Business Context and Reporting Period
This Form 10-Q covers The Gap, Inc. for the quarterly period ended July 29, 1995 (13 weeks) and the year-to-date period ended July 29, 1995 (26 weeks). The company operates retail apparel stores, including the Gap and Old Navy divisions. The financial statements are unaudited but have been reviewed by Deloitte & Touche LLP.
Key Financial Metrics
| Metric | 13 Weeks Ended 7/29/95 | 26 Weeks Ended 7/29/95 | 26 Weeks Ended 7/30/94 |
|---|---|---|---|
| Net Sales ($000) | $868,514 | $1,717,202 | $1,524,801 |
| Net Earnings ($000) | $32,414 | $82,527 | $107,830 |
| Earnings Per Share | $0.22 | $0.57 | $0.74 |
| Cash and Equivalents ($000) | $249,217 | $249,217 | $261,228 |
| Working Capital ($000) | $558,901 | $558,901 | $458,400 |
| Current Ratio | 2.23:1 | 2.23:1 | 2.05:1 |
| Operating Cash Flow ($000) | N/A | $(3,404) | $85,723 |
| Capital Expenditures ($000) | N/A | $(134,662) | $(101,772) |
Margins: Gross margin net of occupancy expenses decreased to 29.9% for the quarter (from 34.3% in 1994) and 31.4% year-to-date (from 36.4% in 1994). Operating expenses as a percentage of net sales decreased to 24.2% for the quarter and 24.0% year-to-date.
Material Changes Versus Prior Period
- Revenue Growth: Net sales increased 12% for the quarter and 13% year-to-date compared to the prior year. This growth was driven by the opening of 195 new stores and expansion of 62 stores, partially offset by a 1% decrease in comparable store sales for the quarter and 4% decrease year-to-date.
- Profitability Decline: Net earnings decreased 27% for the quarter and 23% year-to-date. Earnings per share dropped from $0.30 to $0.22 (quarter) and $0.74 to $0.57 (year-to-date).
- Cash Flow Reversal: Operating cash flow turned negative, using $3.4 million year-to-date compared to providing $85.7 million in the prior year. This was primarily due to a $137.2 million increase in merchandise inventory and a decrease in net earnings.
- Margin Compression: Merchandise margins declined due to lower initial margins and increased markdowns to clear slow-moving inventory. Occupancy expenses as a percentage of sales increased due to a lack of sales leverage from negative comparable store sales.
Guidance, Outlook, and Risks
- Outlook: Management expects the challenging retail sales environment to continue into the third quarter. Comparable store sales decreased 6% for the four weeks ended August 26, 1995. Overall merchandise margins are expected to be lower in the second half of 1995 compared to the second half of 1994.
- Capital Expenditures: The company expects fiscal year 1995 capital expenditures to total $275 to $300 million, funding the addition of 175 to 200 new stores and expansions. A new distribution center in Gallatin, Tennessee, is planned with a cost of $45 to $55 million.
- Liquidity: The company maintains a strong liquidity position with a $250 million revolving credit facility and $402 million in outstanding letters of credit. No long-term debt was outstanding as of July 29, 1995.
- Risks: Risks include the impact of markdowns on earnings, negative comparable store sales in the Gap division, and the ability to achieve sales leverage in new and expanded stores.
Investor Verification Checklist
- Verify the sustainability of the 12% net sales growth given the 1% decline in comparable store sales.
- Monitor the trend in merchandise margins and the extent of future markdowns required to clear inventory.
- Assess the impact of the $137 million inventory build on future operating cash flows.
- Confirm the execution of the store expansion program (175-200 new stores) and its effect on occupancy expense leverage.
- Review the progress of the $45-55 million distribution center project in Tennessee.