Business Context and Reporting Period
This Form 10-Q covers The Gap, Inc. for the thirteen and thirty-nine weeks ended November 3, 2001. The Company operates retail apparel stores under the Gap, Banana Republic, and Old Navy banners. The reporting period reflects a challenging environment characterized by declining comparable store sales, increased promotional activity, and significant tax charges.
Key Financial Metrics
| Metric | 13 Weeks Ended Nov 3, 2001 | 39 Weeks Ended Nov 3, 2001 | 13 Weeks Ended Oct 28, 2000 | 39 Weeks Ended Oct 28, 2000 |
|---|---|---|---|---|
| Net Sales ($000) | $3,333,373 | $9,758,248 | $3,414,668 | $9,094,372 |
| Net Earnings/(Loss) ($000) | $(178,837) | $26,394 | $186,348 | $605,744 |
| Earnings/(Loss) Per Share (Diluted) | $(0.21) | $0.03 | $0.21 | $0.69 |
| Comparable Store Sales Change | (17)% | (11)% | (8)% | (4)% |
| Cash and Equivalents ($000) | $799,510 | $799,510 | $352,201 | $352,201 |
| Working Capital ($000) | $300,591 | $300,591 | $156,053 | $156,053 |
| Current Ratio | 1.09:1 | 1.09:1 | 1.05:1 | 1.05:1 |
Debt and Liquidity: Total debt consists of notes payable ($1.03 billion) and long-term debt ($1.27 billion). The Company maintains committed credit facilities of $1.45 billion and uncommitted facilities of $1.15 billion. Cash provided by operating activities for the 39-week period was $392.9 million.
Material Changes vs. Prior Period
- Profitability Collapse: The Company reported a net loss of $178.8 million for the quarter, a stark reversal from the $186.3 million net earnings in the prior year quarter. Year-to-date earnings dropped to $26.4 million from $605.7 million.
- Sales Decline: Net sales decreased 2% in the quarter and increased 7% year-to-date, driven entirely by new store openings. Comparable store sales declined 17% in the quarter and 11% year-to-date due to poor product acceptance and a promotional environment.
- Margin Compression: Cost of goods sold and occupancy expenses as a percentage of net sales increased 8.3 percentage points in the quarter. This was driven by a 5.3 percentage point decline in merchandise margin (due to markdowns and a $52 million charge for cancelled product orders) and a 3.0 percentage point increase in occupancy expenses.
- Tax Charge: A $131 million tax charge was recorded in the third quarter, primarily reflecting probable settlements of foreign and domestic tax audits. This resulted in an effective tax rate of 49% (excluding the charge) for the period.
- Inventory Build: Merchandise inventory increased to $2.59 billion from $1.90 billion at the end of the prior fiscal year, reflecting a buildup in anticipation of demand that did not materialize.
Guidance, Outlook, and Risks
- Outlook: Management expects negative trends in comparable store sales and gross margins to continue into the fourth quarter. Fourth-quarter earnings per share are projected to be considerably worse than the third-quarter loss, excluding the tax charge.
- Capital Expenditures: Fiscal 2001 capital expenditures are expected to range from $1.1 to $1.2 billion. For fiscal 2002, the range is $600 to $650 million, with a goal to lower this further. Planned square footage growth for fiscal 2002 was revised down to approximately 5% from a previous 10%.
- Workforce Reductions: The Company announced the elimination of approximately 1,600 positions and the closure of distribution facilities in Ventura, CA, and London, consolidating operations in Fresno, CA, and Rugby, England. A $30 million charge was recorded in the second quarter related to these actions.
- Credit Ratings: Moody's and Standard & Poor's have downgraded the Company's credit ratings (to Baa2 and BBB+, respectively) due to deteriorating operating profitability. This may increase the cost of financing and limit access to capital markets.
- Legal Proceedings: The Company is defending against lawsuits regarding labor practices in Saipan. The Company believes the claims are without merit but cannot estimate potential losses.
Investor Verification Checklist
- Inventory Levels: Verify the $2.59 billion inventory balance against current sales velocity to assess potential future markdown risks.
- Tax Liability: Confirm the $131 million tax charge details and the timeline for cash payments related to audit settlements.
- Credit Facility Covenants: Review the impact of recent credit rating downgrades on the Company's ability to access its $1.45 billion committed credit facilities and the cost of new debt issuances.
- Product Assortment: Assess the effectiveness of the cancelled product orders and new assortment strategies in reversing the 17% comparable store sales decline.
- Store Closure Costs: Monitor the execution of distribution facility closures and the associated costs versus the $30 million charge already taken.