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| GPS > SEC Filings for GPS > Form 10-K on 28-Mar-2008 | All Recent SEC Filings |
28-Mar-2008
Annual Report
OVERVIEW
We are a global specialty retailer operating retail and online stores selling casual apparel, accessories, and personal care products for men, women, and children under the Gap, Old Navy, Banana Republic, and Piperlime brands. We operate stores in the United States, Canada, the United Kingdom, France, Ireland, and Japan. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Asia, Europe and the Middle East. Under these agreements, third parties operate or will operate stores that sell apparel, purchased from us, under our brand names. In addition, our U.S. customers can shop online at www.gap.com, www.bananarepublic.com, www.oldnavy.com, and www.piperlime.com. We design virtually all of our products, which are manufactured by independent sources, and sell them under our brands. We also offer products that are designed and manufactured by branded third parties in our online shoe store, Piperlime, which was launched in October 2006.
Fiscal 2007 and 2005 had 52 weeks versus 53 weeks in fiscal 2006. Net sales numbers for the fourth quarter and year for fiscal 2006 include this additional week; however, comparable store sales calculations exclude the 53rd week.
Significant financial items during fiscal 2007 include:
• Net sales for fiscal 2007 were $15.8 billion compared with $15.9 billion in fiscal 2006, and comparable store sales decreased 4 percent compared with a decrease of 7 percent last year.
• Net earnings from continuing operations for fiscal 2007 increased 7 percent to $867 million, or $1.09 per share on a diluted basis, compared with $809 million, or $0.97 per share on a diluted basis for fiscal 2006.
• In February 2007, we announced our decision to close our Forth & Towne store locations. We eliminated about 550 Forth & Towne positions and closed all 19 stores by the end of June 2007. Forth & Towne is presented as a discontinued operation in the accompanying Consolidated Financial Statements. We recorded a loss from the discontinued operation of $34 million, net of income tax benefit, in fiscal 2007 and we expect future charges to be immaterial.
• As part of our efforts to streamline operations, we examined our organizational structure to ensure that we were enabling our brands to make decisions and effect change more efficiently. These cost reduction initiatives resulted in $34 million of expenses in fiscal 2007, of which $32 million were operating expenses and $2 million were cost of goods sold and occupancy expenses. The majority of these expenses were related to severance benefits for employees at our headquarter locations.
• Net earnings for fiscal 2007 were $833 million, or $1.05 per share on a diluted basis, compared with $778 million, or $0.93 per share on a diluted basis for fiscal 2006. Included in net earnings for fiscal 2007 was $68 million, or $0.07 per share on a diluted basis, related to the discontinued operation of Forth & Towne and expenses associated with our cost reduction initiatives described above.
• Our online sales for fiscal 2007 increased 24 percent to $903 million, compared with $730 million for fiscal 2006.
• We generated cash flows from operating activities of $2.1 billion during 2007. During the third quarter of fiscal 2007, we paid $326 million related to the maturity of our 6.90 percent notes payable. Our capital expenditures in fiscal 2007 were $682 million.
• In fiscal 2007, we generated free cash flow of $1.4 billion compared with free cash flow of $678 million in fiscal 2006. Free cash flow is defined as net cash provided by operating activities less the purchase of property and equipment. For a reconciliation of free cash flow, a non-GAAP financial measure, to a GAAP financial measure, see the Financial Condition section in this Management's Discussion and Analysis.
• We repurchased about 89 million shares of our common stock for a total of $1.7 billion under our share repurchase programs in fiscal 2007 which underscores our commitment to return excess cash to shareholders.
In fiscal 2007, we focused on three critical areas to restore the health of the Company: simplifying the business and holding each brand accountable to its priorities, managing our inventory with discipline to enable growth in gross margin and gross profit, and focusing on product and target customers, specifically at Gap and Old Navy. This work helped us increase net earnings and has created the important groundwork for our future. In fiscal 2008, we will focus on four priorities: driving earnings through inventory discipline which supports improved gross margin, continuing cost management, improving return on invested capital, and continuing to focus on product across all brands. We remain committed to returning excess cash to our stockholders through dividends and share repurchases.
In February 2008, we announced that our Board of Directors authorized an additional $1 billion for our share repurchase program and a plan to increase the annual dividend per share by six percent, from $0.32 per share in fiscal 2007 to $0.34 per share in fiscal 2008.
