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EX-31.1 - SECTION 302 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - GAP INCexhibit311q32014.htm
EX-32.1 - SECTION 1350 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - GAP INCexhibit321q32014.htm
EX-32.2 - SECTION 1350 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - GAP INCexhibit322q32014.htm
EX-31.2 - SECTION 302 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - GAP INCexhibit312q32014.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 1, 2014
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 1-7562
THE GAP, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
94-1697231
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
Two Folsom Street, San Francisco, California
 
94105
(Address of principal executive offices)
 
(Zip code)
Registrant’s telephone number, including area code: (415) 427-0100
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ            Accelerated filer  ¨            Non-accelerated filer  ¨            Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨    No  þ
The number of shares of the registrant’s common stock outstanding as of November 28, 2014 was 423,576,007.








FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements other than those that are purely historical are forward-looking statements. Words such as “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan,” “project,” and similar expressions also identify forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding the following:
the impact of the adoption of new accounting standards;
recognition of unrealized gains and losses from designated cash flow hedges;
the impact of the potential settlement of outstanding tax matters and the closing of audits;
the impact of losses due to indemnification obligations;
the outcome of proceedings, lawsuits, disputes, and claims;
operating margin in fiscal 2014;
earnings per share for fiscal 2014;
growing sales with healthy merchandise margins;
managing our expenses in a disciplined manner;
delivering earnings per share growth;
returning excess cash to shareholders;
growing global online sales, driven by continued investment in our omni-channel capabilities;
opening additional stores in Asia with a focus on Gap China, Old Navy China, and Old Navy Japan;
expanding our global outlet presence;
opening additional Athleta stores;
continuing to expand our franchise presence worldwide;
the impact of foreign exchange rate fluctuations on our financial results;
number of Company-operated and franchise store openings in fiscal 2014;
square footage change in fiscal 2014;
the effective tax rate in fiscal 2014;
current cash balances and cash flows being sufficient to support our business operations, including growth initiatives and planned capital expenditures;
ability to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility;
the impact of the seasonality of our operations;
depreciation and amortization expense in fiscal 2014;
capital expenditures in fiscal 2014;
dividend payments in fiscal 2014;
market risk profile; and
the impact of changes in internal control over financial reporting.
Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the following:
the risk that adoption of new accounting pronouncements will impact future results;
the risk that changes in global economic conditions or consumer spending patterns could adversely impact our results of operations;
the highly competitive nature of our business in the United States and internationally;
the risk that we or our franchisees will be unsuccessful in gauging apparel trends and changing consumer preferences;
the risk that if we are unable to manage our inventory effectively, our gross margins will be adversely affected;
the risks to our efforts to expand internationally, including our ability to operate under a global brand structure, foreign exchange, and operating in regions where we have less experience;
the risks to our business, including our costs and supply chain, associated with global sourcing and manufacturing;
the risks to our reputation or operations associated with importing merchandise from foreign countries, including failure of our vendors to adhere to our Code of Vendor Conduct;




the risk that trade matters could increase the cost or reduce the supply of apparel available to us and adversely affect our business, financial condition, and results of operations;
the risk that our franchisees’ operation of franchise stores is not directly within our control and could impair the value of our brands;
the risk that we or our franchisees will be unsuccessful in identifying, negotiating, and securing new store locations and renewing, modifying, or terminating leases for existing store locations effectively;
the risk that comparable sales and margins will experience fluctuations;
the risk that changes in our credit profile or deterioration in market conditions may limit our access to the capital markets and adversely impact our financial results or our business initiatives;
the risk that the failure to attract and retain key personnel could have an adverse impact on our results of operations;
the risk that our investments in omni-channel shopping initiatives may not deliver the results we anticipate;
the risk that updates or changes to our information technology (“IT”) systems may disrupt our operations;
the risk that we are subject to data or other security breaches that may result in increased costs, violations of law, significant legal and financial exposure, and a loss of confidence in our security measures, which could have an adverse effect on our results of operations and our reputation;
the risk that natural disasters, public health crises, political crises, or other catastrophic events could adversely affect our operations and financial results, or those of our franchisees or vendors;
the risk that changes in the regulatory or administrative landscape could adversely affect our financial condition, strategies, and results of operations;
the risk that we do not repurchase some or all of the shares we anticipate purchasing pursuant to our repurchase program; and
the risk that we will not be successful in defending various proceedings, lawsuits, disputes, claims, and audits.
Additional information regarding factors that could cause results to differ can be found in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 and our other filings with the U.S. Securities and Exchange Commission.
Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict. These forward-looking statements are based on information as of December 8, 2014, and we assume no obligation to publicly update or revise our forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.
We suggest that this document be read in conjunction with Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014.





THE GAP, INC.
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.




PART I – FINANCIAL INFORMATION
Item 1.
Financial Statements.

THE GAP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
($ and shares in millions except par value)
November 1,
2014
 
February 1,
2014
 
November 2,
2013
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
954

 
$
1,510

 
$
996

Merchandise inventory
2,553

 
1,928

 
2,471

Other current assets
816

 
992

 
923

Total current assets
4,323

 
4,430

 
4,390

Property and equipment, net of accumulated depreciation of $5,555, $5,401, and $5,448
2,777

 
2,758

 
2,714

Other long-term assets
719

 
661

 
682

Total assets
$
7,819

 
$
7,849

 
$
7,786

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Current maturities of debt
$
22

 
$
25

 
$

Accounts payable
1,477

 
1,242

 
1,513

Accrued expenses and other current liabilities
1,011

 
1,142

 
1,064

Income taxes payable
12

 
36

 
54

Total current liabilities
2,522

 
2,445

 
2,631

Long-term liabilities:
 
 
 
 
 
Long-term debt
1,358

 
1,369

 
1,247

Lease incentives and other long-term liabilities
1,084

 
973

 
952

Total long-term liabilities
2,442

 
2,342

 
2,199

Commitments and contingencies (see Note 12)

 

 

Stockholders’ equity:
 
 
 
 
 
Common stock $0.05 par value
 
 
 
 
 
Authorized 2,300 shares for all periods presented; Issued 424, 1,106, and 1,106 shares; Outstanding 424, 446, and 449 shares
21

 
55

 
55

Additional paid-in capital

 
2,899

 
2,876

Retained earnings
2,680

 
14,218

 
14,000

Accumulated other comprehensive income
154

 
135

 
145

Treasury stock at cost (-, 660, and 657 shares)

 
(14,245
)
 
