Attached files

file filename
EX-32.2 - SECTION 1350 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - GAP INCexhibit322q32017.htm
EX-32.1 - SECTION 1350 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - GAP INCexhibit321q32017.htm
EX-31.2 - SECTION 302 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - GAP INCexhibit312q32017.htm
EX-31.1 - SECTION 302 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - GAP INCexhibit311q32017.htm
EX-10.1 - AGREEMENT WITH SHAWN CURRAN - GAP INCexhibit101q32017.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 28, 2017
 
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  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      No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
 Non-accelerated filer
 Smaller reporting company
 
 
 
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes      No  
The number of shares of the registrant’s common stock outstanding as of November 15, 2017 was 388,857,073.




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 into income;
the impact of the potential settlement of outstanding tax matters;
the impact of losses due to indemnification obligations;
the outcome of proceedings, lawsuits, disputes, and claims;
the impact of continuing depreciation of certain foreign currencies on gross margins for our foreign subsidiaries;
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 or other available market instruments;
the impact of the seasonality of our operations;
dividend payments in fiscal 2017; 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 we or our franchisees will be unsuccessful in gauging apparel trends and changing consumer preferences, including channel preferences;
the highly competitive nature of our business in the United States and internationally;
the risk that failure to maintain, enhance, and protect our brand image could have an adverse effect on our results of operations;
the risk that the failure to attract and retain key personnel, or effectively manage succession, could have an adverse impact on our results of operations;
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 changes in the regulatory or administrative landscape could adversely affect our financial condition, strategies, and results of operations;
the risk that our investments in digital and customer initiatives may not deliver the results we anticipate;
the risk that if we are unable to manage our inventory effectively, our gross margins will be adversely affected;
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 foreign currency exchange rate fluctuations could adversely impact our financial results;
the risks to our business, including our costs and supply chain, associated with global sourcing and manufacturing;
the risk that changes in global economic conditions or consumer spending patterns could adversely impact our results of operations;
the risks to our efforts to expand internationally, including our ability to operate under a global brand structure and operating in regions where we have less experience;
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 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 position or our business initiatives;
the risk that updates or changes to our information technology (“IT”) systems may disrupt our operations;
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 reductions in income and cash flow from our marketing and servicing arrangement related to our private label and co-branded credit cards could adversely affect our operating results and cash flows;
the risk that adoption of new accounting pronouncements will impact future results;
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 January 28, 2017 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 November 22, 2017, 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 January 28, 2017.





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)
October 28,
2017
 
January 28,
2017
 
October 29,
2016
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
1,353

 
$
1,783

 
$
1,522

Merchandise inventory
2,476

 
1,830

 
2,398

Other current assets
654

 
702

 
751

Total current assets
4,483

 
4,315

 
4,671

Property and equipment, net of accumulated depreciation of $6,041, $5,813, and $5,900
2,686

 
2,616

 
2,662

Other long-term assets
726

 
679

 
674

Total assets
$
7,895

 
$
7,610

 
$
8,007

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

 
$
65

 
$
424

Accounts payable
1,330

 
1,243

 
1,413

Accrued expenses and other current liabilities
1,132

 
1,113

 
1,059

Income taxes payable
134

 
32

 
19

Total current liabilities
2,596

 
2,453

 
2,915

Long-term liabilities:
 
 
 
 
 
Long-term debt
1,248

 
1,248

 
1,320

Lease incentives and other long-term liabilities
1,027

 
1,005

 
1,046

Total long-term liabilities
2,275

 
2,253

 
2,366

Commitments and contingencies (see Note 11)

 

 

Stockholders’ equity:
 
 
 
 
 
Common stock $0.05 par value
 
 
 
 
 
Authorized 2,300 shares for all periods presented; Issued and Outstanding 389, 399, and 399 shares
19

 
20

 
20

Additional paid-in capital

 
81

 
57

Retained earnings
2,965

 
2,749

 
2,621

Accumulated other comprehensive income
40

 
54

 
28

Total stockholders’ equity
3,024

 
2,904

 
2,726

Total liabilities and stockholders’ equity
$
7,895

 
$
7,610

 
$
8,007

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)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Net sales
$
3,838

 
$
3,798

 
$
11,077

 
$
11,087

Cost of goods sold and occupancy expenses
2,313

 
2,305

 
6,770

 
6,948

Gross profit
1,525

 
1,493

 
4,307

 
4,139

Operating expenses
1,147

 
1,104

 
3,224

 
3,249

Operating income
378

 
389

 
1,083

 
890

Interest expense
18

 
20

 
53

 
57

Interest income
(4
)
 
(3
)
 
(11
)
 
(6
)
Income before income taxes
364

 
372

 
1,041

 
839

Income taxes
135

 
168

 
398

 
383

Net income
$
229

 
$
204

 
$
643

 
$
456

Weighted-average number of shares - basic
391

 
399

 
395

 
398

Weighted-average number of shares - diluted
393

 
400

 
397

 
400

Earnings per share - basic
$
0.59

 
$
0.51

 
$
1.63

 
$
1.15

Earnings per share - diluted
$
0.58

 
$
0.51

 
$
1.62

 
$
1.14

Cash dividends declared and paid per share
$
0.23

 
$
0.23

 
$
0.69

 
$
0.69

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)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Net income
$
229

 
$
204

 
$
643

 
$
456

Other comprehensive income (loss)
 
 
 
 
 
 
 
Foreign currency translation
(5
)
 
(10
)
 
12

 
(1
)
Change in fair value of derivative financial instruments, net of tax (tax benefit) of $2, $4, $(6), and $(5)
23

 
39

 
(20
)
 
(57
)
Reclassification adjustment for (gains) losses on derivative financial instruments, net of (tax) tax benefit of $6, $-, $4, and $(6)
(1
)
 

 
(6
)
 
1

Other comprehensive income (loss), net of tax
17

 
29

 
(14
)
 
(57
)
Comprehensive income
$
246

 
$
233

 
$
629

 
$
399

See Accompanying Notes to Condensed Consolidated Financial Statements

3



THE GAP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
39 Weeks Ended
($ in millions)
October 28,
2017
 
