The Gap, Inc. — Form 10-Q Summary
Reporting-period note: The filing covers the 13 and 26 weeks ended August 1, 2009 (second quarter and first half of fiscal 2009). This conflicts with the request metadata identifying 2008 Q2; confirm the intended filing period.
Business context and reporting period
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Piperlime and Athleta brands through stores, online channels, catalogs, wholesale and franchise arrangements. Reportable segments are Stores and Direct. The interim statements are unaudited; management says results for the first half are not necessarily indicative of full-year results.
Financial performance and liquidity
| Metric | Q2 2009 | Q2 2008 | First half 2009 | First half 2008 |
|---|---|---|---|---|
| Net sales | $3.245 billion | $3.499 billion | $6.372 billion | $6.883 billion |
| Gross profit / margin | $1.288 billion / 39.7% | $1.338 billion / 38.2% | $2.527 billion / 39.7% | $2.680 billion / 38.9% |
| Operating income / margin | $375 million / 11.6% | $373 million / 10.7% | $728 million / 11.4% | $756 million / 11.0% |
| Net income | $228 million | $229 million | $443 million | $478 million |
| Diluted EPS | $0.33 | $0.32 | $0.63 | $0.66 |
- Q2 comparable-store sales fell 8%, versus a 10% decline a year earlier. First-half comparable-store sales fell 8%, versus 11%.
- Q2 Direct sales increased 17% to $224 million; first-half Direct sales rose 15% to $491 million, primarily reflecting Athleta, added in September 2008. Stores sales declined 9% in both periods.
- First-half operating cash flow was $720 million, versus $562 million. Capital expenditures were $131 million, versus $208 million; free cash flow, as defined by the company, was $589 million, versus $354 million.
- At August 1, 2009, cash and cash equivalents were $2.031 billion and short-term investments were $100 million. The company reported no debt outstanding after repaying $50 million during the first half. Its $500 million revolving facility had $443 million of net availability.
- Total assets were $7.705 billion; stockholders’ equity was $4.745 billion. Inventory was $1.473 billion, down from $1.700 billion a year earlier; management reported inventory per square foot down 14% year over year.
Changes, outlook and management commentary
- Sales fell 7% in Q2 and the first half, driven by lower Stores sales and unfavorable foreign-exchange translation; Direct growth partly offset the decline. Q2 foreign-exchange impact on Stores sales was $39 million; first-half impact was $111 million.
- Gross margin improved as merchandise costs and markdown selling declined, supported by cost-management efforts. Lower sales increased occupancy costs as a percentage of sales. Operating expenses also decreased, principally from lower store costs, corporate payroll and benefits, and favorable currency effects, partly offset by higher marketing.
- Management’s fiscal 2009 outlook: effective tax rate about 39%; capital expenditures about $350 million; approximately 50 store openings and 100 closures, including repositions, with net square footage expected to decline about 2%. The company intended to maintain an annual dividend of $0.34 per share and said it would likely resume share repurchases in Q3.
- Management cited priorities of improving sales trends and customer experience, focusing investment on return, cost management and inventory discipline, and generating free cash flow and returning excess cash to shareholders. It believed cash and operating cash flow would fund operations, capital expenditures and dividends for the foreseeable future.
- Unusual comparative item: first-half 2008 included a $15 million reversal of interest expense, primarily from foreign tax audit events. Lower interest rates also reduced interest income in 2009.
Risks and contingencies
- Key disclosed risks include weak consumer spending and confidence, fashion and preference shifts, competition, comparable-store sales and margin volatility, execution of strategic initiatives, store leasing and locations, supply-chain disruptions, foreign exchange, technology disruptions, regulatory changes, and litigation or tax-audit outcomes.
- Lease guarantees on assigned facilities had a maximum potential exposure of approximately $39 million, with a $2 million recorded liability. Reinsurance-pool guarantees had maximum exposure of $14 million, of which $0.2 million was cash collateralized; the company was winding down its participation.
- The company faced ordinary-course legal claims, including employment, intellectual-property, customer, data-privacy and securities matters. It did not believe current matters, taken as a whole, would materially adversely affect its financial position, results or cash flows, but outcomes are uncertain.
- Foreign-exchange forwards were used for risk management, not trading. Outstanding contracts included hedges of forecast purchases and royalties; derivative fair values were $24 million in assets and $40 million in liabilities. Management reported no material long-lived-asset impairment charges during the period.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Resolve the metadata-period mismatch: this is a Q2 2009 filing, not Q2 2008.
- Assess whether improved gross and operating margins can persist if comparable-store sales remain negative and occupancy leverage worsens.
- Verify the sustainability and drivers of higher operating cash flow and free cash flow, including working-capital movements and planned capital spending.
- Track progress against the stated fiscal-year store, capital expenditure, dividend and share-repurchase plans; repurchases were limited to $5 million in the first half.
- Monitor consumer-demand, foreign-exchange, tax, litigation and guarantee exposures, and confirm that cash and revolving-facility liquidity remain adequate.