But despite widespread disappointment at a 27 percent drop in March same-store sales reported on Thursday, Wall Street still sees Old Navy as a lower-cost chain that can find its way, given a recent management change and the fact that parent Gap Inc's (GPS.N: Quote, Profile, Research) 2008 earnings forecast remains intact.

"It was a very bad number," C.L. King analyst Mark Montagna said of the March sales. "The reason why the stock's holding up is people regard their guidance as having high integrity. People recognize a very poor performance at Old Navy is not unexpected considering it's in transition."

The problem in March was a greater emphasis on youthful women's fashion, while underplaying the basics business and neglecting the chain's core shoppers, such as men picking up T-shirts and cargo pants and mothers clothing their families.

"(The Old Navy customer) doesn't want boring basics either, but when they try to become too fashion forward it doesn't work," said Needham & Co analyst Christine Chen. "It doesn't work at any of their (Gap Inc's) chains."

The trendier offerings were part of a strategy to reverse three-plus years of mostly negative or flat same-store sales at Old Navy, which sells lower-cost clothing in warehouse-like stores, in contrast to the Gap and Banana Republic chains.

But thus far, the plan has backfired, and former Old Navy President Dawn Robertson left her job in February in a "mutual decision" with Chief Executive Glenn Murphy, the company said.

Robertson, hired in late 2006 to reinvigorate sales, was successful in shortening product turnaround times and reducing inventory. But the collection's hipper looks, accompanied by a slick TV advertising campaign, did not captivate shoppers.

The problem for Old Navy is how to differentiate the brand from a host of other low-cost rivals, from Wal-Mart Stores (WMT.N: Quote, Profile, Research) to Kohl's (KSS.N: Quote, Profile, Research) and Target Corp (TGT.N: Quote, Profile, Research), while continuing to offer the kind of easy, effortless clothing that millions of Americans reach for on the weekend.

Old Navy, with interim head Tom Wyatt at the helm, "is very focused on the adjustments we need to make," Gap spokesman Bill Chandler said. "We're determined to find the right balance to fashion and basics."

Meanwhile, margins have improved, helped by fewer markdowns and tighter inventories, and Gap Inc still expects to earn $1.20 to $1.27 per share for the year, up from $1.05 in 2007.

Fewer expenses, including staff cuts and a scaled-back retail expansion plan, also help. Needham's Chen noted the cost structure was now "supportable" even with the sales slump.

RECONCILING FASHION AND FAMILY

Old Navy says its motto is "fashion, family and value." But somewhere along the way since its inception over a decade ago, the clothing became boring, quality suffered and stores became overstocked.

Attempts to fix Old Navy's problems by upgrading product and image while focusing on younger customers may have gone too far, Chen said.

The same issue plagued the company's Gap stores in recent years, as a focus on hipper styles for teenagers was rejected by shoppers and ultimately abandoned by that chain.

"There's been a definite overhaul in the image," Chen said, referring to recent Old Navy television ads focused on hip single women. "It's not really appropriate for what the Old Navy customer has evolved to."

As the company tinkers with its assortment, analysts don't know what to expect later this year when new merchandise designed by Todd Oldham, the quirky designer hired by Robertson last fall as the brand's creative director, hits stores.

But the good news in the interim, Montagna said, is that Old Navy is gradually ridding itself of shoppers trained to expect deep discounts.

"I continue to believe the declining traffic is a smaller problem than most believe," he said. "I believe the traffic declines are from losing the markdown customers who are finding less markdown merchandise."

(Editing by Braden Reddall)