The Gap, Inc. — Form 10-Q Summary
Period clarification: The request metadata says 2015 Q1, but this filing covers the 13 weeks ended April 30, 2016 (fiscal 2016 first quarter), compared with the 13 weeks ended May 2, 2015.
Business context and reporting period
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Athleta, and Intermix through stores, online channels, and franchisees. The company reported one aggregated reportable segment. Results are unaudited and interim; management cautions they are not necessarily indicative of the full fiscal year.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $3.438 billion | $3.657 billion |
| Gross profit / gross margin | $1.209 billion / 35.2% | $1.382 billion / 37.8% |
| Operating income / margin | $222 million / 6.5% | $386 million / 10.6% |
| Net income | $127 million | $239 million |
| Diluted EPS | $0.32 | $0.56 |
| Operating cash flow | $168 million | $211 million |
| Capital expenditures | $139 million | $150 million |
| Free cash flow, company-defined non-GAAP | $29 million | $61 million |
At April 30, 2016, cash and cash equivalents were $1.313 billion, inventory was $1.958 billion, and current assets and current liabilities were $3.945 billion and $2.555 billion, respectively. Debt included $424 million of current maturities and $1.318 billion of long-term debt. The $424 million current amount includes a $400 million term loan due October 2016, which may be extended to October 2017. The company had no borrowings under its $500 million revolving credit facility. Cash dividends paid were $91 million, or $0.23 per share.
Material changes versus the prior comparable period
- Sales declined 6%; comparable sales fell 5%, versus a 4% decline a year earlier. Comparable sales were down 3% at Gap Global, 6% at Old Navy Global, and 11% at Banana Republic Global.
- Gross margin declined 2.6 percentage points, principally due to greater markdown activity at Old Navy and Banana Republic and occupancy costs that did not fall in line with sales.
- Operating expenses fell $9 million, but rose as a share of sales from 27.2% to 28.7%. Operating income fell 42% and net income fell 47%.
- Interest expense increased to $19 million from $5 million. The prior-year comparison included a roughly $14 million reversal of tax-related interest expense following a favorable foreign tax ruling and tax-authority actions.
- Operating cash flow decreased $43 million, mainly reflecting lower net income, partly offset by a $64 million year-over-year improvement in the inventory-related cash-flow change. No shares were repurchased in Q1 2016, compared with $232 million of repurchases in Q1 2015.
- Net sales declined across Gap, Old Navy, and Banana Republic; foreign exchange reduced sales by $21 million. Sales per average square foot declined to $74 from $78.
Outlook, management commentary, risks, and unusual items
- Management said apparel retail conditions remained challenging and business improvement was not progressing at the desired pace. Fiscal 2016 priorities included improving product and customer experience and continuing investment in mobile and digital capabilities.
- On May 19, 2016, after quarter-end, Gap announced plans to close all 53 Old Navy stores in Japan and select Banana Republic stores, primarily internationally, with about 75 total closures related to the measures in fiscal 2016. It estimated about $275 million in annualized pre-tax savings, about $250 million in annualized lost sales, and about $300 million in fiscal 2016 pre-tax restructuring costs, roughly $100 million non-cash.
- Management expected foreign exchange to continue to weigh meaningfully on fiscal 2016 results, primarily gross margin. The company expected cash balances and operating cash flow to fund operations and planned capital expenditures for the next 12 months and beyond; it also cited the revolving facility as a source of potential near-term liquidity.
- The company intended to pay a fiscal 2016 annual dividend of $0.92 per share, consistent with fiscal 2015. The $1 billion February 2016 repurchase authorization remained unused at quarter-end.
- Fitch and S&P downgraded the company from BBB- negative outlook to BB+ stable outlook in May 2016. The filing warns that further credit deterioration could constrain capital-market access and increase financing, lease, or hedging costs.
- Foreign exchange exposure is material: the company hedges forecast purchases and certain intercompany transactions, and reported $85 million of derivative liabilities versus $18 million of derivative assets at quarter-end. Most unrealized cash-flow-hedge gains and losses were expected to enter income within 12 months, at then-current values.
- Legal matters, including commercial, intellectual property, employment, customer, and data-privacy claims, were disclosed; recorded liabilities were not material. Management said no current action was expected to materially affect the financial statements.
Important facts for investors to verify
- Whether sales, comparable sales, markdowns, and gross margins improve, especially at Old Navy and Banana Republic.
- Actual closure timing, restructuring charges, realized savings, and lost sales relative to management’s estimates.
- Repayment or extension of the $400 million term loan due in October 2016 and the effect of credit downgrades on financing costs and access.
- Cash generation, inventory levels, capital spending, and the sustainability of dividends and the unused repurchase authorization.
- Foreign-exchange effects on margins and the eventual income-statement impact of hedge positions.