The Gap, Inc. — Form 10-Q Summary
Period clarification: The filing covers the 13 weeks ended April 28, 2012, the first quarter of fiscal 2012. This differs from the request metadata identifying “2011 Q1.” The filing was signed June 6, 2012.
Business context
Gap operates apparel and accessories brands including Gap, Old Navy, Banana Republic, Piperlime, and Athleta through company-operated stores, online channels, and franchise stores. It reports Stores and Direct segments.
Financial performance
| Metric | Q1 FY2012 | Q1 FY2011 |
|---|---|---|
| Net sales | $3.487 billion | $3.295 billion |
| Gross profit / gross margin | $1.375 billion / 39.4% | $1.304 billion / 39.6% |
| Operating income / operating margin | $395 million / 11.3% | $386 million / 11.7% |
| Net income | $233 million | $233 million |
| Diluted EPS | $0.47 | $0.40 |
| Operating cash flow | $364 million | $231 million |
| Capital expenditures | $148 million | $127 million |
| Free cash flow | $216 million | $104 million |
Sales rose 6%; comparable sales, including comparable online sales, increased 4%, versus a 3% decline a year earlier. Direct sales grew 18% to $410 million. Stores segment sales increased 4%. International comparable sales remained negative at 4% below the prior year. Higher merchandise costs, primarily attributed to cotton prices, contributed to gross-margin compression. Operating expenses increased 7% to $980 million, with higher marketing and store payroll costs. Interest expense rose to $23 million from $6 million, mainly reflecting debt issued in 2011.
Financial position and capital allocation
At April 28, 2012, cash and cash equivalents were $1.972 billion and short-term investments were $75 million. Current assets were $4.445 billion against current liabilities of $2.054 billion. Debt comprised $59 million of current maturities and $1.566 billion of long-term debt. The company had no borrowings under its $500 million revolving facility, with $430 million available after standby letters of credit; China facilities had $19 million drawn and $11 million available.
Cash increased $87 million during the quarter. Operating cash flow improved year over year, primarily reflecting inventory reductions versus an inventory build in the prior-year quarter and lower income-tax payments. Investing used $231 million; financing used $42 million. The company repurchased 0.7 million shares for $18 million and had $984 million remaining under its February 2012 $1 billion authorization. It paid a quarterly dividend of $0.125 per share.
Outlook, commentary, and risks
- Fiscal 2012 diluted EPS guidance was $1.78–$1.83; expected operating margin was about 10% and effective tax rate about 39.5%.
- Management expected fiscal-year capital expenditures of about $600 million and depreciation and amortization, net of lease-incentive amortization, of about $475 million. It expected to pay $0.50 per share in fiscal 2012 dividends.
- Plans included improving comparable sales with healthy merchandise margins, investing prudently, returning excess cash, expanding online and internationally, and opening about 160 company-operated stores while closing about 145. Franchisees were expected to open about 50–75 stores.
- Management said current cash and operating cash flows should support operations and planned investment for the next 12 months and beyond. It warned operating expenses were unlikely to leverage in fiscal 2012.
- Key risks include changing consumer demand and apparel trends, competition, sourcing costs or disruptions, international expansion and franchise execution, store-location and lease risks, foreign exchange, debt and capital-market access, cybersecurity and IT disruption, catastrophic events, and litigation.
- Ordinary-course legal claims included commercial, intellectual-property, customer, employment, and data-privacy matters, including class actions. The company said recorded liabilities were not material and did not expect current actions to have a material overall effect. Store-lease guarantees had a maximum potential exposure of about $5 million, with no liability recorded.
- Six executive post-termination agreements disclosed in the filing provide specified severance and related benefits for qualifying involuntary terminations before February 13, 2015. Management reported effective disclosure controls and no material change in internal control during the quarter.
Most important facts to verify
- Confirm the reporting period: this is Q1 fiscal 2012, ended April 28, 2012, not Q1 2011.
- Review the basis for full-year EPS, operating-margin, tax-rate, capital-expenditure, and dividend expectations; these are forward-looking estimates.
- Assess whether sales growth and comparable-sales improvement can offset cotton-related merchandise costs and higher operating expenses.
- Reconcile reported debt and available liquidity, including the China borrowings and the revolving facility’s standby-letter-of-credit usage.
- Check subsequent developments in litigation, executive agreements, store expansion and closures, and the share-repurchase program.