SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended May 4, 2002 or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ___________ to_____________
Commission File Number 1-7562
THE GAP, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-1697231
- ----------------------- --------------------
(State of Incorporation) (I.R.S. Employer
Identification No.)
Two Folsom Street
San Francisco, California 94105
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 952-4400
_________________________
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.05 par value New York Stock Exchange, Inc.
(Title of class) Pacific Exchange, Inc.
(Name of each exchange where registered)
Securities registered pursuant to Section 12(g) of the Act: None
_________________________
Indicate by check mark whether Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
---
Indicate the number of shares outstanding of each of the issuer's
classes of Common Stock, as of the latest practicable date.
Common Stock, $0.05 par value, 869,819,282 shares as of June 1, 2002
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GAP, INC.
---------
TABLE OF CONTENTS
-----------------
PART I FINANCIAL INFORMATION PAGE NUMBER
Item 1 Financial Statements
Condensed Consolidated Balance Sheets 3
May 4, 2002, February 2, 2002 and May 5, 2001
Condensed Consolidated Statements of Earnings 4
Thirteen weeks ended May 4, 2002 and May 5, 2001
Condensed Consolidated Statements of Cash Flows 5
Thirteen weeks ended May 4, 2002 and May 5, 2001
Notes to Condensed Consolidated Financial Statements 6
Independent Accountants' Report 10
Item 2 Management's Discussion and Analysis of Financial Condition 11
and Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 17
PART II OTHER INFORMATION
Item 1 Legal Proceedings 17
Item 6 Exhibits and Reports on Form 8-K 18
2
GAP INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
($000 except share and par value) May 4, February 2, May 5,
2002 2002 2001
----------- ----------- -----------
ASSETS
Current Assets:
Cash and equivalents $ 2,319,191 $ 1,035,749 $ 663,089
Merchandise inventory 1,686,424 1,677,116 2,048,822
Other current assets 345,423 331,685 350,144
----------- ----------- -----------
Total Current Assets 4,351,038 3,044,550 3,062,055
Property and equipment, net 4,096,600 4,161,290 4,120,883
Lease rights and other assets 419,830 385,486 352,485
----------- ----------- -----------
Total Assets $ 8,867,468 $ 7,591,326 $ 7,535,423
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable $ - $ 41,889 $ 781,224
Current maturities of long-term debt - - 250,000
Accounts payable 935,218 1,105,117 912,215
Accrued expenses and other current 793,092 827,119 697,507
liabilities
Income taxes payable 120,813 82,108 18,050
----------- ----------- -----------
Total Current Liabilities 1,849,123 2,056,233 2,658,996
Long-Term Liabilities:
Long-term debt 3,355,337 1,961,397 1,270,289
Deferred lease credits and other liabilities 585,117 564,115 531,100
----------- ----------- -----------
Total Long-Term Liabilities 3,940,454 2,525,512 1,801,389
Shareholders' Equity:
Common stock $.05 par value
Authorized 2,300,000,000 shares;
Issued 950,670,595; 948,597,949
and 941,407,614 shares;
Outstanding 867,808,385; 865,726,890
and 856,199,748 shares 47,534 47,430 47,070
Additional paid-in capital 485,140 461,408 338,468
Retained earnings 4,927,129 4,890,375 5,090,262
Accumulated other comprehensive losses (55,055) (61,824) (32,332)
Deferred compensation (6,438) (7,245) (12,577)
Treasury stock, at cost (2,320,419) (2,320,563) (2,355,853)
----------- ----------- -----------
Total Shareholders' Equity 3,077,891 3,009,581 3,075,038
----------- ----------- -----------
Total Liabilities and Shareholders' Equity $ 8,867,468 $ 7,591,326 $ 7,535,423
=========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
3
GAP INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Thirteen Weeks Ended
---------------------------------
($000 except share and per share amounts)
May 4, 2002 May 5, 2001
--------------- -------------
Net sales $ 2,890,840 $ 3,179,656
Costs and expenses
Cost of goods sold and occupancy expenses 2,011,762 2,054,482
Operating expenses 766,417 920,412
Interest expense 48,117 24,038
Interest income (7,373) (1,135)
------------- ------------
Earnings before income taxes 71,917 181,859
Income taxes 35,239 66,379
------------- ------------
Net earnings $ 36,678 $ 115,480
============= ============
Weighted average number of shares - basic 866,685,894 854,333,157
Weighted average number of shares - diluted 874,012,082 875,873,227
Earnings per share - basic $ 0.04 $ 0.14
Earnings per share - diluted $ 0.04 $ 0.13
Cash dividends paid per share $ 0.02/(a)/ $ 0.02/(b)/
See accompanying notes to condensed consolidated financial statements.
/(a)/ Includes a dividend of $0.02 per share declared in fourth quarter of
fiscal 2001 but paid in first quarter of fiscal 2002.
