The Gap, Inc. — FY2010 Form 10-K
Period note: The filing covers the 52-week fiscal year ended January 29, 2011, not 2009 Q4 as indicated in the request metadata. Comparisons below are primarily to fiscal 2009.
Business context
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Piperlime, and Athleta through company-operated stores, online channels, and franchises. It reported two segments: Stores and Direct. At year-end it had 3,068 company-operated stores and 178 franchise locations; online sales were available in more than 90 countries.
Financial performance and liquidity
| Metric | FY2010 | FY2009 | Change |
|---|---|---|---|
| Net sales | $14.664 billion | $14.197 billion | Up 3% |
| Gross margin | 40.2% | 40.3% | Down 0.1 percentage point |
| Operating income / margin | $1.968 billion / 13.4% | $1.815 billion / 12.8% | Income up; margin up 0.6 points |
| Net income | $1.204 billion | $1.102 billion | Up 9.3% |
| Diluted EPS | $1.88 | $1.58 | Up 19% |
| Operating cash flow | $1.744 billion | $1.928 billion | Down $184 million |
| Capital expenditures | $557 million | $334 million | Up $223 million |
| Free cash flow | $1.187 billion | $1.594 billion | Down $407 million |
At January 29, 2011, cash, cash equivalents, and short-term investments totaled $1.661 billion; debt was $3 million; working capital was $1.831 billion; and the current ratio was 1.87:1. Total assets were $7.065 billion and stockholders’ equity was $4.080 billion. The company had a $500 million revolving credit facility with no borrowings and $451 million net availability.
Material changes and drivers
- Comparable store sales rose 1%, versus a 3% decline in FY2009. Brand results varied: Gap North America fell 1%, while Old Navy North America rose 2% and Banana Republic North America rose 3%.
- Direct sales increased 16% to $1.299 billion, supported by online growth across brands and the launch of international online sales. Direct represented 9% of revenue; Direct and international sales together represented 22%, versus 20% the prior year.
- Operating margin improved despite a slight gross-margin decline. Lower occupancy costs as a share of sales and operating expenses helped; cost of goods sold as a share of sales rose, primarily reflecting lower regular-price and markdown margins.
- Operating cash flow declined partly because of higher inventory purchases and bonus payments. Capital spending rose, while the company repurchased approximately 96 million shares for $1.956 billion and paid $252 million in dividends.
- Inventory increased to $1.620 billion from $1.477 billion. Company-operated store count fell by 27, while franchise locations increased by 42.
Outlook, risks, and unusual items
- Management expected FY2011 capital expenditures of about $575 million; approximately 115 company-operated store openings and 125 closures, with company-operated square footage expected to decline about 3%; and about 75 new franchise stores.
- The company expected an FY2011 effective tax rate of about 39% and intended to increase the annual dividend to $0.45 per share. In February 2011, the board authorized an additional $2 billion for share repurchases.
- Management said cash and operating cash flows should support operations and planned investments for the next 12 months and beyond. This is a forward-looking expectation, not a guarantee.
- Key risks include rising cotton and other commodity costs, sourcing and shipping disruptions, changing consumer preferences and markdown exposure, economic and competitive pressure, international expansion and franchise execution, store lease economics, and IT or IBM service disruptions. A hypothetical 10% adverse currency movement was estimated to negatively affect net cash-flow exposure by $47 million after hedging.
- Operating leases represented $5.116 billion of future minimum payments; purchase obligations and commitments totaled $2.642 billion. These are contractual commitments, not funded debt. A maximum $21 million exposure remained under assigned-lease guarantees; the company recorded no liability for those guarantees at year-end.
- FY2010 included a $15 million reversal of accrued interest expense, primarily related to tax matters. The company reported $67 million in unrecognized tax benefits and $21 million of accrued related interest. Long-lived asset impairment charges were $8 million; no goodwill or Athleta trade-name impairment was recorded.
- The company stated that current legal proceedings were not expected to have a material adverse effect as a whole. Deloitte issued unqualified opinions on the financial statements and internal control; management also concluded internal controls were effective.
Important facts for investors to verify
- Whether improved comparable sales and operating margin are sustainable, particularly given the slight gross-margin decline and anticipated commodity-cost pressure.
- How much inventory growth reflects planned sales needs versus potential markdown risk, and whether online growth continues to offset store-fleet contraction.
- Whether forecast capital expenditures, store closures, international expansion, and franchise openings deliver expected returns.
- How share repurchases and the planned dividend increase affect cash balances, liquidity, and per-share results alongside $5.116 billion in minimum lease commitments.
- The ultimate cash and earnings impact of tax audits, unrecognized tax benefits, foreign earnings, and the FY2010 interest reversal.