The Gap, Inc. — Form 10-Q summary
Period clarification: The request identifies 2013 Q2, but the supplied filing is for the 13 and 26 weeks ended August 2, 2014, with comparisons to August 3, 2013. Figures below are unaudited; dollar amounts are in millions unless noted.
Business context and reporting period
Gap is a global apparel retailer operating Gap, Old Navy, Banana Republic, Athleta, Piperlime, and Intermix, through company-operated stores, franchisees, and online channels. It reported one aggregated segment. At quarter-end, it had 3,200 company-operated stores and 394 franchise stores.
Financial performance and liquidity
| Metric | 13 weeks ended Aug. 2, 2014 | Prior-year quarter | 26 weeks ended Aug. 2, 2014 | Prior-year half |
|---|---|---|---|---|
| Net sales | $3,981 | $3,868 | $7,755 | $7,597 |
| Gross profit | $1,569 | $1,567 | $3,035 | $3,111 |
| Gross margin | 39.4% | 40.5% | 39.1% | 41.0% |
| Operating income | $567 | $521 | $1,010 | $1,051 |
| Operating margin | 14.2% | 13.5% | 13.0% | 13.8% |
| Net income | $332 | $303 | $592 | $636 |
| Diluted EPS | $0.75 | $0.64 | $1.32 | $1.35 |
Quarterly comparable sales were flat versus +5% a year earlier; first-half comparable sales declined 1% versus +4%. Old Navy was the principal sales-growth contributor: its global comparable sales rose 4% in the quarter and 3% in the half. Gap Global comps fell 5% in both periods, while Banana Republic Global was flat.
- Cash flow: First-half operating cash flow was $996, versus $857 a year earlier. Capital expenditures were $328, resulting in reported free cash flow of $668 versus $542. Investing cash outflow was $208; financing cash outflow was $781, including $608 of share repurchases and $194 of dividends.
- Liquidity and debt: Cash and equivalents were $1,518 at August 2, 2014, compared with $1,925 a year earlier. Current assets were $4,244 and current liabilities $2,262. Debt comprised $1,247 of notes and a $146 Japan term loan, including $24 current maturities. The $500 revolving credit facility had no borrowings.
- Shareholder returns: The company repurchased 14.6 million shares for $583 in the first half at an average $40.09 per share; $383 remained under the $1 billion authorization. It paid $0.44 per share in first-half dividends and intended to raise the fiscal-2014 annual dividend to $0.88 per share.
Material changes and unusual items
- Quarterly sales increased 3%, but gross margin fell 1.1 percentage points, primarily due to increased promotional activity and occupancy costs relative to comparable sales. First-half gross margin fell 1.9 points.
- Second-quarter operating income included a $39 gain on the sale of a building no longer occupied by the company. Lower bonus expense also reduced operating expenses. The first-half comparison was affected by a prior-year $18 reversal of interest expense following favorable resolution of tax matters.
- First-half operating cash flow benefited from changes in credit-card-program receivables timing and an upfront payment related to an amendment of the credit-card program agreement. Management also cited timing-related movements in inventory, payables, accrued expenses, and other liabilities.
- Net sales by brand for the quarter were $1,622 Old Navy, $1,469 Gap, $704 Banana Republic, and $186 Other. Online sales were $515 for the quarter and $1.1 billion for the first half.
Outlook, commentary, and risks
Management expected fiscal-2014 operating margin to be about flat with fiscal 2013, diluted EPS of $2.95–$3.00, and an effective tax rate of about 38.5%. It forecast approximately $750 in fiscal-year capital expenditures, about $520 in depreciation and amortization net of lease-incentive amortization, roughly 115 net company-operated store openings, and about 60 franchise openings. Expected company-store square footage growth was about 2.5%.
Management said cash and operating cash flow should support operations, growth initiatives, and planned capital spending for the next 12 months and beyond. It cautioned that Canadian-dollar and Japanese-yen weakness could reduce translated sales and pressure gross margins because merchandise purchases are primarily in U.S. dollars. Key risks include consumer-spending weakness, competition, changing apparel preferences, inventory and promotional pressure, international and foreign-exchange exposure, sourcing and supply-chain issues, cybersecurity and IT disruption, and uncertain litigation and tax matters. The company reported no material change in risk factors or internal controls; current legal-action liabilities were not material.
Important facts for investors to verify
- Confirm the intended reporting period: the supplied filing covers Q2 2014, not Q2 2013.
- Assess whether the $39 building-sale gain and lower bonus expense make reported quarterly operating improvement less representative of recurring performance.
- Monitor gross-margin recovery, promotional intensity, and comparable-sales trends, especially at Gap Global.
- Evaluate the sustainability and composition of first-half free cash flow, including the credit-card-program payment and working-capital timing effects.
- Track execution against EPS, margin, capital-spending, store-opening, dividend, and repurchase expectations, alongside currency headwinds and remaining repurchase authorization.