Gap Inc. Reports Second Quarter Earnings

Gap Inc. (NYSE:GPS) today reported that net sales for the second quarter of fiscal year 2011, which ended July 30, 2011, increased 2 percent to $3.39 billion compared with $3.32 billion for the second quarter last year. Net income decreased 19 percent to $189 million compared with $234 million for the second quarter last year. Second quarter diluted earnings per share was $0.35 compared with $0.36 last year.

"Despite a difficult quarter, we still delivered a net sales improvement and I continue to believe we have far greater opportunities than challenges ahead of us,” said Glenn Murphy, chairman and chief executive officer of Gap Inc. "Every brand, division, and geography is focused on what matters most – delivering consistent, great product and more effective marketing in order to drive higher levels of performance.”

In the second quarter, the company continued to focus on its goals for fiscal year 2011, including growing top line sales, maintaining strong expense discipline, investing in long-term growth, and returning cash to shareholders.

Second Quarter Financial and Business Highlights

• Net sales increased 2 percent to $3.39 billion compared with last year.
• Net sales for the Gap Inc. Direct division increased 20 percent to $309 million compared with last year.
• Operating expenses were flat to last year and decreased 50 basis points as a percentage of net sales.
• Returned $880 million to shareholders, with $820 million in share repurchases and $60 million in dividends, underscoring the company’s continued commitment to return cash to shareholders.
• Opened 300^th redesigned Old Navy store, focused on improving customer shopping experiences and part of the brand’s ongoing strategy to improve top line sales performance.
• Announced plans to expand Athleta stores to the New York, Los Angeles, Washington D.C., Minneapolis, and Philadelphia markets. Athleta last week opened its doors in Manhattan’s Upper East and Upper West Side neighborhoods.
• Opened first Gap flagship store in Rome, introduced its outlet concept in Italy, and further expanded its outlet business for both Gap and Banana Republic in Japan. The company last week opened its third Gap store in Shanghai, bringing the total to six stores in China.
• Opened new franchise stores in Egypt and Ukraine and announced new agreements to introduce stores to Serbia and Morocco.
• Announced product and marketing collaborations including the GapKids and babyGap collection created by American fashion icon Diane von Furstenberg for Spring 2012 and Banana Republic’s "Mad Men” series-inspired collection.

Second Quarter Comparable Sales Results

The company’s second quarter comparable sales, which include associated comparable online sales, were down 2 percent compared with a 1 percent increase in the second quarter last year. For the second quarter of fiscal year 2011, online sales positively impacted comparable sales for Gap Inc. by 2 percentage points.

Comparable sales for the second quarter of fiscal year 2011, including the associated comparable online sales, were as follows:

• Gap North America: negative 3 percent versus negative 3 percent last year
• Banana Republic North America: negative 2 percent versus positive 4 percent last year
• Old Navy North America: flat versus positive 2 percent last year
• International: negative 4 percent versus positive 3 percent last year

Second Quarter Net Sales Results

The following tables represent the company’s second quarter net sales:

(1) U.S. includes the United States and Puerto Rico.

(2) In July 2010, the company began selling products online to customers in select countries outside the U.S. using a U.S.-based third party that provides logistics and fulfillment services. In August 2010, the company began selling products online to customers in select countries outside the U.S. utilizing its own logistics and fulfillment capabilities.

(3) Other includes our wholesale business, franchise business, Piperlime, and Athleta.

Additional Results and 2011 Outlook

Earnings per Share

The company reaffirmed its guidance for fiscal year 2011 diluted earnings per share of $1.40 to $1.50.

Depreciation and Amortization

The company continues to expect depreciation and amortization expense, net of amortization of lease incentives, for fiscal year 2011 to be about $550 million.

Operating Expenses

The company continued to manage costs tightly in the second quarter of fiscal year 2011. Second quarter operating expenses were $917 million, which was flat to last year. Marketing expenses for the quarter were $114 million, up $13 million compared with last year, driven primarily by Old Navy and the company’s online businesses. As a percentage of net sales, operating expenses leveraged 50 basis points.

Effective Tax Rate

The effective tax rate was 39.6 percent for the second quarter of fiscal year 2011. The company continues to expect that the effective tax rate will be about 39 percent for fiscal year 2011.

Inventory

The company reported that inventory dollars per store were up 5 percent at the end of the second quarter of fiscal year 2011 compared with the second quarter of last year, in line with guidance. As stated earlier this month, the company implemented improvements during the second quarter that enhanced the precision of estimating in-transit inventory. This change did not have any impact to the company’s income statement.

The company expects inventory units per store to be down in the third quarter. However, the company expects inventory dollars per store at the end of the third quarter to be up in the high single digits compared with the third quarter of last year, driven primarily by product cost increases.

Please see the Financials section under the Investors tab on www.gapinc.com for the company’s explanation of numerical range guidance.

Cash and Cash Equivalents and Short-term Investments

The company ended the second quarter of fiscal year 2011 with $2.2 billion in cash and cash equivalents and short-term investments. Year to date, free cash flow, defined as net cash provided by operating activities less purchases of property and equipment, was an inflow of $298 million compared with an inflow of $292 million last year. Please see the reconciliation of free cash flow, a non-GAAP financial measure, from the GAAP financial measure in the tables at the end of this press release.

Share Repurchases

During the first half of fiscal year 2011, the company repurchased about 67 million shares for $1.4 billion. At the end of the second quarter of fiscal year 2011, the company had $671 million remaining on its current $2 billion share repurchase authorization.

