Gap Inc. Reports First Quarter Earnings

SAN FRANCISCO, May 19 /PRNewswire-FirstCall/ -- Gap Inc. today reported that net earnings for the first quarter, which ended April 30, 2005, declined 7 percent versus prior year to $291 million, or $0.31 per share on a diluted basis, compared with $312 million, or $0.33 per share, for the same period last year.

First quarter net sales decreased 1 percent to $3.6 billion, compared with $3.7 billion for the same period last year. Comparable store sales decreased 4 percent, compared with a prior year increase of 7 percent. "Overall, our first quarter results were disappointing as we were up against record high earnings from last year," said Gap Inc. President and CEO Paul Pressler. "Our teams understand our challenges and they are taking the necessary steps to improve. We remain focused on operational discipline and executing our growth strategies."

Store Sales Results By Division

The following table represents the company's first quarter comparable store sales and net sales by division:

First Quarter First Quarter Comparable Store Sales Net Sales ------------------------------------------------ 2005 2004 2005 2004 ------------------------------------------------ Gap North America -4% +4% $1.2 billion $1.3 billion ------------------------------------------------------------------------- Banana Republic North America -4% +21% $512 million $503 million ------------------------------------------------------------------------- Old Navy North America -4% +9% $1.6 billion $1.5 billion ------------------------------------------------------------------------- International -6% -5% $340 million $355 million ------------------------------------------------------------------------- Headquarter Facilities Needs

In the past the company has recorded sub-lease loss reserves for facilities space on which it is obligated to pay rent but does not occupy. The company recently assessed its future office space needs and in mid-May 2005 management decided that it would occupy one of the properties in San Francisco for which such a reserve had been recorded. As a result, the company will reverse the reserve related to the property it will now occupy and will begin expensing rent. The amount of the reserve reversal is $58 million in pre-tax income, and is a second quarter event. The pre-tax impact to fiscal year 2005 earnings will be approximately $51 million in income, which reflects the amount of the reserve reversal, less additional rent expense and related items including interest.

Additional Results and 2005 Outlook Earnings

The company is revising its earnings per share guidance for 2005 and 2006. The revisions are based solely on the real estate decision, discussed above. The company now expects to report earnings per share of $1.44 to $1.48 for fiscal year 2005. Previous earnings per share guidance was $1.41 to $1.45. The company expects earnings per share for 2006 to be $1.58 to $1.62. This guidance does not reflect the new accounting requirement to expense stock options beginning in the first quarter of 2006.

Cash and Debt

The company announced that it ended the quarter with $3.7 billion in cash and short-term and long-term investments, of which $1.0 billion were restricted. This represents $3.2 billion more in cash and investments than funded debt. For the first quarter, free cash flow was an inflow of $113 million, compared with an inflow of $130 million last year. The company expects to generate at least $1 billion in free cash flow in fiscal 2005. Please see the reconciliation of free cash flow to the GAAP financial measure in the table at the end of this release.

On April 5, 2005, Moody's Investors Service upgraded the company's credit rating to investment grade with a Baa3 rating.

The company has fully completed the conversion of its $1.38 billion convertible bond into about 86 million shares, leaving just $513 million of debt on the balance sheet.

Dividends

The company declared a dividend during the first quarter, doubling the amount from $0.0222 to $0.045 per share. The company also paid a $0.0222 per share dividend declared in the fourth quarter of 2004.

Share Repurchases

During the first quarter, the company purchased 26 million shares at an average price of $21.53 per share. Since October 2004, the company has repurchased about 74 million shares at an average price of $21.14. At the end of the first quarter, the company's diluted shares outstanding were 932 million.

Margins

Gross margins declined 2.3 points in the first quarter compared to the prior year, which was entirely driven by lower merchandise margins. Operating margin for the first quarter was 12.8 percent. The company reiterated that operating margins are still expected to be about 13 percent for the full year 2005.

Inventory

The company reported that inventory per square foot was up 5 percent at the end of the first quarter as compared to last year, primarily driven by the timing associated with the early receipt of merchandise. The company will continue its focus on inventory productivity, and expects inventory per square foot at the end of the second quarter to be down on a percentage basis in the low single digits, compared with a 7 percent decline in the prior year. Inventory per square foot at the end of the third quarter is also expected to be down in the low single digits, compared with a 1 percent increase last year.

