The Gap, Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 weeks and 39 weeks ended November 1, 2014, with comparisons to the periods ended November 2, 2013. The request metadata says “2013 Q3,” but the filing itself is for fiscal 2014 Q3.
Business context
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Athleta, Piperlime, and Intermix, through stores, online channels, and franchisees. The company reports one aggregated segment. Fiscal 2014 ends January 31, 2015.
Financial performance
| Metric | Q3 2014 | Q3 2013 | 39 weeks 2014 | 39 weeks 2013 |
|---|---|---|---|---|
| Net sales | $3.972B | $3.976B | $11.727B | $11.573B |
| Gross profit | $1.596B | $1.589B | $4.631B | $4.700B |
| Gross margin | 40.2% | 40.0% | 39.5% | 40.6% |
| Operating income | $554M | $576M | $1.564B | $1.627B |
| Operating margin | 13.9% | 14.5% | 13.3% | 14.1% |
| Net income | $351M | $337M | $943M | $973M |
| Diluted EPS | $0.80 | $0.72 | $2.12 | $2.07 |
Q3 comparable sales declined 2%, versus 1% growth a year earlier; year-to-date comps declined 1%, versus 3% growth. Q3 reported sales were flat, but increased 1% excluding foreign exchange; year-to-date sales rose 1%, or 2% excluding foreign exchange. Online sales were $621M in Q3 and $1.7B year to date.
For the first 39 weeks, operating cash flow was $1.114B, capital expenditures were $508M, and reported free cash flow (operating cash flow less property and equipment purchases) was $606M, up from $466M. Cash declined to $954M from $1.510B at fiscal year-end, largely alongside $1.046B of net financing outflows, including $1.046B of stock repurchases and $290M of dividends. At November 1, total debt was about $1.380B, including $1.247B of notes and a $133M Japan term loan. The $500M revolving facility was undrawn.
Changes and notable items
- Q3 gross margin improved 0.2 percentage points, while operating margin fell 0.6 points. Year-to-date gross and operating margins each declined.
- Management attributed year-to-date merchandise margin pressure partly to increased promotions; weaker comparable store sales also raised occupancy costs as a share of sales.
- Q3 net income and EPS increased despite lower operating income. A one-time distribution of foreign subsidiary earnings generated an approximately $34M tax benefit; Q3 effective tax rate was 34.5%, versus 39.4%.
- Year-to-date operating cash flow benefited from timing of credit-card receivables and an upfront payment following an amendment to the credit-card program agreement. A $121M building-sale proceeds inflow also reduced investing cash use.
- Gap Global Q3 sales declined 3%; Old Navy Global grew 3% and Banana Republic Global grew 1%. The company operated 3,266 stores and had 414 franchise locations at period-end.
Outlook, risks, and contingencies
Management expected fiscal 2014 operating margin of about 12.5%, diluted EPS of $2.73–$2.78, and an effective tax rate of about 38%. It forecast approximately $700M of capital expenditures, $500M of depreciation and amortization net of lease-incentive amortization, about 115 net company-operated store openings, and about 65 franchise openings. The company intended to pay an annual dividend of $0.88 per share.
Management said cash and operating cash flow should support operations and planned investment, with the revolving facility available for additional liquidity. It expected currency weakness, particularly in Canada and Japan, to weigh on translated sales and foreign gross margins. Other identified risks include consumer spending and apparel trends, competition, inventory and promotional pressure, international expansion, sourcing and supply-chain exposure, IT disruption, data security, and legal proceedings. Recorded liabilities for legal matters were not material; the company said it could not predict case outcomes. No material changes to reported risk factors or internal controls were noted.
Important facts to verify
- Confirm the intended period: the supplied filing is for the quarter ended November 1, 2014, not 2013 Q3.
- Assess how much Q3 earnings growth depended on the nonrecurring $34M tax benefit and compare underlying operating performance.
- Review the decline in comparable sales and year-to-date margins, including promotional, occupancy, and foreign-exchange effects.
- Evaluate cash-flow quality and sustainability, given the disclosed timing effects, building sale, elevated inventory, and significant shareholder returns.
- Track delivery against fiscal 2014 EPS, margin, tax, capital-spending, store-opening, and dividend expectations.