The Gap, Inc. — Form 10-Q Summary
Period and scope: The filing covers the 13 and 26 weeks ended July 30, 2011, compared with the periods ended July 31, 2010. Although the request labels the period “2010 Q2,” the filing is for fiscal 2011 Q2. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and financial performance
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Piperlime, and Athleta through company-operated stores, online channels, and franchisees. Its reportable segments are Stores and Direct.
| Metric | Q2 FY2011 | Q2 FY2010 | First half FY2011 | First half FY2010 |
|---|---|---|---|---|
| Net sales | $3,386 | $3,317 | $6,681 | $6,646 |
| Gross profit | $1,251 | $1,314 | $2,555 | $2,715 |
| Gross margin | 36.9% | 39.6% | 38.2% | 40.9% |
| Operating income | $334 | $397 | $720 | $871 |
| Net income | $189 | $234 | $422 | $536 |
| Diluted EPS | $0.35 | $0.36 | $0.74 | $0.81 |
- Q2 revenue rose 2%; comparable sales, including comparable online sales, fell 2%. First-half revenue rose 1%, while comparable sales fell 2%.
- Q2 Direct sales increased 20% to $309 million; first-half Direct sales increased 19% to $657 million. Stores sales grew 1% in Q2 but declined 1% in the first half.
- Operating margin was 9.9% in Q2 versus 12.0% a year earlier, and 10.8% in the first half versus 13.1%. Management attributed the lower gross margin primarily to higher merchandise costs; operating expenses were flat in Q2 and lower by $9 million in the first half.
Cash flow, liquidity, and capital allocation
- First-half operating cash flow was $559 million versus $540 million. Capital expenditures were $261 million, producing reported free cash flow of $298 million versus $292 million.
- Cash and cash equivalents were $2.104 billion, with $75 million of short-term investments, at July 30, 2011. Current liabilities were $2.158 billion.
- Total debt was $1.646 billion: $1.246 billion of notes and a $400 million term loan, with $40 million classified as current. The notes carry a fixed 5.95% coupon and mature in 2021; the term loan is variable-rate and matures in 2016.
- The company issued $1.25 billion of notes and borrowed $400 million under the term loan during the first half. It said cash and operating cash flows should support operations and planned investment, with a $500 million revolving facility available; $457 million was available after letters of credit at quarter-end.
- First-half share repurchases were $1.368 billion for 67.3 million shares. A $2 billion authorization announced in February had approximately $671 million remaining at July 30. First-half dividends paid were $126 million; management intended to raise the fiscal 2011 annual dividend to $0.45 per share from $0.40.
Outlook, risks, and contingencies
- Management’s stated priorities were revenue growth, cost control and returns on invested capital, strong free cash flow and shareholder distributions, and investment in long-term growth. It aimed to stabilize North American revenue and expand internationally, including stores, franchises, and online sales.
- Fiscal 2011 expectations included approximately $575 million of capital expenditures, about 125 company-operated store openings and 125 closures, roughly a 2% decline in company-operated store square footage, and about 75 new franchise stores. Management expected an effective tax rate of approximately 39%; no specific revenue or earnings guidance was provided in the filing text.
- Key disclosed risks include consumer spending and economic conditions, competition and changing fashion preferences, merchandise and sourcing costs, supply-chain disruption, international expansion, store locations and leases, market and credit conditions, technology/vendor disruptions, and litigation. Management cited potential adverse effects from the 2011 Japan earthquake, tsunami, and nuclear crisis.
- The term loan contains financial covenants; a breach could trigger immediate repayment. Lower Moody’s or S&P ratings could increase borrowing costs. The company reported no material recorded liability for legal actions; it also disclosed up to $18 million of potential lease-guarantee payments and $14 million maximum exposure related to a workers’ compensation, general liability, and automobile liability reinsurance pool.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It cautioned that interim results are not necessarily indicative of full-year results.
Most important facts for investors to verify
- Confirm the period: this is a July 30, 2011 filing, not a 2010 Q2 filing.
- Track whether merchandise-cost pressure and comparable-sales declines persist, and whether Direct growth offsets weaker Stores performance.
- Review the effects of new debt, variable-rate exposure, credit ratings, and term-loan covenant compliance.
- Assess whether planned capital spending, store actions, dividends, and repurchases remain supported by operating cash flow and liquidity.
- Monitor the disclosed Japan-related risks, supply-chain and consumer risks, and developments in legal or tax contingencies.