/(b)/ Includes a dividend of $0.02 per share declared in fourth quarter of
fiscal 2000 but paid in first quarter of fiscal 2001.
4
GAP INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
($000) Thirteen Weeks Ended
- ------ ------------------------------
May 4, 2002 May 5, 2001
--------------- -------------
Cash Flows from Operating Activities:
Net earnings $ 36,678 $ 115,480
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 187,884 196,148
Tax benefit from exercise of stock options
and vesting of restricted stock 6,331 16,537
Loss on disposal of property and equipment 5,860 1,063
Changes in operating assets and liabilities:
Merchandise inventory (3,761) (150,422)
Other current assets (9,410) (16,154)
Accounts payable (172,443) (154,359)
Accrued expenses (30,967) 36,888
Income taxes payable 37,729 1,400
Deferred lease credits and other liabilities 15,486 20,529
----------- -----------
Net cash provided by operating activities 73,387 67,110
----------- -----------
Cash Flows from Investing Activities:
Purchase of property and equipment (96,880) (312,194)
Acquisition of lease rights and other assets (322) (4,958)
----------- -----------
Net cash used for investing activities (97,202) (317,152)
----------- -----------
Cash Flows from Financing Activities:
Net increase (decrease) in notes payable (41,942) 5,174
Issuance of long-term debt 1,345,500 495,886
Issuance of common stock 16,629 23,155
Cash dividends paid (19,226) (18,950)
----------- -----------
Net cash provided by financing activities 1,300,961 505,265
----------- -----------
Effect of exchange rate fluctuations on cash 6,296 (928)
----------- -----------
Net increase in cash and equivalents 1,283,442 254,295
Cash and equivalents at beginning of period 1,035,749 408,794
----------- -----------
Cash and equivalents at end of period $ 2,319,191 $ 663,089
=========== ===========
See accompanying notes to condensed consolidated financial statements.
5
GAP INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
---------------------
The condensed consolidated balance sheets as of May 4, 2002 and May 5, 2001 and
the interim condensed consolidated statements of earnings for the thirteen weeks
ended May 4, 2002 and May 5, 2001 and cash flows for the thirteen weeks ended
May 4, 2002 and May 5, 2001 have been prepared by the Company, without audit. In
the opinion of management, such statements include all adjustments (which
include only normal recurring adjustments) considered necessary to present
fairly the financial position, results of operations and cash flows of the
Company at May 4, 2002 and May 5, 2001, and for all periods presented.
Certain information and disclosures normally included in the notes to the annual
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted from these interim
financial statements. It is suggested that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended February 2, 2002.
The condensed consolidated balance sheet as of February 2, 2002 was derived from
the Company's February 2, 2002 balance sheet included in the Company's 2001
Annual Report on Form 10-K.
The results of operations for the thirteen weeks ended May 4, 2002 are not
necessarily indicative of the operating results that may be expected for the
year ending February 1, 2003.
2. COMPREHENSIVE EARNINGS
----------------------
Comprehensive earnings include net earnings and other comprehensive earnings
(losses). Other comprehensive earnings (losses) include foreign currency
translation adjustments and fluctuations in the fair market value of certain
financial instruments. Comprehensive earnings for the thirteen weeks ended May
4, 2002 and May 5, 2001 were as follows:
Thirteen Weeks Ended
------------------------------
($000) May 4, 2002 May 5, 2001
- --------------------------------------------------------------------------
Net earnings $ 36,678 $ 115,480
Other comprehensive earnings (losses) 6,769 (12,159)
------------------------------
Comprehensive earnings $ 43,447 $ 103,321
==============================
3. INTANGIBLE ASSETS
-----------------
We adopted SFAS 142 "Goodwill and Other Intangible Assets" for the fiscal year
beginning February 3, 2002. We concluded that our intangible assets have
definite useful lives equivalent to their original useful lives. Intangible
assets subject to amortization consist of temporary lease rights, which are
amortized over the useful lives of the respective leases, not to exceed 20
years. The adoption of SFAS 142 did not have a significant impact on the
financial statements. The gross carrying value and accumulated amortization of
lease rights was $150 million and $52 million, respectively, as of May 4, 2002,
$146 million and $49 million, respectively, as of February 2, 2002, and $148
million and $44 million, respectively, as of May 5, 2001.
6
Aggregate amortization of lease rights was $2.26 million and $2.28 million for
the thirteen weeks ended May 4, 2002 and May 5, 2001, respectively. Amortization
expense is expected to be $6.1 million through the remainder of 2002, $8.0
million in 2003, $7.6 million in 2004, $6.5 million in 2005, and $5.9 million in
2006.
