The Gap, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the quarter ended October 31, 2009 (fiscal 2009 third quarter), not 2008 Q3 as indicated in the request metadata. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Business context and reporting period
Gap operates apparel and accessories brands including Gap, Old Navy, Banana Republic, Piperlime, and Athleta. It reports two segments: Stores and Direct. The filing compares the 13 and 39 weeks ended October 31, 2009 with the corresponding periods ended November 1, 2008. The interim financial statements are unaudited.
Financial performance and liquidity
| Metric | 13 weeks ended Oct. 31, 2009 | Prior comparable period | 39 weeks ended Oct. 31, 2009 | Prior comparable period |
|---|---|---|---|---|
| Net sales | $3,589 | $3,561 | $9,961 | $10,444 |
| Gross profit | $1,524 | $1,378 | $4,051 | $4,058 |
| Gross margin | 42.5% | 38.7% | 40.7% | 38.9% |
| Operating income | $500 | $394 | $1,228 | $1,150 |
| Operating margin | 13.9% | 11.1% | 12.3% | 11.0% |
| Net income | $307 | $246 | $750 | $724 |
| Diluted EPS | $0.44 | $0.35 | $1.07 | $1.00 |
- Quarterly comparable-store sales were flat, versus a 12% decline a year earlier. For the 39-week period, comparable-store sales fell 5%, versus an 11% decline.
- Operating cash flow for the 39 weeks was $1,152, compared with $834. Capital expenditures were $221, resulting in company-defined free cash flow of $931, versus $519.
- At October 31, cash and cash equivalents were $2,173 and short-term investments were $225. The company reported no debt outstanding and $443 of net availability under its $500 revolving credit facility.
- Total current assets were $5,054 and current liabilities were $2,474. Merchandise inventory was $1,999, down from $2,224 at November 1, 2008.
- Cash dividends were $0.085 per share each quarter, or $0.255 for the 39 weeks.
Material changes versus prior comparable periods
- Third-quarter sales rose 1%, while 39-week sales declined 5%. Old Navy’s third-quarter sales increased 8% by brand, while Gap and Banana Republic sales declined 5% and 4%, respectively. Direct sales increased 5% for the quarter and 11% for the 39 weeks, partly reflecting Athleta, acquired in September 2008.
- Quarterly gross margin improved 3.8 percentage points, with management citing lower merchandise costs and less markdown selling. Operating income increased 27% for the quarter and 7% for the 39 weeks.
- For the 39 weeks, cost management and lower markdowns supported gross margin, but sales declines at Gap and Banana Republic and unfavorable foreign exchange weighed on sales. Operating expenses fell $85, primarily from lower store-related and payroll costs.
- Interest income decreased substantially, primarily because of lower interest rates. Prior-year 39-week interest expense included a $15 reversal related mainly to foreign tax audit events.
- The company repurchased $96 of stock in the 39 weeks, compared with $600 in the prior-year period. In November 2009, the board authorized an additional $500 share repurchase program.
Outlook, management commentary, risks, and unusual items
- Management expected fiscal 2009 capital expenditures of about $350, approximately 50 store openings and 100 closings (including repositions), and a net square-footage decrease of about 2%.
- Management expected a fiscal 2009 effective tax rate of about 39% and intended to maintain an annual dividend of $0.34 per share. It said cash and operating cash flows should fund operations, capital expenditures, and dividends for the foreseeable future.
- Management’s stated priorities included improving sales trends and market share, improving customer experience and return on invested capital, maintaining merchandise margins and inventory discipline, controlling costs, and generating free cash flow.
- Risks highlighted include changing fashion preferences and consumer spending, competition, sales and margin fluctuations, supply-chain and shipment disruption, international expansion, technology-system disruption, regulatory changes, and litigation or claims. The company said current legal actions were not expected to materially affect its overall financial position or results, but outcomes are uncertain.
- Lease guarantees could require up to $36 of future payments; the recorded liability was $1. Reinsurance-pool guarantees had maximum exposure of $14, with $0.2 cash-collateralized; the company was winding down participation.
- In the quarter, Gap changed its estimate for recognizing breakage on unredeemed gift certificates and vouchers from five years to three years; it said the impact was not material. It also recorded an immaterial tax expense after changing its indefinite-reinvestment assertion for approximately $46 of Canadian subsidiary earnings.
Important facts for investors to verify
- Confirm the reporting-period discrepancy: the filing is for fiscal 2009 Q3, despite the request metadata stating 2008 Q3.
- Assess whether margin gains and flat quarterly comparable sales are sustainable, particularly given continued weakness at Gap and Banana Republic and the 39-week sales decline.
- Review holiday-period inventory, markdown, and working-capital trends; the filing notes seasonal sales concentration and inventory management as a key focus.
- Track delivery against fiscal 2009 capital expenditure, store-opening and closing, tax-rate, dividend, and share-repurchase expectations.
- Monitor foreign-exchange hedges, tax contingencies, lease and reinsurance guarantees, and legal proceedings; outcomes or market movements could affect future results.