The Gap, Inc. — Form 10-Q Summary
Period: Quarter ended July 28, 2012 (13 weeks), with year-to-date results for the 26 weeks ended that date; comparisons are with periods ended July 30, 2011. The statements are unaudited. The request metadata says “2011 Q2,” but the filing itself reports fiscal 2012 Q2.
Business context and key financial results
Gap sells apparel and related products under Gap, Old Navy, Banana Republic, Piperlime, and Athleta through stores, online channels, and franchisees. Reportable segments are Stores and Direct. Unless indicated otherwise, amounts are in U.S. dollars.
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Net sales | $3.575 billion | $3.386 billion | $7.062 billion | $6.681 billion |
| Gross profit / margin | $1.427 billion / 39.9% | $1.251 billion / 36.9% | $2.802 billion / 39.7% | $2.555 billion / 38.2% |
| Operating income / margin | $425 million / 11.9% | $334 million / 9.9% | $820 million / 11.6% | $720 million / 10.8% |
| Net income | $243 million | $189 million | $476 million | $422 million |
| Diluted EPS | $0.49 | $0.35 | $0.97 | $0.74 |
- Q2 comparable sales, including comparable online sales, rose 4%, versus a 2% decline a year earlier. First-half comparable sales also rose 4%, versus a 2% decline.
- Q2 Direct sales increased 24% to $384 million; first-half Direct sales rose 21% to $794 million. Q2 Stores sales rose 4% to $3.191 billion.
- Q2 operating expenses were $1.002 billion, or 28.0% of sales, compared with $917 million, or 27.1%. Management cited increased marketing and store payroll. First-half operating expenses were $1.982 billion, or 28.1% of sales.
- Q2 interest expense was $22 million; first-half interest expense was $45 million, versus $28 million a year earlier, mainly reflecting debt issued and the term loan funded in 2011. First-half effective tax rate was 38.8%, versus 39.2%.
Cash flow, balance sheet, and capital allocation
- First-half operating cash flow was $970 million, up from $559 million. Capital expenditures were $297 million, producing reported free cash flow of $673 million, versus $298 million. Free cash flow is a non-GAAP measure defined as operating cash flow less property and equipment purchases.
- At July 28, cash and cash equivalents were $2.039 billion and short-term investments were $75 million. Total current assets were $4.540 billion; current liabilities were $2.238 billion.
- Total debt was $1.614 billion: $1.566 billion long-term debt and $48 million current maturities. The company repaid $40 million of its term loan in April. In August, it notified lenders of its intent to repay the remaining $360 million in fiscal Q3.
- The $500 million revolving facility had no borrowings and $431 million net availability after standby letters of credit. China facilities had $8 million outstanding and $21 million net availability. Management said cash and operating cash flows should support operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond.
- First-half share repurchases totaled $367 million for 13.8 million shares; $635 million remained under the $1 billion authorization at quarter-end. First-half dividends were $0.25 per share; management intended a $0.50 annual dividend for fiscal 2012, up 11% from fiscal 2011.
Changes, outlook, and risks
- Sales growth and margin improvement accompanied improved product acceptance and higher average unit selling prices; management also cited lower occupancy costs as a percentage of sales. Higher cotton costs partly offset first-half cost-of-goods-sold improvements.
- Fiscal 2012 outlook: diluted EPS of $1.95–$2.00, operating margin of about 11%, and effective tax rate of about 39.5%. Capital expenditures were expected to be up to $675 million; depreciation and amortization, net of lease-incentive amortization, about $475 million.
- Management planned about 160 new and 145 closed company-operated stores during fiscal 2012, with company-operated square footage expected to decline about 1%; franchisees were expected to open 50–75 stores. Priorities included improving sales with healthy merchandise margins, disciplined investment, and returning excess cash to shareholders. Management expected operating expenses to deleverage in the second half as it continued investing in the business.
- International comparable sales remained weak: down 5% in Q2 including online sales (down 5% for stores alone). Q2 sales translation had an $18 million unfavorable foreign-exchange impact on the Stores segment. The company hedges significant forecast foreign-currency exposures.
- Risks include consumer spending and apparel trends, competition, sourcing and shipment disruption or cost increases, international and franchise execution, store leases, currency movements, technology and cybersecurity, catastrophic events, and litigation. Ordinary-course lawsuits and claims were described as not material individually or in aggregate based on recorded estimates; outcomes remain uncertain. No material risk-factor changes were reported.
- Disclosure controls were judged effective, and no material change in internal control over financial reporting was reported. The filing says interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether the $1.95–$2.00 EPS and approximately 11% operating-margin outlook was achieved, particularly given planned second-half expense deleverage.
- Whether comparable-sales momentum persisted and international weakness improved; assess the contribution of online, new stores, and franchise sales to growth.
- Whether gross-margin gains were sustainable amid merchandise-cost, sourcing, and foreign-exchange risks.
- Whether the planned $360 million term-loan repayment occurred and how subsequent debt, cash, repurchases, dividends, and capital spending affected liquidity.
- Any material developments in litigation, tax contingencies, or other claims after the filing date; reported legal liabilities were estimates and not material at quarter-end.