October 29,
2016
Cash flows from operating activities:
 
 
 
Net income
$
643

 
$
456

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
418

 
449

Amortization of lease incentives
(46
)
 
(47
)
Share-based compensation
60

 
55

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

 
(4
)
Excess tax benefit from exercise of stock options and vesting of stock units

 
(1
)
Store asset impairment charges
17

 
89

Non-cash and other items
9

 
12

Deferred income taxes
(50
)
 
(10
)
Changes in operating assets and liabilities:
 
 
 
Merchandise inventory
(636
)
 
(513
)
Other current assets and other long-term assets
(60
)
 
(52
)
Accounts payable
55

 
294

Accrued expenses and other current liabilities
(46
)
 
10

Income taxes payable, net of prepaid and other tax-related items
188

 
80

Lease incentives and other long-term liabilities
48

 
(18
)
Net cash provided by operating activities
600

 
800

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(463
)
 
(383
)
Insurance proceeds related to loss on property and equipment
60

 

Other
(3
)
 
(1
)
Net cash used for investing activities
(406
)
 
(384
)
Cash flows from financing activities:
 
 
 
Payments of current maturities of debt
(67
)
 

Proceeds from issuances under share-based compensation plans
23

 
25

Withholding tax payments related to vesting of stock units
(15
)
 
(18
)
Repurchases of common stock
(300
)
 

Excess tax benefit from exercise of stock options and vesting of stock units

 
1

Cash dividends paid
(272
)
 
(275
)
Net cash used for financing activities
(631
)
 
(267
)
Effect of foreign exchange rate fluctuations on cash and cash equivalents
7

 
3

Net increase (decrease) in cash and cash equivalents
(430
)
 
152

Cash and cash equivalents at beginning of period
1,783

 
1,370

Cash and cash equivalents at end of period
$
1,353

 
$
1,522

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest during the period
$
76

 
$
80

Cash paid for income taxes during the period, net of refunds
$
260

 
$
318

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 October 28, 2017 and October 29, 2016, and the Condensed Consolidated Statements of Income and the Condensed Consolidated Statements of Comprehensive Income for the thirteen and thirty-nine weeks ended October 28, 2017 and October 29, 2016, and the Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 28, 2017 and October 29, 2016 have been prepared by The Gap, Inc. (the “Company,” “we,” and “our”). In the opinion of management, such statements include all adjustments (which include normal recurring adjustments) considered necessary to present fairly our financial position, results of operations, and cash flows as of October 28, 2017 and October 29, 2016 and for all periods presented. The Condensed Consolidated Balance Sheet as of January 28, 2017 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 (“U.S. GAAP”) have been omitted from these interim financial statements, although the Company believes that the disclosures made are adequate to make the information not misleading. 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 January 28, 2017.
The results of operations for the thirteen and thirty-nine weeks ended October 28, 2017 are not necessarily indicative of the operating results that may be expected for the 53-week period ending February 3, 2018.

Note 2. Recent Accounting Pronouncements
Except as noted below, the Company has considered all recent accounting pronouncements and has concluded that there are no recent accounting pronouncements that may have a material impact on its Consolidated Financial Statements, based on current information.
Recent Accounting Pronouncements Related to Revenue Recognition
In May 2014, the Financial Accounting Standards Board (“FASB”) 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. ASU No. 2014-09, as amended, is effective retrospectively for fiscal years and interim periods within those years beginning after December 15, 2017.
While we do not expect the adoption of ASU No. 2014-09 and related ASUs to have a material impact on our Consolidated Financial Statements, we expect the adoption to result in change in the timing of recognizing revenue for breakage income for gift cards, gift certificates, and credit vouchers, credit card reward points and certificate liability, as well as sales where we ship the merchandise to the customer from a distribution center or store. Additionally, under the new guidance, we expect to recognize allowances for estimated sales returns on a gross basis rather than net basis on the Consolidated Balance Sheets.
We are currently evaluating the classification of income earned in connection with our private label and co-branded credit cards. We are also evaluating expanded disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
We will adopt these ASUs on a modified retrospective basis beginning in the first quarter of fiscal 2018.

5



Other Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, Leases. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases (with the exception of short-term leases) at the commencement date. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2018. We are still assessing the impact of this ASU on our Consolidated Financial Statements, but it will result in a substantial increase in our long-term assets and liabilities. We will adopt the ASU beginning in the first quarter of fiscal 2019.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting. The amendments are intended to improve the accounting for employee share-based payments and affect all organizations that issue share-based payment awards to their employees. We adopted the provisions of this ASU in the first quarter of fiscal 2017. Beginning in the first quarter of fiscal 2017, we have made the policy election to account for forfeitures when they occur, rather than estimating expected forfeitures, when recognizing share-based compensation cost. We adopted this provision of the ASU using a modified retrospective transition method, which resulted in the cumulative-effect adjustment of a $3 million increase to retained earnings as of the beginning of the first quarter of fiscal 2017. Also, all excess tax benefits and tax deficiencies related to share-based payment awards are now reflected in the Consolidated Statement of Income as a component of the provision for income taxes on a prospective basis, whereas they were recognized in equity under the previous guidance. Additionally, excess tax benefits related to share-based payment awards are now reflected in operating activities, along with other income tax related cash flows, in our Consolidated Statement of Cash Flows on a prospective basis.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. The amendments simplify the subsequent measurement of goodwill and eliminate the two-step goodwill impairment test. The ASU is effective prospectively for fiscal years and interim periods within those years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We early adopted this ASU for the interim goodwill impairment test in the first quarter of fiscal 2017. The adoption of this ASU did not have any impact on the Consolidated Financial Statements.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The amendments are intended to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2018. We are currently assessing the potential impact of this ASU on our Consolidated Financial Statements.

