The Gap, Inc. — Form 10-Q Summary
Period clarification: The request metadata says “2017 Q3,” but the supplied filing is for the thirteen and thirty-nine weeks ended November 3, 2018 (fiscal 2018 Q3), compared with October 28, 2017. The filing was signed November 30, 2018. Dollar amounts below are in millions unless otherwise stated.
Business context and reporting period
Gap is a global apparel retailer operating Old Navy, Gap, Banana Republic, Athleta, Intermix, and Hill City through company-operated stores, online channels, and franchisees. It reported one aggregated reportable segment. Results are unaudited interim figures; management cautions that they are not necessarily indicative of the full fiscal year.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | 39 weeks FY2018 | 39 weeks FY2017 |
|---|---|---|---|---|
| Net sales | $4,089 | $3,838 | $11,957 | $11,077 |
| Gross profit | $1,623 | $1,525 | $4,677 | $4,307 |
| Gross margin | 39.7% | 39.7% | 39.1% | 38.9% |
| Operating income | $363 | $378 | $990 | $1,083 |
| Operating margin | 8.9% | 9.8% | 8.3% | 9.8% |
| Net income | $266 | $229 | $727 | $643 |
| Diluted EPS | $0.69 | $0.58 | $1.86 | $1.62 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $567 | $600 |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $510 | $463 |
| Free cash flow | Not provided for quarter | Not provided for quarter | $57 | $197 |
Q3 comparable sales were flat versus 3% growth a year earlier: Old Navy Global +4%, Gap Global −7%, and Banana Republic Global +2%. For the first 39 weeks, company comparable sales increased 1%, compared with 2% growth in the prior-year period.
At November 3, 2018, cash and cash equivalents were $958, short-term investments $296, and total cash, cash equivalents, and short-term investments approximately $1.3 billion. Long-term debt was $1,249, primarily the $1.25 billion notes due April 2021 with a 5.95% coupon. The $500 million revolving facility had no borrowings. Current assets were $4,714 and current liabilities $2,393.
For the first 39 weeks, the company paid $281 in dividends and repurchased $300 of stock; it distributed $581 to shareholders in total. The remaining share-repurchase authorization was $385. Management intended to pay a fiscal 2018 annual dividend of $0.97 per share, subject to its stated considerations.
Changes versus the prior comparable period
- Reported Q3 sales rose 7% and 39-week sales rose 8%; however, ASC 606 adoption increased reported sales by $170 in Q3 and $449 for the 39-week period through reclassification of credit-card revenue sharing, loyalty-discount reimbursements, and gift-card and voucher breakage. Prior-period figures were not restated, and management said adoption did not significantly affect net income.
- Q3 net income increased to $266 from $229, despite operating income declining to $363 from $378. The lower effective tax rate, 24.0% versus 37.1%, contributed to the net-income increase; the filing attributes the lower rate principally to U.S. tax reform and adjustments to prior provisional estimates.
- Operating margin declined to 8.9% from 9.8% in Q3 and to 8.3% from 9.8% for 39 weeks. Management cited expense growth, including payroll and benefits; for the year-to-date comparison, the prior year also included a $64 insurance-related gain tied to the Fishkill distribution-center fire.
- Gross margin was unchanged in Q3 and improved 0.2 percentage points year to date. Management cited lower product margin at Gap and higher online shipping costs, partly offset by accounting-presentation changes and lower occupancy costs.
- Operating cash flow fell $33 year to date and free cash flow fell to $57 from $197, reflecting working-capital movements and higher capital spending. Investing outflows also included net purchases of available-for-sale securities.
Outlook, commentary, risks, and unusual items
- Management said cash balances and operating cash flows should be sufficient for operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond; the revolver and other market instruments are potential supplemental liquidity.
- Business priorities include improving the underperforming Gap brand, developing on-trend products, investing in digital and customer capabilities, improving the omnichannel experience, and streamlining operations while maintaining expense discipline. The filing gives no specific earnings or sales guidance.
- Management expected to complete its accounting for the Tax Cuts and Jobs Act during fiscal 2018; further adjustments to provisional tax estimates could materially affect that fiscal year’s tax provision and effective tax rate.
- The company planned to adopt the new lease standard on February 4, 2019 and expected a material increase in reported long-term assets and liabilities.
- Key disclosed risks include fashion and consumer-preference execution, competition, inventory and margin management, digital and IT effectiveness, cybersecurity, trade and sourcing costs, foreign exchange, consumer spending, store leases, franchisee performance, and litigation. Current legal proceedings were not considered material in aggregate; outcomes remain uncertain.
- There were no material changes in contractual obligations or commercial commitments outside the normal course, and no material changes to previously disclosed risk factors as described in the filing.
Important facts for investors to verify
- Confirm the intended reporting period: the supplied filing is Q3 FY2018, not Q3 FY2017.
- Separate underlying sales trends from the $170 Q3 and $449 year-to-date ASC 606 presentation increases; prior periods were not restated.
- Assess the durability of Old Navy’s growth and the continued weakness in Gap comparable sales, alongside margin and operating-expense trends.
- Review the composition and timing of cash flows, inventory investment, capital expenditures, and the remaining share-repurchase authorization.
- Monitor final tax-reform accounting and the future balance-sheet impact of lease-standard adoption.