Interest Expense

In part, as a result of the sublease loss reversal, the company now expects full year 2005 gross interest expense to be about $55 million.

Capital Expenditures

First quarter capital expenditures were approximately $112 million compared with $35 million last year, primarily due to a higher number of new stores and remodels during the quarter. The company expects its full-year 2005 capital spending to be about $625 million.

Effective Tax Rate

The company's tax rate for the first quarter was 37.7 percent, reflecting favorable tax audit resolutions, primarily on state audits. The effective tax rate is expected to be 38 percent to 39 percent for fiscal 2005.

Real Estate

Through April 30, 2005, the company opened 41 store locations and closed 25. Net square footage for the first quarter 2005 increased 1 percent compared with the same period last year. For fiscal 2005, the company still expects to open about 170 store locations, weighted toward Old Navy, and close about 135 store locations, weighted toward Gap North America. Net square footage is still 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.

April 30, 2005 ------------------------------------------------------ Beginning Store Store Net Store Q1 Store Locations Locations Locations Sq. Ft. Locations Opened Closed End of Q1 (millions) ------------------------------------------------------ Gap North America 1,396 9 (15) 1,390 13.0 ------------------------------------------------------------------------- Banana Republic North America 462 2 (2) 462 3.9 ------------------------------------------------------------------------- Old Navy North America 889 23 (5) 907 17.6 ------------------------------------------------------------------------- International 247 7 (3) 251 2.4 ------------------------------------------------------------------------- Total 2,994 41 (25) 3,010 36.9 ------------------------------------------------------------------------- May 1, 2004 Beginning Store Store Net Store Q1 Store Locations Locations Locations Sq. Ft. Locations Opened Closed End of Q1 (millions) ------------------------------------------------------ Gap North America 1,493 1 (15) 1,479 13.6 ------------------------------------------------------------------------- Banana Republic North America 435 3 -- 438 3.7 ------------------------------------------------------------------------- Old Navy North America 840 6 (3) 843 16.7 ------------------------------------------------------------------------- International 254 4 (2) 256 2.5 ------------------------------------------------------------------------- Total 3,022 14 (20) 3,016 36.5 ------------------------------------------------------------------------- Webcast and Conference Call Information

Sabrina Simmons, Senior Vice President, Treasury and Investor Relations, will host a summary of Gap Inc.'s first quarter results in a live conference call and real-time webcast at approximately 5:00 p.m. Eastern time today. Ms. Simmons will be joined by Paul Pressler, Gap Inc. President and Chief Executive Officer, Byron Pollitt, Executive Vice President and Chief Financial Officer, and Jenny Ming, President of Old Navy, to discuss details on the business.

To access the conference call, please dial (800) 374-0168 or (706) 634-0994 for international callers. The webcast is located on the Conference Calls & Webcasts page in the Financials & Media section of gapinc.com. Replay of this event will be made available on (800) GAP-NEWS for four weeks after this announcement and archived on gapinc.com.

Forward-Looking Statements

This press release and related conference call and webcast contain forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than those that are purely historical are forward-looking statements. Words such as "expect," "anticipate," "believe," "estimate," "intend," "plan," and similar expressions also identify forward-looking statements. Forward-looking statements include statements regarding: (i) executing growth strategies; (ii) earnings per share for 2005 and 2006; (iii) impact and timing of stock option expensing; (iv) free cash flow for 2005; (v) operating margins for 2005; (vi) year over year change in inventory per square foot at the end of the second and third quarters of 2005; (vii) gross interest expense in 2005; (viii) capital expenditures for 2005; (ix) effective tax rate for 2005; (x) store openings and closings in 2005 and weightings by brand; and (xi) real estate square footage for 2005.

Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause the company's actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the following: the risk that the company will be unsuccessful in gauging fashion trends and changing consumer preferences; the highly competitive nature of the company's business in the U.S. and internationally and its dependence on consumer spending patterns, which are influenced by numerous other factors; the risk that the company will be unsuccessful in identifying and negotiating new store locations effectively; the risk that comparable store sales and margins will experience fluctuations; the risk that the company will be unsuccessful in implementing its strategic, operating and people initiatives; the risk that adverse changes in the company's credit ratings may have a negative impact on its financing costs and structure in future periods; the risk that trade matters, events causing disruptions in product shipments from China and other foreign countries, or IT systems changes may disrupt the company's supply chain or operations; and the risk that the company will not be successful in defending various proceedings, lawsuits, disputes, claims, and audits; any of which could impact net sales, costs and expenses, and/or planned strategies. Additional information regarding factors that could cause results to differ can be found in the company's Annual Report on Form 10-K for the fiscal year ended January 29, 2005.

Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict. These forward-looking statements are based on information as of May 19, 2005 and the company assumes no obligation to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

Gap Inc. Copyright Information

All recordings made on 800-GAP-NEWS have been recorded on behalf of Gap Inc. and consist of copyrighted material. They may not be re-recorded, reproduced, retransmitted or rebroadcast without Gap Inc.'s express written permission. Your participation represents your consent to these terms and conditions, which are governed under California law.

Investor Relations: Media Relations: Mark Webb Debbie Eliades (415) 427-2161 (415) 427-4585 Gap Inc. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS -------------------------------------------------------------------------- (In millions) April 30, 2005 May 1, 2004 (As Restated) (b) -------------------------------------------------------------------------- ASSETS Current Assets Cash and equivalents $1,354 $2,372 Short-term investments 1,254 909 Restricted cash (a) 1,008 1,361 -------------------------------------------------------------------------- Cash and equivalents, short term investments and restricted cash 3,616 4,642 Merchandise inventory 1,917 1,816 Other current assets 502 394 -------------------------------------------------------------------------- Total Current Assets 6,035 6,852 Property and equipment, net 3,315 3,469 Other assets 422 378 Total Assets $9,772 $10,699 ========================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current maturities of long-term debt $-- $271 Accounts payable 1,175 1,075 Accrued expenses and other current liabilities 913 868 Income taxes payable 168 152 -------------------------------------------------------------------------- Total Current Liabilities 2,256 2,366 Long-Term Liabilities Long-term debt 513 937 Senior convertible notes -- 1,380 Lease incentives and other liabilities 980 1,043 -------------------------------------------------------------------------- Total Long-Term Liabilities 1,493 3,360 Total Shareholders' Equity 6,023 4,973 -------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $9,772 $10,699 ==========================================================================

(a) Represents cash that has been restricted to back our letter of credit agreements and certain other obligations.

(b) For discussion of the restatement, see note B of the Consolidated Financial Statements in the company's Form 10-K for the year ended January 29, 2005.

Gap Inc. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------------------------------------------- Thirteen Weeks Ended ------------------------- (in millions except share April 30, 2005 May 1, 2004 and per share amounts) (As Restated) (a) -------------------------------------------------------------------------- Net sales $3,626 $3,668 -------------------------------------------------------------------------- Cost of goods sold and occupancy expenses 2,145 2,088 -------------------------------------------------------------------------- Gross Profit 1,481 1,580 Operating expenses 1,016 998 Loss on early retirement of debt -- 30 Interest expense 23 52 Interest income (25) (12) -------------------------------------------------------------------------- Earnings before income taxes 467 512 Income taxes 176 200 -------------------------------------------------------------------------- Net earnings $291 $312 -------------------------------------------------------------------------- (in thousands) Weighted-average number of shares - basic 888,920 898,082 Weighted-average number of shares - diluted 951,862 996,327 -------------------------------------------------------------------------- Earnings per share - basic $0.33 $0.35 Earnings per share - diluted 0.31 0.33 ==========================================================================

(a) For discussion of the restatement, see note B of the Consolidated Financial Statements in the company's Form 10-K for the year ended January 29, 2005.