4. DEBT AND OTHER CREDIT ARRANGMENTS
---------------------------------
In March 2002, we issued $1.38 billion aggregate principal amount of 5.75
percent senior convertible notes due March 15, 2009, and received the net
proceeds in cash. Interest is payable semi-annually on March 15 and September 15
of each year, commencing on September 15, 2002. We have an option to call the
notes on or after March 20, 2005. The notes are convertible, unless previously
redeemed or repurchased, at the option of the holder at any time prior to
maturity, into shares of our common stock at a conversion price of $16.12 per
share, subject to adjustment in certain events, for a total of 85,607,940
shares. If converted, these additional shares would reduce our future earnings
per share. Prior to conversion, the convertible notes are potentially dilutive
at certain earnings levels. The effects of these dilutive securities are
computed using the if-converted method.
In March 2002, we replaced our existing $1.45 billion bank facilities, $1.3
billion of which was scheduled to expire in June 2002, with a new $1.4 billion
secured 2-year credit facility (the "new Facility"). The new Facility will be
used for general corporate purposes, primarily for trade letters of credit
issuance. The new Facility contains financial and other covenants, including
limitations on capital expenditures, liens, cash dividends and investments, and
maintenance of certain financial ratios, including a fixed charge coverage ratio
and an asset coverage ratio. Violation of these covenants could result in a
default under the new Facility which would permit the participating banks to
restrict our ability to further access the new Facility for letters of credit or
advances and to require the immediate repayment of any outstanding advances
under the new Facility. In addition, such a default could, under certain
circumstances, permit the holders of our outstanding unsecured debt to
accelerate the payment of such obligations.
As of May 4, 2002, we had $764 million in trade letters of credit issued under
the new Facility.
5. EARNINGS PER SHARE
------------------
Basic earnings per share is computed using the weighted average number of shares
of common stock outstanding during the period. Diluted earnings per share
includes the dilutive effect of the Company's potentially dilutive securities,
which include certain stock options, unvested shares of restricted stock and
convertible notes. The following summarizes the incremental shares from the
potentially dilutive securities, calculated using the treasury stock method.
Thirteen Weeks Ended
-------------------------------
May 4, 2002 May 5, 2001
-------------------------------
Weighted-average number of shares - basic 866,685,894 854,333,157
Incremental shares resulting from:
Stock options 7,326,188 21,406,811
Restricted stock - 133,259
-------------------------------
Weighted-average number of shares - diluted 874,012,082 875,873,227
===============================
The calculation above excludes options to purchase 77,667,536 and 27,066,303
shares of common stock during the thirteen weeks ended May 4, 2002 and May 5,
2001, respectively, and senior convertible notes which are convertible to
7
85,607,940 shares of common stock during the thirteen weeks ended May 4, 2002,
because their inclusion would have an anti-dilutive effect on EPS.
6. EXCESS FACILITIES, SEVERANCE AND SUBLEASE LOSS RESERVE
------------------------------------------------------
In 2001, we announced plans to close four distribution facilities in Ventura,
California, Basildon, England, Erlanger, Kentucky and Roosendaal, Holland.
The closure of the Ventura and Basildon facilities were completed by the first
quarter of fiscal 2002, and the Erlanger and Roosendaal facilities are expected
to be closed by the third and second quarter of fiscal 2002, respectively. As of
May 4, 2002 the Erlanger and Roosendaal facilities remained in operation. These
closures will impact approximately 300 employees.
Remaining severance and outplacement costs relate to approximately 300
employees. Employee separation expenses are comprised of severance pay,
outplacement services, medical and other related benefits. Remaining cash
expenditures of $3.5 million associated with employee separations are expected
to be paid by the third quarter of fiscal 2002.
Facilities-related charges associated with distribution center closures include
costs associated with lease terminations, facilities restoration and equipment
removal. Remaining cash expenditures of $5.7 million associated with facilities
as of May 4, 2002 are expected to be paid by the third quarter of fiscal 2002.
The land and buildings of the distribution center in Ventura, California are
classified as held for sale in accordance with Statement of Financial Accounting
Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets". The total carrying value of the land and buildings as of May
4, 2002 was $8.7 million.
During 2001, we consolidated and downsized headquarters facilities in our San
Francisco and San Bruno campuses as part of cost containment efforts. We
recorded charges during fiscal 2001, which primarily related to the difference
between our contract rent obligations and the rate at which we expect to be able
to sublease the properties.
The remaining reserve balance related to the distribution center exit costs and
sublease loss as of May 4, 2002 was as follows:
($000) Severance and Facilities Sublease Loss Total
Outplacement Charges Reserve
- ------------------------------------------------------------------------------------
Balance at February 2, 2002 $ 5,435 $ 7,040 $ 44,220 $ 56,695
Provisions - - - -
Payments/Deductions (1,931) (1,350) (1,670) (4,951)
-----------------------------------------------------
Balance at May 4, 2002 $ 3,504 $ 5,690 $ 42,550 $ 51,744
=====================================================
7. INCOME TAXES
------------
The effective tax rate was 49 percent and 36.5 percent for the first quarter of
fiscal 2002 and 2001, respectively. The increase in tax rate resulted primarily
from the decline in earnings from historical levels. We expect the effective tax
rate for fiscal 2002 to be sensitive to the level and mix of earnings.