Note 3. Debt and Credit Facilities
Long-term debt consists of the following:
($ in millions)
October 28,
2017
 
January 28,
2017
 
October 29,
2016
Notes
$
1,248

 
$
1,248

 
$
1,248

Japan Term Loan

 
65

 
96

Total debt
1,248

 
1,313

 
1,344

Less: Current portion of Japan Term Loan

 
(65
)
 
(24
)
Total long-term debt
$
1,248

 
$
1,248

 
$
1,320

As of October 28, 2017January 28, 2017, and October 29, 2016, the estimated fair value of our $1.25 billion aggregate principal amount of 5.95 percent notes (the “Notes”) due April 2021 was $1.35 billion, $1.32 billion, and $1.34 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 January 28, 2017 and October 29, 2016, the carrying amount of our 15 billion Japanese yen, four-year, unsecured term loan (“Japan Term Loan”) approximated its fair value, as the interest rate varied depending on quoted market rates (level 1 inputs). Repayments of 2.5 billion Japanese yen were paid on January 15 of each year, and a final repayment of 7.5 billion Japanese yen which was due on January 15, 2018 was paid in full in June 2017. Interest was payable at least quarterly based on an interest rate equal to the Tokyo Interbank Offered Rate plus a fixed margin.
In October 2015, we entered into a $400 million unsecured term loan (the “Term Loan”), which was included in current maturities of debt in the Condensed Consolidated Balance Sheet as of October 29, 2016. The Term Loan was repaid in full in January 2017. Interest was payable at least quarterly based on an interest rate equal to the London Interbank Offered Rate plus a fixed margin.
We have a $500 million, five-year, unsecured revolving credit facility (the “Facility”), which is scheduled to expire in May 2020. There were no borrowings and no material outstanding standby letters of credit under the Facility as of October 28, 2017.

6



We maintain multiple agreements with third parties that make unsecured revolving credit facilities available for our operations in foreign locations (the “Foreign Facilities”). These Foreign Facilities are uncommitted and are generally available for borrowings, overdraft borrowings, and the issuance of bank guarantees. The total capacity of the Foreign Facilities was $47 million as of October 28, 2017. As of October 28, 2017, there were no borrowings under the Foreign Facilities. There were $14 million in bank guarantees issued and outstanding primarily related to store leases under the Foreign Facilities as of October 28, 2017.
We have bilateral unsecured standby letter of credit agreements that are uncommitted and do not have expiration dates. As of October 28, 2017, we had $15 million in standby letters of credit issued under these agreements.

Note 4. 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 October 28, 2017 or October 29, 2016. 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 October 28, 2017 or October 29, 2016.

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)
October 28, 2017
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
389

 
$
28

 
$
361

 
$

Derivative financial instruments
31

 

 
31

 

Deferred compensation plan assets
46

 
46

 

 

Total
$
466

 
$
74

 
$
392

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
$
20

 
$

 
$
20

 
$

 
 
 
Fair Value Measurements at Reporting Date Using
($ in millions)
January 28, 2017
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
697

 
$
256

 
$
441

 
$

Derivative financial instruments
58

 

 
58

 

Deferred compensation plan assets
40

 
40

 

 

Total
$
795

 
$
296

 
$
499

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
$
21

 
$

 
$
21

 
$

 
 
 
Fair Value Measurements at Reporting Date Using
($ in millions)
October 29, 2016
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant  Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
596

 
$
106

 
$
490

 
$

Derivative financial instruments
62

 

 
62

 

Deferred compensation plan assets
41

 
41

 

 

Total
$
699

 
$
147

 
$
552

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
$
49

 
$

 
$
49

 
$

We have highly liquid investments classified as cash equivalents, which are placed primarily in time deposits and money market funds. We value these investments at their original purchase prices plus interest that has accrued at the stated rate.

7



Derivative financial instruments primarily include foreign exchange forward contracts. The currencies hedged against changes in the U.S. dollar are Canadian dollars, Japanese yen, British pounds, Euro, Mexican pesos, Chinese yuan, and Taiwan dollars. 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 and non-employee directors to defer compensation up to a maximum amount. Plan investments are directed by participants and are recorded at market value and 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.

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. The fair value of the long-lived assets is determined using level 3 inputs and based on discounted future cash flows of the asset or asset group using a discount rate commensurate with the risk. The asset group is defined as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of other groups of assets, which for our retail stores is primarily at the store level.
During the thirteen weeks ended October 28, 2017, we recorded a charge for the impairment of long-lived assets of $4 million, which reduced the then carrying amount of the applicable long-lived assets of $5 million to their fair value of $1 million. The impairment charge was recorded in operating expenses in the Condensed Consolidated Statement of Income.
During the thirty-nine weeks ended October 28, 2017, we recorded a charge for the impairment of long-lived assets of $17 million, which reduced the then carrying amount of the applicable long-lived assets of $18 million to their fair value of $1 million. The impairment charge was recorded in operating expenses in the Condensed Consolidated Statement of Income.
In May 2016, the Company announced measures to close its fleet of 53 Old Navy stores in Japan and select Banana Republic stores, primarily internationally. During the thirteen weeks ended October 29, 2016, we recorded charges for impairment of long-lived assets of $2 million related to the announced store closures, and an additional $31 million for long-lived assets that were unrelated to the announced measures. The impairment charges were recorded in operating expenses in the Condensed Consolidated Statement of Income and reduced the then carrying amount of the applicable long-lived assets of $34 million to their fair value of $1 million.
During the thirty-nine weeks ended October 29, 2016, we recorded charges for impairment of long-lived assets of $54 million related to the announced store closures, primarily related to Old Navy Japan, and an additional $35 million for long-lived assets that were unrelated to the announced measures. The impairment charges were recorded in operating expenses in the Condensed Consolidated Statement of Income and reduced the then carrying amount of the applicable long-lived assets of $102 million to their fair value of $13 million.
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 impairment charges recorded for goodwill or other indefinite-lived intangible assets for the thirteen and thirty-nine weeks ended October 28, 2017 or October 29, 2016.

