By  on August 19, 2005

NEW YORK — Despite posting flat sales for the second quarter, Gap Inc. reported a 39.5 percent rise in earnings and beat analysts' consensus estimates by 2 cents, thanks partially to a dip in operating expenses.

Nevertheless, Gap said business was challenging during the quarter and reinforced its commitment to boost performance in the second half of the year. The company reduced its full-year earnings guidance to below analysts' estimates.

In the 13 weeks ended July 30, the company earned $272 million, or 30 cents a diluted share, compared with $195 million, or 21 cents, a year ago.

Net sales were $3.716 billion versus $3.721 billion last year. Same-store sales were down nearly across the board among the company's four divisions, putting consolidated comps at negative 3 percent. By division, comps fell 4 percent in Gap's domestic division; 3 percent at Banana Republic, and 4 percent at Old Navy. However, comps rose 1 percent in the company's international division.

In the first half of the year, Gap had an 11 percent increase in net earnings to $563 million, or 61 cents a diluted share, compared with $507 million, or 53 cents, last year. Revenues were also relatively flat at $7.3 billion.

"At Gap, as we expected, women's second-quarter performance was disappointing as summer product did not reflect our fresh casual American style," said Paul Pressler, president and chief executive officer of Gap, on a subsequent conference call with analysts. "None of us is satisfied with our current performance. We know what needs to be done for our company to be successful, and we're committed to the flawless execution required to get us there."

Gross profit margin fell 120 basis points to 37.3 as a percent of sales during the quarter, while merchandise margins fell 180 basis points, the company said.

As a positive, however, operating expenses fell 5.8 percent during the quarter to $957 million, thanks in part to a decrease in interest expense. Net interest income for the quarter totaled $15 million versus interest expense of $31 million last year, the company said on the call.

Also during the quarter, Gap reversed a sublease loss related to a San Francisco building that it now plans to occupy. The one-time gain from the reserve reversal was $58 million pretax, or 4 cents a share, which is included in its second-quarter earnings.Stock buybacks helped boost the company's earnings per share as well: 45 million shares were repurchased during the quarter. In all, the weighted average number of diluted shares at the end of the second quarter totaled 905.2 million, compared with 1 billion at the end of last year's second quarter. The company's board has approved an additional $500 million share repurchase program.

"While we are not satisfied with our operating results, when combined with our debt reduction and share repurchase strategies, we are pleased to have delivered an increase in recorded EPS for the quarter," said Byron Pollitt, chief financial officer of Gap, on the call. "Having said that, we are acutely aware that to generate significant value, we need to strengthen our top-line performance."

On the call, Pressler updated analysts on the company's growth plans, saying it plans to open four Banana Republic stores in Japan next month. And its newest concept, Forth & Towne, is expected to launch Wednesday in the New York area, followed by four test stores in Chicago opening on Aug. 31.

Meanwhile, citing month-to-date August sales that are below expectations, Gap cut its full-year EPS outlook to $1.30 to $1.34 from a prior estimate of $1.44 to $1.48. Analysts' consensus is $1.41.

The company reported results after the market closed. Shares of Gap finished Thursday down 1.6 percent to $20.15 in trading on the New York Stock Exchange. The shares are down almost 2 percent year-over-year.

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