Gap Inc. - 10-Q quarterly report FY2019 Q2

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 3, 2019



☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 1-7562

THE GAP, INC.

(Exact name of registrant as specified in its charter)



Delaware			94-1697231
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

Two Folsom Street,	San Francisco,	California	94105
(Address of principal executive offices)			(Zip code)

Registrant’s telephone number, including area code: (415) 427-0100



Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock, $0.05 par value	GPS	The New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☑	Accelerated filer	☐	Non-accelerated filer	☐	Smaller reporting company	☐
						Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☑

The number of shares of the registrant’s common stock outstanding as of August 26, 2019 was 375,787,585.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements other than those that are purely historical are forward-looking statements. Words such as “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan,” “project,” and similar expressions also identify forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding the following:


•	the impact of recent accounting pronouncements;


•	recognition of revenue deferrals as revenue;


•	unrealized gains and losses from designated cash flow hedges;


•	total gross unrecognized tax benefits;


•	the impact of losses due to indemnification obligations;


•	the outcome of proceedings, lawsuits, disputes, and claims;


•	structure and timing of completion of the planned separation transaction;


•	process of completing the separation transaction, including estimated costs;


•	anticipated strategic, financial, operational or other benefits of the separation transaction, including future financial performance of the independent companies following the proposed separation transaction;


•	plans to restructure the Gap brand specialty fleet, including anticipated store closures and timing, impact to annualized sales, associated costs, and effect on annualized savings;


•	offering product that is consistently brand-appropriate and on-trend with high customer acceptance;


•	investing in digital and customer capabilities, as well as store experience;


•	increasing productivity by leveraging our scale and streamlining operations and processes;


•	attracting and retaining strong talent in our businesses and functions;


•	continuing to integrate social and environmental sustainability into business practices;


•	investing strategically in the business while maintaining operating discipline and driving efficiency;


•	continuing to transform our product to market processes;


•	continuing our investment in customer experience to drive higher customer engagement and loyalty;


•	continuing to invest in strengthening brand awareness, customer acquisition, and digital capabilities;


•	current cash balances and cash flows being sufficient to support our business operations, including growth initiatives, Gap brand specialty fleet restructuring costs, separation related costs, and planned capital expenditures;


•	ability to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility or other available market instruments;


•	the impact of the seasonality of our operations;


•	dividend payments in fiscal 2019; and


•	the impact of changes in internal control over financial reporting.

Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the following:


•	the risks associated with our plan to separate into two independent publicly-traded companies, including that the separation may not be completed in accordance with the expected plans or anticipated timeframe, or at all;


•	the risk that our plan to separate into two publicly-traded companies may not achieve some or all of the anticipated benefits;


•	the risk that we or our franchisees will be unsuccessful in gauging apparel trends and changing consumer preferences;


•	the highly competitive nature of our business in the United States and internationally;


•	the risk that failure to maintain, enhance and protect our brand image could have an adverse effect on our results of operations;


•	the risk that the failure to attract and retain key personnel, or effectively manage succession, could have an adverse impact on our results of operations;


•	the risk that our investments in customer, digital, and omni-channel shopping initiatives may not deliver the results we anticipate;


•	the risk that if we are unable to manage our inventory effectively, our gross margins will be adversely affected;


•	the risk that we are subject to data or other security breaches that may result in increased costs, violations of law, significant legal and financial exposure, and a loss of confidence in our security measures, which could have an adverse effect on our results of operations and our reputation;


•	the risk that a failure of, or updates or changes to, our information technology (“IT”) systems may disrupt our operations;


•	the risks to our business, including our costs and supply chain, associated with global sourcing and manufacturing;


•	the risk that changes in global economic conditions or consumer spending patterns could adversely impact our results of operations;


•	the risks to our efforts to expand internationally, including our ability to operate in regions where we have less experience;


•	the risks to our reputation or operations associated with importing merchandise from foreign countries, including failure of our vendors to adhere to our Code of Vendor Conduct;


•	the risk that our franchisees’ operation of franchise stores is not directly within our control and could impair the value of our brands;


•	the risk that we or our franchisees will be unsuccessful in identifying, negotiating, and securing new store locations and renewing, modifying, or terminating leases for existing store locations effectively;


•	the risk that foreign currency exchange rate fluctuations could adversely impact our financial results;


•	the risk that comparable sales and margins will experience fluctuations;


•	the risk that changes in our credit profile or deterioration in market conditions may limit our access to the capital markets and adversely impact our financial results or our business initiatives;


•	the risk that trade matters could increase the cost or reduce the supply of apparel available to us and adversely affect our business, financial condition, and results of operations;


•	the risk that changes in the regulatory or administrative landscape could adversely affect our financial condition and results of operations;


•	the risk that natural disasters, public health crises, political crises, negative global climate patterns, or other catastrophic events could adversely affect our operations and financial results, or those of our franchisees or vendors;


•	the risk that reductions in income and cash flow from our credit card arrangement related to our private label and co-branded credit cards could adversely affect our operating results and cash flows;


•	the risk that the adoption of new accounting pronouncements will impact future results;


•	the risk that we do not repurchase some or all of the shares we anticipate purchasing pursuant to our repurchase program; and


•	the risk that we will not be successful in defending various proceedings, lawsuits, disputes, and claims.

Additional information regarding factors that could cause results to differ can be found in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019 and our other filings with the U.S. Securities and Exchange Commission.

Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict. These forward-looking statements are based on information as of August 30, 2019, and we assume no obligation to publicly update or revise our forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

We suggest that this document be read in conjunction with Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019.

THE GAP, INC.

TABLE OF CONTENTS



		Page
	PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements	1

	Condensed Consolidated Balance Sheets as of August 3, 2019, February 2, 2019, and August 4, 2018	1

	Condensed Consolidated Statements of Income for the Thirteen and Twenty-Six Weeks Ended August 3, 2019 and August 4, 2018	2

	Condensed Consolidated Statements of Comprehensive Income for the Thirteen and Twenty-Six Weeks Ended August 3, 2019 and August 4, 2018	3

	Condensed Consolidated Statements of Stockholders' Equity for the Thirteen and Twenty-Six Weeks Ended August 3, 2019 and August 4, 2018	4

	Condensed Consolidated Statements of Cash Flows for the Twenty-Six Weeks Ended August 3, 2019 and August 4, 2018	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26

Item 4.	Controls and Procedures	26

	PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	27

Item 1A.	Risk Factors	27

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27

Item 6.	Exhibits	28

PART I – FINANCIAL INFORMATION


Item 1.	Financial Statements.

