Business context and reporting period
The Gap, Inc. is a global apparel retailer operating Gap, Old Navy, Banana Republic and other brands through stores and direct channels. This filing reports the 13 weeks ended May 1, 2010, the first quarter of fiscal 2010—not 2009 as stated in the request metadata. The comparable quarter ended May 2, 2009.
Financial performance and position
| Metric | Q1 FY2010 | Q1 FY2009 |
|---|---|---|
| Net sales | $3.329 billion | $3.127 billion |
| Gross profit / gross margin | $1.401 billion / 42.1% | $1.239 billion / 39.6% |
| Operating income / operating margin | $474 million / 14.2% | $353 million / 11.3% |
| Net income | $302 million | $215 million |
| Diluted EPS | $0.45 | $0.31 |
| Operating cash flow | $329 million | $202 million |
| Capital expenditures | $107 million | $63 million |
| Free cash flow (non-GAAP) | $222 million | $139 million |
At May 1, 2010, cash and cash equivalents were $2.056 billion and short-term investments were $425 million. The company reported no debt outstanding, current assets of $4.664 billion, current liabilities of $2.091 billion, and total stockholders’ equity of $4.907 billion. Cash and short-term investments totaled approximately $2.5 billion. The $500 million revolving facility had no borrowings and $445 million of net availability after standby letters of credit.
Material changes versus the prior comparable period
- Sales rose 6%; comparable-store sales increased 4%, versus an 8% decline a year earlier. Brand comparable-store sales were Gap +2%, Old Navy +7%, and Banana Republic +5%; international was flat.
- Management attributed store-segment sales growth partly to comparable-store improvement and $54 million of favorable foreign-exchange translation. Direct sales increased 10%, supported by online growth, especially Piperlime and Athleta.
- Gross margin expanded 2.5 percentage points, primarily from lower merchandise costs and fewer markdowns. Operating expenses increased $41 million but declined as a share of sales, to 27.8% from 28.3%.
- Net income increased 40% and diluted EPS rose from $0.31 to $0.45. Weighted-average diluted shares fell to 676 million from 697 million, reflecting repurchases.
- Operating cash flow increased $127 million, principally due to higher net income and lower income-tax payments. Investing outflows increased, including higher capital spending and net purchases of short-term investments.
Outlook, commentary, risks and unusual items
- Management’s FY2010 priorities include improving sales while maintaining healthy margins, cost control, return on invested capital, free cash flow and shareholder returns, alongside investment and earnings growth. International plans include Gap stores in China and Italy, Banana Republic expansion in Europe, additional outlets, and online launches in selected markets.
- FY2010 capital expenditures were expected to be about $575 million; management expected about 65 store openings and 110 closures, with net square footage declining about 3%. The company intended to raise its annual dividend from $0.34 in FY2009 to $0.40 in FY2010.
- The company repurchased 14.3 million shares for $296 million in the quarter at an average $20.63 per share. A new $1 billion authorization had $949 million remaining at quarter-end.
- The effective tax rate was 37.7%, versus 39.1%; management expected about 39% for FY2010, subject to income mix, earnings levels and tax-contingency resolutions. Tax matters included an $11 million interest-expense reversal and approximately $74 million of IRS refund payments, including interest. Management also reported a $43 million decrease in gross unrecognized tax benefits.
- Management said cash and operating cash flows should support operations, capital expenditures and dividends for the foreseeable future. Results for the quarter are not necessarily indicative of the full fiscal year.
- Risks include changing fashion preferences and consumer spending, competition, sales and margin fluctuations, store-location and lease challenges, supply-chain disruption, international expansion, information-technology disruption, vendor conduct, regulatory changes, share-repurchase execution and litigation. The filing reported no material change in risk factors from the prior 10-K.
- Contingencies include guarantees of up to $27 million for assigned leases, with a $1 million recorded liability, and up to $14 million exposure from a reinsurance pool. The company also disclosed ordinary-course legal claims, including wage-and-hour matters; it did not expect current actions, taken as a whole, to have a material adverse effect.
Most important facts for investors to verify
- Confirm the period: the filing is for Q1 FY2010, ended May 1, 2010.
- Assess whether the improved comparable sales and margins persisted beyond the quarter, and distinguish operating improvement from favorable foreign exchange.
- Consider the effect of the $11 million tax-related interest reversal on reported pretax income and the sustainability of the roughly 39% expected full-year tax rate.
- Track cash generation against planned capital expenditures, dividends and share repurchases, including execution of the remaining $949 million authorization.
- Review the status and potential financial effects of tax uncertainties, legal proceedings, lease guarantees and reinsurance-pool exposure.