(14,120
)
Total stockholders’ equity
2,855

 
3,062

 
2,956

Total liabilities and stockholders’ equity
$
7,819

 
$
7,849

 
$
7,786

See Accompanying Notes to Condensed Consolidated Financial Statements

1



THE GAP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
13 Weeks Ended
 
39 Weeks Ended
($ and shares in millions except per share amounts)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net sales
$
3,972

 
$
3,976

 
$
11,727

 
$
11,573

Cost of goods sold and occupancy expenses
2,376

 
2,387

 
7,096

 
6,873

Gross profit
1,596

 
1,589

 
4,631

 
4,700

Operating expenses
1,042

 
1,013

 
3,067

 
3,073

Operating income
554

 
576

 
1,564

 
1,627

Interest expense
19

 
21

 
55

 
41

Interest income
(1
)
 
(1
)
 
(2
)
 
(3
)
Income before income taxes
536

 
556

 
1,511

 
1,589

Income taxes
185

 
219

 
568

 
616

Net income
$
351

 
$
337

 
$
943

 
$
973

Weighted-average number of shares - basic
432

 
463

 
439

 
465

Weighted-average number of shares - diluted
437

 
468

 
444

 
471

Earnings per share - basic
$
0.81

 
$
0.73

 
$
2.15

 
$
2.09

Earnings per share - diluted
$
0.80

 
$
0.72

 
$
2.12

 
$
2.07

Cash dividends declared and paid per share
$
0.22

 
$
0.20

 
$
0.66

 
$
0.50

See Accompanying Notes to Condensed Consolidated Financial Statements

2



THE GAP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net income
$
351

 
$
337

 
$
943

 
$
973

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation
(22
)
 
9

 
(13
)
 
(32
)
Change in fair value of derivative financial instruments, net of tax (tax benefit) of $27, $(5), $24, and $17
59

 
(7
)
 
51

 
27

Reclassification adjustment for realized gains on derivative financial instruments, net of tax of $(6), $(7), $(11), and $(19)
(12
)
 
(13
)
 
(19
)
 
(31
)
Other comprehensive income (loss), net of tax
25

 
(11
)
 
19

 
(36
)
Comprehensive income
$
376

 
$
326

 
$
962

 
$
937

See Accompanying Notes to Condensed Consolidated Financial Statements

3



THE GAP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
39 Weeks Ended
($ in millions)
November 1,
2014
 
November 2,
2013
Cash flows from operating activities:
 
 
 
Net income
$
943

 
$
973

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
412

 
398

Amortization of lease incentives
(47
)
 
(49
)
Share-based compensation
76

 
86

Tax benefit from exercise of stock options and vesting of stock units
34

 
54

Excess tax benefit from exercise of stock options and vesting of stock units
(35
)
 
(55
)
Non-cash and other items
(52
)
 
(37
)
Deferred income taxes
(29
)
 
27

Changes in operating assets and liabilities:
 
 
 
Merchandise inventory
(644
)
 
(723
)
Other current assets and other long-term assets
174

 
(50
)
Accounts payable
244

 
370

Accrued expenses and other current liabilities
(99
)
 
(41
)
Income taxes payable, net of prepaid and other tax-related items
(8
)
 
(6
)
Lease incentives and other long-term liabilities
145

 
6

Net cash provided by operating activities
1,114

 
953

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(508
)
 
(487
)
Proceeds from sale of property and equipment
121

 

Maturities of short-term investments

 
50

Other
(1
)
 
(2
)
Net cash used for investing activities
(388
)
 
(439
)
Cash flows from financing activities:
 
 
 
Issuances under share-based compensation plans, net
25

 
90

Repurchases of common stock
(1,046
)
 
(875
)
Excess tax benefit from exercise of stock options and vesting of stock units
35

 
55

Cash dividends paid
(290
)
 
(232
)
Other

 
(1
)
Net cash used for financing activities
(1,276
)
 
(963
)
Effect of foreign exchange rate fluctuations on cash and cash equivalents
(6
)
 
(15
)
Net decrease in cash and cash equivalents
(556
)
 
(464
)
Cash and cash equivalents at beginning of period
1,510

 
1,460

Cash and cash equivalents at end of period
$
954

 
$
996

Non-cash investing activities:
 
 
 
Purchases of property and equipment not yet paid at end of period
$
93

 
$
87

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest during the period
$
77

 
$
76

Cash paid for income taxes during the period, net of refunds
$
570

 
$
587

See Accompanying Notes to Condensed Consolidated Financial Statements

4



THE GAP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The Condensed Consolidated Balance Sheets as of November 1, 2014 and November 2, 2013, the Condensed Consolidated Statements of Income and the Condensed Consolidated Statements of Comprehensive Income for the thirteen and thirty-nine weeks ended November 1, 2014 and November 2, 2013, and the Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended November 1, 2014 and November 2, 2013 have been prepared by The Gap, Inc. (the “Company,” “we,” and “our”). In the opinion of management, such statements include all adjustments (which include only normal recurring adjustments) considered necessary to present fairly our financial position, results of operations, and cash flows as of November 1, 2014 and November 2, 2013 and for all periods presented. The Condensed Consolidated Balance Sheet as of February 1, 2014 has been derived from our audited financial statements.
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted from these interim financial statements. We suggest that you read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014.
The results of operations for the thirteen and thirty-nine weeks ended November 1, 2014 are not necessarily indicative of the operating results that may be expected for the 52-week period ending January 31, 2015.

Note 2. Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued an accounting standards update ("ASU") No. 2014-09,  Revenue from Contracts with Customers, to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. This ASU is effective retrospectively for fiscal years and interim periods within those years beginning after December 15, 2016. We are currently assessing the potential impact of this ASU on our Condensed Consolidated Financial Statements.

Note 3. Goodwill and Other Intangible Assets
Goodwill and intangible assets consist of the following and are included in other long-term assets in the Condensed Consolidated Balance Sheets:
($ in millions)
November 1,
2014
 
February 1,
2014
 
November 2,
2013
Goodwill
$
180

 
$
180

 
$
177

Trade names
$
92

 
$
92

 
$
92

Other indefinite-lived intangible assets
$
6

 
$
6

 
$
6

Intangible assets subject to amortization
$
18

 
$
18

 
$
18

Less: Accumulated amortization
(17
)
 
(17
)
 
(17
)
Intangible assets subject to amortization, net
$
1

 
$
1

 
$
1

Goodwill
During the thirteen and thirty-nine weeks ended November 1, 2014 and November 2, 2013, there were no changes to the $99 million carrying amount of goodwill related to Athleta.
The carrying amount of goodwill related to Intermix decreased by $7 million to $78 million during the thirty-nine weeks ended November 2, 2013 and was further adjusted to $81 million as of February 1, 2014. These changes were due to an adjustment of the initial fair values, which were preliminary and subject to adjustments as of December 31, 2012, the date of acquisition. As of February 1, 2014, the purchase price allocation for Intermix was complete. During the thirteen and thirty-nine weeks ended November 1, 2014, there were no changes to the $81 million carrying amount of goodwill related to Intermix.

