The Gap, Inc. — Form 10-Q Summary
Period note: The request identifies “2009 Q3,” but the supplied filing is for the 13 weeks ended October 30, 2010 (third quarter of fiscal 2010), with comparisons to the 13 weeks ended October 31, 2009. The 39-week figures are year-to-date comparisons. Amounts are in U.S. dollars; financial statement amounts are generally in millions.
Business context and reporting period
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Piperlime, and Athleta through stores, online and catalog channels, wholesale, and franchise arrangements. It reports Stores and Direct segments. The interim statements are unaudited and include normal recurring adjustments. Management cautions that interim results are not necessarily indicative of the full fiscal year.
Financial performance and liquidity
| Metric | 13 weeks ended Oct. 30, 2010 | 13 weeks ended Oct. 31, 2009 | 39 weeks ended Oct. 30, 2010 | 39 weeks ended Oct. 31, 2009 |
|---|---|---|---|---|
| Net sales | $3,654 | $3,589 | $10,300 | $9,961 |
| Gross profit / margin | $1,505 / 41.2% | $1,524 / 42.5% | $4,220 / 41.0% | $4,051 / 40.7% |
| Operating income / margin | $504 / 13.8% | $500 / 13.9% | $1,375 / 13.3% | $1,228 / 12.3% |
| Net income | $303 | $307 | $839 | $750 |
| Diluted EPS | $0.48 | $0.44 | $1.29 | $1.07 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $936 | $1,152 |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $413 | $221 |
| Free cash flow | Not provided for quarter | Not provided for quarter | $523 | $931 |
Quarterly sales rose 2%; comparable-store sales were flat. Direct sales increased 15% to $342 million. Year-to-date sales rose 3%, including 2% comparable-store growth. For the quarter, cost of goods sold as a share of sales increased, mainly from lower regular-price and markdown margins; lower occupancy and operating expenses partly offset the pressure.
At October 30, 2010, cash and cash equivalents were $1.403 billion and short-term investments were $251 million, totaling $1.654 billion. Current assets were $4.477 billion and current liabilities were $2.412 billion. Total assets were $7.728 billion. The balance sheet reports no long-term debt; the company had $3 million borrowed under China facilities. Its $500 million revolving facility had no borrowings and $451 million net availability after standby letters of credit.
Material changes versus the prior comparable period
- Quarterly net income declined $4 million despite higher sales and operating income; management attributed the decrease to a higher effective tax rate. Diluted EPS increased as share repurchases reduced weighted-average shares.
- Quarterly gross margin fell 1.3 percentage points to 41.2%. Year-to-date gross margin improved 0.3 points to 41.0%; operating margin improved 1.0 point to 13.3%.
- Year-to-date operating cash flow decreased $216 million, while capital expenditures increased $192 million. Free cash flow declined $408 million.
- Cash fell from $2.348 billion at fiscal year-end to $1.403 billion, primarily amid substantial shareholder returns. The company repurchased 67.3 million shares for approximately $1.358 billion during the 39 weeks; cash dividends paid were $192 million.
- Company-owned store count declined to 3,082 from 3,143 a year earlier; total square footage fell 2.5%. Direct sales benefited from online growth and new international online sales.
Outlook, management commentary, risks, and contingencies
- Management expected fiscal 2010’s effective tax rate to be about 39%, capital expenditures of about $575 million, approximately 65 store openings and 100 closures, and a roughly 2% decline in net square footage. It expected an annual dividend of $0.40 per share.
- Management said cash balances and operating cash flows should support operations, growth initiatives, planned capital expenditures, and dividends for the foreseeable future. Priorities included improving sales while maintaining healthy margins, cost management, return on invested capital, free cash flow, and international and online expansion.
- Key risks cited include consumer spending and economic conditions, fashion and inventory execution, competition, comparable-sales and margin variability, supply-chain disruption, international expansion, technology disruption, credit-rating changes, and legal proceedings.
- Foreign-exchange contracts had $4 million of assets and $56 million of liabilities at fair value. The company hedges forecast purchases, royalties, and certain foreign-currency exposures; substantially all unrealized cash-flow-hedge amounts were expected to enter income within 12 months.
- Assigned-lease guarantees had a maximum potential exposure of about $24 million, with a $1 million recorded liability. Reinsurance-pool guarantees had maximum exposure of $14 million, expected to decline as participation winds down. The company reported various ordinary-course lawsuits and claims but did not expect current matters, taken as a whole, to materially adversely affect its financial position, results, or cash flows.
- The company received approximately $74 million in tax refunds during the first quarter and recorded an $11 million year-to-date interest expense reversal primarily related to tax matters. It expected no significant change in gross unrecognized tax benefits over the next 12 months.
Most important facts for investors to verify
- Confirm the intended filing period: the supplied 10-Q is for Q3 fiscal 2010, not Q3 2009.
- Assess whether lower merchandise margins and flat quarterly comparable sales persisted beyond this interim period.
- Reconcile the year-to-date cash-flow and free-cash-flow decline with higher inventory investment and capital spending.
- Review the pace and remaining authorization of share repurchases, and their effects on cash, share count, and EPS.
- Track delivery against management’s fiscal-year tax, capital-expenditure, store-opening/closing, and dividend expectations.
- Evaluate foreign-exchange exposure, tax contingencies, lease guarantees, and litigation developments.