The Gap, Inc. — Form 10-Q Summary
Period note: The request identifies “2017 Q2,” but the filing is for the 13 and 26 weeks ended August 4, 2018 (fiscal 2018 second quarter and first half), compared primarily with periods ended July 29, 2017.
Business context and reporting period
Gap is a global apparel retailer operating Old Navy, Gap, Banana Republic, Athleta, and Intermix through stores, online channels, and franchise arrangements. The company reported one aggregated reportable segment. Financial statements are unaudited; the interim results are not necessarily indicative of full-year results.
Financial results and liquidity
- Second quarter: Net sales were $4.085 billion, up 8% reported; comparable sales rose 2%. Gross profit was $1.627 billion and gross margin was 39.8%, versus 38.9% a year earlier. Operating income was $398 million, with a 9.7% operating margin, versus $451 million and 11.9%. Net income was $297 million versus $271 million; diluted EPS was $0.76 versus $0.68.
- First half: Net sales were $7.868 billion, up 9% reported; comparable sales increased 1%. Operating income was $627 million versus $705 million; net income was $461 million versus $414 million. Diluted EPS was $1.18 versus $1.04. Gross margin was 38.8% versus 38.4%; operating margin was 8.0% versus 9.7%.
- Cash flow, first half: Operating cash flow was $546 million, compared with $486 million. Capital expenditures were $326 million versus $275 million; reported free cash flow, a non-GAAP measure, was $220 million versus $270 million. Cash, cash equivalents, and restricted cash declined $459 million to $1.340 billion. The company also held $286 million of short-term investments.
- Balance sheet at August 4: Current assets were $4.590 billion and current liabilities $2.341 billion. Long-term debt was $1.249 billion, consisting principally of $1.25 billion of 5.95% notes due April 2021. No borrowings were outstanding under the $500 million revolving facility.
- Shareholder returns: First-half repurchases were $200 million and dividends paid were $188 million; together, $388 million was distributed. The company stated its intention to pay $0.97 per share in dividends for fiscal 2018, versus $0.92 in fiscal 2017.
Material changes and comparability
- Adoption of ASC 606 increased reported net sales by $139 million in the quarter and $279 million in the first half, primarily from reclassifying credit-card revenue sharing, gift-card and credit-voucher breakage, and loyalty-discount reimbursements previously recorded as reductions to expenses. Prior periods were not restated; management said adoption did not significantly affect first-half net income.
- Second-quarter sales growth was attributed to Old Navy comparable-sales growth, new stores, and the ASC 606 presentation changes. First-half sales growth also reflected a $65 million favorable foreign-exchange translation impact.
- Operating margin comparisons were affected by a $64 million insurance gain recorded in the prior-year quarter for the Fishkill distribution-center fire. The current quarter also had higher operating expenses, including payroll and benefits costs.
- The effective tax rate declined to 23.5% for the quarter and 24.1% for the first half, from 38.3% and 38.8%, respectively, primarily following the U.S. federal tax-rate reduction under the Tax Cuts and Jobs Act.
Outlook, commentary, and risks
Management provided no specific earnings or sales guidance in this filing. It said existing cash and operating cash flows should support operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond, with the revolving facility or other market instruments available if needed. Priorities include improving product execution, investing in digital and customer capabilities, enhancing the combined store-and-digital experience, and increasing productivity while maintaining expense discipline.
Key disclosed risks include changing apparel trends and consumer preferences, competition, inventory management and margin pressure, the effectiveness of digital and omnichannel investments, cybersecurity and IT disruptions, trade and global sourcing exposure, foreign-exchange fluctuations, and potential effects of economic conditions. The company also faces ordinary-course legal claims, including commercial, intellectual-property, customer, employment, and data-privacy matters; it reported no material aggregate litigation liability and did not expect current actions to materially affect results. It made immaterial adjustments to its provisional $57 million fiscal 2017 TCJA charge and expected to complete the related accounting during fiscal 2018. Lease accounting changes expected to be adopted in fiscal 2019 are expected to materially increase reported long-term assets and liabilities.
Most important facts for investors to verify
- Assess underlying sales and margin trends separately from the $139 million quarterly and $279 million first-half ASC 606 revenue presentation increases; comparative periods were not restated.
- Evaluate operating performance in light of the prior-year $64 million Fishkill insurance gain and the current period’s higher operating expenses.
- Track brand-level comparable sales: second-quarter Old Navy was up 5%, Gap down 5%, and Banana Republic up 2%.
- Monitor inventory, which was $2.202 billion at quarter-end, and the impact of online shipping costs, Gap product margins, and inventory write-offs.
- Confirm execution of the stated fiscal 2018 dividend plan, capital spending, repurchases, and liquidity expectations; these are forward-looking statements, not guarantees.