THE GAP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



($ and shares in millions except par value)	August 3, 2019		February 2, 2019		August 4, 2018
ASSETS
Current assets:
Cash and cash equivalents	$	1,177	$	1,081	$	1,322
Short-term investments	294		288		286
Merchandise inventory	2,326		2,131		2,202
Other current assets	770		751		780
Total current assets	4,567		4,251		4,590
Property and equipment, net of accumulated depreciation of $5,926, $5,755, and $6,063	3,141		2,912		2,832
Operating lease assets	5,807		—		—
Other long-term assets	528		886		588
Total assets	$	14,043	$	8,049	$	8,010
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,246	$	1,126	$	1,297
Accrued expenses and other current liabilities	908		1,024		1,026
Current portion of operating lease liabilities	946		—		—
Income taxes payable	34		24		18
Total current liabilities	3,134		2,174		2,341
Long-term liabilities:
Long-term debt	1,249		1,249		1,249
Long-term operating lease liabilities	5,644		—		—
Lease incentives and other long-term liabilities	391		1,073		1,080
Total long-term liabilities	7,284		2,322		2,329
Commitments and contingencies (see Note 12)
Stockholders’ equity:
Common stock $0.05 par value
Authorized 2,300 shares for all periods presented; Issued and Outstanding 376, 378, and 385 shares	19		19		19
Additional paid-in capital	—		—		—
Retained earnings	3,551		3,481		3,268
Accumulated other comprehensive income	55		53		53
Total stockholders’ equity	3,625		3,553		3,340
Total liabilities and stockholders’ equity	$	14,043	$	8,049	$	8,010

See Accompanying Notes to Condensed Consolidated Financial Statements

THE GAP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)



	13 Weeks Ended						26 Weeks Ended
($ and shares in millions except per share amounts)	August 3, 2019			August 4, 2018			August 3, 2019			August 4, 2018
Net sales	$	4,005		$	4,085		$	7,711		$	7,868
Cost of goods sold and occupancy expenses	2,449			2,458			4,811			4,814
Gross profit	1,556			1,627			2,900			3,054
Operating expenses	1,274			1,229			2,302			2,427
Operating income	282			398			598			627
Interest expense	19			17			39			33
Interest income	(8		)	(7		)	(14		)	(13		)
Income before income taxes	271			388			573			607
Income taxes	103			91			178			146
Net income	$	168		$	297		$	395		$	461
Weighted-average number of shares - basic	378			387			378			388
Weighted-average number of shares - diluted	379			390			380			391
Earnings per share - basic	$	0.44		$	0.77		$	1.04		$	1.19
Earnings per share - diluted	$	0.44		$	0.76		$	1.04		$	1.18
Cash dividends declared and paid per share	$	0.2425		$	0.2425		$	0.485		$	0.485

See Accompanying Notes to Condensed Consolidated Financial Statements

THE GAP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)



	13 Weeks Ended						26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018			August 3, 2019			August 4, 2018
Net income	$	168		$	297		$	395		$	461
Other comprehensive income (loss), net of tax
Foreign currency translation	—			(16		)	(1		)	(23		)
Change in fair value of derivative financial instruments, net of tax (tax benefit) of $1, $3, $5, and $(3)	1			18			10			46
Reclassification adjustment for gains on derivative financial instruments, net of (tax) tax benefit of $(3), $-, $(5), and $9	(3		)	—			(7		)	(6		)
Other comprehensive income (loss), net of tax	(2		)	2			2			17
Comprehensive income	$	166		$	299		$	397		$	478

See Accompanying Notes to Condensed Consolidated Financial Statements

THE GAP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)



	Common Stock				Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income
($ and shares in millions except per share amounts)	Shares		Amount		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance as of May 5, 2018	387		$	19	$	—		$	3,127		$	51		$	3,197
Net income for the thirteen weeks ended August 4, 2018								297						297
Other comprehensive income, net of tax											2			2
Repurchases and retirement of common stock	(3	)	—		(38		)	(62		)				(100		)
Issuance of common stock related to stock options and employee stock purchase plans	—		—		13									13
Issuance of common stock and withholding tax payments related to vesting of stock units	1		—		(1		)							(1		)
Share-based compensation, net of forfeitures					26									26
Common stock dividends ($0.2425 per share)								(94		)				(94		)
Balance as of August 4, 2018	385		$	19	$	—		$	3,268		$	53		$	3,340
Balance as of February 3, 2018	389		19		8			3,081			36			3,144
Cumulative effect of a change in accounting principle related to revenue recognition								36						36
Net income for the twenty-six weeks ended August 4, 2018								461						461
Other comprehensive income, net of tax											17			17
Repurchases and retirement of common stock	(6	)	—		(78		)	(122		)				(200		)
Issuance of common stock related to stock options and employee stock purchase plans	1		—		33									33
Issuance of common stock and withholding tax payments related to vesting of stock units	1		—		(20		)							(20		)
Share-based compensation, net of forfeitures					57									57
Common stock dividends ($0.485 per share)								(188		)				(188		)
Balance as of August 4, 2018	385		19		—			3,268			53			3,340

Balance as of May 4, 2019	378		$	19	—			$	3,495		$	57		$	3,571
Net income for the thirteen weeks ended August 3, 2019								168						168
Other comprehensive loss, net of tax											(2		)	(2		)
Repurchases and retirement of common stock	(3	)	—		(29		)	(21		)				(50		)
Issuance of common stock related to stock options and employee stock purchase plans	—		—		7									7
Issuance of common stock and withholding tax payments related to vesting of stock units	1		—		(1		)							(1		)
Share-based compensation, net of forfeitures					23									23
Common stock dividends ($0.2425 per share)								(91		)				(91		)
Balance as of August 3, 2019	376		$	19	$	—		$	3,551		$	55		$	3,625
Balance as of February 2, 2019	378		19		—			3,481			53			3,553
Cumulative effect of a change in accounting principle related to leases								(86		)				(86		)
Net income for the twenty-six weeks ended August 3, 2019								395						395
Other comprehensive income, net of tax											2			2
Repurchases and retirement of common stock	(5	)	—		(44		)	(56		)				(100		)
Issuance of common stock related to stock options and employee stock purchase plans	1		—		17									17
Issuance of common stock and withholding tax payments related to vesting of stock units	2		—		(20		)							(20		)
Share-based compensation, net of forfeitures					47									47
Common stock dividends ($0.485 per share)								(183		)				(183		)
Balance as of August 3, 2019	376		$	19	$	—		$	3,551		$	55		$	3,625

See Accompanying Notes to Condensed Consolidated Financial Statements

THE GAP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018
Cash flows from operating activities:
Net income	$	395		$	461
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	277			280
Amortization of lease incentives	—			(29		)
Share-based compensation	47			48
Non-cash and other items	10			12
Gain on sale of building	(191		)	—
Deferred income taxes	46			24
Changes in operating assets and liabilities:
Merchandise inventory	(166		)	(224		)
Other current assets and other long-term assets	29			(46		)
Accounts payable	147			104
Accrued expenses and other current liabilities	(14		)	(180		)
Income taxes payable, net of prepaid and other tax-related items	43			62
Lease incentives and other long-term liabilities	24			34
Operating lease assets and liabilities, net	(64		)	—
Net cash provided by operating activities	583			546
Cash flows from investing activities:
Purchases of property and equipment	(324		)	(326		)
Purchase of building	(343		)	—
Proceeds from sale of building	220			—
Purchases of short-term investments	(150		)	(322		)
Proceeds from sales and maturities of short-term investments	146			36
Purchase of Janie and Jack	(69		)	—
Other	—			(6		)
Net cash used for investing activities	(520		)	(618		)
Cash flows from financing activities:
Proceeds from issuances under share-based compensation plans	17			33
Withholding tax payments related to vesting of stock units	(20		)	(20		)
Repurchases of common stock	(100		)	(200		)
Cash dividends paid	(183		)	(188		)
Other	—			(1		)
Net cash used for financing activities	(286		)	(376		)
Effect of foreign exchange rate fluctuations on cash, cash equivalents, and restricted cash	(2		)	(11		)
Net decrease in cash, cash equivalents, and restricted cash	(225		)	(459		)
Cash, cash equivalents, and restricted cash at beginning of period	1,420			1,799
Cash, cash equivalents, and restricted cash at end of period	$	1,195		$	1,340
Supplemental disclosure of cash flow information:
Cash paid for interest during the period	$	38		$	38
Cash paid for income taxes during the period, net of refunds	$	90		$	61
Cash paid for operating lease liabilities	$	612		$	—

