Gap Q3 Conference Call
A Fool Conference Call Synopsis*
by Yi-Hsin Chang (TMFPuck)
Gap Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %>
One Harrison Street
San Francisco, CA 94105
Phone: (650) 952-4400
http://www.gap.com
ALEXANDRIA, VA (Nov. 12, 1998) /FoolWire/ -- Casual clothing retailer Gap Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %> reported third quarter earnings of $237.7 million, up 44.5% from $164.5 million in the same year-earlier period. This was the sixth consecutive third quarter with a double-digit earnings increase. On a per-share basis, earnings rose 50% to $0.60 from $0.40 a year ago. (Analysts had projected EPS of $0.56.) Adjusting for the previously announced 3-for-2 stock split, which will take effect November 30, EPS would be $0.40 for this year and $0.27 for last year.
EPS growth was helped by the company's aggressive share buyback efforts during the quarter. Gap repurchased about 8.9 million shares for $520 million, completing its three-year 45 million share buyback program in just two years. Late last month, the company announced board authorization to repurchase up to an additional 30 million shares, though the company won't be buying back shares as aggressively as it did in Q3.
Gap's sales increased 36% to $2.4 billion from $1.766 billion. Comparable-store sales improved 13%, versus 9% in 1997 -- making it the fourth consecutive quarter the Gap has delivered double-digit comp sales growth.
For the first nine months of the year, earnings totaled $510.7 million, a 60.5% increase from $318.3 million a year ago. Earnings per share gained 65% to $1.27 from $0.77. Adjusting for the upcoming stock split, the numbers would be $0.84 for 1998 and $0.52 for 1997. Sales increased 39% to $6.025 billion from $4.342 billion, with same-store sales up 16% compared with 4% growth in 1997.
Operations Overview. All of Gap's divisions contributed to the company's earnings growth, and all grew on top of "tough numbers" from the same year-earlier period. Although the company doesn't break out numbers for its individual divisions, CFO Warren Hashagen did describe comp-store sales growth for each of the divisions:
Gap -- high single-digits versus low double-digits a year ago
GapKids/babyGap -- low single-digits versus low double-digits a year ago
Banana Republic -- mid-teens versus mid-single-digits a year ago
Old Navy -- low 20s versus low single-digits a year ago
International -- "incredibly strong across all markets"
Sales productivity increased 12% to $138 a square foot from $123 a square foot last year. Gross margin net of occupancy costs was 42.7% compared with 40.8% a year ago, making this year's figure the highest reported Q3 margin in more than a decade. Three-fourths of the year-over-year improvement resulted from lower occupancy costs as a percentage of sales, while the remaining fourth of the improvement came from better merchandise margins.
For the first nine months of the year, gross margin net of occupancy costs was 41.2% versus 37.4% for the same year-ago period. Half of the improvement can be attributed to lower occupancy costs, while the other half can be pinned on higher merchandise margins.
Inventory was up 40% to $1.4 billion from $981 million last year. The largest contributor to the increase in inventory was Old Navy, which is still building and trying to determine the optimal level of inventory. Gap's pre-tax return on sales climbed to 15.9% from 14.9%. The company's tax rate remained unchanged at 37.5%.
Expenses. Q3 operating costs rose to 26.5% of sales from 25.7%, largely due to increased spending on advertising and marketing, as Gap promoted all three of its brands on TV and in more print media. The third quarter was the second quarter in a row in which advertising and marketing spending exceeded $100 million. The company expects ad spending to total around $350 million this year and to fall into the range of 4% to 4.5% of sales going forward.
Gap and Old Navy are still experimenting with the ad mix to figure out how much to advertise and in what formats. Banana Republic launched its new catalog during the quarter, and the company opened its GapKids and babyGap online stores earlier this month in preparation for the busy holiday season. CFO Hashagen said the Old Navy and Banana Republic brands need to have their own websites, even if they aren't stores.
Capital expenditures for the first nine months totaled $600 million net of disposals. For the year, the company expects cap ex to exceed $750 million, up from the previous guidance of $700 million, due to new-store growth, the company's remodeling and expansion efforts, as well as accelerated spending on new and expanded distribution facilities. Gap expects square footage growth of more than 20% for the year.
New Stores. Gap opened 224 new stores in the first three quarters versus 237 a year ago. It also closed 10 stores and expanded 103 others. Total square footage jumped 22%. Gap is "on plan" to open 300 to 350 stores this year, as the company has been saying all year. As of the end of the third quarter, the store count was 2,344 with a total square footage of 17.9 million, which breaks down as follows:
Gap -- 7.6 million square feet over 1,083 stores
GapKids/babyGap -- 2.6 million square feet over 616 stores
Banana Republic -- 1.9 million square feet over 281 stores
Old Navy -- 5.8 million square feet over 364 stores
Again, Gap has no plans of entering any new markets overseas. It will focus particularly on Canada, the U.K., and Japan. A reassessment of the Canadian market has led the company to believe it can put more Gap stores there than it previously thought. Its U.K. business "could easily double." As for Japan, the company started the year with 15 stores and expects to end the year with 30 stores. It anticipates doubling that number to 60 next year.
Looking Ahead. CFO Hashagen said he expects Q4 comparable-store sales growth to be in the mid- to high single-digits (last year's Q4 comp figure was 10%). For the year, sales are estimated to reach $8.5 billion -- $2 billion more than last year -- with a "modest" improvement on margins. As far as Q4 earnings are concerned, the CFO said, "I would not expect to see changes from current consensus [estimates]."
For 1999, Gap is likely to budget more than $1 billion for capital expenditures as it opens 425 to 450 new stores, and continues remodeling and expanding existing stores. A point of clarification: The company has decided that many of the markets in which it had planned to open combination stores consisting of Gap, GapKids, and babyGap are in fact big enough to support two side-by-side stores. So about 70 of the 425 to 450 new stores will actually come from counting combo stores as two separate stores.
Here's a breakdown by division of anticipated store openings next year:
Gap/GapKids/BabyGap -- 180 to 200
Banana Republic -- 40 to 50
Old Navy -- 130 to 150
International -- 80 to 100
The company expects total square footage growth to top 20% in 1999.