8
Income tax payments for the full fiscal years 2001 and 2000 were approximately
$151 million and $427 million, respectively.
8. NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for
all fiscal years beginning after December 15, 2001. SFAS 142 requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. We adopted SFAS
142 for the fiscal year beginning February 3, 2002. The adoption of SFAS 142 did
not have a significant impact on the financial statements.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143 ("SFAS 143"), "Accounting for Asset Retirement Obligations," which is
effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses the
financial accounting and reporting for obligations and retirement costs related
to the retirement of tangible long-lived assets. We do not expect that the
adoption of SFAS 143 will have a significant impact on our financial statements.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets," which is effective for fiscal years beginning after December 15, 2001.
SFAS 144 supersedes FASB Statement No 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the
accounting and reporting provisions relating to the disposal of a segment of a
business of Accounting Principles Board Opinion No. 30. The adoption of SFAS 144
did not have a significant impact on the financial statements.
9. SUBSEQUENT EVENTS
-----------------
On May 9, 2002 and May 24, 2002, the outlook on our credit ratings was changed
from stable to negative by Standard & Poor's and Moody's, respectively.
9
Deloitte & Touche LLP
50 Fremont Street
San Francisco, California 94105-2230
Tel: (415) 783 4000
Fax: (415) 783 4329
www.us.deloitte.com
Deloitte
& Touche
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Shareholders of
The Gap, Inc.:
We have reviewed the accompanying condensed consolidated balance sheets of
The Gap, Inc. and subsidiaries as of May 4, 2002 and May 5, 2001, and the
related condensed consolidated statements of earnings and cash flows for
the thirteen week periods ended May 4, 2002 and May 5, 2001. These
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical
procedures to financial data and of making inquiries of persons responsible
for financial and accounting matters. It is substantially less in scope
than an audit conducted in accordance with auditing standards generally
accepted in the United States of America, the objective of which is the
expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to such condensed consolidated financial statements for them
to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
The Gap, Inc. and subsidiaries as of February 2, 2002, and the related
consolidated statements of operations, shareholders' equity, and cash flows
for the year then ended (not presented herein); and in our report dated
March 12, 2002, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of February 2, 2002 is
fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
/s/ Deloitte & Touche LLP
San Francisco, California
May 15, 2002
10
GAP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
The information below contains certain forward-looking statements which reflect
the current view of Gap Inc. (the "Company,""we" and "our") with respect to
future events and financial performance. Wherever used, the words "expect,"
"plan," "anticipate," "believe," "may" and similar expressions identify
forward-looking statements.
Any such forward-looking statements are subject to risks and uncertainties and
our future results of operations could differ materially from historical results
or current expectations. Some of these risks include, without limitation,
ongoing competitive pressures in the apparel industry, risks associated with
challenging domestic and international retail environments, changes in the level
of consumer spending or preferences in apparel, trade restrictions and political
or financial instability in countries where our goods are manufactured, and/or
other factors that may be described in our Annual Report on Form 10-K and/or
other filings with the Securities and Exchange Commission. Future economic and
industry trends that could potentially impact revenues and profitability are
difficult to predict.
We suggest that this document be read in conjunction with the Management's
Discussion and Analysis included in our Annual Report on Form 10-K for the year
ended February 2, 2002.
We assume no obligation to publicly update or revise our forward-looking
statements even if experience or future changes make it clear that any projected
results expressed or implied therein will not be realized.
11
RESULTS OF OPERATIONS
Net Sales
- --------------------------------------------------------------------------------
Thirteen Weeks Ended
--------------------------
May 4, May 5,
2002 2001
- --------------------------------------------------------------------------------
Net sales ($000) $ 2,890,840 $ 3,179,656
Total net sales (decrease) increase percentage (9) 16
Comparable store sales (decrease) percentage (17) (7)
Net sales per average square foot $ 77 $ 96
Square footage of gross store space - 36,942 33,271
at end of period (000)
Number of Store Concepts:
Beginning of Year 4,171 3,676
New store concepts 71 195
Expanded store concepts/(1)/ 16 55
Closed store concepts (14) (21)
End of Period 4,228 3,850
- --------------------------------------------------------------------------------
Number of Store Locations:
Beginning of Year 3,097 2,848
New store locations 41 110
Closed store locations (13) (11)
End of Period 3,125 2,947
- --------------------------------------------------------------------------------
Store count and square footage at quarter end for fiscal 2002 and 2001 were as
follows:
May 4, 2002 May 5, 2001
- ------------------------------------------------------------------------------------------------
Number of Number of Sq. Ft. Number of Number of Sq. Ft.
