The Gap, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the 13 and 39 weeks ended October 29, 2011, not 2010 Q3. It was filed December 7, 2011. Financial statements are unaudited.
Business context and reporting period
Gap operates apparel and accessories brands including Gap, Old Navy, Banana Republic, Piperlime, and Athleta, through stores, online sales, wholesale, and franchise arrangements. Its reportable segments are Stores and Direct. Results below compare the 2011 periods with the corresponding periods ended October 30, 2010.
Financial performance and position
| Metric | 13 weeks ended Oct. 29, 2011 | 39 weeks ended Oct. 29, 2011 |
|---|---|---|
| Net sales | $3.585 billion, down 2% | $10.266 billion, essentially flat |
| Gross profit / gross margin | $1.314 billion / 36.7% (41.2% prior year) | $3.869 billion / 37.7% (41.0% prior year) |
| Operating income / margin | $346 million / 9.7% (13.8% prior year) | $1.066 billion / 10.4% (13.3% prior year) |
| Net income | $193 million, down from $303 million | $615 million, down from $839 million |
| Diluted EPS | $0.38, versus $0.48 | $1.12, versus $1.29 |
For the 39-week period, operating cash flow was $638 million, capital expenditures were $416 million, and company-defined free cash flow was $222 million, down from $523 million a year earlier. Cash and cash equivalents were $1.392 billion at October 29, 2011; short-term investments were $25 million. Current assets were $4.554 billion and current liabilities $2.482 billion.
Debt included $1.25 billion of 5.95% notes due 2021 and a $400 million variable-rate term loan due 2016; reported long-term debt was $1.606 billion, with $52 million of current maturities of debt (including China facility borrowings). The $500 million revolving facility was undrawn, with $457 million net availability after letters of credit. The company repurchased 106.5 million shares for $2.013 billion during the 39 weeks and paid $0.3375 per share in dividends.
Material changes versus prior comparable periods
- Quarterly comparable sales, including comparable online sales, fell 5%, versus 1% growth a year earlier. Year-to-date comparable sales fell 3%, versus 2% growth.
- Quarterly gross margin contracted 4.5 percentage points, primarily from higher merchandise costs and, to a lesser extent, occupancy costs against lower store sales.
- Direct sales grew 21% in the quarter and 20% year to date, while Stores sales fell 4% and 2%, respectively. International online sales contributed to Direct growth.
- Operating expenses declined, but the reduction did not offset weaker gross profit. Lower corporate overhead and higher credit-card agreement income were partly offset by higher marketing and store payroll costs.
- Interest expense increased following the 2011 debt issuance and term loan funding. The prior-year year-to-date period included an $11 million interest expense reversal related primarily to tax matters.
- Cash from operations fell $298 million year to date, principally reflecting lower net income. The company issued debt and continued substantial share repurchases; weighted-average diluted shares fell to 547 million from 651 million year to date.
Outlook, commentary, risks, and contingencies
- Management’s stated priorities were revenue growth, cost management and returns on invested capital, free cash flow and shareholder returns, and investment in long-term growth. Plans included international store, franchise, and online expansion while seeking to stabilize comparable sales in established markets.
- Fiscal 2011 outlook included capital expenditures of about $575 million, an effective tax rate of about 40%, and annual dividends of $0.45 per share. Management expected about 125 company-operated store openings and 150 closures, and about 60 franchise openings.
- Management said cash balances and operating cash flows should support operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond. Results for the interim period were not necessarily indicative of the full fiscal year.
- Risks identified include weak economic conditions and consumer spending, competition, fashion and preference changes, international expansion, sourcing and shipping disruptions, margin and comparable-sales volatility, execution and IT risks, and limits on capital-market access or higher borrowing costs.
- Debt agreements include financial covenants on the term loan and revolving facility; a covenant breach could trigger default remedies. The notes are unsecured and have no financial covenants. Moody’s and Fitch rated the company Baa3 and BBB-, respectively; S&P rated it BB+.
- Potential lease guarantees were about $17 million; reinsurance-pool guarantees had maximum exposure of $14 million. The filing reported no material recorded liability for these guarantees or for litigation matters, while noting outcomes are uncertain and adverse developments could affect income.
- No material impairment charges were reported. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the filing period: the document covers 2011 Q3, despite the request metadata stating 2010 Q3.
- Track whether merchandise-cost pressure and negative comparable sales persist, and whether margins recover.
- Assess the sustainability of online growth relative to declining Stores sales and the costs and returns of international expansion.
- Review inventory levels, seasonal cash needs, operating cash flow, and capital spending; inventory was $2.322 billion at quarter-end.
- Evaluate the effects of debt-funded repurchases on leverage, interest expense, liquidity, and per-share results, including covenant compliance and ratings changes.
- Compare actual full-year results with management’s tax-rate, capital-expenditure, dividend, and store-opening/closure expectations.