Skip to main content

Consumers Are Dressing Up Again, So Of Course Banana Had Gap Inc.’s Best Q2 Result

Gap Inc.’s second-quarter net sales fell 8 percent to $3.86 billion, but trends seem to be improving lately.

In a Nutshell: The Old Navy, Gap, Banana Republic and Athleta owner said Thursday it’s withdrawing its prior fiscal 2022 outlook, citing the actions the company has underway in midst of a CEO transition, combined with the uncertain macroenvironment.

“We have four strong brands and leverage in the portfolio to deliver over the long-term, however our recent execution challenges combined with the uncertain macro trends requires us to manage the levers in our control and take the actions necessary to drive improvement across our entire business,” said Katrina O’Connell, executive vice president and chief financial officer of Gap Inc. “In the near-term, we are taking actions to sequentially reduce inventory, rebalance our assortments to better meet changing consumer needs, aggressively manage and reevaluate investments, and fortifying our balance sheet. While we have work to do, we believe these are the right initial steps to position Gap Inc. back on its path toward growth, margin expansion and delivering value for our shareholders over the long term.”

Coming off peak inflation and the higher gas prices particularly impacting the lower-income consumer in June, the company said it has seen an improvement in sales trends in July and into August consistent with many other retailers. While the company is making progress balancing its assortments, it remains cautiously optimistic in light of the consumer environment as it relates to its revenue in the second half of fiscal 2022.

In the second half of fiscal 2022, air freight expense is expected to normalize and the company will be anniversarying last year’s air freight investments resulting in roughly 400 basis points of margin leverage versus last year. Roughly half of the air freight leverage is expected to be offset by continued inflationary cost deleverage.

Related Story

Gap Inc. said while it’s taking actions to balance its assortment and right size inventory, the company has seen the most significant variability versus its expectations in its discount rate. Further limiting near-term discount rate visibility is the uncertain consumer environment and increasingly promotional environment.

The company expects third quarter ending inventory growth to moderate substantially and is targeting negative inventories versus last year by the end of fiscal 2022 as a result of its inventory actions, reduction of receipts, and anniversary of higher in-transit levels last year. By Spring, the company expects to begin to lean into its responsive levers, providing the flexibility to better align inventory levels with demand trends.

Gap Inc. expects to open about 30 to 40 Athleta stores and 20 to 30 Old Navy stores in fiscal year 2022. As part of its 350-store closure plan, it continues to expect to close about 50 Gap and Banana Republic stores in North America during the year. The company ended the quarter with 3,390 store locations in over 40 countries, of which 2,799 were company operated.

The retailer continues to expect a net benefit to earnings in the third quarter due to the sale of its U.K. distribution center now that its European partnership model transition is complete. This will be reflected in the company’s adjusted diluted earnings per share (EPS) in the third quarter fiscal 2022.

The company ended the quarter with cash and cash equivalents of $708 million. Net cash from operating activities was negative $207 million and year-to-date free cash flow, defined as net cash from operating activities less purchases of property and equipment, was negative $613 million.

Ending inventory of $3.1 billion was up 37 percent year-over-year. This includes nearly 10 percentage points of pack and hold inventory and 7 percentage points of in-transit. More than half of the remaining balance of the increase is attributable to basics.

During the quarter, the company completed an amendment and extension of its secured revolving credit facility, securing modestly improved pricing while increasing flexibility and liquidity within our capital structure. Year-to-date capital expenditures were $406 million.

Sales: Net sales for the second quarter ended July 30 declined 8 percent from the prior-year period to $3.86 billion.

Comparable sales were down 10 percent year-over-year. Online sales declined 6 percent compared to last year and represented 34 percent of total net sales, while store sales fell 10 percent year over year.

Old Navy net sales were down 13 percent in the period to $2.1 billion. Sales in the quarter were negatively impacted by size and assortment imbalances, ongoing inventory delays, product acceptance issues in some key categories and slowing demand stemming from the lower-income consumer. Comparable sales were down 15 percent.

Gap net sales decreased 10 percent to $881 million, impacted by category mix imbalances during the quarter. The decrease in net sales was also driven by strategic store closures. In addition, the Gap outlet business is experiencing near-term softness stemming from inflationary pressures impacting the lower-income consumer.

Global comparable sales were down 7 percent and North America comparable sales were fell 10 percent.

Net sales at Banana Republic rose 9 percent to $539 million. The company said the brand maintained its focus on delivering quality product through a differentiated experience and continues to capitalize on the current shift in consumer trends while realizing ongoing benefits since last year’s brand relaunch. Comparable sales were up 8 percent.

Athleta net sales were up 1 percent to $344 million. While the brand continues to make progress in driving awareness and establishing authority in the women’s active and wellness category, the company said it is experiencing softness related to the shift in consumer preference from athleisure to occasion and work-based categories, as well as modest Spring-Summer product acceptance challenges. Comparable sales were down 8 percent.

Earnings: Gap Inc. reported a net loss of $49 million in the quarter.

Adjusted net income was $30 million, which excludes the inventory impairment and the transition of Old Navy’s Mexico business.

The company reported a diluted loss per share of 13 cents. Adjusted diluted EPS was 8 cents. Reported and adjusted diluted EPS includes an estimated 10 cents of impact related to transitory elevated air freight expense during the quarter.

Gross margin was 34.5 percent and adjusted gross margin, excluding the charge related to the impairment of unproductive inventory, was 36 percent, deleveraging 730 basis points versus last year.

Merchandise margins were down 850 basis points versus last year, while adjusted for the inventory impairment, merchandise margins declined 700 basis points. Merchandise margins were negatively impacted by an estimated $50 million, or 130 basis points, of incremental transitory air freight costs, and the remaining decline of approximately 570 basis points was driven by higher discounting, primarily at Old Navy, and inflationary commodity price increases. The declines were partially offset by the benefit of lower discounting at Banana Republic.

CEO’s Take: Bob Martin, executive chairman and interim CEO of Gap Inc., said: “This is a pivotal moment in time. While we search for a new leader, I am taking on the role as interim president and CEO of Gap Inc. with a deep commitment to the company’s success and impatience for change. Having navigated the global retail industry across brands and markets, I am not approaching this work from the sidelines. We are taking actions to better optimize profitability and cash flow in the near term, reducing operating costs, as well as impairing unproductive inventory. While our elevated inventory and pressured margins are current realities against unsettled market conditions, they do not define our ability to capitalize on Gap Inc.’s strengths to win.”

“Gap Inc.’s iconic brands, powerful assets, well-established values and scaled omni-platform are central to our strategic direction,” Martin added. “Our team has the capabilities to deliver what our customers, and our shareholders, expect–what’s needed for profitable growth. Importantly, as we adopt behaviors that enable sustainable change, I’m confident we will unleash our potential and drive value creation over the long term.”