Store Store (millions) Store Store (millions)
Concepts Locations Concepts Locations
- ------------------------------------------------------------------------------------------------
Gap Domestic 2,309 1,489 13.2 2,143 1,475 12.4
Gap 657 374 3.6 575 340 3.2
International/(2)/
Banana 441 441 3.7 415 415 3.3
Republic/(3)/
Old Navy/(4)/ 821 821 16.4 717 717 14.4
- ------------------------------------------------------------------------------------------------
Total 4,228 3,125 36.9 3,850 2,947 33.3
- ------------------------------------------------------------------------------------------------
12
Since the beginning of fiscal 2000, Gap Brand stores have been reported based on
concepts. Any Gap Adult, GapKids, babyGap or GapBody that meets a certain square
footage threshold has been counted as a store, even when residing within a
single physical location. In the table above we present the number of store
concepts and the number of locations.
/(1)/ Expanded stores do not change store count.
/(2)/ Includes store concepts and locations in the following countries:
United Kingdom: 235 and 196 store concepts and 147 and 128 store
locations in 2002 and 2001, respectively.
Canada: 192 and 172 store concepts and 110 and 98 store locations in
2002 and 2001, respectively.
Japan: 156 and 126 store concepts and 72 and 63 store locations in
2002 and 2001, respectively.
France: 54 and 58 store concepts and 35 and 39 store locations in 2002
and 2001, respectively.
Germany: 20 and 23 stores concepts and 10 and 12 store locations in
2002 and 2001, respectively.
/(3)/ Includes 16 and 13 stores in Canada in 2002 and 2001, respectively.
/(4)/ Includes 23 and 12 stores in Canada for 2002 and 2001 respectively.
Net sales for the first quarter of fiscal 2002 decreased $289 million compared
to the same period last year. Comparable store sales declined $507 million
offset by a $218 million increase in non-comparable store sales. The
non-comparable store sales increase was primarily due to the increase in retail
selling space, both through the opening of new stores (net of stores closed) and
the expansion of existing stores. The effects of heavy promotional activity
drove the decrease in comparable store sales for the first quarter.
Comparable store sales by division for the first quarter were as follows:
... Gap Domestic reported negative 20% versus a negative 5% last year
... Gap International reported negative 19% versus a negative 7% last year
... Banana Republic reported negative 9% versus a negative 8% last year
... Old Navy reported negative 18% versus negative 9% last year
The decrease in net sales per average square foot for the first quarter was
primarily attributable to negative comparable store sales.
Cost of Goods Sold and Occupancy Expenses
Cost of goods sold and occupancy expenses as a percentage of net sales increased
5.0 percentage points in the first quarter of fiscal 2002 from the same period
in fiscal 2001. Lower merchandise margin and higher occupancy expenses of 2.6
and 2.4 percentage points drove the increase.
The decline in merchandise margin was primarily a result of heavier markdown
selling and lower markdown margins.
The increase in occupancy expenses as a percentage of net sales for the first
quarter was due to loss of sales leverage.
Operating Expenses
Operating expenses as a percentage of net sales decreased 2.4 percentage points
for the first quarter of fiscal 2002 from the same period in fiscal 2001. The
decrease in operating expenses as a percentage of net sales was attributable to
timing or unusual items in the first quarter of fiscal 2001 and 2002 and cost
reductions from expense management programs established at the end of the first
quarter of fiscal 2001, which accounted for a total 5.5 percentage points
decrease, partially offset by a 3.1 percentage points increase in operating
expenses as a percentage of net sales due to loss of sales leverage. The timing
or unusual items in the first quarter of fiscal 2001 and 2002 accounted for a
3.2 percentage points decrease in operating expenses as percentage of net sales,
and included reserves for excess corporate office space in fiscal 2001, a shift
in the timing of advertising from first quarter to second quarter this year,
13
and lower bonus provisions in the first quarter of fiscal 2002. The cost
reductions from expense management programs established at the end of the first
quarter of 2001 accounted for a 2.3 percentage points decrease.
Interest Expense
The increase in interest expense in the first quarter of fiscal 2002 as compared
to the same period in fiscal 2001 was primarily due to an increase in long-term
borrowing and higher interest rates on new debt issuance, partially offset by
lower average short-term borrowings.
Interest Income
The increase in interest income in the first quarter of fiscal 2002 as compared
to the same period in fiscal 2001 was primarily due to increases in average cash
available for investment offset by lower average investment rates.
Income Taxes
The effective tax rate was 49 percent and 36.5 percent for the first quarter of
fiscal 2002 and 2001, respectively. The increase in tax rate resulted primarily
from the decline in earnings from historical levels. We expect the effective tax
rate for fiscal 2002 to be sensitive to the level and mix of earnings.
