The Gap, Inc. Form 10-Q Summary
Period note: The request identifies 2018 Q2, but the supplied filing is for the 13 and 26 weeks ended August 3, 2019 (fiscal 2019 Q2 and first half). Comparisons below are with the periods ended August 4, 2018.
Business context and reporting period
Gap is a global apparel retailer operating Old Navy, Gap, Banana Republic, Athleta, Intermix, Janie and Jack, and Hill City, through stores, online channels, and franchisees. The company reported one aggregate reportable segment. It announced plans to separate Old Navy from the remaining businesses, targeting completion in 2020, subject to conditions.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $4.005 billion | $4.085 billion | $7.711 billion | $7.868 billion |
| Gross profit / margin | $1.556 billion / 38.9% | $1.627 billion / 39.8% | $2.900 billion / 37.6% | $3.054 billion / 38.8% |
| Operating income / margin | $282 million / 7.0% | $398 million / 9.7% | $598 million / 7.8% | $627 million / 8.0% |
| Net income | $168 million | $297 million | $395 million | $461 million |
| Diluted EPS | $0.44 | $0.76 | $1.04 | $1.18 |
- Comparable sales fell 4% in Q2, versus 2% growth a year earlier. By brand in Q2: Old Navy Global -5%, Gap Global -7%, and Banana Republic Global -3%.
- Q2 operating expenses were $1.274 billion, up $45 million, primarily reflecting separation and restructuring costs and Janie and Jack expenses, partly offset by lower bonus expense.
- First-half operating cash flow was $583 million, compared with $546 million. Capital expenditures for property and equipment were $324 million; reported free cash flow was $259 million, versus $220 million.
- At August 3, cash and cash equivalents were $1.177 billion and short-term investments were $294 million. Long-term debt was $1.249 billion; the $500 million revolving facility had no borrowings. The company reported $6.590 billion of operating lease liabilities, including $946 million current.
- First-half cash uses included $100 million of share repurchases and $183 million of dividends. The company paid $0.485 per share in first-half dividends.
Material changes, outlook, and notable items
- Sales declined 2% year over year in both Q2 and the first half. Management attributed the decrease mainly to Gap Global and unfavorable foreign exchange, partly offset by Athleta, Janie and Jack, and higher credit-card agreement income. Q2 foreign-exchange impact was $22 million; first-half impact was $56 million.
- Q2 gross margin fell 0.9 percentage points, primarily due to higher Old Navy promotional activity and occupancy costs against lower sales. Management described the retail environment as challenging.
- The effective tax rate rose to 38.0% in Q2 from 23.5%, and to 31.1% for the first half from 24.1%. The increase primarily reflected a $30 million adjustment to the fiscal 2017 tax liability following Treasury guidance on the Tax Cuts and Jobs Act.
- Gap plans to close about 230 Gap specialty stores in fiscal 2019 and 2020. Estimated pretax costs are $250 million to $300 million, largely cash lease-related costs; estimated annualized sales loss is about $625 million, with annualized pretax savings of about $90 million. First-half restructuring costs were $15 million.
- First-half separation costs were $42 million. The separation’s timing and completion remain subject to conditions, including Board approval, a tax opinion, and SEC registration effectiveness.
- Management said cash and operating cash flows should support operations, growth initiatives, restructuring and separation costs, and planned capital expenditures for the next 12 months and beyond; the revolving facility or other market instruments could supplement liquidity. The company intended to pay an annual fiscal 2019 dividend of $0.97 per share, consistent with fiscal 2018.
- A first-quarter building sale generated a $191 million pretax gain, while the company also bought a building for $343 million. These transactions affected first-half cash flows and operating expenses.
- Adoption of lease accounting standard ASC 842 added $5.7 billion of lease assets and $6.6 billion of lease liabilities at adoption and reduced opening retained earnings by $86 million after tax. Janie and Jack was acquired for $69 million; its post-acquisition operating results were not material.
- Risks highlighted include separation execution and benefits, changing consumer preferences and competition, inventory and margin management, foreign exchange and sourcing, trade matters, cybersecurity and IT disruptions, and litigation. The company reported no material change to previously disclosed risk factors; recorded legal liabilities were not material.
Important facts for investors to verify
- Confirm the filing period: the supplied 10-Q covers fiscal 2019 Q2, not 2018 Q2.
- Track comparable sales, promotional intensity, and gross-margin trends, particularly at Old Navy and Gap.
- Monitor separation milestones, costs, conditions, and any revised timing or expected benefits.
- Compare actual store closures, cash restructuring costs, sales impacts, and savings with management’s estimates.
- Assess liquidity and cash generation against lease obligations, planned investment, dividends, repurchases, and separation costs.
- Distinguish recurring operating performance from the $191 million building-sale gain and the higher tax charge.