The Gap, Inc. — Form 10-Q Summary
Period clarification: The request identifies 2017 Q1, but the supplied filing is for the 13 weeks ended May 5, 2018 (fiscal 2018 Q1), compared primarily with the 13 weeks ended April 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. Fiscal 2018 has 52 weeks, compared with 53 weeks in fiscal 2017; the filing says the calendar shift favorably affected quarterly sales.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $3.783 billion | $3.440 billion |
| Gross profit / gross margin | $1.427 billion / 37.7% | $1.303 billion / 37.9% |
| Operating income / operating margin | $229 million / 6.1% | $254 million / 7.4% |
| Net income | $164 million | $143 million |
| Diluted EPS | $0.42 | $0.36 |
| Operating cash flow | $(66) million | $91 million |
| Capital expenditures | $138 million | $110 million |
| Free cash flow (non-GAAP) | $(204) million | $(5) million |
- Comparable sales increased 1%, versus a 2% increase in the prior-year quarter: Old Navy +3%, Gap -4%, and Banana Republic +3%.
- At May 5, cash and cash equivalents were $1.210 billion, short-term investments were $164 million, and total current assets were $4.187 billion against current liabilities of $2.058 billion.
- Total debt was $1.249 billion, all long-term; the $500 million revolving credit facility had no borrowings. The company stated cash and operating cash flows should support operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond.
- The company paid $94 million in dividends and repurchased $100 million of stock during the quarter. It stated an intention to pay $0.97 per share in dividends for fiscal 2018.
Material changes and comparability
- Reported net sales increased 10%, but the increase included $141 million of presentation changes from adopting ASC 606, favorable foreign exchange of $42 million, and the favorable calendar shift. Prior-year figures were not restated. Without ASC 606, the filing presents Q1 2018 net sales of $3.642 billion.
- ASC 606 moved credit-card revenue-sharing income and loyalty-discount reimbursements into net sales from operating-expense and cost-of-goods-sold offsets. Adoption increased opening retained earnings by $36 million, net of tax, and did not significantly affect quarterly net income.
- Gross margin decreased 0.2 percentage points, with the filing citing higher promotional activity and inventory write-offs. Operating margin declined 1.3 points; operating expenses rose partly because of presentation changes, higher payroll and benefits, and favorable lease-termination settlements recorded in 2017.
- Net income rose despite lower operating income, primarily alongside a lower effective tax rate: 25.1% versus 39.9%, principally reflecting the federal tax-rate reduction under the Tax Cuts and Jobs Act.
- Operating cash flow fell to an outflow, primarily due to changes in accrued expenses and other current liabilities, including a higher bonus payout, and changes in other assets. Investing outflows also increased, including purchases of short-term investments.
Outlook, risks, and unusual items
- Management emphasized product and brand relevance, digital and customer capabilities, customer experience, productivity, and operating-expense discipline. The filing provides no earnings or sales guidance.
- The company had recorded a provisional $57 million net charge for the Tax Cuts and Jobs Act in fiscal 2017 and expected to complete its tax accounting during fiscal 2018; later adjustments could materially affect the tax provision and effective rate.
- The company cited apparel-trend and consumer-preference uncertainty, competition, inventory and margin execution, global sourcing and trade risks, foreign-exchange exposure, technology disruption, and cybersecurity and privacy risks. It specifically updated its risk disclosure regarding data security and privacy.
- Ordinary-course lawsuits and claims include commercial, intellectual-property, customer, employment, and data-privacy matters; recorded liabilities were not material, and management did not expect current actions to materially affect results. Indemnification obligations are not readily quantifiable.
- The company said adoption of the new lease accounting standard, planned for fiscal 2019, would materially increase reported long-term assets and liabilities. The revolving credit facility was extended after quarter-end to expire in May 2023.
Important facts for investors to verify
- Confirm the filing period: the supplied 10-Q is for Q1 2018, not Q1 2017.
- Separate underlying sales performance from ASC 606 presentation changes, foreign exchange, and the calendar shift; compare comparable sales by brand.
- Monitor promotional activity, inventory write-offs, and operating expenses given the declines in gross and operating margins.
- Assess cash generation and capital allocation in light of negative operating cash flow and free cash flow, dividends, repurchases, and planned investment.
- Track final Tax Cuts and Jobs Act accounting, cybersecurity and privacy exposure, and the effects of the upcoming lease-accounting standard.