Other Intangible Assets
Trade names consist of $54 million and $38 million related to Athleta and Intermix, respectively, as of November 1, 2014, February 1, 2014, and November 2, 2013.

5



The intangible assets subject to amortization consist of customer relationships and non-compete agreements related to Athleta and Intermix of $15 million and $3 million, respectively. Athleta's intangible assets subject to amortization were fully amortized by the end of fiscal 2012. Intermix's non-compete agreements were fully amortized by the end of fiscal 2013 and its customer relationships are being amortized over a period of four years.
There was no material amortization expense for intangible assets subject to amortization recorded in operating expenses in the Condensed Consolidated Statements of Income for the thirteen and thirty-nine weeks ended November 1, 2014 and November 2, 2013.

Note 4. Debt and Credit Facilities
($ in millions)
November 1,
2014
 
February 1,
2014
 
November 2,
2013
Notes
$
1,247

 
$
1,247

 
$
1,247

Japan Term Loan
133

 
147

 

Total long-term debt
1,380

 
1,394

 
1,247

Less: Current portion
(22
)
 
(25
)
 

Total long-term debt, less current portion
$
1,358

 
$
1,369

 
$
1,247

As of November 1, 2014February 1, 2014, and November 2, 2013, the estimated fair value of our $1.25 billion aggregate principal amount of 5.95 percent notes (the "Notes”) due April 2021 was $1.41 billion, $1.39 billion, and $1.38 billion, respectively, and was based on the quoted market price of the Notes (level 1 inputs) as of the last business day of the respective fiscal quarter. The aggregate principal amount of the Notes is recorded in long-term debt in the Condensed Consolidated Balance Sheets, net of the unamortized discount.
As of November 1, 2014 and February 1, 2014, the carrying amount of our 15 billion Japanese yen ($133 million as of November 1, 2014), four-year, unsecured term loan ("Japan Term Loan") approximated its fair value, as the interest rate varies depending on quoted market rates (level 1 inputs). Repayments of 2.5 billion Japanese yen ($22 million as of November 1, 2014) are payable on January 15 of each year, commencing on January 15, 2015, with a final repayment of 7.5 billion Japanese yen ($67 million as of November 1, 2014) due on January 15, 2018. Interest is payable at least quarterly based on an interest rate equal to the Tokyo Interbank Offered Rate ("TIBOR") plus a fixed margin.
We have a $500 million, five-year, unsecured revolving credit facility (the “Facility”), which is scheduled to expire in May 2018. There were no borrowings and no material outstanding standby letters of credit under the Facility as of November 1, 2014.
We maintain multiple agreements to make unsecured revolving credit facilities available for our operations in foreign locations (the “Foreign Facilities”). They are uncommitted and are generally available for borrowings, overdraft borrowings, and the issuance of bank guarantees. The total capacity of the Foreign Facilities was $51 million as of November 1, 2014. As of November 1, 2014, there were no borrowings under the Foreign Facilities. There were $10 million in bank guarantees primarily related to store leases under the Foreign Facilities as of November 1, 2014.
We have a bilateral unsecured standby letter of credit agreement that is uncommitted and does not have an expiration date. As of November 1, 2014, we had $23 million in standby letters of credit issued under this agreement. We also have a $50 million, two-year, unsecured committed letter of credit agreement, which is set to expire in September 2016. We had no trade letters of credit issued under this letter of credit agreement as of November 1, 2014.

Note 5. Fair Value Measurements
There were no purchases, sales, issuances, or settlements related to recurring level 3 measurements during the thirteen and thirty-nine weeks ended November 1, 2014 or November 2, 2013. There were no transfers of financial assets or liabilities into or out of level 1 and level 2 during the thirteen and thirty-nine weeks ended November 1, 2014 or November 2, 2013.


6



Financial Assets and Liabilities
Financial assets and liabilities measured at fair value on a recurring basis and cash equivalents are as follows:
 
 
 
Fair Value Measurements at Reporting Date Using
($ in millions)
November 1, 2014
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
241

 
$
29

 
$
212

 
$

Derivative financial instruments
98

 

 
98

 

Deferred compensation plan assets
40

 
40

 

 

Total
$
379

 
$
69

 
$
310

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
$
2

 
$

 
$
2

 
$

 
 
 
Fair Value Measurements at Reporting Date Using
($ in millions)
February 1, 2014
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
519

 
$
196

 
$
323

 
$

Derivative financial instruments
64

 

 
64

 

Deferred compensation plan assets
37

 
37

 

 

Total
$
620

 
$
233

 
$
387

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
$
15

 
$

 
$
15

 
$

 
 
 
Fair Value Measurements at Reporting Date Using
($ in millions)
November 2, 2013
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant  Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
307

 
$
126

 
$
181

 
$

Derivative financial instruments
47

 

 
47

 

Deferred compensation plan assets
37

 
37

 

 

Total
$
391

 
$
163

 
$
228

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
$
11

 
$

 
$
11

 
$

We have highly liquid investments classified as cash equivalents, which are placed primarily in money market funds, time deposits, and commercial paper. These investments are classified as held-to-maturity based on our positive intent and ability to hold the securities to maturity. We value these investments at their original purchase prices plus interest that has accrued at the stated rate.
Derivative financial instruments primarily include foreign exchange forward contracts. The principal currencies hedged against changes in the U.S. dollar are British pounds, Canadian dollars, Euro, and Japanese yen. The fair value of the Company’s derivative financial instruments is determined using pricing models based on current market rates. Derivative financial instruments in an asset position are recorded in other current assets or other long-term assets in the Condensed Consolidated Balance Sheets. Derivative financial instruments in a liability position are recorded in accrued expenses and other current liabilities or lease incentives and other long-term liabilities in the Condensed Consolidated Balance Sheets.
We maintain the Gap Inc. Deferred Compensation Plan (“DCP”), which allows eligible employees to defer compensation up to a maximum amount. Plan investments are recorded at market value and are designated for the DCP. The fair value of the Company’s DCP assets is determined based on quoted market prices, and the assets are recorded in other long-term assets in the Condensed Consolidated Balance Sheets.


