Turnaround Is Slow for Gap

Earnings meet estimates, but the retailer expects sales to continue to fall in the first part of the year.
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Updated from 5:57 p.m. EST

Gap

(GPS) - Get Report

plans to return more cash to shareholders to tide them over as they wait for a turnaround that seems nowhere in sight.

The specialty-retailing empire outlined plans Thursday to raise its dividend by 78% next year and expand its share-repurchasing program, even as it reported declining sales and earnings for its holiday quarter. The results stayed in line with Wall Street's expectations, but its outlook for 2006 reflected little optimism.

Gap reported net income of $337 million, or 39 cents a share, for the fourth quarter, down from earnings of $378 million, or 40 cents a share a year earlier. The earnings matched Thomson First Call's mean analyst estimate. Total sales dropped 2% to $4.8 billion andsame-store sales fell 6%.

The results suggest that the San Francisco-based retailer, which runs Gap stores, Old Navy and Banana Republic, continues to bleed market share to trendier apparel chains like

Abercrombie & Fitch

(ANF) - Get Report

and

American Eagle Outfitters

(AEOS)

.

"None of us are satisfied with our performance in 2005,"said the company's chairman and CEO, Paul Pressler, on a conference call with analysts. "We are acting with a tremendous sense of urgency to win back our customers."

But after disappointing customers now for a string of retailing seasons, it becomes more difficult to win them back, and the company acknowledged an uncertainty about the timing of the turnaround it's striving to reach.

Gap, noting that February traffic is down 13% month to date, said it expects same-store sales, a key retail metric that gauges sales at stores open for at least a year, will remain negative in the first half of 2006 and turn "modestly positive" in the back half of the year. The retailer expects its bottom line could continue to sag, projecting fiscal-year earnings of $1.23 to $1.27 a share, including about 3 cents in stock-option expenses. Analysts, on average, were expecting earnings of $1.34 a share for the fiscal year, while last year's earnings totaled $1.24 a share.

On the conference call, Chief Financial Officer Byron Pollitt said he expects the company's operating margin to decline this year to a range from 10% to 10.5%. Last year's operating margin reached 10.9%. Also, while the company has long highlighted its strong cash flow, Pollitt said free cash flow will likely decline this year to $900 million from $951 million.

As for growth plans this year, Gap plans to open 175 stores, the majority of which will be under the Old Navy banner. The company will close 135 stores, mostly the ones under its namesake chain.

Shares of Gap were recently down $1.06, or 5.6%, to $18.04 in after-hours trading.

Gap plans to increase its annual dividend by 78%, to 32 cents from 18 cents a share. Its board also authorized an additional $500 million for its share-repurchase program, bringing the total to $3.5 billion. Since October of 2004, Gap has repurchased 146 million shares.

When questioned by an analyst on how the company has the confidence to take these actions given its gloomy outlook, Pressler expressed a faith in Gap's brands.

"It's all a matter of getting the product right, and once we do that, we're confident that we'll be able to continue returning value to shareholders," Pressler said.