See Accompanying Notes to Condensed Consolidated Financial Statements

THE GAP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Accounting Policies

Basis of Presentation

The Condensed Consolidated Balance Sheets as of August 3, 2019 and August 4, 2018, and the Condensed Consolidated Statements of Income, the Condensed Consolidated Statements of Comprehensive Income, and the Condensed Consolidated Statements of Stockholders' Equity for the thirteen and twenty-six weeks ended August 3, 2019 and August 4, 2018, and the Condensed Consolidated Statements of Cash Flows for the twenty-six weeks ended August 3, 2019 and August 4, 2018 have been prepared by The Gap, Inc. (the “Company,” “we,” and “our”). In the opinion of management, such statements include all adjustments (which include normal recurring adjustments) considered necessary to present fairly our financial position, results of operations, stockholders' equity, and cash flows as of August 3, 2019 and August 4, 2018 and for all periods presented. The Condensed Consolidated Balance Sheet as of February 2, 2019 has been derived from our audited financial statements.

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted from these interim financial statements, although the Company believes that the disclosures made are adequate to make the information not misleading. We suggest that you read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019.

The results of operations for the thirteen and twenty-six weeks ended August 3, 2019 are not necessarily indicative of the operating results that may be expected for the 52-week period ending February 1, 2020.

Accounting Pronouncements Recently Adopted

ASU No. 2016-02, Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued accounting standards update (“ASU”) No. 2016-02, Leases. Under the new guidance, lessees are required to recognize a lease liability and a right-of-use asset for leases at the commencement date. We adopted ASU No. 2016-02 and related amendments (collectively "ASC 842") on February 3, 2019 using the optional transition method, which allows for the prospective application of the standard. As of the effective date, we recorded a decrease to opening retained earnings of $86 million, net of tax, which consisted primarily of impairments for certain store and operating lease assets. In addition, we elected the package of practical expedients permitted under the transition guidance within the standard, which allowed us to carry forward our historical lease classification, to not reassess prior conclusions related to initial direct costs, and to not reassess whether any expired or existing contracts are or contain leases. We also elected the lessee practical expedient to combine lease and nonlease components for new leases and modified leases. The adoption of ASC 842 resulted in the recording of operating lease assets and operating lease liabilities of $5.7 billion and $6.6 billion, respectively, on our Consolidated Balance Sheet as of February 3, 2019.

See Note 9 of Notes to Condensed Consolidated Financial Statements for information regarding required disclosures related to our leases.

ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The amendments are intended to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. In addition, this guidance amends and expands disclosure requirements. We adopted this ASU on a prospective basis on February 3, 2019. The adoption of this standard did not have a material impact on our Consolidated Financial Statements.

See Note 5 of Notes to Condensed Consolidated Financial Statements for information regarding derivative financial instruments.

Accounting Pronouncements Not Yet Adopted

Except as noted below, the Company has considered all recent accounting pronouncements and concluded that there are no recent accounting pronouncements that may have a material impact on our Consolidated Financial Statements, based on current information.

ASU No. 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The ASU is intended to align the requirements for capitalization of implementation costs incurred in a cloud computing arrangement that is a service contract with the existing guidance for internal-use software. This guidance is effective for annual periods beginning after December 15, 2019, with early adoption permitted. The guidance provides flexibility in adoption, allowing for either retrospective adjustment or prospective adjustment for all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact this guidance may have on our Consolidated Financial Statements and related disclosures.

Restricted Cash

Any cash that is legally restricted from use is classified as restricted cash. If the purpose of restricted cash is related to acquiring a long-term asset, liquidating a long-term liability, or is otherwise unavailable for a period longer than one year from the balance sheet date, the restricted cash is included within other long-term assets on our Condensed Consolidated Balance Sheets. Otherwise, restricted cash is included within other current assets on our Condensed Consolidated Balance Sheets.

As of August 3, 2019, restricted cash primarily included consideration that serves as collateral for our insurance obligations. The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within our Condensed Consolidated Balance Sheets to the total shown on our Condensed Consolidated Statements of Cash Flows:



($ in millions)	August 3, 2019		August 4, 2018
Cash and cash equivalents, per Condensed Consolidated Balance Sheets	$	1,177	$	1,322
Restricted cash included in other current assets	—		—
Restricted cash included in other long-term assets	18		18
Total cash, cash equivalents, and restricted cash, per Condensed Consolidated Statements of Cash Flows	$	1,195	$	1,340

Note 2. Revenue

The Company’s revenues include merchandise sales at stores, online, and through franchise agreements. We also receive revenue sharing from our credit card agreement for private label and co-branded credit cards, and breakage revenue related to our gift cards, credit vouchers, and outstanding loyalty points. Breakage revenue is recognized based upon historical redemption patterns. For online sales and catalog sales, the Company has elected to treat shipping and handling as fulfillment activities and not a separate performance obligation. Accordingly, we recognize revenue for our single performance obligation related to online sales and catalog sales at the time control of the merchandise passes to the customer, which is generally at the time of shipment. We also record an allowance for estimated returns based on our historical return patterns and various other assumptions that management believes to be reasonable. Revenues are presented net of any taxes collected from customers and remitted to governmental authorities.

Our credit card agreement provides for certain payments to be made to us, including a share of revenue from the performance of the credit card portfolios and reimbursements of loyalty program discounts. We have identified separate performance obligations related to our credit card agreement that include both providing a license and an obligation to redeem loyalty points issued under the loyalty rewards program. Our obligation to provide a license is satisfied when the subsequent sale or usage occurs and our obligation to redeem loyalty points is deferred until those loyalty points are redeemed. Income related to our credit card agreement is classified within net sales on our Condensed Consolidated Statements of Income.

We also have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic, and Old Navy stores in a number of countries throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. We have identified separate performance obligations related to our franchise agreements that include both providing our franchise partners with a license and an obligation to supply franchise partners with our merchandise. Our obligation to provide a license is satisfied when the subsequent sale or usage occurs and our obligation to supply franchise partners with our merchandise is satisfied when control of the merchandise transfers. As of the quarter ended August 3, 2019 and August 4, 2018, there were no material contract liabilities related to our franchise agreements.

We defer revenue when cash payments are received in advance of performance for unsatisfied obligations related to our gift cards, credit vouchers, outstanding loyalty points, and reimbursements of loyalty program discounts associated with our credit card agreement. For the thirteen weeks ended August 3, 2019, the opening balance of deferred revenue for these obligations was $206 million, of which $71 million was recognized as revenue during the period. For the twenty-six weeks ended August 3, 2019, the opening balance of deferred revenue for these obligations was $227 million, of which $134 million was recognized as revenue during the period. The closing balance of deferred revenue related to gift cards, credit vouchers, outstanding loyalty points, and reimbursements of loyalty program discounts was $195 million as of August 3, 2019.

We expect that the majority of our revenue deferrals as of the quarter ended August 3, 2019, will be recognized as revenue in the next 12 months as our performance obligations are satisfied.