Note 5. Derivative Financial Instruments
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations. We use derivative financial instruments to manage our exposure to foreign currency exchange rate risk and do not enter into derivative financial contracts for trading purposes. 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. These contracts are entered into with large, reputable financial institutions that are monitored for counterparty risk. The currencies hedged against changes in the U.S. dollar are Canadian dollars, Japanese yen, British pounds, Euro, Mexican pesos, Chinese yuan, and Taiwan dollars. Cash flows from derivative financial instruments are classified as cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows.


8



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 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. 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. The effective portion of the gain or loss on the derivative financial instruments is reported as a component of other comprehensive income and is recognized in income in the period in which the underlying transaction impacts the income statement.

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.

Other Derivatives Not Designated as Hedging Instruments
We enter into 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 that represent economic hedges, 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.


9



Outstanding Notional Amounts
We had foreign exchange forward contracts outstanding in the following notional amounts:
($ in millions)
October 28,
2017
 
January 28,
2017
 
October 29,
2016
Derivatives designated as cash flow hedges
$
873

 
$
1,101

 
$
1,201

Derivatives designated as net investment hedges
30

 
31

 
31

Derivatives not designated as hedging instruments
581

 
618

 
664

Total
$
1,484

 
$
1,750

 
$
1,896


Quantitative Disclosures about Derivative Financial Instruments
The fair values of foreign exchange forward contracts are as follows:
($ in millions)
October 28,
2017
 
January 28,
2017
 
October 29,
2016
Derivatives designated as cash flow hedges:
 
 
 
 
 
Other current assets
$
16

 
$
28

 
$
35

Other long-term assets
$
4

 
$
16

 
$
13

Accrued expenses and other current liabilities
$
11

 
$
10

 
$
26

Lease incentives and other long-term liabilities
$
2

 
$
1

 
$
8

 
 
 
 
 
 
Derivatives designated as net investment hedges:
 
 
 
 
 
Other current assets
$

 
$

 
$
1

Other long-term assets
$

 
$

 
$

Accrued expenses and other current liabilities
$
2

 
$

 
$

Lease incentives and other long-term liabilities
$

 
$

 
$

 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
Other current assets
$
11

 
$
13

 
$
13

Other long-term assets
$

 
$
1

 
$

Accrued expenses and other current liabilities
$
5

 
$
10

 
$
14

Lease incentives and other long-term liabilities
$

 
$

 
$
1

 
 
 
 
 
 
Total derivatives in an asset position
$
31

 
$
58

 
$
62

Total derivatives in a liability position
$
20

 
$
21

 
$
49

The majority of the unrealized gains and losses from designated cash flow hedges as of October 28, 2017 will be recognized in income within the next 12 months at the then-current values, which may differ from the fair values as of October 28, 2017 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 $8 million, $18 million, and $9 million as of October 28, 2017January 28, 2017, and October 29, 2016, respectively. If we did elect to offset, the net amounts of our derivative financial instruments in an asset position would be $23 million, $40 million, and $53 million and the net amounts of the derivative financial instruments in a liability position would be $12 million, $3 million, and $40 million as of October 28, 2017, January 28, 2017 and October 29, 2016, respectively.
See Note 4 of Notes to Condensed Consolidated Financial Statements for disclosures on the fair value measurements of our derivative financial instruments.

10



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)
October 28,
2017

October 29,
2016

October 28,
2017

October 29,
2016
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Gain (loss) recognized in other comprehensive income
$
25

 
$
43

 
$
(26
)
 
$
(62
)
Gain (loss) reclassified into cost of goods sold and occupancy expenses
$
(5
)
 
$
2

 
$
2

 
$
15

Loss reclassified into operating expenses
$

 
$
(2
)
 
$

 
$
(10
)
 
 
 
 
 
 
 
 
Derivatives in net investment hedging relationships:
 
 
 
 
 
 
 
Gain (loss) recognized in other comprehensive income
$
1

 
$
1

 
$
(1
)
 
$
(1
)
For the thirteen and thirty-nine weeks ended October 28, 2017 and October 29, 2016, there were no amounts of gains or losses reclassified from accumulated other comprehensive income into net 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)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Gain (loss) recognized in operating expenses
$
10

 
$
12

 
$
(13
)
 
$
(5
)

Note 6. Share Repurchases
Share repurchase activity is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
($ and shares in millions except average per share cost)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Number of shares repurchased (1)
3.8

 

 
12.5

 

Total cost
$
100

 
$

 
$
300

 
$

Average per share cost including commissions
$
26.64

 
$

 
$
24.21

 
$

__________
(1)
Excludes shares withheld to settle employee statutory tax withholding related to the vesting of stock units.
In February 2016, we announced that the Board of Directors approved a $1.0 billion share repurchase authorization, of which $700 million was remaining as of October 28, 2017.
All of the share repurchases were paid for as of October 28, 2017. All common stock repurchased is immediately retired.


11



Note 7. 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 January 28, 2017
$
29

 
$
25

 
$
54

13 Weeks Ended April 29, 2017:
 
 
 
 
 
Foreign currency translation
(4
)
 

 
(4
)
Change in fair value of derivative financial instruments

 

 

Amounts reclassified from accumulated other comprehensive income

 
(4
)
 
(4
)
Other comprehensive loss, net of tax
(4
)
 
(4
)
 
(8
)
Balance at April 29, 2017
25

 
21

 
46

13 Weeks Ended July 29, 2017:
 
 
 
 
 
Foreign currency translation
21

 

 
21

Change in fair value of derivative financial instruments

 
(43
)
 
(43
)
Amounts reclassified from accumulated other comprehensive income

 
(1
)
 
(1
)
Other comprehensive income (loss), net of tax
21

 
(44
)
 
(23
)
Balance at July 29, 2017
46

 
(23
)
 
23

13 Weeks Ended October 28, 2017:
 
 
 
 
 
Foreign currency translation
(5
)
 

 
(5
)
Change in fair value of derivative financial instruments

 
23

 
23

Amounts reclassified from accumulated other comprehensive income

 
(1
)
 
(1
)
Other comprehensive income (loss), net of tax
(5
)
 
22

 
17

Balance at October 28, 2017
$
41

 
$
(1
)
 
$
40

 
 
 
 