7



Nonfinancial Assets
We review the carrying amount of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We review the carrying amount of goodwill and other indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount may not be recoverable.
There were no material impairment charges recorded for goodwill, other indefinite-lived intangible assets, or other long-lived assets for the thirteen and thirty-nine weeks ended November 1, 2014 or November 2, 2013.

Note 6. Derivative Financial Instruments
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations. Consistent with our risk management guidelines, we hedge a portion of our transactions related to merchandise purchases for foreign operations and certain intercompany transactions using foreign exchange forward contracts. The principal currencies hedged against changes in the U.S. dollar are British pounds, Canadian dollars, Euro, and Japanese yen. We do not enter into derivative financial contracts for trading purposes. Cash flows from derivative financial instruments are classified as cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows.

Cash Flow Hedges
We designate the following foreign exchange forward contracts as cash flow hedges: (1) forward contracts used to hedge forecasted merchandise purchases and related costs denominated primarily in U.S. dollars made by our international subsidiaries whose functional currencies are their local currencies; (2) forward contracts used to hedge forecasted intercompany royalty payments denominated in foreign currencies received by entities whose functional currencies are U.S. dollars; and (3) forward contracts used to hedge forecasted intercompany revenue transactions related to merchandise sold from our regional purchasing entity, whose functional currency is the U.S. dollar, to certain international subsidiaries in their local currencies of British pounds and Euro. The foreign exchange forward contracts entered into to hedge forecasted merchandise purchases and related costs, intercompany royalty payments, and intercompany revenue transactions generally have terms of up to 24 months.
There were no material amounts recorded in the Condensed Consolidated Statements of Income for the thirteen and thirty-nine weeks ended November 1, 2014 or November 2, 2013 as a result of hedge ineffectiveness, hedge components excluded from the assessment of effectiveness, or the discontinuance of cash flow hedges because the forecasted transactions were no longer probable.

Net Investment Hedges
We also use foreign exchange forward contracts to hedge the net assets of international subsidiaries to offset the foreign currency translation and economic exposures related to our investment in the subsidiaries.
There were no material amounts recorded in the Condensed Consolidated Statements of Income for the thirteen and thirty-nine weeks ended November 1, 2014 or November 2, 2013 as a result of hedge ineffectiveness, hedge components excluded from the assessment of effectiveness, or the discontinuance of net investment hedges.

Other Derivatives Not Designated as Hedging Instruments
We use foreign exchange forward contracts to hedge our market risk exposure associated with foreign currency exchange rate fluctuations for certain intercompany balances denominated in currencies other than the functional currency of the entity with the intercompany balance. The gain or loss on the derivative financial instruments, as well as the remeasurement impact of the underlying intercompany balances, is recorded in operating expenses in the Condensed Consolidated Statements of Income in the same period and generally offset. We generally enter into foreign exchange forward contracts as needed to hedge intercompany balances that bear foreign exchange risk.

Outstanding Notional Amounts
We had foreign exchange forward contracts outstanding in the following notional amounts:
(notional amounts in millions)
November 1,
2014
 
February 1,
2014
 
November 2,
2013
U.S. dollars (1)
$
1,615

 
$
1,309

 
$
1,468

Canadian dollars
C$
14

 
C$
8

 
C$
8

Euro
1

 
25

 
25

Japanese yen
¥

 
¥

 
¥
30,000

__________ 
(1)
The principal currencies hedged against changes in the U.S. dollar were British pounds, Canadian dollars, Euro, and Japanese yen.


8



Contingent Features
We had no derivative financial instruments with credit-risk-related contingent features underlying the agreements as of November 1, 2014February 1, 2014, or November 2, 2013.

Quantitative Disclosures about Derivative Financial Instruments
The fair values of foreign exchange forward contracts are as follows:
($ in millions)
November 1,
2014
 
February 1,
2014
 
November 2,
2013
Derivatives designated as cash flow hedges:
 
 
 
 
 
Other current assets
$
59

 
$
48

 
$
27

Other long-term assets
$
23

 
$
6

 
$
7

Accrued expenses and other current liabilities
$
1

 
$
13

 
$
8

Lease incentives and other long-term liabilities
$

 
$
1

 
$
2

 
 
 
 
 
 
Derivatives designated as net investment hedges:
 
 
 
 
 
Other current assets
$

 
$
1

 
$
4

Other long-term assets
$

 
$

 
$

Accrued expenses and other current liabilities
$

 
$

 
$

Lease incentives and other long-term liabilities
$

 
$

 
$

 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
Other current assets
$
16

 
$
9

 
$
9

Other long-term assets
$

 
$

 
$

Accrued expenses and other current liabilities
$
1

 
$
1

 
$
1

Lease incentives and other long-term liabilities
$

 
$

 
$

 
 
 
 
 
 
Total derivatives in an asset position
$
98

 
$
64

 
$
47

Total derivatives in a liability position
$
2

 
$
15

 
$
11

Substantially all of the unrealized gains and losses from designated cash flow hedges as of November 1, 2014 will be recognized in income within the next 12 months at the then-current values, which may differ from the fair values as of November 1, 2014 shown above.
Our foreign exchange forward contracts are subject to master netting arrangements with each of our counterparties and such arrangements are enforceable in the event of default or early termination of the contract. We do not elect to offset the fair values of our derivative financial instruments in the Condensed Consolidated Balance Sheets, and as such, the fair values shown above represent gross amounts. The amounts subject to enforceable master netting arrangements are $2 million, $1 million, and $2 million as of November 1, 2014February 1, 2014, and November 2, 2013, respectively. If we did elect to offset, the net amounts of our derivative financial instruments in an asset position would be $96 million, $63 million, and $45 million and the net amounts of the derivative financial instruments in a liability position would be zero, $14 million, and $9 million as of November 1, 2014February 1, 2014, and November 2, 2013, respectively.
See Note 5 of Notes to Condensed Consolidated Financial Statements for disclosures on the fair value measurements of our derivative financial instruments.