LIQUIDITY AND CAPITAL RESOURCES
The following sets forth certain measures of our liquidity:
- --------------------------------------------------------------------------------
Thirteen Weeks Ended
-----------------------------
May 4, 2002 May 5, 2001
- --------------------------------------------------------------------------------
Cash provided by operating activities ($000) $ 73,387 $ 67,110
Working capital ($000) $2,501,915 $403,059
Current ratio 2.35:1 1.15:1
- --------------------------------------------------------------------------------
For the thirteen weeks ended May 4, 2002, the increase in cash flows provided by
operating activities, compared to the same period in the prior year, was
primarily attributable to a decrease in the growth of merchandise inventory and
changes in other operating assets and liabilities which were primarily driven by
timing of certain payments. This increase was partially offset by a decrease in
net earnings. The increase in working capital and the current ratio was
primarily driven by an increase in cash due to the issuance of $1.38 billion
senior convertible notes, and a decrease in short-term borrowings and current
maturities of long-term debt.
The Company funds inventory expenditures during normal and peak periods through
a combination of cash flows provided by operations as well as long-term
financing arrangements. The Company's business follows a seasonal pattern,
peaking over a total of about 13 weeks during the Back-to-School and Holiday
periods.
In March 2002, we replaced our existing $1.45 billion bank facilities, $1.3
billion of which was scheduled to expire in June 2002, with a new $1.4 billion
secured 2-year credit facility (the "new Facility"). The new Facility will be
used for general corporate purposes, primarily for trade letters of credit
issuance. The fees related to the new Facility will fluctuate based on our
senior unsecured credit ratings.
The new Facility contains financial and other covenants, including limitations
on capital expenditures, liens, cash dividends, and investments, and maintenance
of certain financial ratios, including a fixed-charge coverage ratio and an
asset coverage ratio. Violation of these covenants could result in a default
under the new Facility which would permit
14
the participating banks to restrict our ability to further access the new
Facility for letters of credit or advances and to require the immediate
repayment of any outstanding advances under the new Facility. In addition, such
a default could, under certain circumstances, permit the holders of our
outstanding unsecured debt to accelerate the payment of such obligations.
As of May 4, 2002, we had $764 million in trade letters of credit issued under
the new Facility.
We also have standby letters of credit, surety bonds and guarantees outstanding
at May 4, 2002, amounting to $29 million, $19.3 million and $6.3 million,
respectively.
On February 14, 2002, Moody's reduced our long and short-term senior unsecured
credit ratings from Baa3 to Ba2 and from Prime-3 to Not Prime, respectively,
with a negative outlook on our long-term ratings, and Standard & Poor's reduced
our long and short-term credit ratings from BBB+ to BB+ and from A-2 to B,
respectively, with a stable outlook on our long-term ratings. On February 27,
2002 Moody's reduced our long-term senior unsecured credit ratings from Ba2 to
Ba3 and stated that its outlook on our long-term ratings was stable. In April
2002, Standard & Poor's assigned a BBB- rating to our new Facility. On May 9,
2002 and May 24, 2002, the outlook on our credit ratings was changed from stable
to negative by Standard & Poor's and Moody's, respectively. As a result of the
recent downgrades in or long-term credit ratings, the interest rates payable by
us on $700 million of our outstanding notes are subject to increase by 175 basis
points, effective June 15, 2002, to 9.90 percent per annum on the 2005 notes and
10.55 percent per annum on the 2008 notes. Any further downgrades of our
long-term credit ratings by these rating agencies would result in further
increases in the interest rates payable by us on the notes. As a result of the
downgrades in our short-term credit ratings, we no longer have meaningful access
to the commercial paper market. In addition, we expect both the recent, and any
future, lowering of the ratings on our debt to result in reduced access to the
capital markets and higher interest costs on future financings.
In March 2002, we issued $1.38 billion aggregate principal amount of 5.75
percent senior convertible notes due March 15, 2009, and received the net
proceeds in cash. Interest is payable semi-annually on March 15 and September 15
of each year, commencing on September 15, 2002. We have an option to call the
notes on or after March 20, 2005. The notes are convertible, unless previously
redeemed or repurchased, at the option of the holder at any time prior to
maturity, into shares of our common stock at a conversion price of $16.12 per
share, subject to adjustment in certain events, for a total of 85,607,940
shares. If converted, these additional shares would reduce our future earnings
per share. Prior to conversion, the convertible notes are potentially dilutive
at certain earnings levels. The effects of these dilutive securities are
computed using the if-converted method.
For the thirteen weeks ended May 4, 2002, capital expenditures, net of tenant
allowance for construction and lease incentives, totaled approximately $91
million. The majority of these expenditures were used for expansion of the store
base and information technology. During the first quarter of 2002, we increased
retail square footage by 2% and ended the quarter with 4,228 store concepts
which equates to 3,125 store locations.
Rent expense for all operating leases was $241 million and $231 million, for the
thirteen weeks ended May 4, 2002 and May 5, 2001 respectively.
For the year, we continue to expect net square footage growth to be around 3%
with about 75% of the growth occurring in the first and second quarters. New
store concept openings remains approximately 170 to 190, which equates to 100 to
120 store locations. We anticipate store closures to be about the same as the 92
store concepts (51 store locations) we closed in 2001.