 
 
($ in millions)
Foreign Currency Translation
 
Cash Flow Hedges
 
Total
Balance at January 30, 2016
$
22

 
$
63

 
$
85

13 Weeks Ended April 30, 2016:
 
 
 
 
 
Foreign currency translation
31

 

 
31

Change in fair value of derivative financial instruments

 
(89
)
 
(89
)
Amounts reclassified from accumulated other comprehensive income

 
(7
)
 
(7
)
Other comprehensive income (loss), net of tax
31

 
(96
)
 
(65
)
Balance at April 30, 2016
53

 
(33
)
 
20

13 Weeks Ended July 30, 2016:
 
 
 
 
 
Foreign currency translation
(22
)
 

 
(22
)
Change in fair value of derivative financial instruments

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

 
8

 
8

Other comprehensive income (loss), net of tax
(22
)
 
1

 
(21
)
Balance at July 30, 2016
31

 
(32
)
 
(1
)
13 Weeks Ended October 29, 2016:
 
 
 
 
 
Foreign currency translation
(10
)
 

 
(10
)
Change in fair value of derivative financial instruments

 
39

 
39

Amounts reclassified from accumulated other comprehensive income

 

 

Other comprehensive income (loss), net of tax
(10
)
 
39

 
29

Balance at October 29, 2016
$
21

 
$
7

 
$
28

See Note 5 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 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)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Stock units
$
14

 
$
14

 
$
47

 
$
43

Stock options
3

 
4

 
10

 
9

Employee stock purchase plan
1

 
1

 
3

 
3

Share-based compensation expense
18

 
19

 
60

 
55

Less: Income tax benefit
(7
)
 
(8
)
 
(23
)
 
(25
)
Share-based compensation expense, net of tax
$
11

 
$
11

 
$
37

 
$
30


Note 9. Income Taxes
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, the United Kingdom, China, Hong Kong, Japan, and India. 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 is in continual discussions with taxing authorities regarding tax matters in the various U.S. and foreign jurisdictions in the normal course of business. As of October 28, 2017, it is reasonably possible that we will recognize a decrease in gross unrecognized tax benefits within the next 12 months of up to $6 million, primarily due to 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.

Note 10. 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)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Weighted-average number of shares - basic
391

 
399

 
395

 
398

Common stock equivalents
2

 
1

 
2

 
2

Weighted-average number of shares - diluted
393

 
400

 
397

 
400

The above computations of weighted-average number of shares – diluted exclude 9 million and 8 million shares related to stock options and other stock awards for the thirteen weeks ended October 28, 2017 and October 29, 2016, respectively, and 9 million and 7 million shares related to stock options and other stock awards for the thirty-nine weeks ended October 28, 2017 and October 29, 2016, respectively, as their inclusion would have an anti-dilutive effect on earnings per share.

Note 11. 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.

13



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 October 28, 2017, 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 October 28, 2017January 28, 2017, and October 29, 2016, 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 October 28, 2017January 28, 2017, and October 29, 2016 was not material for any individual Action or in total. Subsequent to October 28, 2017 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.
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.
Fire at the Fishkill Distribution Center
On August 29, 2016, a fire occurred in one of the buildings at a Company-owned distribution center campus in Fishkill, New York. The impacted building primarily held Gap and Banana Republic products for distribution to stores and fulfilled online orders for Gap and Old Navy in the Northeast region of the United States.
The Company maintains property and business interruption insurance coverage. Based on the provisions of the Company’s insurance policies, the Company recorded insurance recoveries based on the determination that recovery of certain fire-related costs is probable. During fiscal 2016, the Company incurred a total of $133 million in certain fire-related costs. In January of fiscal 2016, the Company agreed upon a partial settlement of $159 million related to the loss on inventory and recorded a gain of $73 million, representing the excess over the loss on inventory, which was recorded in operating expenses in the Consolidated Statement of Income. During fiscal 2016, the Company received $174 million of insurance proceeds. As a result, the insurance receivable balance was $32 million as of January 28, 2017 and was recorded in other current assets in the Consolidated Balance Sheet.

During the thirteen and thirty-nine weeks ended October 28, 2017, the Company incurred immaterial costs and $15 million, respectively, in certain fire-related costs for which the Company recorded insurance recoveries based on the determination that recovery of these fire-related costs is probable. In June 2017, the Company also agreed upon a partial settlement and recorded a gain of $64 million, primarily related to property and equipment, representing the excess over the loss on fire-related recoverable costs, which was recorded in operating expenses in the Condensed Consolidated Statement of Income.

The Company received $29 million and $131 million of insurance proceeds during the thirteen and thirty-nine weeks ended October 28, 2017, respectively. Included in the $29 million was $20 million in insurance proceeds related to business interruption, which were recorded as a reduction to cost of goods sold and occupancy expenses in the Condensed Consolidated Statement of Income. The remaining $9 million and $111 million of insurance proceeds received during the thirteen and thirty-nine weeks ended October 28, 2017, respectively, were recorded as a reduction to the insurance receivable balance. As a result, the insurance proceeds received in excess of expected recoveries was less than $1 million as of October 28, 2017.

We will continue to incur additional logistics costs related to the disruption to our North American supply chain network. As settlements are reached, any recoveries related to business interruption insurance will be recognized as a reduction to cost of goods sold and occupancy expenses in the Condensed Consolidated Statements of Income.
During the thirty-nine weeks ended October 28, 2017, we allocated $60 million of insurance proceeds to the loss on property and equipment based on the partial settlement of claims reported as insurance proceeds related to loss on property and equipment, a component of cash flows from investing activities, in the Condensed Consolidated Statement of Cash Flows.

Note 12. Segment Information
The Gap, Inc. is a global retailer that sells apparel, accessories, and personal care products under the Gap, Old Navy, Banana Republic, Athleta, Intermix, and Weddington Way brands. We identify our operating segments according to how our business activities are managed and evaluated. As of October 28, 2017, our operating segments included Gap Global, Old Navy Global, Banana Republic Global, Athleta, and Intermix. We have determined that each of our operating segments share similar economic and other qualitative characteristics, and therefore the results of our operating segments are aggregated into one reportable segment as of October 28, 2017.