RESULTS OF OPERATIONS
Net Sales
Net Sales by Brand, Region and Channel
Net sales consist of retail sales, online sales and shipping fees received from customers for delivery of merchandise. Outlet retail sales are reflected within the respective results of each brand. Fiscal 2007 and 2005 had 52 weeks versus 53 weeks in fiscal 2006. Net sales numbers for the fourth quarter and year for fiscal 2006 include this additional week; however, comparable stores sales calculations exclude the 53rd week. Net sales for the additional week in fiscal 2006 were approximately $200 million. Net sales by brand, region and channel are as follows:
(in millions) Banana
52 Weeks Ended February 2, 2008 Gap Old Navy Republic Other (2) Total
U.S. (1) Stores $ 4,146 $ 5,776 $ 2,351 $ - $ 12,273
Direct (Online) 308 428 136 31 903
Canada 364 461 147 - 972
Europe 822 - - 5 827
Asia 613 - 89 36 738
Other (2) - - - 50 50
Total $ 6,253 $ 6,665 $ 2,723 $ 122 $ 15,763
Global Sales Growth (Decline) (4 )% (2 )% 7 % 213 % (1 )%
Banana
53 Weeks Ended February 3, 2007 Gap Old Navy Republic Other (2) Total
U.S. (1) Stores $ 4,494 $ 6,042 $ 2,251 $ - $ 12,787
Direct (Online) 261 345 117 7 730
Canada 379 442 119 - 940
Europe 792 - - 1 793
Asia 581 - 61 7 649
Other (2) - - - 24 24
Total $ 6,507 $ 6,829 $ 2,548 $ 39 $ 15,923
Global Sales Growth (Decline) (5 )% - 11 % 56 % (1 )%
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18 Gap Inc. Form 10-K
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Table of Contents
Banana
52 Weeks Ended January 28, 2006 Gap Old Navy Republic Other (2) Total
U.S. (1) Stores $ 4,767 $ 6,153 $ 2,100 $ - $ 13,020
Direct (Online) 233 268 91 3 595
Canada 409 435 96 - 940
Europe 825 - - 2 827
Asia 603 - 14 1 618
Other (2) - - - 19 19
Total $ 6,837 $ 6,856 $ 2,301 $ 25 $ 16,019
Global Sales Growth (Decline) (6 )% 2 % 1 % 127 % (2 )%
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(1) U.S. includes the United States and Puerto Rico.
(2) Other includes our wholesale business, franchise business beginning September 2006, Piperlime.com beginning October 2006, and Business Direct which ended in July 2006.
Comparable Store Sales
A store is included in comparable store sales ("Comp") when it has been open at least one fiscal year and the square footage has not changed by 15 percent or more within the past year. A store is included in Comp on the first day it has comparable prior year sales. Stores in which square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from Comp until the first day they have comparable prior year sales. Current year foreign exchange rates are applied to both current year and prior year Comp store sales to achieve a consistent basis for comparison.
A store is considered non-comparable ("Non-comp") when it has been open for less than one fiscal year or it has changed its square footage by 15 percent or more within the past fiscal year. Non-store sales such as online revenues are also considered Non-comp.
A store is considered "Closed" if it is temporarily closed for three or more full consecutive days or is permanently closed. When a temporarily closed store reopens, the store will be placed in the Comp/Non-comp status it was in prior to its closure. If a store was in Closed status for three or more days in the prior year then the store will be in Non-comp status for the same days in the following year.
The difference between prior year and current year net sales can be classified as follows:
($ in millions) Banana
52 Weeks Ended February 2, 2008 Gap (3)(4) Old Navy (3) Republic (3)(4) Other (5) Total
2006 Net Sales $ 6,507 $ 6,829 $ 2,548 $ 39 $ 15,923
Increase (decrease) in:
Comparable stores (252 ) (410 ) 23 - (639 )
Non-comparable and closed stores (1) (112 ) 127 86 59 160
Direct (Online) 47 83 19 24 173
Foreign exchange (2) 63 36 47 - 146
2007 Net Sales $ 6,253 $ 6,665 $ 2,723 $ 122 $ 15,763
Banana
53 Weeks Ended February 3, 2007 Gap (3)(4) Old Navy (3) Republic (3)(4) Other (5) Total
2005 Net Sales $ 6,837 $ 6,856 $ 2,301 $ 25 $ 16,019
Increase (decrease) in:
Comparable stores (475 ) (518 ) 5 - (988 )
Non-comparable and closed stores (1) 95 387 211 10 703
Direct (Online) 28 77 26 4 135
Foreign exchange (2) 22 27 5 - 54
2006 Net Sales $ 6,507 $ 6,829 $ 2,548 $ 39 $ 15,923
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(1) Non-comparable and closed stores include the impact of the 53rd week in fiscal 2006.
(2) Foreign exchange is the translation impact if prior year sales were translated at current year exchange rates.
(3) Includes Canadian stores.
(4) Includes international stores.
(5) Includes wholesale business, franchise business beginning September 2006, Piperlime.com beginning October 2006, and Business Direct which ended in July 2006.