Our store growth plans for fiscal 2002 is as follows:
Fiscal 2002
15
- --------------------------------------------------------------------------------
Number of Store Number of Store Net Sq. Ft. Range*
Concepts Locations
- --------------------------------------------------------------------------------
Gap Domestic 70-75 20-25 1-3%
Gap International 30-35 10-15 1-3%
Banana Republic 15-20 15-20 3-5%
Old Navy 55-60 55-60 4-6%
- --------------------------------------------------------------------------------
Total 170-190 100-120 About 3%
================================================================================
*Net of store closures.
Since the beginning of fiscal 2000, Gap Brand stores have been reported based on
concepts. Any Gap Adult, GapKids, babyGap or GapBody that meets a certain square
footage threshold has been counted as a store, even when residing within a
single physical location. In the table above we present the number of store
concepts and the number of store locations.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for
all fiscal years beginning after December 15, 2001. SFAS 142 requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. We adopted SFAS
142 for the fiscal year beginning February 3, 2002. The adoption of SFAS 142 did
not have a significant impact on the financial statements.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143 ("SFAS 143"), "Accounting for Asset Retirement Obligations," which is
effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses the
financial accounting and reporting for obligations and retirement costs related
to the retirement of tangible long-lived assets. We do not expect that the
adoption of SFAS 143 will have a significant impact on our financial statements.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets," which is effective for fiscal years beginning after December 15, 2001.
SFAS 144 supersedes FASB Statement No 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the
accounting and reporting provisions relating to the disposal of a segment of a
business of Accounting Principles Board Opinion No. 30. The adoption of SFAS 144
did not have a significant impact on the financial statements.
RISKS OF MANAGEMENT SUCCESSION
On May 21, 2002, we announced that Millard S. Drexler, our Chief Executive
Officer since 1995 and President since 1987, plans to retire as soon as our
Board of Directors appoints his successor. We cannot provide assurance as to
when Mr. Drexler's successor will join us or that there will not be disruptions
arising from the transition.
16
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------------------------------------------------------------------
We operate in foreign countries which exposes us to market risk associated with
foreign currency exchange rate fluctuations. Our risk management policy is to
hedge substantially all merchandise purchases for foreign operations as well as
a portion of our Euro-denominated sales through the use of foreign exchange
forward contracts to minimize this risk. We also use forward contracts to hedge
our market risk exposure associated with foreign currency exchange rate
fluctuations for certain loans denominated in currencies other than the
functional currency of the entity holding or issuing the loan.
The outstanding mark-to-market net liability for all derivatives reflected in
the condensed consolidated balance sheet as of May 4, 2002, was $17.9 million.
We have limited exposure to interest rate fluctuations on our borrowings. The
interest on our long-term debt is set at a fixed coupon, with the exception of
the interest rates payable by us on $700 million of our outstanding notes, which
are subject to change based on our long-term credit ratings. The interest rates
on our cash and equivalents could fluctuate in line with short-term interest
rates.
In March 2002, we issued $1.38 billion aggregate principal amount of 5.75
percent senior convertible notes due March 15, 2009, and received the net
proceeds in cash. Interest is payable semi-annually on March 15 and September 15
of each year, commencing on September 15, 2002. These debt securities are
recorded in the balance sheet at their issuance amount net of unamortized
discount.
The market risk of the Company's financial instruments as of May 4, 2002 has not
significantly changed since February 2, 2002. The market risk profile of the
Company on February 2, 2002 is disclosed on the Company's 2001 Annual Report on
Form 10-K.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
- -------------------------
In 1999, the Company was named as a defendant in two lawsuits relating to
sourcing of products from Saipan (Commonwealth of the Northern Mariana Islands).
A complaint was filed on January 13, 1999 in California Superior Court in San
Francisco by the Union of Needletrades Industrial and Textile Employees,
AFL-CIO; Global Exchange; Sweatshop Watch; and Asian Law Caucus against the
Company and 17 other parties. The plaintiffs allege violations of California's
unlawful, fraudulent and unfair business practices and untrue and misleading
advertising statutes in connection with labeling of product and labor practices
regarding workers of factories that make product for the Company in Saipan. The
plaintiffs seek injunctive relief, restitution, disgorgement of profits and
other damages. Trial has not been set in the state case. On October 31, 2001,
the Company filed a motion for summary judgment, or in the alternative, for
summary adjudication. The hearing date for the motion originally set for March
1, 2002, has been continued by the Court to a date yet to be determined.
A second complaint was filed on January 13, 1999, in Federal District
Court, Central District of California, by various unidentified worker plaintiffs
against the Company and 27 other parties. Those unidentified worker plaintiffs
seek class-action status and allege, among other things, that the Company (and
other defendants) violated the Racketeer Influenced and Corrupt Organizations
Act in connection with the labor practices and treatment of workers of factories
in Saipan that make product for the Company. The plaintiffs seek injunctive
relief as well as actual and punitive damages. On September 29, 1999, the action
was transferred to the United States District Court, State of Hawaii. On April
28, 2000, plaintiffs filed a First Amended Complaint adding 22 new defendants.