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 October 28, 2017
 
 
 
 
 
 
U.S. (1)
 
$
750

 
$
1,587

 
$
467

 
$
200

 
$
3,004

 
79
%
Canada
 
109

 
143

 
57

 
1

 
310

 
8

Europe
 
154

 

 
4

 

 
158

 
4

Asia
 
278

 
13

 
21

 

 
312

 
8

Other regions
 
31

 
15

 
8

 

 
54

 
1

Total
 
$
1,322

 
$
1,758

 
$
557

 
$
201

 
$
3,838

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (3)
 
Total
 
Percentage of Net Sales
13 Weeks Ended October 29, 2016
 
 
 
 
 
 
U.S. (1)
 
$
756

 
$
1,507

 
$
479

 
$
172

 
$
2,914

 
77
%
Canada
 
102

 
131

 
55

 
1

 
289

 
8

Europe
 
150

 

 
14

 

 
164

 
4

Asia
 
296

 
55

 
25

 

 
376

 
10

Other regions
 
36

 
12

 
7

 

 
55

 
1

Total
 
$
1,340

 
$
1,705

 
$
580

 
$
173

 
$
3,798

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (2)
 
Total
 
Percentage of Net Sales
39 Weeks Ended October 28, 2017
 
 
 
 
 
 
U.S. (1)
 
$
2,137

 
$
4,609

 
$
1,396

 
$
633

 
$
8,775

 
79
%
Canada
 
277

 
387

 
156

 
2

 
822

 
8

Europe
 
435

 

 
11

 

 
446

 
4

Asia
 
780

 
34

 
69

 

 
883

 
8

Other regions
 
83

 
47

 
21

 

 
151

 
1

Total
 
$
3,712

 
$
5,077

 
$
1,653

 
$
635

 
$
11,077

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Gap Global
 
Old Navy Global
 
Banana
Republic Global
 
Other (3)
 
Total
 
Percentage of Net Sales
39 Weeks Ended October 29, 2016
 
 
 
 
 
 
U.S. (1)
 
$
2,203

 
$
4,335

 
$
1,456

 
$
550

 
$
8,544

 
77
%
Canada
 
264

 
358

 
159

 
2

 
783

 
7

Europe
 
453

 

 
45

 

 
498

 
5

Asia
 
856

 
171

 
80

 

 
1,107

 
10

Other regions
 
100

 
32

 
23

 

 
155

 
1

Total
 
$
3,876

 
$
4,896

 
$
1,763

 
$
552

 
$
11,087

 
100
%
__________
(1)
U.S. includes the United States, Puerto Rico, and Guam.
(2)
Includes Athleta, Intermix, and Weddington Way.
(3)
Includes Athleta and Intermix.
Net sales by region are allocated based on the location of the store where the customer paid for and received the merchandise or the distribution center or store from which the products were shipped.

15



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, Athleta, Intermix, and Weddington Way brands. We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico. We have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic, and Old Navy stores throughout Asia, Australia, 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. Our products are also available to customers online through Company-owned websites and through the use of third parties that provide logistics and fulfillment services. In addition to operating in the specialty, outlet, online, and franchise channels, we also use our omni-channel capabilities to bridge the digital world and physical stores to further enhance our shopping experience for our customers. Our omni-channel services, including order-in-store, reserve-in-store, find-in-store, and ship-from-store, as well as enhanced mobile experiences, are tailored uniquely across our portfolio of brands. 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, primarily at our Intermix brand.
 
OVERVIEW
Results for the first three quarters of fiscal 2017 include a gain from insurance proceeds of $64 million related to the fire that occurred in one of the buildings at a Company-owned distribution center campus in Fishkill, New York on August 29, 2016 (“the Fishkill fire”), which was recorded in operating expenses in the Condensed Consolidated Statement of Income. During the third quarter of fiscal 2017, we also received $20 million in insurance proceeds related to business interruption, which were recorded as a reduction to cost of goods sold and occupancy expenses in the Condensed Consolidated Statement of Income. Fiscal 2016 results were impacted by the previously announced measures to better align talent and financial resources against our most important priorities to position the Company for improved business performance and long-term success. In connection with these measures, the Company incurred $29 million and $179 million in restructuring costs during the thirteen and thirty-nine weeks ended October 29, 2016, respectively, on a pre-tax basis.
Financial results for the third quarter of fiscal 2017 are as follows:
Net sales for the third quarter of fiscal 2017 increased 1 percent compared with the third quarter of fiscal 2016.
Comparable sales for the third quarter of fiscal 2017 increased 3 percent compared with a 3 percent decrease for the third quarter of fiscal 2016, which included an estimated negative impact from the Fishkill fire of approximately 2 percentage points.
Gross profit for the third quarter of fiscal 2017 and fiscal 2016 were $1.5 billion. Gross margin for the third quarter of fiscal 2017 was 39.7 percent compared with 39.3 percent for the third quarter of fiscal 2016.
Operating margin for the third quarter of fiscal 2017 was 9.8 percent compared with 10.2 percent for the third quarter of fiscal 2016.
Net income for the third quarter of fiscal 2017 was $229 million compared with $204 million for the third quarter of fiscal 2016.
Diluted earnings per share was $0.58 for the third quarter of fiscal 2017 compared with $0.51 for the third quarter of fiscal 2016. Diluted earnings per share for the third quarter of fiscal 2016 included about a $0.09 impact of restructuring costs incurred in the third quarter of fiscal 2016.
During the first three quarters of fiscal 2017, we distributed $572 million to shareholders through share repurchases and dividends.
Our business priorities for fiscal 2017 remain as follows:
offering product that is consistently brand-appropriate and on-trend with high customer acceptance, with a focus on expanding our advantage in loyalty categories;
investing in digital and customer capabilities to support growth;
creating a unique and differentiated customer experience that builds loyalty, with focus on both the physical and digital expressions of our brands;
attracting and retaining great talent in our businesses and functions; and
leveraging our scale to improve the effectiveness and efficiency of our processes.

