Business context and reporting period
The Gap, Inc. is a global apparel retailer operating Old Navy, Gap, Banana Republic, Athleta, Intermix, Janie and Jack, and Hill City, through stores, online channels, and franchises. Although the request labels this as 2018 Q1, the filing is for the 13 weeks ended May 4, 2019, compared with the 13 weeks ended May 5, 2018.
Financial performance and position
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Net sales | $3.706 billion | $3.783 billion |
| Gross profit / margin | $1.344 billion / 36.3% | $1.427 billion / 37.7% |
| Operating income / margin | $316 million / 8.5% | $229 million / 6.1% |
| Net income | $227 million | $164 million |
| Diluted EPS | $0.60 | $0.42 |
| Operating cash flow | $29 million | $(66) million |
| Capital expenditures | $165 million | $138 million |
| Free cash flow (non-GAAP) | $(136) million | $(204) million |
- Comparable sales fell 4%, versus a 1% increase a year earlier: Old Navy declined 1%, Gap declined 10%, and Banana Republic declined 3%.
- Cash and cash equivalents were $941 million and short-term investments were $272 million at May 4, 2019. Cash, cash equivalents, and restricted cash totaled $958 million.
- Long-term debt was $1.249 billion. The company also reported $6.526 billion of operating lease liabilities after adopting the new lease standard. Its $500 million revolving facility had no borrowings.
- Quarterly dividends were $0.2425 per share; the company repurchased $50 million of stock.
Material changes versus the prior comparable period
- Sales declined $77 million, or 2%; foreign currency translation reduced sales by $34 million. Gap Global was the main source of the decline, partly offset by Old Navy growth.
- Gross margin contracted 1.4 percentage points, primarily from increased promotional activity and lower sales relative to occupancy costs.
- Reported operating income and net income rose, but results included a $191 million pre-tax gain on a building sale. Management said the gain increased operating margin by approximately 5 percentage points and diluted EPS by about $0.37.
- Operating cash flow improved by $95 million, largely because of a lower bonus payout compared with the prior-year quarter.
- Share repurchases decreased to $50 million from $100 million. The company adopted ASC 842, recording $5.7 billion of lease assets and $6.6 billion of lease liabilities at adoption, and an $86 million after-tax reduction to opening retained earnings.
Outlook, management commentary, and risks
- No earnings or sales guidance for the remainder of fiscal 2019 is provided. Management said cash balances and operating cash flows should support operations, restructuring, growth initiatives, and planned capital spending for the next 12 months and beyond; the revolver or other market instruments could supplement liquidity if needed.
- The company plans to separate Old Navy from the remaining brands, targeting completion in 2020, subject to conditions including board approval, a tax opinion, and an effective SEC registration statement. Separation-related costs were $4 million pre-tax this quarter.
- Gap plans to close approximately 230 specialty stores during fiscal 2019 and 2020. Estimated pre-tax costs are $250 million to $300 million, mostly lease-related cash costs; estimated annualized sales loss is $625 million, with annualized pre-tax savings of about $90 million. The quarter included $1 million of related costs.
- The company acquired select Janie and Jack assets for $69 million; results since acquisition were not material. It also purchased a building for $343 million and sold another for $220 million as part of a tax exchange, recognizing the $191 million gain noted above.
- Management described the retail environment as challenging and highlighted product relevance, customer experience, digital investment, productivity, and preparing for the separation as priorities. Key risks include execution and benefits of the separation and store closures, changing consumer preferences, competition, inventory and margin management, cybersecurity and IT disruption, sourcing and trade issues, foreign exchange, and litigation.
- Management intends to pay $0.97 per share in dividends for fiscal 2019, subject to its consideration of sustainability, performance, liquidity, and market conditions.
Important facts for investors to verify
- Whether sales, comparable sales, and gross margin stabilize, particularly at Gap Global.
- How much of reported earnings reflects the building-sale gain versus recurring operations.
- Progress, costs, timing, and expected benefits of the proposed separation and Gap store closures.
- Cash generation after capital spending, liquidity needs, and the obligations associated with the newly recognized operating leases.
- Whether the planned dividend and share repurchases remain consistent with operating cash flow and investment requirements.