9



The effective portion of gains and losses on foreign exchange forward contracts in cash flow hedging and net investment hedging relationships recorded in other comprehensive income and the Condensed Consolidated Statements of Income, on a pre-tax basis, are as follows:

13 Weeks Ended

39 Weeks Ended
($ in millions)
November 1,
2014

November 2,
2013

November 1,
2014

November 2,
2013
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Gain (loss) recognized in other comprehensive income
$
86

 
$
(12
)
 
$
75

 
$
44

Gain reclassified into cost of goods sold and occupancy expenses
$
16

 
$
17

 
$
26

 
$
43

Gain reclassified into operating expenses
$
2

 
$
3

 
$
4

 
$
7

 
 
 
 
 
 
 
 
Derivatives in net investment hedging relationships:
 
 
 
 

 

Gain recognized in other comprehensive income
$
2

 
$
3

 
$
2

 
$
2

For the thirteen and thirty-nine weeks ended November 1, 2014 and November 2, 2013, there were no amounts of gain or loss reclassified from accumulated other comprehensive income into income for derivative financial instruments in net investment hedging relationships, as we did not sell or liquidate (or substantially liquidate) any of our hedged subsidiaries during the periods.
Gains and losses on foreign exchange forward contracts not designated as hedging instruments recorded in the Condensed Consolidated Statements of Income, on a pre-tax basis, are as follows:
 
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Gain (loss) recognized in operating expenses
$
8

 
$
(2
)
 
$
6

 
$
1


Note 7. Share Repurchases
Share repurchase activity is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
($ and shares in millions except average per share cost)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Number of shares repurchased
11.4

 
20.4

 
26.0

 
22.7

Total cost
$
433

 
$
790

 
$
1,016

 
$
875

Average per share cost including commissions
$
37.95

 
$
38.77

 
$
39.15

 
$
38.49


Between January 2013 and November 2013, we announced that the Board of Directors authorized a total of $2.0 billion for share repurchases, all of which was completed by the end of October 2014. In October 2014, we announced that the Board of Directors approved a new $500 million share repurchase authorization, of which $450 million was remaining as of November 1, 2014.
All of the share repurchases were paid for as of November 1, 2014 and November 2, 2013. All except $30 million of total share repurchases were paid for as of February 1, 2014.
As of March 1, 2014, the Company retired all existing treasury stock. Upon retirement, the treasury stock balance as of March 1, 2014 was reduced for the amount originally recorded for the shares repurchased. Common stock was also reduced, at par, for the shares repurchased, and the remaining balance was allocated between additional paid-in capital and retained earnings. All common stock repurchased subsequent to March 1, 2014 is immediately retired and all shares related to stock options and other stock awards are issued from authorized but unissued common stock.


10



Note 8. Share-Based Compensation
Share-based compensation expense recognized in the Condensed Consolidated Statements of Income, primarily in operating expenses, is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Stock units
$
18

 
$
21

 
$
64

 
$
72

Stock options
3

 
3

 
8

 
10

Employee stock purchase plan
2

 
2

 
4

 
4

Share-based compensation expense
23

 
26

 
76

 
86

Less: Income tax benefit
(8
)
 
(10
)
 
(29
)
 
(33
)
Share-based compensation expense, net of tax
$
15

 
$
16

 
$
47

 
$
53



11



Note 9. Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive income by component, net of tax, are as follows:
($ in millions)
Foreign Currency Translation
 
Cash Flow Hedges
 
Total
Balance at February 1, 2014
$
107

 
$
28

 
$
135

13 Weeks Ended May 3, 2014:
 
 
 
 
 
Foreign currency translation
11

 

 
11

Change in fair value of derivative financial instruments

 
(11
)
 
(11
)
Amounts reclassified from accumulated other comprehensive income

 
(5
)
 
(5
)
Other comprehensive income (loss), net
11

 
(16
)
 
(5
)
Balance at May 3, 2014
118

 
12

 
130

13 Weeks Ended August 2, 2014:
 
 
 
 
 
Foreign currency translation
(2
)
 

 
(2
)
Change in fair value of derivative financial instruments

 
3

 
3

Amounts reclassified from accumulated other comprehensive income

 
(2
)
 
(2
)
Other comprehensive income (loss), net
(2
)
 
1

 
(1
)
Balance at August 2, 2014
116

 
13

 
129

13 Weeks Ended November 1, 2014:
 
 
 
 
 
Foreign currency translation
(22
)
 

 
(22
)
Change in fair value of derivative financial instruments

 
59

 
59

Amounts reclassified from accumulated other comprehensive income

 
(12
)
 
(12
)
Other comprehensive income (loss), net
(22
)
 
47

 
25

Balance at November 1, 2014
$
94

 
$
60

 
$
154

 
 
 
 
 
 
($ in millions)
Foreign Currency Translation
 
Cash Flow Hedges
 
Total
Balance at February 2, 2013
$
158

 
$
23

 
$
181

13 Weeks Ended May 4, 2013:
 
 
 
 
 
 Foreign currency translation
(28
)
 

 
(28
)
 Change in fair value of derivative financial instruments

 
22

 
22

 Amounts reclassified from accumulated other comprehensive income

 
(8
)
 
(8
)
 Other comprehensive income (loss), net
(28
)
 
14

 
(14
)
Balance at May 4, 2013
130

 
37

 
167

13 Weeks Ended August 3, 2013:
 
 
 
 
 
Foreign currency translation
(13
)
 

 
(13
)
Change in fair value of derivative financial instruments

 
12

 
12

Amounts reclassified from accumulated other comprehensive income

 
(10
)
 
(10
)
Other comprehensive income (loss), net
(13
)
 
2

 
(11
)
Balance at August 3, 2013
117

 
39

 
156

13 Weeks Ended November 2, 2013:
 
 
 
 
 
Foreign currency translation
9

 

 
9

Change in fair value of derivative financial instruments

 
(7
)
 
(7
)
Amounts reclassified from accumulated other comprehensive income

 
(13
)
 
(13
)
Other comprehensive income (loss), net
9

 
(20
)
 
(11
)
Balance at November 2, 2013
$
126

 
$
19

 
$
145

See Note 6 of Notes to Condensed Consolidated Financial Statements for additional disclosures about reclassifications out of accumulated other comprehensive income and their corresponding effects on the respective line items in the Condensed Consolidated Statements of Income.


12



Note 10. Income Taxes
Effective February 2, 2014, we adopted ASU No. 2013-11, Income Taxes, which clarifies the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This adoption did not have a material impact on our Condensed Consolidated Financial Statements.
The Company conducts business globally, and as a result, files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as the United States, Canada, France, China, Hong Kong, Japan, India, and the United Kingdom. We are no longer subject to U.S. federal income tax examinations for fiscal years before 2009, and with few exceptions, we are also no longer subject to U.S. state, local, or non-U.S. income tax examinations for fiscal years before 2008.
The Company has discussions with taxing authorities regarding tax matters in the various U.S. and foreign jurisdictions in the normal course of business. As of November 1, 2014, it is reasonably possible that we will recognize a decrease in gross unrecognized tax benefits within the next 12 months of approximately $18 million, primarily due to the potential settlement of outstanding tax matters and the closing of audits. If we do recognize such a decrease, the net impact on the Condensed Consolidated Statement of Income would not be material.
In connection with a review of the Company’s cash position and anticipated cash needs for business operations, the Company made a non-recurring distribution of earnings from certain of its foreign subsidiaries during the thirteen weeks ended November 1, 2014. This distribution resulted in a net tax benefit of approximately $34 million because the estimated foreign tax credits associated with the distribution were greater than the estimated tax due on the distribution of the foreign earnings.
During the thirty-nine weeks ended November 2, 2013, we recognized an interest expense reversal of $18 million as a result of the favorable resolution of tax matters.

