Gap (GPS)

Q1 2011 Earnings Call

May 19, 2011 5:00 pm ET

Executives

Mark Webb -

Glenn Murphy - Chairman and Chief Executive Officer

Sabrina Simmons - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance

Analysts

Dana Telsey - Telsey Advisory Group

Stacy Pak - Barclays Capital

Jeff Black - Citigroup Inc

Michelle Tan - Goldman Sachs Group Inc.

Paul Lejuez - Nomura Securities Co. Ltd.

Brian Tunick - JP Morgan Chase & Co

Jeffrey Klinefelter - Piper Jaffray Companies

Kimberly Greenberger - Morgan Stanley

Evren Kopelman - Wells Fargo Securities, LLC

Janet Kloppenburg - JJK Research

Lorraine Hutchinson - BofA Merrill Lynch

Edward Yruma - KeyBanc Capital Markets Inc.

Presentation

Operator

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» Gap's CEO Discusses Q4 2010 Results - Earnings Call Transcript
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» Gap CEO Discusses Q2 2010 Results - Earnings Call Transcript

Good afternoon, ladies and gentlemen. My name is Kristen, and I'll be your conference operator today. I would like to welcome everyone to the Gap Inc. First Quarter 2011 Conference Call. [Operator Instructions] I would now like to introduce your host, Mark Webb, Vice President of Investor Relations. Please go ahead.

Mark Webb

Good afternoon, everyone. Welcome to Gap Inc.'s First Quarter 2011 Earnings Conference Call. For those of you participating in the webcast, please turn to Slides 2 and 3.

I'd like to remind you that the information made available on this webcast and conference call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from the forward-looking statements, as well as reconciliations of measures we are required to reconcile to GAAP financial measures, please refer to today's press release, as well as our most recent annual report on Form 10-K, both of which are available on gapinc.com. These forward-looking statements are based on information as of May 19, 2011, and we assume no obligation to publicly update or revise our forward-looking statements.

Joining us on the call today are Chairman and CEO, Glenn Murphy; and Executive Vice President and CFO, Sabrina Simmons. Now, I'd like to turn the call over to Sabrina.

Sabrina Simmons

Thank you, Mark. Good afternoon, everyone. In the face of a challenging quarter, we continue to focus on levers that drive long-term value. On the balance sheet and capital structure plan, we repurchased 25 million shares during the quarter, and we raised $1.65 billion of debt, providing us the flexibility to deliver additional cash to shareholders.

On the operating side, we continue to drive forward on our long-term growth initiatives while maintaining expense discipline and delivering operating expenses below the prior year.

Please turn to Slide 4 for our earnings recap. In the first quarter, net income was $233 million, down 23%, and EPS was $0.40 per share versus $0.45 last year.

Turning to Slide 5. First quarter net sales were down 1% to $3.3 billion, and this includes the impact of the events in Japan. Comparable store sales were down 3%. Online sales grew 18% overall and had a positive impact of 2 points on comp sales in the first quarter. Total sales and comps by division are listed in today's press release.

Turning to Slide 6 for margins. First quarter gross margin was down 250 basis points compared to last year's strong first quarter. Rent and occupancy deleveraged only slightly by 10 basis points. Merchandise margins were down 240 basis points, driven by rising cotton prices, which in turn increased our average unit costs. First quarter gross profit of $1.3 billion was down $97 million to last year.

Turning to Slide 7 for inventory. At the end of the first quarter, inventory per store was up 9.9%, with the increase in North America several points below that of Gap Inc. This is a bit higher than our expectation we laid out in February with the variance driven by the unit sales miss in Japan, which was worth about one point.

Please turn to Slide 8 for operating expenses. We continued our commitment to managing cost tightly in the first quarter and delivered operating expenses down $9 million to last year and about flat as a percent to sales. Total operating expenses for the quarter were $918 million and included $119 million of marketing, up $6 million to last year, driven by Athleta and China.

Please turn to Slide 9 for capital expenditures and store count. We ended the quarter with 3,245 stores including franchised stores. Net square footage for wholly-owned stores was 37.8 million, down 2% compared to Q1 2010, and first quarter capital expenditures were $127 million. Store count and square footage by division are listed in today's press release.

Regarding cash on Slide 10. For the quarter, free cash flow was an inflow of $104 million. We repurchased 25 million shares in the first quarter for $548 million and ended the quarter with $2.5 billion in cash.

And now, I'd like to discuss our outlook for the rest of the year. Please turn to Slide 11. As we stated on our fourth quarter earnings call, we continue to expect 2011 average unit cost increases to more than outweigh, offsetting average unit retail increases, especially in our sizable value channel. This is, in fact, how Q1 played out, driving our merchandise margins down 240 basis points.

At the time of our fourth quarter call, we had only completed purchases for our spring and summer seasons. Although we anticipated escalation of average unit cost for the back half, our costs are now actualizing well above our initial expectations at about up 20% versus last year.

Due to the sharp escalation of second half costing, we are ever more focused on increasing our average unit retail. In addition, you can count on us to remain disciplined in managing our operating expenses tightly. Also as a reminder, we'll incur about $70 million in interest expense as a result of our recent debt issuance.

Driven primarily by the higher back half average unit costing, we are revising our full year 2011 EPS guidance, which we now expect to be $1.40 to $1.50. It's important to note that we see this significant costing pressure as temporary. Therefore, we remain steadfast in supporting our long-term brand health through marketing and investing in initiatives that will enable future growth.

Regarding inventory, we plan to buy units down to last year for the remainder of the year. However, given the sharp increases in average unit cost I've already discussed, coupled with international store openings, we expect Q2 ending inventory per store to be up in the teens. We anticipate the increase in North America to be several points below that of Gap Inc.

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