Dividends

The company paid a dividend of $0.1125 per share during the second quarter of fiscal year 2011, which was an increase of 13 percent compared with last year.

Capital Expenditures

Year to date, capital expenditures were $261 million. The company continues to expect fiscal year 2011 capital spending of about $575 million.

Real Estate

During the second quarter of fiscal year 2011, the company opened 31 store locations and closed 28 store locations.

The company ended the second quarter of fiscal year 2011 with 3,248 store locations in 34 countries, including 195 franchise stores. Net square footage of company-operated stores decreased 2 percent to 37.7 million compared with last year.

The company continues to expect net openings of about 75 stores, including franchise stores, during fiscal year 2011. Full year net square footage for company-operated stores is expected to decrease by about 2 percent for fiscal year 2011.

Webcast and Conference Call Information

Katrina O'Connell, vice president of Corporate Finance and Investor Relations at Gap Inc., will host a summary of the company’s second quarter fiscal year 2011 results during a live conference call and real-time webcast at approximately 5 p.m. Eastern Time today. Ms. O’Connell will be joined by Glenn Murphy, Gap Inc. chairman and chief executive officer, and Sabrina Simmons, Gap Inc. chief financial officer.

To access the conference call, please dial (800) 374-1731, or (706) 679-5876 for international callers. The webcast is located on the Financial News and Events page of the Investors section at www.gapinc.com. A replay of this event will be available on www.gapinc.com.

August Sales

The company will report August sales on September 1, 2011.

Forward-Looking Statements

This press release and related conference call and webcast contain forward-looking statements within the "safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements other than those that are purely historical are forward-looking statements. Words such as "expect,” "anticipate,” "believe,” "estimate,” "intend,” "plan,” "project,” and similar expressions also identify forward-looking statements. Forward-looking statements include statements regarding the following:

• greater opportunities than challenges ahead;
• driving higher levels of performance;
• growing top line sales;
• maintaining strong expense discipline;
• investing in long-term growth;
• returning cash to shareholders;
• international expansion, including stores in China and Italy, franchise stores, global outlet, and online;
• Athleta and Piperlime expansion;
• earnings per share for fiscal year 2011;
• depreciation and amortization for fiscal year 2011;
• effective tax rate for fiscal year 2011;
• inventory units and dollars per store at the end of the third quarter of fiscal year 2011;
• capital expenditures for fiscal year 2011;
• store openings and closings for fiscal year 2011;
• real estate square footage for fiscal year 2011;
• growing the store base internationally;
• reducing North America square footage;
• back half average unit costs, average unit retail, and unit sales; and
• significant pressure on margins.

Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause the company’s actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the following:

• the risk that additional information may arise during the company’s close process or as a result of subsequent events that would require the company to make adjustments to the financial information;
• the risk that changes in general economic conditions or consumer spending patterns will have a negative impact on the company’s financial performance or strategies;
• the highly competitive nature of the company’s business in the United States and internationally;
• the risk that the company will be unsuccessful in gauging fashion trends and changing consumer preferences;
• the risk that the company’s efforts to expand internationally may not be successful and could impair the value of its brands;
• the risk that trade matters, sourcing costs, events causing disruptions in product shipments from China and other foreign countries, or an inability to secure sufficient manufacturing capacity may disrupt the company’s supply chain or operations, or impact its financial results;
• the risk that the impacts of the March 2011 earthquake, tsunami and nuclear crisis in Japan, including damage to stores and infrastructure, and reduced consumer spending, will have adverse effects on the company’s business, financial position and strategies;
• the risk that the company’s franchisees will be unable to successfully open, operate, and grow the company’s franchised stores;
• the risk that the company will be unsuccessful in identifying, negotiating, and securing new store locations and renewing or modifying leases for existing store locations effectively;
• the risk that comparable sales and margins will experience fluctuations;
• the risk that the company will be unsuccessful in implementing its strategic, operating and people initiatives;
• the risk that changes in the company’s credit profile or deterioration in market conditions may limit its access to the capital markets and adversely impact its financial results and its ability to service its debt while maintaining other initiatives;
• the risk that updates or changes to the company’s information technology ("IT”) systems may disrupt its operations;
• the risk that acts or omissions by the company’s third-party vendors, including a failure to comply with the company’s code of vendor conduct, could have a negative impact on its reputation or operations;
• the risk that the company does not repurchase some or all of the shares it anticipates purchasing pursuant to its repurchase program;
• the risk that the adoption of new accounting pronouncements will impact future results;
• the risk that changes in the regulatory or administrative landscape could adversely affect the company’s financial condition, strategies, and results of operations; and
• the risk that the company will not be successful in defending various proceedings, lawsuits, disputes, claims, and audits.

Additional information regarding factors that could cause results to differ can be found in the company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2011, as well as the company’s most recent Quarterly Report on Form 10-Q.

These forward-looking statements are based on information as of August 18, 2011. The company assumes no obligation to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

About Gap Inc.

Gap Inc. is a leading global specialty retailer offering clothing, accessories, and personal care products for men, women, children, and babies under the Gap, Banana Republic, Old Navy, Piperlime, and Athleta brands. Fiscal year 2010 net sales were $14.7 billion. Gap Inc. products are available for purchase in over 90 countries worldwide through about 3,100 company-operated stores, about 200 franchise stores, and e-commerce sites. For more information, please visit www.gapinc.com.