Note 11. Earnings Per Share
Weighted-average number of shares used for earnings per share is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
(shares in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Weighted-average number of shares - basic
432

 
463

 
439

 
465

Common stock equivalents
5

 
5

 
5

 
6

Weighted-average number of shares - diluted
437

 
468

 
444

 
471

The above computations of weighted-average number of shares – diluted exclude 2 million and 1 million shares related to stock options and other stock awards for the thirteen weeks ended November 1, 2014 and November 2, 2013, respectively, and 1 million shares related to stock options and other stock awards for each of the thirty-nine weeks ended November 1, 2014 and November 2, 2013, as their inclusion would have an anti-dilutive effect on earnings per share.

Note 12. Commitments and Contingencies
We are a party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to our commercial contracts, operating leases, trademarks, intellectual property, financial agreements, and various other agreements. Under these contracts, we may provide certain routine indemnifications relating to representations and warranties (e.g., ownership of assets, environmental or tax indemnifications) or personal injury matters. The terms of these indemnifications range in duration and may not be explicitly defined. Generally, the maximum obligation under such indemnifications is not explicitly stated, and as a result, the overall amount of these obligations cannot be reasonably estimated. Historically, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any of these matters, the loss would not have a material effect on our Condensed Consolidated Financial Statements taken as a whole.
As a multinational company, we are subject to various proceedings, lawsuits, disputes, and claims (“Actions”) arising in the ordinary course of our business. Many of these Actions raise complex factual and legal issues and are subject to uncertainties. As of November 1, 2014, Actions filed against us included commercial, intellectual property, customer, employment, and data privacy claims, including class action lawsuits. The plaintiffs in some Actions seek unspecified damages or injunctive relief, or both. Actions are in various procedural stages and some are covered in part by insurance. As of November 1, 2014February 1, 2014, and November 2, 2013, we recorded a liability for an estimated loss if the outcome of an Action is expected to result in a loss that is considered probable and reasonably estimable. The liability recorded as of November 1, 2014February 1, 2014, and November 2, 2013 was not material for any individual Action or in total. Subsequent to November 1, 2014 and through the filing date of this Quarterly Report on Form 10-Q, no information has become available that indicates a change is required that would be material to our Condensed Consolidated Financial Statements taken as a whole.

13



We cannot predict with assurance the outcome of Actions brought against us. Accordingly, developments, settlements, or resolutions may occur and impact income in the quarter of such development, settlement, or resolution. However, we do not believe that the outcome of any current Action would have a material effect on our Condensed Consolidated Financial Statements taken as a whole.

Note 13. Segment Information
The Gap, Inc. is a global retailer that sells apparel, accessories, and personal care products under the Gap, Old Navy, Banana Republic, Piperlime, Athleta, and Intermix brands. We identify our operating segments according to how our business activities are managed and evaluated. Our operating segments include Gap Global, Old Navy Global, Banana Republic Global, and Growth, Innovation, and Digital (“GID”).  GID manages our newer brands, Piperlime, Athleta, and Intermix.  We believe each of our operating segments share similar economic and other qualitative characteristics and aggregate the results of our operating segments into one reportable segment.

14



Net sales by brand and region are as follows:
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (2)
 
Total
 
Percentage of Net Sales
13 Weeks Ended November 1, 2014
 
 
 
 
 
 
U.S. (1)
 
$
907

 
$
1,390

 
$
581

 
$
152

 
$
3,030

 
76
%
Canada
 
105

 
129

 
63

 
1

 
298

 
8

Europe
 
198

 

 
22

 

 
220

 
6

Asia
 
296

 
39

 
33

 

 
368

 
9

Other regions
 
49

 

 
7

 

 
56

 
1

Total
 
$
1,555

 
$
1,558

 
$
706

 
$
153

 
$
3,972

 
100
%
Sales growth (decline)
 
(3
)%
 
3
%
 
1
%
 
(2
)%
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (2)
 
Total
 
Percentage of Net Sales
13 Weeks Ended November 2, 2013
 
 
 
 
 
 
U.S. (1)
 
$
960

 
$
1,371

 
$
572

 
$
155

 
$
3,058

 
77
%
Canada
 
111

 
126

 
60

 
1

 
298

 
7

Europe
 
199

 

 
21

 

 
220

 
6

Asia
 
282

 
20

 
37

 

 
339

 
8

Other regions
 
53

 

 
8

 

 
61

 
2

Total
 
$
1,605

 
$
1,517

 
$
698

 
$
156

 
$
3,976

 
100
%
Sales growth
 
3
 %
 
%
 
%
 
75
 %
 
3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (2)
 
Total
 
Percentage of Net Sales
39 Weeks Ended November 1, 2014
 
 
 
 
 
 
U.S. (1)
 
$
2,585

 
$
4,202

 
$
1,705

 
$
519

 
$
9,011

 
77
%
Canada
 
280

 
357

 
174

 
3

 
814

 
7

Europe
 
605

 

 
71

 

 
676

 
6

Asia
 
856

 
102

 
107

 

 
1,065

 
9

Other regions
 
139

 

 
22

 

 
161

 
1

Total
 
$
4,465

 
$
4,661

 
$
2,079

 
$
522

 
$
11,727

 
100
%
Sales growth (decline)
 
(2
)%
 
3
%
 
2
%
 
10
 %
 
1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (2)
 
Total
 
Percentage of Net Sales
39 Weeks Ended November 2, 2013
 
 
 
 
 
 
U.S. (1)
 
$
2,750

 
$
4,121

 
$
1,682

 
$
472

 
$
9,025

 
78
%
Canada
 
293

 
346

 
167

 
3

 
809

 
7

Europe
 
567

 

 
61

 

 
628

 
5

Asia
 
802

 
49

 
112

 

 
963

 
9

Other regions
 
128

 

 
20

 

 
148

 
1

Total
 
$
4,540

 
$
4,516

 
$
2,042

 
$
475

 
$
11,573

 
100
%
Sales growth
 
4
 %
 
5
%
 
2
%
 
71
 %
 
6
%
 
 
__________
(1)
U.S. includes the United States, Puerto Rico, and Guam.
(2)
Includes Piperlime, Athleta, and Intermix.
Online and franchise sales are reflected within the respective results of each brand and region in the net sales above.
Total online sales were $621 million and $589 million for the thirteen weeks ended November 1, 2014 and November 2, 2013, respectively. Total online sales were $1.7 billion and $1.6 billion for the thirty-nine weeks ended November 1, 2014 and November 2, 2013, respectively.