Number of store locations open at end of period 3,010 3,016 Total square footage at end of period 36,851,154 36,489,080 ========================================================================== Gap Inc. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------------------------------------------- Thirteen Weeks Ended Thirteen Weeks Ended (In millions) April 30, 2005 May 1, 2004 (As Restated) (c) -------------------------------------------------------------------------- Cash Flows from Operating Activities: Net earnings $291 $312 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 146 155 Other non-cash reconciling adjustments 4 9 Deferred income taxes (35) (4) Changes in operating assets and liabilities: Merchandise inventory (106) (120) Other assets (99) (47) Accounts payable (65) (98) Accrued expenses and other liabilities (40) (7) Income taxes payable 102 (75) Lease incentives and other liabilities 27 40 --------- --------- Net cash provided by operating activities 225 165 --------- --------- Cash Flows from Investing Activities: Purchase of property and equipment (112) (35) Purchase of short term investments (725) (529) Maturities of short term investments 293 693 Purchase of long term investments (50) -- Restricted cash (a) 7 (10) Changes in other assets (3) 2 --------- --------- Net cash (used for) provided by investing activities (590) 121 --------- --------- Cash Flows from Financing Activities: Payments of long-term debt (b) -- (170) Issuance of common stock (b) 24 29 Purchase of treasury stock (488) -- Cash dividends paid (62) (20) --------- --------- Net cash used for financing activities (526) (161) --------- --------- Effect of exchange rate fluctuations on cash -- (14) --------- --------- Net (decrease) increase in cash and equivalents (891) 111 Cash and equivalents at beginning of year 2,245 2,261 --------- --------- Cash and equivalents at end of year $1,354 $2,372 ========= ========= --------------------------------------------------------------------------

(a) Represents cash that has been restricted to back our letter of credit agreements and certain other obligations.

(b) Does not include the non-cash conversion of our senior convertible debt of $1.37 billion to 85,143,950 shares of common stock.

(c) For discussion of the restatement, see note B of the Consolidated Financial Statements in the company's Form 10-K for the year ended January 29, 2005.

Gap Inc. SEC REGULATION G RECONCILIATION OF FREE CASH FLOW TO GAAP FINANCIAL MEASURES -------------------------------------------------------------------------- Thirteen Weeks Ended (In millions) April 30, 2005 -------------------------------------------------------------------------- Net cash provided by operating activities $225 Net cash used for investing activities (590) Net cash used for financing activities (526) Effect of exchange rate fluctuations on cash -- -------------------------------------------------------------------------- Net decrease in cash and equivalents (891) -------------------------------------------------------------------------- Net cash provided by operating activities $225 Less: Purchase of property and equipment (112) -------------------------------------------------------------------------- Free Cash Flow (a) $113 ========================================================================== Thirteen Weeks Ended (In millions) May 1, 2004 (As Restated) (b) -------------------------------------------------------------------------- Net cash provided by operating activities $165 Net cash provided by investing activities 121 Net cash used for financing activities (161) Effect of exchange rate fluctuations on cash (14) -------------------------------------------------------------------------- Net increase in cash and equivalents 111 -------------------------------------------------------------------------- Net cash provided by operating activities $165 Less: Purchase of property and equipment (35) -------------------------------------------------------------------------- Free Cash Flow (a) $130 ========================================================================== RECONCILIATION OF GAP INC.'S EXPECTATION OF AT LEAST $1 BILLION IN FREE CASH FLOW FOR FISCAL 2005, 2006, AND 2007 TO GAAP FINANCIAL MEASURES Fifty-Two Weeks Ending (In millions) January 28, 2006 -------------------------------------------------------------------------- Minimum net cash provided by operating activities $1,625 Less: Estimated net purchase of property and equipment (625) -------------------------------------------------------------------------- Free cash flow (a) $1,000 ========================================================================== Fifty-Three Weeks Ended (In millions) February 3, 2007 -------------------------------------------------------------------------- Minimum net cash provided by operating activities $1,725 Less: Estimated net purchase of property and equipment (725) -------------------------------------------------------------------------- Free cash flow (a) $1,000 ========================================================================== Fifty-Two Weeks Ended (In millions) February 2, 2008 Minimum net cash provided by operating activities $1,725 Less: Estimated net purchase of property and equipment (725) -------------------------------------------------------------------------- Free cash flow (a) $1,000 ==========================================================================

(a) Free cash flow is a non-GAAP measure. We believe free cash flow is an important metric, as it represents a measure of how profitable a company is on a cash basis after the deduction of capital expenses, as most companies require regular capital expenditures to build and maintain stores and purchase new equipment to keep the business growing. We use this metric internally, as we believe our sustained ability to increase free cash flow is an important driver of value creation.

(b) For discussion of the restatement, see note B of the Consolidated Financial Statements in the company's Form 10-K for the year ended January 29, 2005.