The Gap, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the 13 and 26 weeks ended July 31, 2010, with comparisons to the periods ended August 1, 2009. The request metadata says “2009 Q2,” but the filing itself is for the second quarter of fiscal 2010. Gap operates the Gap, Old Navy, Banana Republic, Piperlime, and Athleta brands through stores and direct channels.
Financial performance
| Metric | 13 weeks ended July 31, 2010 | 26 weeks ended July 31, 2010 |
|---|---|---|
| Net sales | $3.317 billion; up 2% | $6.646 billion; up 4% |
| Gross profit / gross margin | $1.314 billion / 39.6% | $2.715 billion / 40.9% |
| Operating income / operating margin | $397 million / 12.0% | $871 million / 13.1% |
| Net income | $234 million | $536 million |
| Diluted earnings per share | $0.36 | $0.81 |
| Operating cash flow | Not presented for the quarter alone | $540 million |
| Capital expenditures | Not presented for the quarter alone | $248 million |
| Free cash flow | Not presented for the quarter alone | $292 million |
At July 31, cash and cash equivalents were $1.353 billion and short-term investments were $350 million. The company reported no debt outstanding, $2.029 billion of current liabilities, and $4.053 billion of current assets. Its $500 million revolving credit facility had no borrowings and $451 million of net availability.
Changes versus the prior comparable periods
- Second-quarter sales rose 2%, comparable-store sales increased 1% versus an 8% decline a year earlier, and direct sales grew 15% to $258 million.
- Quarterly net income increased from $228 million and diluted EPS from $0.33. Operating margin improved from 11.6% to 12.0%, while gross margin edged down from 39.7% to 39.6%.
- First-half net income rose from $443 million to $536 million and diluted EPS from $0.63 to $0.81. First-half gross margin increased from 39.7% to 40.9% and operating margin from 11.4% to 13.1%.
- First-half operating cash flow fell to $540 million from $720 million; free cash flow declined to $292 million from $589 million, reflecting higher inventory purchases, taxes, and capital spending.
- Cash and cash equivalents declined from $2.348 billion at fiscal year-end, primarily amid $1.098 billion of share repurchases and $130 million of dividends during the half.
Outlook, commentary, risks, and unusual items
- Management expected fiscal 2010 capital expenditures of about $575 million, approximately 65 store openings and 110 closures, and a roughly 3% decrease in net store square footage. It expected the effective tax rate to be about 39%.
- The company intended to increase its fiscal 2010 annual dividend to $0.40 per share from $0.34 in fiscal 2009. A further $750 million share-repurchase authorization was announced in August 2010; the earlier $1 billion authorization had used $850 million by July 31.
- Management cited product alignment, healthier sales and margins, cost management, return on invested capital, international expansion, and online growth as priorities. Direct sales increased across brands, especially Piperlime and Athleta.
- Second-quarter cost of goods sold as a percentage of sales rose, primarily due to lower regular-price and markdown margins. First-half improvement reflected reduced markdown selling. The second-quarter effective tax rate was 41.2%, partly affected by expected valuation allowances for projected China and Italy losses and tax adjustments related to Canadian dividends.
- First-half results included an $11 million reversal of interest expense related primarily to a federal tax accounting-method application and resolution of IRS reviews and refund claims; the company also received approximately $74 million in tax refunds.
- Key risks include fashion and consumer-demand uncertainty, competition, sales and margin fluctuations, international expansion, supply-chain disruption, currency exposure, systems changes, and litigation or tax matters. The filing states that current legal proceedings are not expected to have a material adverse effect overall, but outcomes remain uncertain.
- Lease guarantees had a maximum potential exposure of approximately $26 million, with about $1 million recorded as a liability. Reinsurance-pool guarantees had maximum exposure of $14 million. The filing also describes indemnities whose maximum obligations cannot generally be estimated.
Investor verification checklist
- Confirm the period: the filing is for fiscal 2010 Q2, despite the request metadata stating 2009 Q2.
- Review the sustainability of comparable-store sales and gross margins, particularly Gap North America’s 4% comparable-store sales decline in the quarter.
- Assess cash generation after planned capital expenditures, dividends, and announced repurchases; first-half free cash flow was materially lower year over year.
- Verify the impact of the tax refund and $11 million interest reversal on reported first-half earnings and the expected full-year tax rate.
- Monitor execution and costs of international, store, and online expansion, along with outstanding legal, lease-guarantee, and reinsurance exposures.