Our fiscal 2007 net sales decreased $160 million, or 1 percent compared with fiscal 2006. Fiscal 2006 consisted of 53 weeks, and the additional week contributed approximately $200 million of net sales. Our fiscal 2007 comparable store sales declined 4 percent compared with the prior year. The 3 percentage point difference between net sales and comparable store sales was primarily due to the impact of new stores and a 24 percent increase in online sales for fiscal 2007 compared with fiscal 2006. Overall, our net square footage increased 1.8 percent in fiscal 2007 from the prior year and sales productivity was $376 per average square foot for fiscal 2007 compared with $395 per average square foot in fiscal 2006. We opened 214 new stores and closed 178 stores in fiscal 2007. This includes the conversion of 45 Old Navy Outlet stores to Old Navy, which are reflected in both openings and closings, and the closure of 19 Forth & Towne stores.
Our fiscal 2006 sales decreased $96 million, or 0.6 percent, compared with fiscal 2005. During fiscal 2006, our comparable store sales declined 7 percent compared with the prior year primarily due to our product assortments at the Gap and Old Navy brands which did not perform to our expectations. Our total non-comparable store sales increase was due to the 194 new store openings and the additional week of sales in fiscal 2006. Our overall net square footage increased 2.9 percent over the prior year and sales productivity in fiscal 2006 was $395 per average square foot compared with $412 per average square foot in fiscal 2005. We closed 116 stores in fiscal 2006, mainly for Gap brand.
Comparable store sales percentage by brand for fiscal 2007 and fiscal 2006 were as follows:
• Gap North America: negative 5 percent in fiscal 2007 versus negative 7 percent in fiscal 2006;
• Old Navy North America: negative 7 percent in fiscal 2007 versus negative 8 percent in fiscal 2006;
• Banana Republic North America: positive 1 percent in fiscal 2007 versus flat in fiscal 2006; and
• International: negative 1 percent in fiscal 2007 versus negative 8 percent in fiscal 2006.
Store Count and Square Footage
Store count and square footage for our wholly owned stores were as follows:
February 2, 2008 February 3, 2007
Number of Square Footage Number of Square Footage
Store Locations (in millions) Store Locations (in millions)
Gap North America 1,249 12.2 1,293 12.3
Gap Europe 173 1.5 168 1.5
Gap Asia 110 1.1 105 1.0
Old Navy North America 1,059 20.0 1,012 19.3
Banana Republic North America 555 4.7 521 4.5
Banana Republic Asia 21 0.1 13 0.1
Forth & Towne - - 19 0.2
Total 3,167 39.6 3,131 38.9
Increase over Prior Year 1.1 % 1.8 % 2.6 % 2.9 %
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20 Gap Inc. Form 10-K
Outlet stores are reflected in each of the respective brands. We have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Bahrain, Indonesia, Kuwait, Malaysia, Philippines, Oman, Qatar, Saudi Arabia, Singapore, South Korea, Turkey, United Arab Emirates, Greece, Romania, Bulgaria, Cyprus and Croatia. We had 68 and 7 franchise stores that were open as of February 2, 2008 and February 3, 2007, respectively.
Cost of Goods Sold and Occupancy Expenses
Cost of goods sold and occupancy expenses include:
• the cost of merchandise;
• inventory shortage and valuation adjustments;
• freight charges;
• costs associated with our sourcing operations, including payroll and related benefits;
• production costs;
• insurance costs related to merchandise; and
• occupancy, rent, common area maintenance, real estate taxes, utilities, and depreciation for our stores and distribution centers.
The classification of these expenses varies across the retail industry.
Percentage of Net Sales
52 Weeks 53 Weeks 52 Weeks 52 Weeks 53 Weeks 52 Weeks
Ended Ended Ended Ended Ended Ended
February 2, February 3, January 28, February 2, February 3, January 28,
($ in millions) 2008 2007 2006 2008 2007 2006
Cost of Goods Sold and
Occupancy Expenses $ 10,071 $ 10,266 $ 10,145 63.9 % 64.5 % 63.3 %
Gross Profit/Gross Margin
% $ 5,692 $ 5,657 $ 5,874 36.1 % 35.5 % 36.7 %
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Cost of goods sold and occupancy expenses as a percentage of net sales decreased 0.6 percentage points in fiscal 2007 compared with fiscal 2006. Cost of goods sold as a percentage of net sales decreased 1.4 percentage points, or $307 million, in fiscal 2007 compared with fiscal 2006. The decrease was driven primarily by an increase in selling at regular price and a higher margin achieved for marked down merchandise. As a percentage of sales, occupancy expenses increased 0.8 percentage points in fiscal 2007 compared with fiscal 2006.