For the thirteen weeks ended August 4, 2018, the opening balance of deferred revenue for these obligations was $201 million, of which $87 million of the opening balance was recognized as revenue during the period. For the twenty-six weeks ended August 4, 2018, the opening balance of deferred revenue for these obligations was $232 million, of which $145 million of the opening balance was recognized as revenue during the period. The closing balance of deferred revenue for these obligations was $194 million as of August 4, 2018.

See Note 13 of Notes to Condensed Consolidated Financial Statements for disaggregation of revenue by brand and by region.

Note 3. Debt and Credit Facilities

As of August 3, 2019, February 2, 2019, and August 4, 2018, the estimated fair value of our $1.25 billion aggregate principal amount of 5.95 percent notes (the “Notes”) due April 2021 was $1.30 billion, $1.30 billion, and $1.31 billion, respectively, and was based on the quoted market price of the Notes (level 1 inputs) as of the last business day of the respective fiscal quarter. The aggregate principal amount of the Notes is recorded in long-term debt on the Condensed Consolidated Balance Sheets, net of the unamortized discount.

We have a $500 million, five-year, unsecured revolving credit facility (the “Facility”), which is scheduled to expire in May 2023. There were no borrowings and no material outstanding standby letters of credit under the Facility as of August 3, 2019.

We maintain multiple agreements with third parties that make unsecured revolving credit facilities available for our operations in foreign locations (the “Foreign Facilities”). These Foreign Facilities are uncommitted and are generally available for borrowings, overdraft borrowings, and the issuance of bank guarantees. The total capacity of the Foreign Facilities was $56 million as of August 3, 2019. As of August 3, 2019, there were no borrowings under the Foreign Facilities. There were $17 million in bank guarantees issued and outstanding primarily related to store leases under the Foreign Facilities as of August 3, 2019.

We have bilateral unsecured standby letter of credit agreements that are uncommitted and do not have expiration dates. As of August 3, 2019, we had $17 million in standby letters of credit issued under these agreements.

Note 4. Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including derivatives and available-for-sale debt securities. The Company categorizes financial assets and liabilities recorded at fair value based upon a three-level hierarchy that considers the related valuation techniques.

There were no purchases, sales, issuances, or settlements related to recurring level 3 measurements during the thirteen and twenty-six weeks ended August 3, 2019 or August 4, 2018. There were no transfers of financial assets or liabilities into or out of level 1, level 2, and level 3 during the thirteen and twenty-six weeks ended August 3, 2019 or August 4, 2018.

Financial Assets and Liabilities

Financial assets and liabilities measured at fair value on a recurring basis and cash equivalents are as follows:



			Fair Value Measurements at Reporting Date Using
($ in millions)	August 3, 2019		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents	$	312	$	31	$	281	$	—
Short-term investments	294		131		163		—
Derivative financial instruments	27		—		27		—
Deferred compensation plan assets	51		51		—		—
Other assets	2		—		—		2
Total	$	686	$	213	$	471	$	2
Liabilities:
Derivative financial instruments	$	9	$	—	$	9	$	—
			Fair Value Measurements at Reporting Date Using
($ in millions)	February 2, 2019		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents	$	373	$	26	$	347	$	—
Short-term investments	288		125		163		—
Derivative financial instruments	20		—		20		—
Deferred compensation plan assets	48		48		—		—
Other assets	2		—		—		2
Total	$	731	$	199	$	530	$	2
Liabilities:
Derivative financial instruments	$	11	$	—	$	11	$	—
			Fair Value Measurements at Reporting Date Using
($ in millions)	August 4, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents	$	481	$	21	$	460	$	—
Short-term investments	286		109		177		—
Derivative financial instruments	40		—		40		—
Deferred compensation plan assets	53		53		—		—
Total	$	860	$	183	$	677	$	—
Liabilities:
Derivative financial instruments	$	7	$	—	$	7	$	—

We have highly liquid investments classified as cash equivalents, which are placed primarily in time deposits, money market funds, and commercial paper. With the exception of our available-for-sale investments noted below, we value these investments at their original purchase prices plus interest that has accrued at the stated rate.

Our available-for-sale securities are comprised of investments in debt securities. These securities are recorded at fair value using market prices. As of August 3, 2019 and August 4, 2018, the Company held $294 million and $286 million, respectively, of available-for-sale debt securities with maturity dates greater than three months and less than two years within short-term investments on the Condensed Consolidated Balance Sheets. In addition, as of August 3, 2019 and August 4, 2018, the Company held $15 million and $14 million of available-for-sale debt securities with maturities of less than three months at the time of purchase within cash and cash equivalents on the Condensed Consolidated Balance Sheets. Unrealized gains or losses on available-for-sale debt securities included within accumulated other comprehensive income were immaterial as of August 3, 2019 and August 4, 2018.

The Company regularly reviews its available-for-sale debt securities for other-than-temporary impairment. For the thirteen and twenty-six weeks ended August 3, 2019 and August 4, 2018, the Company did not consider any of its securities to be other-than-temporarily impaired and, accordingly, did not recognize any impairment loss.

Derivative financial instruments primarily include foreign exchange forward contracts. The fair value of the Company’s derivative financial instruments is determined using pricing models based on current market rates. See Note 5 of the Notes to the Condensed Consolidated Financial Statements for information regarding currencies hedged against the U.S. dollar.

We maintain the Gap Inc. Deferred Compensation Plan (“DCP”), which allows eligible employees and non-employee directors to defer base compensation up to a maximum percentage. Plan investments are directed by participants and are recorded at market value and designated for the DCP. The fair value of the Company’s DCP assets is determined based on quoted market prices, and the assets are recorded in other long-term assets on the Condensed Consolidated Balance Sheets.

Nonfinancial Assets

We review the carrying amount of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The fair value of the long-lived assets is determined using level 3 inputs and based on discounted future cash flows of the asset or asset group using a discount rate commensurate with the risk. The asset group is defined as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of other groups of assets, which for our retail stores, is primarily at the store level.

There were no material impairment charges recorded for long-lived assets for the thirteen and twenty-six weeks ended August 3, 2019, or August 4, 2018.

As discussed in Note 1, we recorded a decrease to fiscal year 2019 opening retained earnings due to the adoption of ASC 842 related to impairments as of the effective date.

We review the carrying amount of goodwill and other indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount may not be recoverable.

There were no material impairment charges recorded for goodwill or other indefinite-lived intangible assets for the thirteen and twenty-six weeks ended August 3, 2019, or August 4, 2018.

Note 5. Derivative Financial Instruments

We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations. We use derivative financial instruments to manage our exposure to foreign currency exchange rate risk and do not enter into derivative financial contracts for trading purposes. Consistent with our risk management guidelines, we hedge a portion of our transactions related to merchandise purchases for foreign operations and certain intercompany transactions using foreign exchange forward contracts. These contracts are entered into with large, reputable, financial institutions that are monitored for counterparty risk. The currencies hedged against changes in the U.S. dollar are Canadian dollars, Japanese yen, British pounds, Mexican pesos, Euro, Chinese yuan, and Taiwan dollars. Cash flows from derivative financial instruments are classified as cash flows from operating activities on the Condensed Consolidated Statements of Cash Flows.

