strong second-quarter results despite challenging market conditions. The company reported net income of $228 million or 33 cents per share during the quarter, compared to $229 million or 32 cents per share in the year-earlier quarter. The earnings also exceeded the Zacks Consensus Estimate by a penny.

Net sales during the quarter were $3.25 billion compared to $3.50 billion in the year-ago quarter, primarily due to a soft economy. The continued economic downturn has led to a reduction in disposable income and a cut in consumer discretionary spending. Consequently, consumers are more attracted to national and local department stores and discount stores that offer products at fire-sale prices.

Overall comparable store sales decreased 8% year-over-year, while online sales increased 17% to $224 million. Both gross and operating margins increased year-over-year, while operating expenses declined by $52 million.

The Gap is now focusing more on improving its business model by striking the right balance between its cost structure and merchandise by better aligning inventory with sales trends.

The company reported a 14% decrease in year-over-year inventory per square foot. The Gap also anticipates inventory per square foot to reduce in the third quarter of 2009 compared to the year-earlier quarter due to prudent inventory management policies.

At quarter end, Gap Inc. had $2.1 billion of cash and cash equivalents. Year-to-date, free cash flow of the company was $589 million. The Gap defines free cash flow as net cash generated from operating activities less expenses relating to the purchases of property and equipment.

During the quarter, The Gap opened 12 stores and closed 16 store locations, bringing the year-to-date figures at 23 and 27, respectively. For fiscal year 2009, the company expects to open about 50 stores and close 100 stores Incorporatedluding repositioning. We maintain our Neutral recommendation of Gap Inc.

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