Cost of goods sold and occupancy expenses as a percentage of net sales increased 1.2 percentage points in fiscal 2006 compared with fiscal 2005. Cost of goods sold as a percentage of net sales increased 1.3 percentage points, or $156 million, in fiscal 2006 compared with fiscal 2005, as product acceptance challenges drove additional promotions and markdowns. As a percentage of sales, occupancy expenses decreased 0.1 percentage points compared with fiscal 2005. The decrease was primarily due to a net decrease in occupancy expenses of $31 million related to the fiscal 2005 amortization of key money paid to acquire the rights of tenancy in France ($50 million) net of a lease accounting adjustment to true-up amounts which were estimated in our fiscal 2004 financial statements ($19 million).
As a general business practice, we review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and use markdowns to clear the majority of this merchandise.
Operating Expenses
Operating expenses include:
• payroll and related benefits (for our store operations, field management, distribution centers, and corporate functions);
• advertising;
• general and administrative expenses;
• costs to design and develop our products;
• merchandise handling and receiving in distribution centers and stores;
• distribution center general and administrative expenses;
• rent, occupancy, and depreciation for headquarter facilities; and
• other expense (income).
The classification of these expenses varies across the retail industry.
Percentage of Net Sales
52 Weeks 53 Weeks 52 Weeks 52 Weeks 53 Weeks 52 Weeks
Ended Ended Ended Ended Ended Ended
February 2, February 3, January 28, February 2, February 3, January 28,
($ in millions) 2008 2007 2006 2008 2007 2006
Operating Expenses $ 4,377 $ 4,432 $ 4,099 27.8 % 27.8 % 25.6 %
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Included in operating expenses are costs related to store closures and our sublease loss reserve. The following discussion should be read in conjunction with Note 6 of Notes to the Consolidated Financial Statements.
Operating expenses as a percentage of net sales were flat, but decreased $55 million in fiscal 2007 compared with fiscal 2006 primarily due to the following:
• $97 million in decreased marketing expenses, primarily for Gap and Old Navy; offset by
• $32 million of expenses, the majority of which were severance payments, recognized in fiscal 2007 as a result of our cost reduction initiatives not included in fiscal 2006;
• $31 million of income recognized in fiscal 2006 related to the change in our estimate of the elapsed time for recording income associated with unredeemed gift cards not included in fiscal 2007; and
• $14 million of income recognized in fiscal 2006 related to the Visa/Mastercard litigation settlement.
The remaining decrease is due to lower payroll and other expenses across the organization.
Operating expenses as a percentage of net sales increased 2.2 percentage points, or $333 million, in fiscal 2006 compared with fiscal 2005. The increase was primarily due to:
• $162 million in increased payroll and related expenses for more employees and merit increases;
• $84 million in increased marketing and store related activities;
• $61 million of income recognized in fiscal 2005 as a result of the effect of the sublease loss reserve reversal not included fiscal 2006;
• $32 million in increased share-based compensation as a result of the adoption of Statement of Financial Accounting Standards No. ("SFAS") 123(R), "Share-Based Payment", in the first quarter of fiscal 2006;
• $26 million in increased impairment of long-lived assets; offset by
22 Gap Inc. Form 10-K
• $31 million of income in fiscal 2006 relating to the change in our estimate of the elapsed time for recording income associated with unredeemed gift cards; and
• $14 million of income recognized in fiscal 2006 related to the Visa/Mastercard litigation settlement.
Operating margin was 8.3 percent, 7.7 percent, and 11.1 percent in fiscal 2007, 2006, and 2005, respectively. For fiscal 2008, we expect operating margin to be approximately 8.5 percent to 9.5 percent.
Interest Expense
Percentage of Net Sales
52 Weeks 53 Weeks 52 Weeks 52 Weeks 53 Weeks 52 Weeks
Ended Ended Ended Ended Ended Ended
February 2, February 3, January 28, February 2, February 3, January 28,
($ in millions) 2008 2007 2006 2008 2007 2006
Interest Expense $ 26 $ 41 $ 45 0.2 % 0.3 % 0.3 %
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The decrease of $15 million in interest expense for fiscal 2007, compared with fiscal 2006, was primarily due to the maturity of our $326 million, 6.90 percent notes repaid in September 2007 and reduction of interest accruals resulting from the resolutions of tax audits and outstanding tax contingencies completed in fiscal 2007.
The decrease of $4 million in interest expense for fiscal 2006, compared with fiscal 2005, was primarily due to lower debt levels as a result of our March 2005 redemption of convertible notes.
We anticipate that fiscal 2008 interest expense will be about $20 million.
Interest Income
Percentage of Net Sales
52 Weeks 53 Weeks 52 Weeks 52 Weeks 53 Weeks 52 Weeks
Ended Ended Ended Ended Ended Ended
February 2, February 3, January 28, February 2, February 3, January 28,
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