Business context and reporting period
The Gap, Inc. is a global apparel retailer operating Gap, Old Navy, Banana Republic, Athleta, and Intermix, with company-operated stores, franchise locations, and online sales. This 10-Q reports the 13 and 26 weeks ended August 1, 2015; although the request metadata says 2014 Q2, the filing itself is for fiscal 2015 Q2. Comparisons below are with the corresponding 2014 periods.
Financial performance
| Metric | 13 weeks ended Aug. 1, 2015 | Year-over-year change | 26 weeks ended Aug. 1, 2015 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $3.898 billion | Down 2% | $7.555 billion | Down 3% |
| Gross profit | $1.458 billion | Down $111 million | $2.840 billion | Down $195 million |
| Gross margin | 37.4% | Down 2.0 percentage points | 37.6% | Down 1.5 percentage points |
| Operating income | $369 million | Down $198 million | $755 million | Down $255 million |
| Operating margin | 9.5% | Down 4.7 percentage points | 10.0% | Down 3.0 percentage points |
| Net income | $219 million | Down $113 million | $458 million | Down $134 million |
| Diluted EPS | $0.52 | Compared with $0.75 | $1.09 | Compared with $1.32 |
For Q2, comparable sales fell 2% versus flat a year earlier. By global brand, Q2 comps were down 6% at Gap, up 3% at Old Navy, and down 4% at Banana Republic. First-half company comps declined 3%. Excluding foreign exchange, sales were flat in both Q2 and the first half. Online sales were $529 million in Q2, up from $515 million, and $1.1 billion for each first-half period.
First-half operating cash flow was $642 million, down from $996 million. Capital expenditures were $301 million, producing reported free cash flow of $341 million, versus $668 million. Cash and cash equivalents were $1.043 billion at August 1, 2015, compared with $1.518 billion a year earlier. Total debt was approximately $1.348 billion, including $20 million current and $1.328 billion long-term. The $500 million revolving facility had no borrowings; its expiration was extended to May 2020.
In the first half, the company repurchased $622 million of stock and paid $192 million in dividends. It reported distributing $814 million to shareholders. The declared and paid dividend was $0.46 per share for the first half.
Material changes versus the prior comparable period
- Q2 sales declined $83 million, including an estimated $100 million unfavorable foreign-exchange translation impact; first-half sales declined $200 million, including a $188 million FX impact.
- Gross margin weakened as markdown activity and incremental shipping costs increased, with West Coast port congestion contributing to shipping costs and delayed or canceled merchandise receipts. Foreign currency also pressured margins because merchandise purchases are primarily in U.S. dollars.
- Operating expenses included $83 million of Q2 strategic-action charges, primarily tied to Gap brand. The prior-year Q2 included a gain on sale of a building.
- First-half operating cash flow was lower, reflecting, among other factors, lower net income, inventory timing, and the prior-year timing of credit-card-program-related cash receipts and an upfront payment.
- Gap Global and Banana Republic Global sales declined in the first half, while Old Navy Global sales increased. The company closed 56 company-operated stores and opened 85 during the first half; total company-operated and franchise locations increased to 3,751.
Outlook, management commentary, and risks
Management identified improving Gap brand performance as a priority and announced plans to close approximately 175 Gap specialty stores in North America and a limited number in Europe over the next few years, including about 140 closures in fiscal 2015. The company also expects to eliminate approximately 250 Gap headquarters roles during fiscal 2015. It expects total fiscal 2015 strategic-action charges of approximately $130 million to $140 million.
Management plans continued investment in digital and omni-channel capabilities, international growth—with a focus on Gap China, Old Navy China, and Old Navy Japan—and additional Athleta stores in the U.S. It expects foreign-exchange fluctuations to continue to negatively affect reported sales and foreign-subsidiary gross margins in fiscal 2015. Management believes cash balances and operating cash flow will support operations, growth initiatives, and planned capital expenditures, with the revolving facility available for supplemental liquidity. The company intended to pay $0.92 per share in dividends for fiscal 2015, subject to its dividend considerations.
Key risks include apparel-trend and consumer-demand shifts, competition, inventory and markdown execution, FX volatility, supply-chain disruption, international expansion, cybersecurity and IT risks, and uncertain litigation and tax matters. The filing reported no material recorded liability for pending legal actions. A favorable foreign tax ruling and related tax-authority actions led to a roughly $15 million first-half reversal of tax-related interest expense; the filing says the related tax-benefit reduction was offset in the tax provision. Management stated disclosure controls were effective and there were no material changes in internal control during the quarter.
Important facts for investors to verify
- Whether Gap brand sales and comparable-sales trends improve as store closures, workforce reductions, and product actions proceed.
- Whether the expected $130 million to $140 million of fiscal 2015 strategic-action charges, including the timing and impact of planned closures, are realized as described.
- Whether port-related merchandise delays, markdowns, and FX pressures continue to weigh on gross margin and cash generation.
- Whether cash flow, capital spending, repurchases, and dividends remain consistent with management’s liquidity assessment and planned shareholder returns.
- How foreign-exchange exposures, tax matters, and pending legal or other contingencies develop; the filing cautions that outcomes may differ from current estimates.