The Gap, Inc. — Form 10-Q Summary
Period: The filing covers the 13 and 39 weeks ended October 27, 2012 (fiscal 2012 third quarter and year to date), not 2011 Q3 as stated in the request metadata. Unaudited interim statements; amounts below are in U.S. dollars.
Business context and results
Gap operates apparel and accessories brands through Stores and Direct segments, including Gap, Old Navy, Banana Republic, Piperlime and Athleta. Its products are sold through stores, online channels and franchisees.
| Metric | Q3 2012 | Q3 2011 | 39 weeks 2012 | 39 weeks 2011 |
|---|---|---|---|---|
| Net sales | $3.864B | $3.585B | $10.926B | $10.266B |
| Gross profit | $1.593B | $1.314B | $4.395B | $3.869B |
| Operating income | $520M | $346M | $1.340B | $1.066B |
| Net income | $308M | $193M | $784M | $615M |
| Diluted EPS | $0.63 | $0.38 | $1.60 | $1.12 |
| Gross margin | 41.2% | 36.7% | 40.2% | 37.7% |
| Operating margin | 13.5% | 9.7% | 12.3% | 10.4% |
Financial position and cash flow
- At October 27, cash and cash equivalents were $1.720B and short-term investments were $50M. Current assets were $4.833B and current liabilities $2.628B.
- Total debt was approximately $1.248B: $1.246B of 5.95% notes due April 2021 and $2M borrowed under China facilities. Gap repaid the remaining $360M term-loan balance in August. Its $500M revolving facility had no borrowings and $434M net availability after standby letters of credit.
- For the first 39 weeks, operating cash flow was $1.225B, capital expenditures were $449M and company-defined free cash flow was $776M, versus $638M, $416M and $222M, respectively, a year earlier. Cash declined $165M from fiscal year-end to $1.720B.
- Cash generation benefited from higher earnings and changes in tax payables, accrued liabilities and accounts payable; management cites tax-payment timing and payment volume/timing among the drivers. Inventory use of cash was $655M.
- Gap repurchased 16.5M shares for $463M during the 39 weeks and paid $182M in dividends. It had $539M remaining on its $1B repurchase authorization at quarter-end.
Changes and management commentary
- Q3 sales rose 8%; comparable sales, including associated comparable online sales, increased 6%, versus a 5% decline in the prior-year quarter. North American brand comps were positive; international comps declined 3%.
- Direct sales rose 23% in Q3 to $509M. For the 39 weeks, Direct sales increased 22% to $1.303B; growth reflected online demand across brands and new Athleta stores.
- Q3 gross margin improved 4.5 percentage points, attributed chiefly to lower cotton-related merchandise costs and better occupancy leverage. Year-to-date improvement also reflected stronger product acceptance and average selling prices.
- Operating expenses rose $105M in Q3 and increased as a share of sales by 0.8 percentage points, mainly from marketing, store payroll and bonus expense. Management expects expense deleverage in Q4 as it continues business investment.
- The effective tax rate was 38.3% for Q3 and 38.6% year to date; management expects about 39.0% for fiscal 2012.
Outlook, risks and contingencies
- Fiscal 2012 diluted EPS guidance was $2.20–$2.25; expected operating margin was about 12%. Planned capital expenditures were about $675M and depreciation and amortization, net of lease-incentive amortization, about $475M.
- Management expected about 15 net openings of company-operated stores and 50–75 net new franchise stores for fiscal 2012, with company-operated square footage down about 1%. It intended to pay an annual dividend of $0.50 per share, an 11% increase from fiscal 2011.
- Management said available cash and operating cash flows should fund operations, growth initiatives and planned capital spending for the next 12 months and beyond.
- Risks include consumer-spending and economic changes, competition and fashion uncertainty, sourcing and shipment disruption, international expansion, comparable-sales and margin fluctuations, access to capital, technology and cybersecurity disruption, catastrophic events, vendor conduct, and litigation or regulatory changes.
- Ordinary-course legal matters include commercial, intellectual-property, customer, employment and data-privacy claims, including class actions. Recorded loss liabilities were not material; management said it could not assure outcomes but did not expect current actions collectively to materially affect the company.
- The filing reports no material change in risk factors, contractual obligations or internal control over financial reporting. Disclosure controls were concluded to be effective.
Important facts for investors to verify
- Confirm the intended reporting period: this filing is for Q3 fiscal 2012, ended October 27, 2012.
- Assess whether Q3 margin improvement—particularly the benefit from lower cotton costs—can persist, while accounting for planned operating-expense deleverage.
- Review the quality and repeatability of operating cash flow growth, including working-capital and tax-payment timing effects.
- Track comparable sales by geography and brand, Direct growth, and progress against store-opening and capital-spending plans.
- Monitor execution of the EPS and operating-margin outlook, debt repayment and shareholder-return plans, and developments in litigation or tax contingencies.