16



In fiscal 2017, we are focused on investing strategically in the business while also maintaining operating expense discipline. One of our primary objectives is to continue transforming our product to market process, with the development of a more efficient operating model, allowing us to more fully leverage our scale. To enable this, we have several product, supply chain, and IT initiatives underway. Further, we expect to continue our investment in customer experience, both in stores and online, to drive higher customer engagement and loyalty, resulting in market share gains. Finally, we will continue to invest in strengthening brand awareness, customer acquisition, and digital capabilities.
In fiscal 2017, we expect that gross margins for our foreign subsidiaries, net of the impact from our merchandise hedge program, will continue to be negatively impacted by the depreciation of certain foreign currencies as our merchandise purchases are primarily in U.S. dollars.

RESULTS OF OPERATIONS
Net Sales
See Note 12 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q, for net sales by brand and region.

Comparable Sales (“Comp Sales”)
The percentage change in Comp Sales by global brand and for The Gap, Inc., as compared with the preceding year, is as follows:
 
13 Weeks Ended
 
39 Weeks Ended
 
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Gap Global
1
 %
 
(8
)%
 
(1
)%
 
(5
)%
Old Navy Global
4
 %
 
3
 %
 
5
 %
 
(1
)%
Banana Republic Global
(1
)%
 
(8
)%
 
(4
)%
 
(9
)%
The Gap, Inc.
3
 %
 
(3
)%
 
2
 %
 
(3
)%
Comp Sales for the third quarter of fiscal 2016 include an estimated negative impact from the Fishkill fire of approximately 4 percentage points for Gap Global, approximately 1 percentage point for Old Navy Global, and approximately 2 percentage points for Banana Republic Global.
Comp Sales include the results of Company-operated stores and sales through online channels in those countries where we have existing comparable store sales. The calculation of The Gap, Inc. Comp Sales includes the results of Athleta and Intermix but excludes the results of our franchise business.
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 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.
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 are as follows:
 
13 Weeks Ended
 
39 Weeks Ended
 
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Net sales per average square foot (1)
$
82

 
$
81

 
242

 
$
240

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


17



Store count, openings, closings, and square footage for our stores are as follows:
 
January 28, 2017
 
39 Weeks Ended October 28, 2017
 
October 28, 2017
 
Number of
Store Locations
 
Number of
Stores Opened
 
Number of
Stores Closed
 
Number of
Store Locations
 
Square Footage
(in millions)
Gap North America
844

 
6

 
15

 
835

 
8.6

Gap Asia
311

 
24

 
26

 
309

 
3.0

Gap Europe
164

 
2

 
9

 
157

 
1.3

Old Navy North America
1,043

 
20

 
6

 
1,057

 
17.6

Old Navy Asia
13

 

 

 
13

 
0.2

Banana Republic North America
601

 
4

 
9

 
596

 
5.0

Banana Republic Asia
48

 
1

 
1

 
48

 
0.2

Banana Republic Europe
1

 

 
1

 

 

Athleta North America
132

 
8

 

 
140

 
0.6

Intermix North America
43

 

 
5

 
38

 
0.1

Company-operated stores total
3,200

 
65

 
72

 
3,193

 
36.6

Franchise
459

 
31

 
44

 
446

 
 N/A

Total
3,659

 
96

 
116

 
3,639

 
36.6

Decrease over prior year
 
 
 
 
 
 
(2.8
)%
 
(2.9
)%
 
 
 
 
 
 
 
 
 
 
 
January 30, 2016
 
39 Weeks Ended October 29, 2016
 
October 29, 2016
 
Number of
Store Locations
 
Number of
Stores Opened
 
Number of
Stores Closed
 
Number of
Store Locations
 
Square Footage
(in millions)
Gap North America
866

 
11

 
19

 
858

 
9.0

Gap Asia
305

 
18

 
8

 
315

 
3.0

Gap Europe
175

 
1

 
10

 
166

 
1.4

Old Navy North America
1,030

 
19

 
10

 
1,039

 
17.4

Old Navy Asia
65

 
5

 
10

 
60

 
0.9

Banana Republic North America
612

 
7

 
7

 
612

 
5.1

Banana Republic Asia
51

 

 
2

 
49

 
0.2

Banana Republic Europe
10

 

 

 
10

 
0.1

Athleta North America
120

 
10

 

 
130

 
0.5

Intermix North America
41

 
2

 
1

 
42

 
0.1

Company-operated stores total
3,275

 
73

 
67

 
3,281

 
37.7

Franchise
446

 
52

 
37

 
461

 
N/A

Total
3,721

 
125

 
104

 
3,742

 
37.7

Decrease over prior year
 
 
 
 
 
 
(1.4
)%
 
(2.3
)%
Gap and Banana Republic outlet and factory stores are reflected in each of the respective brands.

Net Sales
Our net sales for the third quarter of fiscal 2017 increased $40 million, or 1 percent, compared with the third quarter of fiscal 2016 primarily driven by an increase in net sales at Old Navy, partially offset by a decrease in net sales at Gap and Banana Republic. The increase in Comp Sales of 3 percent for the third quarter of fiscal 2017 was offset by the impact of lost sales primarily from international store closures in fiscal 2016.
Our net sales for the first three quarters of fiscal 2017 decreased $10 million compared with the first three quarters of fiscal 2016 primarily driven by a decrease in net sales at Gap and Banana Republic, as well as an unfavorable impact of foreign exchange of $49 million, partially offset by an increase in net sales at Old Navy. The unfavorable impact of foreign exchange was primarily due to the weakening of the Japanese yen, British pound, and Chinese yuan against the U.S. dollar. The foreign exchange impact is the translation impact if net sales for the first three quarters of fiscal 2016 were translated at exchange rates applicable during the first three quarters of fiscal 2017. The increase in Comp Sales of 2 percent for the first three quarters of fiscal 2017 was offset by the impact of lost sales primarily from international store closures in fiscal 2016.


