Macy's, Inc. quarterly report, Q1 FY2018

Macy’s, Inc. Form 10-Q Summary

Reporting period: The provided filing is for the 13 weeks ended May 5, 2018, compared with the 13 weeks ended April 29, 2017. Although the request metadata identifies “2017 Q1,” the filing itself is the first quarter of fiscal 2018.

Business Context

Macy’s is an omnichannel retailer operating approximately 850 Macy’s, Bloomingdale’s, bluemercury, Backstage and STORY locations, along with related websites and mobile applications. The company operates in 44 states, the District of Columbia, Guam and Puerto Rico. Retail performance is seasonal, and first-quarter results exclude the important holiday period.

Strategic initiatives included expanding Macy’s Backstage, investing in Growth50 stores, improving digital and fulfillment capabilities, expanding bluemercury and adding tender-neutral rewards to the Star Rewards program.
During the quarter, Macy’s acquired STORY and agreed to end its joint venture with Fung Retailing Limited while retaining its Alibaba TMall and social-media presence in China.

Financial Performance and Key Metrics

Metric	Q1 2018	Q1 2017	Change
Net sales	$5.541 billion	$5.350 billion	Up 3.6%
Credit card revenues, net	$157 million	$161 million	Down $4 million
Operating income	$238 million	$219 million	Up $19 million
Operating margin	4.3%	4.1%	Up 20 basis points
Net income attributable to Macy’s shareholders	$139 million	$78 million	Up $61 million
Diluted EPS	$0.45	$0.26	Up $0.19
Net cash from operating activities	$322 million	$237 million	Up $85 million

Comparable sales increased 3.9% on an owned basis and 4.2% on an owned-plus-licensed basis. Excluding a roughly 250-basis-point timing benefit from the Spring Friends and Family promotion, owned-plus-licensed comparable sales increased an estimated 1.7%.
Cost of sales declined to 61.0% of net sales from 61.7%, reflecting fresher inventory and lower markdowns. The implied gross margin increased to approximately 39.0% from 38.3%.
SG&A increased 1.3% to $2.083 billion, but declined to 37.6% of sales from 38.5%, despite investments in Growth50 stores, digital operations, Backstage, bluemercury and employee incentives.
Real estate gains were $24 million versus $68 million in the prior-year quarter. Q1 2018 also included $19 million of impairment and other costs associated with winding down Macy’s China Limited.
Interest expense declined to $71 million from $86 million, while net interest expense declined by $18 million according to management, primarily because debt was reduced from approximately $6.7 billion to $5.9 billion.
The effective tax rate was 28.4%, compared with 46.9%, benefiting from U.S. federal tax reform and other tax items.

Liquidity, Cash Flow and Capital Structure

Cash and cash equivalents were $1.531 billion at May 5, 2018, compared with $1.455 billion at February 3, 2018 and $1.201 billion at April 29, 2017. Cash, cash equivalents and restricted cash totaled $1.580 billion at quarter-end.
Net cash used in investing activities was $156 million, including $132 million of property and equipment purchases and $58 million of capitalized software, partially offset by $23 million of asset-disposition proceeds.
Net cash used in financing activities was $99 million, including $116 million of dividends and $3 million of debt repayments. No debt repurchases occurred during the quarter.
Short-term debt was $25 million and long-term debt was $5.857 billion at May 5, 2018, compared with total debt of approximately $6.7 billion at the end of the prior-year quarter.
The company had no borrowings or letters of credit outstanding under its $1.5 billion revolving credit facility and no borrowings under its $1.5 billion commercial paper program. The facility expires May 6, 2021.
The company reported an interest coverage ratio of 9.59 against a minimum requirement of 3.25 and a leverage ratio of 2.02 against a maximum requirement of 3.75.
Management stated that cash on hand, operating cash flow, available credit and other resources should be sufficient for foreseeable working capital, capital expenditures, debt service and other cash needs.

Material Changes Versus the Prior Comparable Period

Sales and comparable sales improved substantially, supported by strong digital performance, increased international tourism and strength in fine jewelry, fragrances, men’s tailored clothing, dresses, children’s, active and home categories.
Profitability improved despite lower real estate gains and new China wind-down charges. Shareholder net income rose 78%, and diluted EPS rose 73%.
Operating leverage improved through lower cost-of-sales and SG&A rates, while debt reduction lowered interest expense.
Operating cash flow increased 36%, although investing outflows were higher because the prior-year period benefited from substantially greater real estate-sale proceeds.
Inventory declined to $5.291 billion from $5.626 billion year over year, while merchandise accounts payable increased to $2.045 billion from $2.028 billion.
The company adopted ASC Topic 606, the new revenue standard, retrospectively. Management said the overall effect on operations and financial position was not material, although presentation and timing of certain revenue items changed. The company also adopted new pension-cost and restricted-cash presentation standards and reclassified $164 million of stranded tax effects to retained earnings.

Guidance, Outlook, Commentary and Risks

On May 16, 2018, Macy’s raised fiscal 2018 adjusted diluted EPS guidance by $0.20 to $3.75–$3.95, excluding anticipated defined-benefit-plan settlement charges and impairment and other costs.
Fiscal 2018 total sales were expected to range from a 1.0% decline to a 0.5% increase. Owned-plus-licensed comparable sales were expected to increase 1%–2%; owned comparable sales were expected to be 20–30 basis points lower.
Management expected approximately 40 additional Backstage locations inside Macy’s stores in the second quarter and approximately 100 total Backstage openings during fiscal 2018. It also expected 23 additional freestanding bluemercury locations later in the year.
Key risks include intense competition across physical and online retail, changes in consumer spending and confidence, weather and natural disasters, execution of strategic initiatives, cybersecurity and systems failures, employee-benefit costs, real estate transactions, foreign sourcing and supply-chain disruptions, currency and interest-rate movements, tariffs and geopolitical conditions.
The company expects the lease standard effective February 3, 2019 to have a material impact, primarily by recognizing operating lease right-of-use assets and liabilities on the balance sheet. The adoption method had not yet been selected.
Legal proceedings were described as incidental to the normal course of business and not expected to have a material adverse effect. No material changes to previously disclosed risk factors or market risk were reported.

Important Facts for Investors to Verify

Confirm that fiscal 2018 comparable-sales growth is sustainable after removing the approximately 250-basis-point promotional timing benefit.
Track whether the improved merchandise margin and lower SG&A rate persist as Backstage, Growth50, digital and bluemercury investments expand.
Assess the quality and repeatability of earnings excluding real estate gains, China wind-down costs and other unusual items.
Monitor debt reduction, interest coverage, leverage and the company’s capacity to maintain dividends and potentially repurchase securities.
Evaluate the effect of the new lease standard on reported assets, liabilities, leverage and future real estate-sale gains.
Verify the execution and returns associated with Backstage expansion, Growth50 stores, vendor-direct fulfillment, bluemercury expansion and digital initiatives.