Cash Flow Hedges

We currently designate the following foreign exchange forward contracts as cash flow hedges: (1) forward contracts used to hedge forecasted merchandise purchases and related costs denominated in U.S. dollars made by our international subsidiaries whose functional currencies are their local currencies; and (2) forward contracts used to hedge forecasted intercompany revenue transactions related to merchandise sold from our regional purchasing entity, whose functional currency is the U.S. dollar, to certain international subsidiaries in their local currencies. The foreign exchange forward contracts entered into to hedge forecasted merchandise purchases and related costs, and intercompany revenue transactions generally have terms of up to 24 months. The effective portion of the gain or loss on the derivative financial instruments is reported as a component of other comprehensive income and is recognized into income during the period in which the underlying transaction impacts the Condensed Consolidated Statements of Income.

Net Investment Hedges

We may also use foreign exchange forward contracts to hedge the net assets of international subsidiaries to offset the foreign currency translation and economic exposures related to our investment in these subsidiaries.

Other Derivatives Not Designated as Hedging Instruments

We use foreign exchange forward contracts to hedge our market risk exposure associated with foreign currency exchange rate fluctuations for certain intercompany balances denominated in currencies other than the functional currency of the entity with the intercompany balance. The gain or loss on the derivative financial instruments that represent economic hedges, as well as the remeasurement impact of the underlying intercompany balances, is recorded in operating expenses on the Condensed Consolidated Statements of Income in the same period and generally offset.

Outstanding Notional Amounts

We had foreign exchange forward contracts outstanding in the following notional amounts:



($ in millions)	August 3, 2019		February 2, 2019		August 4, 2018
Derivatives designated as cash flow hedges	$	652	$	774	$	1,052
Derivatives not designated as hedging instruments	1,046		660		646
Total	$	1,698	$	1,434	$	1,698

Quantitative Disclosures about Derivative Financial Instruments

The fair values of foreign exchange forward contracts are as follows:



($ in millions)	August 3, 2019		February 2, 2019		August 4, 2018
Derivatives designated as cash flow hedges:
Other current assets	$	15	$	15	$	19
Other long-term assets	1		—		7
Accrued expenses and other current liabilities	1		3		3
Lease incentives and other long-term liabilities	1		—		1

Derivatives not designated as hedging instruments:
Other current assets	11		5		14
Accrued expenses and other current liabilities	7		8		3

Total derivatives in an asset position	$	27	$	20	$	40
Total derivatives in a liability position	$	9	$	11	$	7

Substantially all of the unrealized gains and losses from designated cash flow hedges as of August 3, 2019, will be recognized into income within the next 12 months at the then-current values, which may differ from the fair values as of August 3, 2019, shown above.

Our foreign exchange forward contracts are subject to master netting arrangements with each of our counterparties and such arrangements are enforceable in the event of default or early termination of the contract. We do not elect to offset the fair values of our derivative financial instruments on the Condensed Consolidated Balance Sheets, and as such, the fair values shown above represent gross amounts. The amounts subject to enforceable master netting arrangements were $3 million, $4 million, and $4 million as of August 3, 2019, February 2, 2019, and August 4, 2018, respectively. If we did elect to offset, the net amounts of our derivative financial instruments in an asset position would have been $24 million, $16 million, and $36 million and the net amounts of the derivative financial instruments in a liability position would have been $6 million, $7 million, and $3 million as of August 3, 2019, February 2, 2019, and August 4, 2018, respectively.

See Note 4 of Notes to Condensed Consolidated Financial Statements for disclosures on the fair value measurements of our derivative financial instruments.

The effective portion of gains and losses on foreign exchange forward contracts designated in a cash flow hedging relationship recorded in other comprehensive income, on a pre-tax basis, are as follows:



	13 Weeks Ended				26 Weeks Ended
($ in millions)	August 3, 2019		August 4, 2018		August 3, 2019		August 4, 2018
Gain recognized in other comprehensive income	$	2	$	21	$	15	$	43

The pre-tax amounts recognized in income related to derivative instruments are as follows:



	Location and Amount of (Gain) Loss Recognized in Income
	13 Weeks Ended August 3, 2019						13 Weeks Ended August 4, 2018
($ in millions)	Cost of goods sold and occupancy expense			Operating expenses			Cost of goods sold and occupancy expense		Operating expenses
Total amount of expense line items presented in the Condensed Consolidated Income Statement in which the effects of derivatives are recorded	$	2,449		$	1,274		$	2,458	$	1,229

(Gain) recognized in income
Derivatives designated as cash flow hedges	$	(6	)	$	—		$	—	$	—
Derivatives not designated as hedging instruments	—			(3		)	—		(12		)
Total (gain) recognized in income	$	(6	)	$	(3	)	$	—	$	(12	)



	Location and Amount of (Gain) Loss Recognized in Income
	26 Weeks Ended August 3, 2019						26 Weeks Ended August 4, 2018
($ in millions)	Cost of goods sold and occupancy expense			Operating expenses			Cost of goods sold and occupancy expense			Operating expenses
Total amount of expense line items presented in the Condensed Consolidated Income Statement in which the effects of derivatives are recorded	$	4,811		$	2,302		$	4,814		$	2,427

(Gain) recognized in income
Derivatives designated as cash flow hedges	$	(12	)	$	—		$	(3	)	$	—
Derivatives not designated as hedging instruments	—			(12		)	—			(24		)
Total (gain) recognized in income	$	(12	)	$	(12	)	$	(3	)	$	(24	)

For the thirteen and twenty-six weeks ended August 3, 2019, and August 4, 2018, there were no amounts of gains or losses reclassified from accumulated other comprehensive income into net income for derivative financial instruments in net investment hedging relationships, as we did not sell or liquidate any of our hedged subsidiaries during the periods.

Note 6. Share Repurchases

Share repurchase activity is as follows:



	13 Weeks Ended				26 Weeks Ended
($ and shares in millions except average per share cost)	August 3, 2019		August 4, 2018		August 3, 2019		August 4, 2018
Number of shares repurchased (1)	2.7		3.2		4.6		6.4
Total cost	$	50	$	100	$	100	$	200
Average per share cost including commissions	$	18.41	$	30.95	$	21.54	$	31.08

__________


(1)	Excludes shares withheld to settle employee statutory tax withholding related to the vesting of stock units.

In February 2019, the Board of Directors approved a new $1.0 billion share repurchase authorization (the "February 2019 repurchase program") which superseded and replaced a February 2016 repurchase authorization. The February 2019 repurchase program had $900 million remaining as of August 3, 2019.

The February 2016 repurchase authorization had $287 million remaining as of February 2, 2019.

All of the share repurchases were paid for as of August 3, 2019, February 2, 2019, and August 4, 2018. All common stock repurchased is immediately retired.