15



Total franchise sales were $101 million and $105 million for the thirteen weeks ended November 1, 2014 and November 2, 2013, respectively. Total franchise sales were $291 million and $267 million for the thirty-nine weeks ended November 1, 2014 and November 2, 2013, respectively.
Net sales by region are recorded based on the location in which the sale was originated. Store sales are recorded based on the location of the store, and online sales are recorded based on the location of the distribution center or store from where the products were shipped.

16




Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
OUR BUSINESS
We are a global retailer offering apparel, accessories, and personal care products for men, women, and children under the Gap, Old Navy, Banana Republic, Piperlime, Athleta, and Intermix brands. We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, and beginning in March 2014, Taiwan. We also have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic, and Old Navy stores throughout Asia, Australia, Eastern Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. In addition, our products are available to customers online through Company-owned websites and through the use of third parties that provide logistics and fulfillment services. Most of the products sold under our brand names are designed by us and manufactured by independent sources. We also sell products that are designed and manufactured by branded third parties, especially at our Piperlime and Intermix brands.
 
OVERVIEW
Financial highlights for the third quarter of fiscal 2014 are as follows:
Net sales were flat at $4.0 billion for each of the third quarter of fiscal 2014 and 2013. Excluding the impact of foreign exchange, our net sales increased 1 percent for the third quarter of fiscal 2014 compared with the third quarter of fiscal 2013. See Net Sales discussion for impact of foreign exchange.
Comparable sales for the third quarter of fiscal 2014, which include the associated comparable online sales, decreased 2 percent compared with a 1 percent increase for the third quarter of fiscal 2013.
Gross profit was $1.6 billion for each of the third quarter of fiscal 2014 and 2013. Gross margin for the third quarter of fiscal 2014 was 40.2 percent compared with 40.0 percent for third quarter of fiscal 2013.
Operating margin for the third quarter of fiscal 2014 was 13.9 percent compared with 14.5 percent for the third quarter of fiscal 2013.
Net income for the third quarter of fiscal 2014 was $351 million compared with $337 million for the third quarter of fiscal 2013, and diluted earnings per share was $0.80 for the third quarter of fiscal 2014 compared with $0.72 for the third quarter of fiscal 2013.
During the first three quarters of fiscal 2014, we generated free cash flow of $606 million compared with free cash flow of $466 million during the first three quarters of fiscal 2013. Free cash flow is defined as net cash provided by operating activities less purchases of property and equipment. For a reconciliation of free cash flow, a non-GAAP financial measure, from a GAAP financial measure, see Liquidity and Capital Resources section.
Our full year business and financial priorities for fiscal 2014 remain as follows:
grow sales with healthy merchandise margins;
manage our expenses in a disciplined manner;
deliver earnings per share growth; and
return excess cash to shareholders.
In addition to increasing sales within our existing business, our goal is to grow revenues through our newer brands, channels, and geographies, including the following:
growing global online sales, driven by continued investments in our omni-channel capabilities;
opening additional stores in Asia with a focus on Gap China, Old Navy China, and Old Navy Japan;
expanding our global outlet presence;
opening additional Athleta stores; and
continuing to expand our franchise presence worldwide.
In fiscal 2014, we expect foreign exchange rate fluctuations to have a meaningful negative impact on the results of our largest foreign subsidiaries in Canada and Japan. With the depreciation of the Canadian dollar and Japanese yen, we expect net sales in Canadian dollars and Japanese yen translated into U.S. dollars will decrease and negatively impact our total Company net sales growth. In addition, we expect gross margins for our largest foreign subsidiaries to be negatively impacted as our merchandise purchases are primarily in U.S. dollars.


17



RESULTS OF OPERATIONS
Net Sales
Net sales primarily consist of retail sales from stores and online, and franchise revenues.
See Item 1, Financial Statements, Note 13 of Notes to Condensed Consolidated Financial Statements for net sales by brand and region.

Comparable Sales
The percentage change in comparable ("Comp") sales by global brand and for total Company, including the associated comparable online sales, as compared with the preceding year, is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Gap Global
(5
)%
 
1
 %
 
(5
)%
 
3
 %
Old Navy Global
1
 %
 
 %
 
2
 %
 
3
 %
Banana Republic Global
 %
 
(1
)%
 
 %
 
(1
)%
The Gap, Inc.
(2
)%
 
1
 %
 
(1
)%
 
3
 %
Comparable online sales favorably impacted total Company Comp sales by 2 percent and 4 percent in the third quarter of fiscal 2014 and 2013, respectively. Comparable online sales favorably impacted total Company Comp sales by 2 percent and 3 percent in the first three quarters of fiscal 2014 and 2013, respectively.
Only Company-operated stores are included in the calculations of Comp sales. Gap and Banana Republic outlet and factory store Comp sales are reflected within the respective results of each global brand. The calculation of total Company Comp sales includes the results of Athleta stores and online, Intermix stores and online, and the Piperlime store, but excludes the results of our franchise business and Piperlime online.
A store is included in the Comp sales calculations when it has been open and operated by the Company for at least one year and the selling square footage has not changed by 15 percent or more within the past year. A store is included in the Comp sales calculations on the first day it has comparable prior year sales. Stores in which the selling square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from the Comp sales calculations until the first day they have comparable prior year sales.
A store is considered non-comparable (“Non-comp”) when it has been open and operated by the Company for less than one calendar year or has changed its selling square footage by 15 percent or more within the past year.
A store is considered “Closed” if it is temporarily closed for three or more full consecutive days or it is permanently closed. When a temporarily closed store reopens, the store will be placed in the Comp/Non-comp status it was in prior to its closure. If a store was in Closed status for three or more days in the prior year, the store will be in Non-comp status for the same days the following year.
Online Comp sales are defined as sales through online channels in all countries where we have existing Comp store sales.
Current year foreign exchange rates are applied to both current year and prior year Comp sales to achieve a consistent basis for comparison.

