Gap Inc. today announced that preliminary earnings for the 2004 fourth quarter increased 4 percent to $370 million, or $0.40 per share on a diluted basis. Full year 2004 earnings increased 11 percent to $1.1 billion, or $1.20 per share, compared to $1.09 per share for full year 2003. The company also announced that fourth quarter and full year earnings and earnings per share are subject to adjustments based on the outcome of a pending review by the company of its lease-related accounting.
“In 2004, we delivered solid earnings performance, while mining growth opportunities within our brands, significantly strengthening our balance sheet, retiring debt and completing a $1 billion share repurchase program,” said Gap Inc. President and CEO Paul Pressler. “Having stabilized our operations and well positioned our brands in the marketplace, we have a strong foundation for 2005. Going forward we will focus on driving growth opportunities across our brand portfolio, strengthening operating performance and enhancing shareholder value through cash distributions.”
Fourth Quarter Results
Net sales for the fourth quarter, which ended Jan. 29, 2005, were flat to last year at $4.9 billion. Comparable store sales decreased 3 percent, compared with an increase of 3 percent during the same period last year.
The company reported preliminary net income of $370 million, or $0.40 per diluted share, for the fourth quarter, compared with net income of $356 million, or $0.37 per diluted share, in the same period last year.
Fiscal 2004 Results
Net sales of $16.3 billion for the 52 weeks ended Jan. 29, 2005, increased 3 percent, compared with net sales of $15.9 billion for same period ended Jan. 31, 2004. The company's comparable store sales for the year were flat, compared with an increase of 7 percent in the prior year.
For the year, the company reported preliminary net income of $1.1 billion, or $1.20 per diluted share, compared with net income of $1.0 billion, or $1.09 per diluted share, last year.
The following table represents the company's fourth quarter comparable store sales, fourth quarter net sales, fiscal year 2004 comparable store sales and fiscal year 2004 sales by division.
Lease-Related Accounting Adjustments
In light of a recent SEC clarification and consultation with its auditors, Deloitte & Touche LLP, the company has re-evaluated its lease accounting practices. Like many other public companies that are correcting commonly accepted lease accounting practices, the company will change the way it accounts for its leases, including the accounting for rent holidays and tenant allowances.
These adjustments will have no impact on cash, revenues and comparable store sales.
The company currently believes that these adjustments will reduce net income on a pre-tax basis for fiscal year 2004 and prior fiscal years by an aggregate amount of $170 million to $200 million, the vast majority of which relates to periods prior to fiscal year 2002. The company has not yet reached a final decision as to whether these matters will require a restatement of its previously issued annual and interim financial statements or whether the adjustments will all be reflected in the fiscal year 2004 financial statements, but believes that restatement of prior periods is likely. This estimate is subject to change as the company completes its internal review and the results are reviewed by Deloitte & Touche LLP.
In prior periods, and consistent with industry practice, the company had recognized the straight line expense for leases beginning on the commencement date of the lease, which had the effect of excluding the construction period of its stores from the calculation of the period over which it expenses rent. In addition, a portion of tenant allowances were reflected as a reduction to store build out costs instead of being classified as deferred lease credits and were amortized over the asset life instead of the lease term. The accounting for rent expense and tenant allowances will be corrected.
Additional Results and 2005 Outlook
Earnings
The company stated that it expects earnings per share to be $1.41 to $1.45 per share for fiscal year 2005. This estimate does not reflect expenses related to stock option expensing, which are expected to begin in the third quarter. This estimate reflects the proper accounting for leases.
Cash and Debt
After repurchasing about 48 million shares for $1 billion, the company ended the fourth quarter with $2.2 billion more in cash and short-term investments than debt. Fiscal year 2004 free cash flow, defined as net cash provided by operating activities less purchase of property and equipment, was an inflow of $1.2 billion. The company expects at least $1 billion in free cash flow for fiscal 2005. Please see the reconciliation of free cash flow to a GAAP financial measure in the table at the end of this release.
During fiscal year 2004, the company retired a total of $871 million in debt, of which $596 million was retired early. Full year earnings reflect $105 million in losses on early retirement of debt due to premiums paid and $36 million in pretax interest savings.
Standard and Poor's recently raised the company's credit rating to investment grade, BBB-. Moody's currently has the company's credit rating one notch below investment grade and is reviewing the company for a possible upgrade.
The company expects to call its convertible bond in late March 2005.
Dividends
The company announced in a separate release today that its Board of Directors intends to increase the annual dividend per share from $0.0888 to $0.18 for fiscal year 2005, not including the previously announced $0.0222 per share dividend payable on February 23, 2005. The dividend is expected to be payable quarterly in late April, July, October and January.
Share Repurchase Program
In a separate release issued today, the company also announced that its Board of Directors has authorized an additional $1.5 billion for its share repurchase program, effective immediately. The company has completed a $1 billion share repurchase program, repurchasing about 48 million shares in 2004.
Margins
Disciplined inventory and fleet management helped drive a 150 basis point improvement in gross margin for the year. Gross margin for the fourth quarter was 36.6 percent. Operating margin for the full year 2004, excluding charges related to early retirement of debt, was 12.7 percent. Operating margin for the full year of 2005 is expected to be about 13 percent. This estimate does not reflect expenses related to the expensing of stock options, which are expected to begin in the third quarter. This estimate reflects the proper accounting for leases.
Inventory
The company reported that inventory per square foot increased 6 percent year-over-year at the end of the fourth quarter. The company expects inventory per square foot at the end of the first quarter of 2005 to be flat, versus down 12 percent last year. Inventory per square foot at the end of the second quarter of 2005 is expected to be a low-single-digit decrease versus a 7 percent decrease for the same period last year.
Capital Expenditures and Effective Tax Rate
The company expects capital spending to be about $625 million in 2005. Full-year 2004 capital spending was $441 million. The company said that it expects an effective tax rate of 38 to 39 percent for 2005.
Real Estate
During the fiscal year 2004, the company opened 130 store locations and closed 158. Net square footage for the fourth quarter 2004 was up slightly compared with last year. For fiscal 2005, the company expects to open about 175 store locations, weighted toward Old Navy, and close about 135 store locations, weighted toward Gap brand. Square footage is expected to increase 2 percent for fiscal 2005.
The following table represents the number of store location openings and closings, and square footage by brand.