Note 7. Accumulated Other Comprehensive Income

Changes in accumulated other comprehensive income by component, net of tax, are as follows:



($ in millions)	Foreign Currency Translation			Cash Flow Hedges			Total
Balance at February 2, 2019	$	47		$	6		$	53
13 Weeks Ended May 4, 2019:
Foreign currency translation	(1		)	—			(1		)
Change in fair value of derivative financial instruments	—			9			9
Amounts reclassified from accumulated other comprehensive income	—			(4		)	(4		)
Other comprehensive income (loss), net of tax	(1		)	5			4
Balance at May 4, 2019	46			11			57
13 Weeks Ended August 3, 2019:
Foreign currency translation	—			—			—
Change in fair value of derivative financial instruments	—			1			1
Amounts reclassified from accumulated other comprehensive income	—			(3		)	(3		)
Other comprehensive (loss), net of tax	—			(2		)	(2		)
Balance at August 3, 2019	$	46		$	9		$	55

($ in millions)	Foreign Currency Translation			Cash Flow Hedges			Total
Balance at February 3, 2018	$	64		$	(28	)	$	36
13 Weeks Ended May 5, 2018:
Foreign currency translation	(7		)	—			(7		)
Change in fair value of derivative financial instruments	—			28			28
Amounts reclassified from accumulated other comprehensive income	—			(6		)	(6		)
Other comprehensive income (loss), net of tax	(7		)	22			15
Balance at May 5, 2018	57			(6		)	51
13 Weeks Ended August 4, 2018:
Foreign currency translation	(16		)	—			(16		)
Change in fair value of derivative financial instruments	—			18			18
Amounts reclassified from accumulated other comprehensive income	—			—			—
Other comprehensive income (loss), net of tax	(16		)	18			2
Balance at August 4, 2018	$	41		$	12		$	53

See Note 5 of Notes to Condensed Consolidated Financial Statements for additional disclosures about reclassifications out of accumulated other comprehensive income and their corresponding effects within the respective line items on the Condensed Consolidated Statements of Income.

Note 8. Share-Based Compensation

Share-based compensation expense recognized on the Condensed Consolidated Statements of Income, primarily in operating expenses, is as follows:



	13 Weeks Ended						26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018			August 3, 2019			August 4, 2018
Stock units	$	17		$	22		$	36		$	38
Stock options	5			4			9			8
Employee stock purchase plan	1			1			2			2
Share-based compensation expense	23			27			47			48
Less: Income tax benefit	(9		)	(6		)	(15		)	(12		)
Share-based compensation expense, net of tax	$	14		$	21		$	32		$	36

Note 9. Leases

The Company is a party to many agreements involving commitments to make payments to third parties. The majority of our long-term contractual obligations relate to operating leases for our retail stores. We also lease some of our corporate facilities and distribution centers. These operating leases expire at various dates through fiscal 2040. Most store leases have a five-year base period and include options that allow us to extend the lease term beyond the initial base period, subject to terms agreed upon at lease inception. Some leases also include early termination options, which can be exercised under specific conditions. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

We record our lease liabilities at the present value of the lease payments not yet paid, discounted at the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term. As the Company's leases do not provide an implicit interest rate, the Company uses an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We recognize operating lease cost over the estimated term of the lease, which includes options to extend lease terms that are reasonably certain of being exercised, starting when possession of the property is taken from the landlord, which normally includes a construction period prior to the store opening. When a lease contains a predetermined fixed escalation of the minimum rent, we recognize the related operating lease cost on a straight-line basis over the lease term. In addition, certain of our lease agreements include variable lease payments, such as payments based on a percentage of sales that are in excess of a predetermined level and/or increases based on a change in the consumer price index or fair market value. These variable lease payments are excluded from minimum lease payments and are included in the determination of net lease cost when it is probable that the expense has been incurred and the amount can be reasonably estimated.

As of August 3, 2019, the Company's finance leases were not material to our Condensed Consolidated Financial Statements.

Net lease cost recognized on our Condensed Consolidated Statement of Income is summarized as follows:



	13 Weeks Ended			26 Weeks Ended
($ in millions)	August 3, 2019			August 3, 2019
Operating lease cost	$	301		$	597
Variable lease cost	156			321
Sublease income	(1		)	(6		)
Net lease cost	$	456		$	912

As of August 3, 2019, the maturities of lease liabilities based on the total minimum lease commitment amount including options to extend lease terms that are reasonably certain of being exercised are as follows:



($ in millions)
Fiscal Year
Remainder of 2019	$	608
2020	1,150
2021	1,024
2022	913
2023	811
Thereafter	3,665
Total minimum lease payments	8,171
Less: Interest	(1,581		)
Present value of operating lease liabilities	6,590
Less: Current portion of operating lease liabilities	(946		)
Long-term operating lease liabilities	$	5,644

During the thirteen and twenty-six weeks ended August 3, 2019, additions of operating lease assets were $290 million and $456 million, respectively. As of August 3, 2019, the minimum lease commitment amount for operating leases signed but not yet commenced, primarily for retail stores, was $304 million.

As of August 3, 2019, the weighted-average remaining operating lease term was 8.6 years and the weighted-average discount rate was 4.7 percent for operating leases recognized on our Condensed Consolidated Financial Statements.

In accordance with Accounting Standards Codification ("ASC") 840, Leases, the aggregate minimum non-cancelable annual lease payments under operating leases in effect on February 2, 2019 were as follows:



($ in millions)
Fiscal Year
2019	$	1,156
2020	1,098
2021	892
2022	730
2023	539
Thereafter	1,520
Total minimum lease commitments	$	5,935

The total minimum lease commitment amount above does not include minimum sublease income of $12 million receivable in the future under non-cancelable sublease agreements. In addition, the total minimum lease commitment amount above excludes options to extend lease terms that are reasonably certain of being exercised.

Note 10. Income Taxes

The effective income tax rate was 38.0 percent for the thirteen weeks ended August 3, 2019, compared with 23.5 percent for the thirteen weeks ended August 4, 2018. The effective income tax rate was 31.1 percent for the twenty-six weeks ended August 3, 2019, compared with 24.1 percent for the twenty-six weeks ended August 4, 2018. The increase in the effective tax rate is primarily due to adjustments to our fiscal 2017 tax liability for additional guidance issued by the U.S. Treasury Department regarding the Tax Cuts and Jobs Act of 2017 ("TCJA").

The Company conducts business globally, and as a result, files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as the United States, Canada, France, the United Kingdom, China, Hong Kong, Japan, and India. We are no longer subject to U.S. federal income tax examinations for fiscal years before 2009, and with few exceptions, we are also no longer subject to U.S. state, local, or non-U.S. income tax examinations for fiscal years before 2008.

The Company is in continual discussions with taxing authorities regarding tax matters in the various U.S. and foreign jurisdictions in the normal course of business. As of August 3, 2019, it is reasonably possible that we will recognize a decrease in gross unrecognized tax benefits within the next 12 months of up to $4 million, primarily due to the closing of audits. If we do recognize such a decrease, the net impact on the Condensed Consolidated Statements of Income would not be material.

Note 11. Earnings Per Share

Weighted-average number of shares used for earnings per share is as follows:



	13 Weeks Ended		26 Weeks Ended
(shares in millions)	August 3, 2019	August 4, 2018	August 3, 2019	August 4, 2018
Weighted-average number of shares - basic	378	387	378	388
Common stock equivalents	1	3	2	3
Weighted-average number of shares - diluted	379	390	380	391

The above computations of weighted-average number of shares – diluted exclude 17 million and 6 million shares related to stock options and other stock awards for the thirteen weeks ended August 3, 2019 and August 4, 2018, respectively, and 13 million and 6 million shares related to stock options and other stock awards for the twenty-six weeks ended August 3, 2019 and August 4, 2018, respectively, as their inclusion would have an anti-dilutive effect on earnings per share.