Store Count and Square Footage Information
Net sales per average square foot is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net sales per average square foot (1)
$
86

 
$
89

 
260

 
$
264

__________
(1)
Excludes net sales associated with our online and franchise businesses.


18



Store count, openings, closings, and square footage for our stores are as follows:
 
February 1, 2014
 
39 Weeks Ended November 1, 2014
 
November 1, 2014
 
Number of
Store Locations
 
Number of
Stores Opened
 
Number of
Stores Closed
 
Number of
Store Locations
 
Square Footage
(in millions)
Gap North America
968

 
32

 
23

 
977

 
10.2

Gap Asia
228

 
24

 
3

 
249

 
2.5

Gap Europe
193

 

 
4

 
189

 
1.6

Old Navy North America
1,004

 
27

 
16

 
1,015

 
17.3

Old Navy Asia
18

 
18

 

 
36

 
0.5

Banana Republic North America
596

 
25

 
11

 
610

 
5.1

Banana Republic Asia
43

 
4

 
2

 
45

 
0.2

Banana Republic Europe
11

 

 

 
11

 
0.1

Athleta North America
65

 
28

 
1

 
92

 
0.4

Piperlime North America
1

 

 

 
1

 

Intermix North America
37

 
4

 

 
41

 
0.1

Company-operated stores total
3,164

 
162

 
60

 
3,266

 
38.0

Franchise
375

 
51

 
12

 
414

 
 N/A

Total
3,539

 
213

 
72

 
3,680

 
38.0

Increase over prior year
 
 
 
 
 
 
4.7
%
 
2.2
%
 
 
 
 
 
 
 
 
 
 
 
February 2, 2013
 
39 Weeks Ended November 2, 2013
 
November 2, 2013
 
Number of
Store Locations
 
Number of
Stores Opened
 
Number of
Stores Closed
 
Number of
Store Locations
 
Square Footage
(in millions)
Gap North America
990

 
26

 
38

 
978

 
10.2

Gap Asia
191

 
31

 
2

 
220

 
2.2

Gap Europe
198

 
3

 
7

 
194

 
1.7

Old Navy North America
1,010

 
19

 
22

 
1,007

 
17.3

Old Navy Asia
1

 
13

 

 
14

 
0.2

Banana Republic North America
590

 
12

 
6

 
596

 
5.0

Banana Republic Asia
38

 
6

 
1

 
43

 
0.2

Banana Republic Europe
10

 
1

 

 
11

 
0.1

Athleta North America
35

 
26

 

 
61

 
0.2

Piperlime North America
1

 

 

 
1

 

Intermix North America
31

 
5

 
1

 
35

 
0.1

Company-operated stores total
3,095

 
142

 
77

 
3,160

 
37.2

Franchise
312

 
46

 
3

 
355

 
N/A

Total
3,407

 
188

 
80

 
3,515

 
37.2

Increase over prior year
 
 
 
 
 
 
5.3
%
 
0.8
%
Gap and Banana Republic outlet and factory stores are reflected in each of the respective brands.
In fiscal 2014, we expect net openings of about 115 Company-operated store locations. We expect square footage for Company-operated stores to increase about 2.5 percent at the end of fiscal 2014. We expect our franchisees to open about 65 franchise stores in fiscal 2014.

Net Sales
Our net sales for the third quarter of fiscal 2014 decreased $4 million compared with the third quarter of fiscal 2013 primarily due to a decrease in net sales at Gap and the unfavorable impact of foreign exchange of $31 million; offset by an increase in net sales at Old Navy. The unfavorable impact of foreign exchange was primarily due to the weakening of the Canadian dollar and Japanese yen against the U.S. dollar. The foreign exchange impact is the translation impact if net sales for the third quarter of fiscal 2013 were translated at exchange rates applicable during the third quarter of fiscal 2014. On this basis, our net sales for the third quarter of fiscal 2014 increased 1 percent compared with the third quarter of fiscal 2013. We believe this metric enhances the visibility of underlying business trends by excluding the impact of foreign currency exchange rate fluctuations.


19



Our net sales during the first three quarters of fiscal 2014 increased $154 million, or 1 percent, compared with the first three quarters of fiscal 2013 primarily due to an increase in net sales at Old Navy and Athleta; partially offset by a decrease in net sales at Gap and the unfavorable impact of foreign exchange of $52 million. The unfavorable impact of foreign exchange was primarily due to the weakening of the Canadian dollar and Japanese yen against the U.S. dollar; partially offset by the favorable impact of the weakening of the U.S. dollar against the British pound. The foreign exchange impact is the translation impact if net sales during the first three quarters of fiscal 2013 were translated at exchange rates applicable during the first three quarters of fiscal 2014. On this basis, our net sales for the first three quarters of fiscal 2014 increased 2 percent compared with the first three quarters of fiscal 2013. We believe this metric enhances the visibility of underlying business trends by excluding the impact of foreign currency exchange rate fluctuations.

Cost of Goods Sold and Occupancy Expenses
  
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Cost of goods sold and occupancy expenses
$
2,376

 
$
2,387

 
$
7,096

 
$
6,873

Gross profit
$
1,596

 
$
1,589

 
$
4,631

 
$
4,700

Cost of goods sold and occupancy expenses as a percentage of net sales
59.8
%
 
60.0
%
 
60.5
%
 
59.4
%
Gross margin
40.2
%
 
40.0
%
 
39.5
%
 
40.6
%
Cost of goods sold and occupancy expenses as a percentage of net sales decreased 0.2 percent in the third quarter of fiscal 2014 compared with the third quarter of fiscal 2013.
Cost of goods sold decreased 0.9 percent as a percentage of net sales in the third quarter of fiscal 2014 compared with the third quarter of fiscal 2013, primarily driven by the reclassification of a portion of income related to our credit card program from operating expenses to cost of goods sold.
Occupancy expenses increased 0.7 percent as a percentage of net sales in the third quarter of fiscal 2014 compared with the third quarter of fiscal 2013, primarily driven by the decrease in Comp store sales without a corresponding decrease in occupancy expenses.
Cost of goods sold and occupancy expenses as a percentage of net sales increased 1.1 percent during the first three quarters of fiscal 2014 compared with the first three quarters of fiscal 2013.
Cost of goods sold increased 0.7 percent as a percentage of net sales during the first three quarters of fiscal 2014 compared with the first three quarters of fiscal 2013, primarily driven by increased promotional activities; partially offset by the reclassification of a portion of income related to our credit card program from operating expenses to cost of goods sold.
Occupancy expenses increased 0.4 percent as a percentage of net sales during the first three quarters of fiscal 2014 compared with the first three quarters of fiscal 2013, primarily driven by the decrease in Comp store sales without a corresponding decrease in occupancy expenses.

Operating Expenses
  
13 Weeks Ended