18



Cost of Goods Sold and Occupancy Expenses
  
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Cost of goods sold and occupancy expenses
$
2,313

 
$
2,305

 
$
6,770

 
$
6,948

Gross profit
$
1,525

 
$
1,493

 
$
4,307

 
$
4,139

Cost of goods sold and occupancy expenses as a percentage of net sales
60.3
%
 
60.7
%
 
61.1
%
 
62.7
%
Gross margin
39.7
%
 
39.3
%
 
38.9
%
 
37.3
%
Cost of goods sold and occupancy expenses decreased 0.4 percent as a percentage of net sales in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016.
Cost of goods sold was flat as a percentage of net sales in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016, primarily driven by improved average selling price per unit at Old Navy and Banana Republic, offset by higher average unit cost at all global brands.
Occupancy expenses decreased 0.4 percent as a percentage of net sales in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016, primarily driven by an increase in online sales without a corresponding increase in occupancy expenses and the closure of international stores in fiscal 2016, partially offset by real estate expenses for new stores at the Times Square, New York location for Gap and Old Navy.
Cost of goods sold and occupancy expenses decreased 1.6 percent as a percentage of net sales during the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016.
Cost of goods sold decreased 1.2 percent as a percentage of net sales during the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016, primarily driven by higher margins achieved as a result of improved average selling price per unit at all global brands, partially offset by higher average unit cost at all global brands.
Occupancy expenses decreased 0.4 percent as a percentage of net sales during the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016, primarily driven by an increase in online sales without a corresponding increase in occupancy expenses and the closure of international stores in fiscal 2016, partially offset by real estate expenses incurred for new stores at the Times Square, New York location for Gap and Old Navy.

Operating Expenses
  
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Operating expenses
$
1,147

 
$
1,104

 
$
3,224

 
$
3,249

Operating expenses as a percentage of net sales
29.9
%
 
29.1
%
 
29.1
%
 
29.3
%
Operating margin
9.8
%
 
10.2
%
 
9.8
%
 
8.0
%
Operating expenses increased $43 million, or 0.8 percent as a percentage of net sales, in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016. The increase in operating expenses for the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016 was primarily due to the following:
an increase in payroll-related expenses primarily driven by an increase in bonus expense; and
an increase in marketing and investments in digital and customer initiatives; partially offset by
$36 million of restructuring costs incurred in the third quarter of fiscal 2016; and
a decrease of $27 million of store asset impairment charges unrelated to restructuring activities.
Operating expenses decreased $25 million, or 0.2 percent as a percentage of net sales, during the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016. The decrease in operating expenses for the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016 was primarily due to the following:
$171 million of restructuring costs incurred during the first three quarters of fiscal 2016;
a gain from insurance proceeds of $64 million related to the Fishkill fire recorded in the second quarter of fiscal 2017; and
a decrease of $18 million of store asset impairment charges unrelated to restructuring activities; partially offset by
an increase in payroll-related expenses primarily driven by an increase in bonus expense; and
an increase in marketing and investments in digital and customer initiatives.

19




Interest Expense
  
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Interest expense
$
18

 
$
20

 
$
53

 
$
57

Interest expense for the third quarter and the first three quarters of fiscal 2017 and fiscal 2016 primarily includes interest on overall borrowings and obligations mainly related to our $1.25 billion 5.95 percent Notes.

Income Taxes
  
13 Weeks Ended
 
39 Weeks Ended
($ in millions)
October 28,
2017
 
October 29,
2016
 
October 28,
2017
 
October 29,
2016
Income taxes
$
135

 
$
168

 
$
398

 
$
383

Effective tax rate
37.1
%
 
45.2
%
 
38.2
%
 
45.6
%
The decrease in the effective tax rate for the third quarter and first three quarters of fiscal 2017 compared with the third quarter and first three quarters of fiscal 2016 was primarily due to the impact of restructuring costs incurred for foreign subsidiaries during the third quarter of fiscal 2016 and resulting valuation allowances on certain foreign deferred tax assets. The decrease in the effective tax rate for the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016 was partially offset by the impact of the adoption of ASU No. 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting in fiscal 2017. See Note 2 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for additional disclosures on the adoption of the accounting standard.

LIQUIDITY AND CAPITAL RESOURCES
Our largest source of cash flows is cash collections from the sale of our merchandise. Our primary uses of cash include merchandise inventory purchases, occupancy costs, personnel-related expenses, purchases of property and equipment, and payment of taxes. In addition, we may have dividend payments, debt repayments, and share repurchases. As of October 28, 2017, cash and cash equivalents were $1.4 billion, the majority of which was held in the United States and is generally accessible without any limitations.
We believe that current cash balances and cash flows from our operations will be sufficient to support our business operations, including growth initiatives and planned capital expenditures, for the next 12 months and beyond. We are also able to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility or other available market instruments.

Cash Flows from Operating Activities
Net cash provided by operating activities during the first three quarters of fiscal 2017 decreased $200 million compared with the first three quarters of fiscal 2016, primarily due to the following:
Net income
an increase of $187 million in net income.
Non-cash items
a decrease of $72 million related to store asset impairment charges during the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016 primarily due to restructuring activities in fiscal 2016.
Changes in operating assets and liabilities
a decrease of $239 million related to accounts payable primarily due to the timing of lease payments and other non-merchandise payables;
a decrease of $123 million related to merchandise inventory primarily due to the volume and timing of receipts; and
a decrease of $56 million related to accrued expenses and other current liabilities in part due to the timing of severance payments as a result of fiscal 2016 restructuring activities; partially offset by
an increase of $108 million related to income taxes payable, net of prepaid and other tax-related items, primarily due to an increase in taxable income during the first three quarters of fiscal 2017 compared with the first three quarters of fiscal 2016 as well as the timing of tax payments.
We fund inventory expenditures during normal and peak periods through cash flows from operating activities and available cash. Our business follows a seasonal pattern, with sales peaking during the end-of-year holiday period. The seasonality of our operations may lead to significant fluctuations in certain asset and liability accounts between fiscal year-end and subsequent interim periods.