Note 12. Commitments and Contingencies

We are a party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to our commercial contracts, operating leases, trademarks, intellectual property, financial agreements, and various other agreements. Under these contracts, we may provide certain routine indemnifications relating to representations and warranties (e.g., ownership of assets, environmental or tax indemnifications), or personal injury matters. The terms of these indemnifications range in duration and may not be explicitly defined. Generally, the maximum obligation under such indemnifications is not explicitly stated, and as a result, the overall amount of these obligations cannot be reasonably estimated. Historically, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any of these matters, the loss would not have a material effect on our Condensed Consolidated Financial Statements taken as a whole.

As a multinational company, we are subject to various proceedings, lawsuits, disputes, and claims (“Actions”) arising in the ordinary course of our business. Many of these Actions raise complex factual and legal issues and are subject to uncertainties. As of August 3, 2019, Actions filed against us included commercial, intellectual property, customer, and employment claims, including class action lawsuits. The plaintiffs in some Actions seek unspecified damages or injunctive relief, or both. Actions are in various procedural stages and some are covered in part by insurance. As of August 3, 2019, February 2, 2019, and August 4, 2018, we recorded a liability for an estimated loss if the outcome of an Action is expected to result in a loss that is considered probable and reasonably estimable. The liability recorded as of August 3, 2019, February 2, 2019, and August 4, 2018, was not material for any individual Action or in total. Subsequent to August 3, 2019, and through the filing date of this Quarterly Report on Form 10-Q, no information has become available that indicates a change is required that would be material to our Condensed Consolidated Financial Statements taken as a whole.

We cannot predict with assurance the outcome of Actions brought against us. Accordingly, developments, settlements, or resolutions may occur and impact income in the quarter of such development, settlement, or resolution. However, we do not believe that the outcome of any current Action would have a material effect on our Condensed Consolidated Financial Statements taken as a whole.

Note 13. Segment Information

We identify our operating segments according to how our business activities are managed and evaluated. As of August 3, 2019, our operating segments included Old Navy Global, Gap Global, Banana Republic Global, Athleta, and Intermix. Each operating segment has a brand president who is responsible for various geographies and channels. Each of our brands serves customers through its store and online channels, allowing us to execute on our omni-channel strategy where customers can shop seamlessly across all of our brands in retail stores and online through desktop or mobile devices. We have determined that each of our operating segments share similar economic and other qualitative characteristics, and therefore the results of our operating segments were aggregated into one reportable segment as of August 3, 2019. We continually monitor and review our segment reporting structure in accordance with authoritative guidance to determine whether any changes have occurred that would impact our reportable segments.

Net sales by brand and region are as follows:



($ in millions)	Old Navy Global		Gap Global		Banana Republic Global (2)		Other (3)		Total		Percentage of Net Sales
13 Weeks Ended August 3, 2019	Old Navy Global		Gap Global		Banana Republic Global (2)		Other (3)		Total		Percentage of Net Sales
U.S. (1)	$	1,794	$	645	$	530	$	331	$	3,300	83	%
Canada	148		85		53		—		286		7
Europe	—		131		4		—		135		3
Asia	11		201		23		—		235		6
Other regions	19		24		6		—		49		1
Total	$	1,972	$	1,086	$	616	$	331	$	4,005	100	%

($ in millions)	Old Navy Global		Gap Global		Banana Republic Global		Other (3)		Total		Percentage of Net Sales
13 Weeks Ended August 4, 2018	Old Navy Global		Gap Global		Banana Republic Global		Other (3)		Total		Percentage of Net Sales
U.S. (1)	$	1,816	$	728	$	514	$	264	$	3,322	82	%
Canada	151		94		58		—		303		7
Europe	—		145		3		—		148		4
Asia	11		229		22		—		262		6
Other regions	14		29		7		—		50		1
Total	$	1,992	$	1,225	$	604	$	264	$	4,085	100	%

($ in millions)	Old Navy Global		Gap Global		Banana Republic Global (2)		Other (3)		Total		Percentage of Net Sales
26 Weeks Ended August 3, 2019	Old Navy Global		Gap Global		Banana Republic Global (2)		Other (3)		Total		Percentage of Net Sales
U.S. (1)	$	3,435	$	1,253	$	1,017	$	617	$	6,322	82	%
Canada	276		154		100		1		531		7
Europe	—		252		7		—		259		3
Asia	21		434		49		—		504		7
Other regions	39		45		11		—		95		1
Total	$	3,771	$	2,138	$	1,184	$	618	$	7,711	100	%

($ in millions)	Old Navy Global		Gap Global		Banana Republic Global		Other (3)		Total		Percentage of Net Sales
26 Weeks Ended August 4, 2018	Old Navy Global		Gap Global		Banana Republic Global		Other (3)		Total		Percentage of Net Sales
U.S. (1)	$	3,406	$	1,408	$	993	$	533	$	6,340	81	%
Canada	278		171		108		1		558		7
Europe	—		280		7		—		287		4
Asia	23		513		47		—		583		7
Other regions	30		57		13		—		100		1
Total	$	3,737	$	2,429	$	1,168	$	534	$	7,868	100	%

__________


(1)	U.S. includes the United States, Puerto Rico, and Guam.


(2)	Beginning on March 4, 2019, Banana Republic Global includes net sales for the Janie and Jack brand.


(3)	Primarily consists of net sales for the Athleta and Intermix brands, as well as a portion of income related to our credit card agreement. Beginning in the third quarter of fiscal year 2018, the Hill City brand is also included.

Net sales by region are allocated based on the location of the store where the customer paid for and received the merchandise or the distribution center or store from which the products were shipped.

Note 14. Acquisition

On March 4, 2019, the Company acquired select assets of Gymboree, Inc. related to Janie and Jack, a premium children's clothing brand, through a bankruptcy auction. We purchased intellectual property and property and equipment at the Janie and Jack store locations. We assumed the leases for the majority of Janie and Jack stores and entered into a separate transaction to purchase Janie and Jack inventory.

The purchase price for the net assets acquired was $69 million. The total purchase price was allocated to the net tangible and intangible assets acquired based on their estimated fair values. Such estimated fair values require management to make estimates and judgments, especially with respect to intangible assets.

Amounts recorded for assets acquired and liabilities assumed on the acquisition date were as follows:



($ in millions)	As of March 4, 2019
Inventory	$	34
Property and equipment	15
Operating lease assets	51
Intangible assets	37
Net assets acquired	137
Operating lease liabilities	(64		)
Other liabilities	(4		)
Total consideration paid	$	69

The results of operations for Janie and Jack since the date of acquisition were not material to the Condensed Consolidated Statement of Income.


Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.

OUR BUSINESS

We are a global omni-channel retailer offering apparel, accessories, and personal care products for men, women, and children under the Old Navy, Gap, Banana Republic, Athleta, Intermix, Janie and Jack, and Hill City brands. We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico. We have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic, and Old Navy stores throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. Our products are also available to customers online through Company-owned websites and through the use of third parties that provide logistics and fulfillment services. In addition to operating in the specialty, outlet, online, and franchise channels, we also use our omni-channel capabilities to bridge the digital world and physical stores to further enhance our shopping experience for our customers. Our omni-channel services, including order-in-store, find-in-store, ship-from-store, and buy online pick-up in store, as well as enhanced mobile experiences, are tailored uniquely across our portfolio of brands. Most of the products sold under our brand names are designed by us and manufactured by independent sources. We also sell products that are designed and manufactured by branded third parties, primarily at our Intermix brand.

