The Gap, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the 13 weeks ended April 30, 2011 (first quarter of fiscal 2011), compared with the 13 weeks ended May 1, 2010. The filing is unaudited. This differs from the request metadata’s “2010 Q1.” Gap operates apparel and accessories brands through stores and online channels; reportable segments are Stores and Direct.
Financial results and liquidity
| Metric | Q1 FY2011 | Prior year | Change |
|---|---|---|---|
| Net sales | $3.295 billion | $3.329 billion | Down 1% |
| Gross profit / margin | $1.304 billion / 39.6% | $1.401 billion / 42.1% | Margin down 2.5 percentage points |
| Operating income / margin | $386 million / 11.7% | $474 million / 14.2% | Income down 19% |
| Net income | $233 million | $302 million | Down 23% |
| Diluted EPS | $0.40 | $0.45 | Down 11% |
| Operating cash flow | $231 million | $329 million | Down $98 million |
| Free cash flow | $104 million | $222 million | Down $118 million |
Merchandise cost was the principal driver of gross-margin pressure; cost of goods sold and occupancy rose to 60.4% of sales from 57.9%. Operating expenses declined $9 million but were nearly flat as a share of sales. Comparable sales including associated online sales fell 3%, versus a 5% increase a year earlier. Direct sales grew 18% to $348 million; Stores sales declined 3% to $2.947 billion. Stores operating income fell to $304 million from $402 million, while Direct operating income rose to $82 million from $72 million.
At April 30, cash and cash equivalents were $2.417 billion and short-term investments were $50 million. Current assets were $4.870 billion and current liabilities $2.090 billion. Long-term debt of $1.246 billion was recorded, primarily reflecting the new notes; stockholders’ equity was $3.771 billion. The company issued $1.25 billion of 5.95% unsecured notes due 2021, receiving $1.24 billion net. A separate $400 million five-year term loan was arranged in April and funded in May, so it was not included in April 30 debt balances. The company also reported $3 million drawn under China credit facilities and $451 million net availability under its $500 million revolving facility.
Material changes, outlook, and risks
- Management attributed the sales decline to weaker Stores performance, partly offset by Direct growth, and noted that first-quarter results included effects of the March 2011 Japan earthquake and related events. Costlier merchandise reduced gross margin.
- Share repurchases totaled 24.8 million shares for $548 million during the quarter. The company had used $509 million of its new $2 billion authorization through April 30. Dividends paid were $0.1125 per share; management intended to increase the fiscal 2011 annual dividend to $0.45 per share.
- Management expected a fiscal 2011 effective tax rate of about 39%, capital expenditures of about $575 million, approximately 125 company-operated store openings and 125 closings, and about 75 new franchise openings. Company-operated net square footage was expected to decline about 2%. These are forward-looking estimates, not guarantees.
- Management said cash and operating cash flows should support operations, growth initiatives, and planned capital expenditures, with the revolving facility as a potential liquidity source. It cited a $1.2 billion target cash balance and a continuing focus on liquidity and credit quality.
- Key risks include weaker consumer spending, fashion and competitive pressures, supply-chain disruption and sourcing costs, Japan-related impacts, international expansion execution, comparable-sales and margin volatility, and credit-rating or capital-market deterioration. The term loan has financial covenants; breach could trigger immediate repayment. Moody’s and Fitch rated the company Baa3 and BBB-, respectively; S&P remained BB+.
- Legal proceedings and claims arose in the ordinary course of business; the company reported no material accrued liability and did not expect current actions, individually or collectively, to materially affect its financial position or results. Potential future lease-guarantee payments were approximately $20 million; reinsurance-pool maximum exposure was $14 million.
Important facts for investors to verify
- Confirm the reporting period: the filed quarter ended April 30, 2011, despite the request metadata identifying 2010 Q1.
- Track whether gross-margin pressure, negative comparable sales, and lower Stores operating income persist, and whether Direct growth offsets them.
- Review subsequent debt balances and servicing costs after the $400 million term loan funded in May, including covenant compliance and credit-rating changes.
- Compare actual fiscal 2011 tax rate, capital spending, store plans, dividends, and share repurchases with management’s stated expectations.
- Assess cash generation and liquidity against the $1.2 billion target cash balance and the company’s substantial repurchase activity.