On June 23, 2000, the United States District Court, State of Hawaii, ordered the
case transferred to the United States District Court, District of the Mariana
Islands. On March 23, 2001, the Ninth Circuit Court of Appeals denied
plaintiffs' writ of mandamus requesting that the action either be transferred
back to the District Court in Hawaii or to the Central District of California.
On October 29, 2001, the District Court of the Mariana Islands issued an order
granting in part and denying in part the motion to dismiss. On December 17,
2001, plaintiffs filed a Second Amended Complaint.
17
On May 10, 2002, the Court granted in part and denied in part the defendants'
motion to dismiss the Second Amended Complaint, giving plaintiffs leave to amend
some of the dismissed claims. Also on May 10, 2002, the Court granted
plaintiffs' motions for class certification and for preliminary settlement
approval.
The Company continues to defend itself in both lawsuits and believes the
claims against the Company are without merit.
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
a) Exhibits
(10.1) Credit Agreement, dated as of March 7, 2002, among The
Gap, Inc., the LC Subsidiaries, the Subsidiary
Borrowers, the Lenders and the Issuing Banks (as such
terms are defined in the Credit Agreement), Salomon
Smith Barney Inc., ("SSB") and Banc of America
Securities, LLC ("BAS") as Joint Book Managers, BAS,
HSBC Bank USA and JP Morgan Securities, Inc. ("JPM")
as Co-Syndication Agents, ABN AMRO Bank N.V. as
Documentation Agent, SSB, BAS, and JPM as Joint Lead
Arrangers, and Citicorp USA, Inc. as Agent for the
Lenders and the Issuing Banks thereunder, filed as
Exhibit 99.1 to Registrant's Form 8-K, dated March 21,
2002, Commission File No. 1-7562
(10.2) Indenture, dated March 5, 2002, between the Registrant
and The Bank of New York filed as Exhibit 4.1 to
Registrant's Form S-3, dated May 2, 2002, Commission
File No. 333-87442
(15) Letter re: Unaudited Interim Financial Information
b) Reports on Form 8-K
We filed the following reports on Form 8-K during the three
months ended May 4, 2002:
1. On February 26, 2002 we announced our
intent to offer $1,000,000,000 in principal amount of
convertible notes of the Company pursuant to a private
placement under rule 144A and Regulation S, filed on Form
8-K on February 27, 2002;
2. On February 27, 2002 we announced our
agreement to sell $1,200,000,000 aggregate principal amount
of 5.75% convertible notes due March 2009 of the Company
pursuant to a private placement under Rule 144A and
Regulation S, filed on Form 8-K on February 28, 2002;
3. On March 7, 2002 we announced the closing
of the sale of $1,200,000,000 aggregate principal amount of
5.75% convertible notes due March 2009 of the Company,
filed on Form 8-K on March 7, 2002;
4. On March 8, 2002 we announced the closing
of an additional $180,000,000 aggregate principal amount of
5.75% convertible notes due March 2009 of the Company,
filed on Form 8-K on March 11, 2002; and
5. On March 22, 2002, we filed a report on
Form 8-K attaching as an exhibit the Company's 2-year
$1,400,000,000 secured credit facility dated March 7, 2002.
18
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE GAP, INC.
Date: June 7, 2002 By /s/ Heidi Kunz
--------------
Heidi Kunz
Chief Financial Officer
(Principal financial officer of
the registrant)
Date: June 7, 2002 By /s/ Millard S. Drexler
----------------------
Millard S. Drexler
President and Chief Executive
Officer
19
EXHIBIT INDEX
(10.1) Credit Agreement, dated as of March 7, 2002, among The Gap, Inc., the
LC Subsidiaries, the Subsidiary Borrowers, the Lenders and the Issuing
Banks (as such terms are defined in the Credit Agreement), Salomon
Smith Barney Inc., ("SSB") and Banc of America Securities, LLC ("BAS")
as Joint Book Managers, BAS, HSBC Bank USA and JP Morgan Securities,
Inc. ("JPM") as Co-Syndication Agents, ABN AMRO Bank N.V. as
Documentation Agent, SSB, BAS, and JPM as Joint Lead Arrangers, and
Citicorp USA, Inc. as Agent for the Lenders and the Issuing Banks
thereunder, filed as Exhibit 99.1 to Registrant's Form 8-K, dated March
21, 2002, Commission File No. 1-7562
(10.2) Indenture, dated March 5, 2002, between the Registrant and The Bank of
New York filed as Exhibit 4.1 to Registrant's Form S-3, dated May 2,
2002, Commission File No. 333-87442
(15) Letter re: Unaudited Interim Financial Information
20