By  on February 24, 2006

NEW YORK — Gap Inc. is still far from recovery. On Thursday, the struggling retailer reported declines in fourth-quarter and year-end sales, margins, earnings and traffic.

Net earnings for the fourth quarter were down 10.8 percent to $337 million, or 39 cents per share on a diluted basis, compared with $378 million, or 40 cents per share, for the same period last year. Fiscal year 2005 earnings per share were $1.24, up from $1.21 in 2004.

Net sales of $4.8 billion for the fourth quarter ended Jan. 28 decreased 2 percent compared with $4.9 billion for the same period last year. Comparable-store sales decreased 6 percent, compared with a decrease of 3 percent for the same period last year.

For the year, Gap posted sales of $16 billion, a 2 percent drop compared with $16.3 billion for 2004. Comp-store sales for the year decreased 5 percent, compared with flat sales last year.

Concerns about getting the product right and getting customers to shop stores with greater frequency surfaced during a conference call, but the news wasn't all bad. Officials said cash flow was up, enabling dividend increases and more share repurchasing; expenses were down, largely because TV advertising was temporarily scrapped; bonuses were lower; inventory management is improving and e-commerce is accelerating after Web sites were revamped. The officials stressed intensified efforts to improve product are in the works and characterized two launches, Banana Republic in Japan and the new Forth & Towne division aimed at an older audience, as "overall" successes, though Gap was hoping for more traffic at Forth & Towne. Five units are operating and 10 are slated to open this year.

"None of us is satisfied with the overall results. We did not deliver on expectations. We know we can do better," said Gap Inc. president and chief executive officer Paul Pressler. He cited the "strength of Gap brands, the balance sheet and talent in the organization" as the keys to a better future. "We are acting with a tremendous sense of urgency to win back our customers."

He added that the company is "100 percent focused on improving product in each of our brands" and that the level of traffic in stores "suggests we have not lost our customers. They are still visiting our stores, but shopping us less frequently than before because of product disappointment. We believe traffic lags product improvements by one or two quarters. The first half will be challenging and we will begin gaining traction in the second half."Gap executives also said they are seeing sales improvements on some items from efforts to restore the historic Gap aesthetic and focus on classics. The company said comps will remain negative in the first half and turn "modestly positive" in the second half. Fiscal year earnings are projected at $1.23 to $1.27 per share, including options expensing, which the firm sees amounting to about 3 cents per share.

After repurchasing 98.5 million shares for $2 billion during the year, the company ended the fourth quarter with $3 billion in cash and short-term investments. The company expects to generate at least $900 million in free cash flow for fiscal year 2006.

The company also announced an additional $500 million for its share repurchase program and expects to increase the annual dividend per share from 18 cents in fiscal year 2005 to 32 cents for fiscal year 2006.

Product promotions and markdowns contributed to a 260 basis point decline in gross margin in 2005 to 36.6 percent. Operating margin for fiscal year 2005 was 10.9 percent and is seen slipping to 10 percent or 10.5 percent this year.

Inventory per square foot decreased 11 percent at the end of the fourth quarter, and will continue to decline this quarter, but at a slower rate, the company said.

Last year, the company opened 198 locations and closed 139. This year, the company expects to open about 175 store locations, weighted toward the Old Navy brand, and close about 135 store locations, weighted toward the Gap brand. Square footage is expected to increase between 1 percent and 2 percent for fiscal year 2006.

Asked by one analyst to grade the Gap goods in the stores, Cynthia Harriss, president of Gap Brand, observed, "Spring product is not reflective of what you will continue to see with the Gap brand with the progress we are making. We are getting some traction on specific items, but we don't [yet] see the dominance that we will see in the future.

"It all starts with product," Harriss said. "We are at our best with exquisite, updated classics, rooted in key categories including T-shirts, hoodies, great clean bottoms and, most importantly, denim."As for Gap's renovation campaign, which included 60 redos last year and 20 more for this year, Harriss said, "Customers are responding well. A comprehensive rollout will take time." Another 200 stores will be "refreshed" — they won't be overhauled, but "it's more than a little paint. You will see a visible difference" that extends to service and windows as well as the physical plant, said Harriss.

Jenny Ming, president of Old Navy, said the division last year focused on price, and product was less differentiated, but now with designers relocated to San Francisco and working more closely with other staff, the chain can develop more fashionable product in three months, and has shorter lead times and better open-to-buy positions. In March, stripes for the whole family will be featured, as will embellished tanks, cargo capris and espadrilles. TV ads will begin next Thursday, with a focus on stripes and, subsequently, naturals. In April, new signs will be rolled out and in July, front-of-store fixtures will be upgraded. Knits, cargoes and twills are Old Navy's strongest areas, Ming said, adding she felt good about product improvements.

Pressler said Banana Republic's positioning is to "affordable luxury, versatile essentials and key big ideas" including classic white shirts and chinos, and "everyday style." This week in Manhattan bus stops, billboards and subway stations will have Banana Republic ads promoting the launch of the handbag collection.

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