The Gap, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the 13 and 39 weeks ended October 31, 2015 (fiscal 2015 third quarter), not 2014 Q3 as stated in the request metadata. Comparative periods ended November 1, 2014. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and reporting period
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Athleta, and Intermix, through stores, online, and franchise channels. Management reports the brands as one reportable segment. The interim financial statements are unaudited; management notes that results for the 13 and 39 weeks are not necessarily indicative of the full fiscal year ending January 30, 2016.
Financial results and liquidity
| Metric | 13 weeks ended Oct. 31, 2015 | 13 weeks ended Nov. 1, 2014 | 39 weeks ended Oct. 31, 2015 | 39 weeks ended Nov. 1, 2014 |
|---|---|---|---|---|
| Net sales | $3,857 | $3,972 | $11,412 | $11,727 |
| Gross profit / margin | $1,440 / 37.3% | $1,596 / 40.2% | $4,280 / 37.5% | $4,631 / 39.5% |
| Operating income / margin | $414 / 10.7% | $554 / 13.9% | $1,169 / 10.2% | $1,564 / 13.3% |
| Net income | $248 | $351 | $706 | $943 |
| Diluted EPS | $0.61 | $0.80 | $1.69 | $2.12 |
| Operating cash flow | Not provided for quarter | $734 | $1,114 | |
| Capital expenditures | Not provided for quarter | $505 | $508 | |
| Free cash flow (non-GAAP) | Not provided for quarter | $229 | $606 |
- Third-quarter sales fell 3%; excluding foreign exchange, sales were flat. Comparable sales declined 2%, matching the prior-year decline.
- Gross margin contracted 2.9 percentage points in the quarter, primarily from increased markdowns, foreign-exchange effects on U.S.-dollar merchandise purchases, and higher occupancy costs relative to sales.
- At October 31, cash and cash equivalents were $1,042; current assets were $4,361 and current liabilities $2,768. Merchandise inventory was $2,498, up from $1,889 at January 31, 2015.
- Debt included $421 of current maturities, including a new $400 unsecured term loan due October 2016 (with a possible extension to October 2017), and $1,331 of long-term debt. The $500 revolving credit facility had no borrowings and was extended to May 2020.
- For the first 39 weeks, the company repurchased $807 of stock and paid $285 in dividends. Cash dividends were $0.69 per share; management intended an annual fiscal 2015 dividend of $0.92 per share.
Material changes versus the prior comparable period
- For the quarter, net income decreased $103 and diluted EPS declined $0.19. For the first 39 weeks, net income fell $237 and diluted EPS fell $0.43.
- Foreign exchange reduced quarterly reported sales by $99 and 39-week sales by $287; management said constant-currency sales were flat in both periods.
- Brand performance was mixed in the quarter: Old Navy global sales rose 4% and comparable sales rose 4%; Gap global sales fell 7% and comps fell 4%; Banana Republic global sales fell 11% and comps fell 12%.
- Operating cash flow declined $380 year over year for the first 39 weeks, while free cash flow fell $377. Management cited lower earnings, timing of credit-card-program receipts and payments, lower lease-incentive inflows, and accounts-payable timing.
- The company borrowed $400 under a new term loan and repurchased fewer shares than in the prior-year period. Cash declined from $1,515 at January 31, 2015 to $1,042 at October 31, 2015.
Outlook, management commentary, risks, and unusual items
- Management said cash balances and operating cash flows should support operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond; the revolver or other market instruments could supplement liquidity if needed.
- Fiscal 2015 priorities included improving product-to-market processes at Gap and Banana Republic, continued digital and omnichannel investment, and international growth, particularly in China and Japan, plus additional Athleta stores in the U.S.
- Gap planned to close about 175 specialty stores in North America and a limited number in Europe, and now expected a limited number of closures in Asia. About 140 closures were expected in fiscal 2015; the Gap headquarters workforce was expected to be reduced by approximately 250 roles.
- Strategic-action charges were $107 for the first 39 weeks. The company expected total fiscal 2015 charges of approximately $130–$140, primarily related to Gap brand store closures, workforce reductions, impairments, and related costs.
- Management expected foreign exchange to continue to weigh on reported sales and foreign subsidiary gross margins, partly offset by favorable translation of expenses. Key risks include apparel trends and consumer demand, competition, inventory and markdown management, foreign exchange, sourcing and supply-chain disruption, cybersecurity, and litigation.
- A favorable foreign tax ruling and tax-authority actions led to a roughly $15 reversal of tax-related interest expense in the first 39 weeks; the related reduction in unrecognized tax benefits was $31, with no tax-provision impact due to an offsetting U.S. indirect effect. Potential additional tax-benefit reductions of up to $5 over the next 12 months were not expected to have a material income-statement impact.
- Management said current legal proceedings and recorded liabilities were not material in aggregate, but outcomes remain uncertain. Disclosure controls were assessed as effective, with no material change in internal control reported.
Important facts for investors to verify
- Confirm the reporting-period mismatch: this filing covers fiscal 2015 Q3, not 2014 Q3.
- Track whether markdown pressure, foreign-exchange effects, and weaker Gap and Banana Republic sales improve, and whether Old Navy sustains growth.
- Monitor inventory levels, seasonal cash requirements, operating cash flow, and free cash flow relative to the prior year.
- Review execution and total costs of planned store closures and workforce reductions against the $130–$140 expected fiscal 2015 charge range.
- Assess repayment or extension of the $400 term loan, ongoing repurchases and dividends, and the company’s liquidity through the holiday selling season.
- Check subsequent filings for changes in tax matters, litigation, and the expected effects of foreign exchange and strategic actions.