OVERVIEW

On February 28, 2019, the Company announced that its Board of Directors approved a plan to separate the Company into two independent publicly-traded companies: Old Navy and the new Gap Inc., which will consist of Gap brand, Athleta, Banana Republic, Intermix, Janie and Jack, and Hill City. The separation is intended to enable both companies to capitalize on their respective opportunities in an evolving retail environment by creating distinct financial profiles, tailored operating priorities and unique capital allocation strategies. Both companies will be positioned to create value for customers, shareholders and employees with enhanced focus and flexibility, aligned investments and incentives to meet the unique strategic goals, and optimized cost structures to deliver growth. The transaction is targeted to be completed in 2020 and is subject to certain conditions, including final approval by the Company’s Board of Directors, receipt of a tax opinion from counsel, and the filing and effectiveness of a registration statement with the U.S. Securities and Exchange Commission. For the thirteen and twenty-six weeks ended August 3, 2019, we incurred separation costs of $38 million and $42 million, respectively, which primarily included external adviser and consulting fees.

In addition, on February 28, 2019, the Company announced plans to restructure the specialty fleet and revitalize the Gap brand, including closing about 230 Gap specialty stores during fiscal 2019 and fiscal 2020. The Company believes these actions will drive a healthier specialty fleet and will serve as a more appropriate foundation for brand revitalization. During the two-year period, the Company estimates pre-tax costs associated with these closure actions to be about $250 million to $300 million, with the majority expected to be cash expenditures for lease-related costs. The remaining charges are expected to primarily include employee-related costs and the net impact of write-offs related to long-term assets and liabilities. The Company estimates an annualized sales loss of approximately $625 million as a result of these store closures, with resulting annualized pre-tax savings of about $90 million. For the thirteen and twenty-six weeks ended August 3, 2019, we incurred restructuring costs of $14 million and $15 million, respectively, which primarily included lease and employee-related costs.

During the first quarter of fiscal 2019, we adopted the new lease accounting standard, ASC 842, using the optional transition method and recorded a decrease to opening retained earnings of $86 million, net of tax. The adoption of ASC 842 resulted in the recording of operating lease assets and operating lease liabilities of $5.7 billion and $6.6 billion, respectively, as of February 3, 2019. The adoption of ASC 842 did not have a material impact to our Condensed Consolidated Statement of Income or Condensed Consolidated Statement of Cash Flows.

During the first quarter of fiscal 2019, the Company purchased a building for $343 million. In addition, as part of a related tax exchange, during the thirteen weeks ended May 4, 2019 the Company also sold a building for $220 million, which resulted in a pre-tax gain on sale of $191 million.

Financial results for the second quarter of fiscal 2019 are as follows:


•	Net sales for the second quarter of fiscal 2019 decreased 2 percent compared with the second quarter of fiscal 2018.


•	Comparable sales for the second quarter of fiscal 2019 decreased 4 percent compared with a 2 percent increase for the second quarter of fiscal 2018.


•	Gross profit for the second quarter of fiscal 2019 was $1.56 billion compared with $1.63 billion for the second quarter of fiscal 2018. Gross margin for the second quarter of fiscal 2019 was 38.9 percent compared with 39.8 percent for the second quarter of fiscal 2018.


•	Operating margin for the second quarter of fiscal 2019 was 7.0 percent compared with 9.7 percent for the second quarter of fiscal 2018.


•	The effective income tax rate for the second quarter of fiscal 2019 was 38.0 percent, compared with 23.5 percent for the second quarter of fiscal 2018, which included an increase related to an adjustment to our fiscal 2017 tax liability for additional guidance issued by the Treasury Department regarding the TCJA.


•	Net income for the second quarter of fiscal 2019 was $168 million compared with $297 million for the second quarter of fiscal 2018.


•	Diluted earnings per share were $0.44 for the second quarter of fiscal 2019 compared with $0.76 for the second quarter of fiscal 2018.


•	During the first half of fiscal 2019, we paid dividends of $183 million.


•	During the first half of fiscal 2019, share repurchases were $100 million.

Our business priorities for fiscal 2019 are as follows:


•	offering product that is consistently brand-appropriate and on-trend with high customer acceptance, with a focus on expanding our advantage in core businesses and loyalty categories, with leading customer-focused product innovation;


•	preparing for successful separation;


•	restructuring the Gap brand specialty fleet globally to create a healthier, more profitable base from which to grow;


•	improving inventory productivity by leveraging responsive capabilities;


•	investing in digital and customer capabilities as well as store experience to create a unique and differentiated converged retail experience that attracts new customers, retains existing customers, and builds loyalty;


•	increasing productivity by leveraging our scale and streamlining operations and processes throughout the organization;


•	attracting and retaining strong talent in our businesses and functions; and


•	continuing to integrate social and environmental sustainability into business practices to support long term growth.

In fiscal 2019, while we work through the plan for separation, we remain focused on investing strategically in the business while maintaining operating expense discipline and driving efficiency through our productivity initiative. One of our primary objectives is to continue transforming our product to market process, with the development of a more efficient operating model. Furthermore, we expect to continue our investment in customer experience, both in stores and online, to drive higher customer engagement and loyalty across all of our brands and channels, resulting in market share gains. Finally, we will continue to invest in strengthening brand awareness, customer acquisition, and digital capabilities. Underpinning these strategies is a focus on utilizing data, analytics, and technology to respond faster while making decisions that will fuel market share gains and lead to a more nimble organization. The current retail environment is quite challenging, but we remain committed to our long-term strategic priorities.

RESULTS OF OPERATIONS

Net Sales

See Note 13 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q, for net sales by brand and region.

Comparable Sales (“Comp Sales”)

The percentage change in Comp Sales by global brand and for The Gap, Inc., as compared with the preceding year, is as follows:



	13 Weeks Ended				26 Weeks Ended
	August 3, 2019		August 4, 2018		August 3, 2019		August 4, 2018
Old Navy Global	(5	)%	5	%	(3	)%	4	%
Gap Global	(7	)%	(5	)%	(9	)%	(5	)%
Banana Republic Global	(3	)%	2	%	(3	)%	2	%
The Gap, Inc.	(4	)%	2	%	(4	)%	1	%

Comp Sales include merchandise sales in Company-operated stores and merchandise sales through online channels in those countries where we have existing comparable store sales. A store is included in the Comp Sales calculations when it has been open and operated by the Company for at least one year and the selling square footage has not changed by 15 percent or more within the past year. A store is included in the Comp Sales calculations on the first day it has comparable prior year sales. Stores in which the selling square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from the Comp Sales calculations until the first day they have comparable prior year sales. The calculation of The Gap, Inc. Comp Sales includes the results of Athleta and Intermix, but excludes the results of our franchise business, Janie and Jack, and Hill City.

A store is considered non-comparable (“Non-comp”) when it has been open and operated by the Company for less than one year or has changed its selling square footage by 15 percent or more within the past year.

A store is considered “Closed” if it is temporarily closed for three or more full consecutive days or it is permanently closed. When a temporarily closed store reopens, the store will be placed in the Comp/Non-comp status it was in prior to its closure. If a store was in Closed status for three or more days in the prior year, the store will be in Non-comp status for the same days the following year.

Current year foreign exchange rates are applied to both current year and prior year Comp Sales to achieve a consistent basis for comparison.

Store Count and Square Footage Information

Net sales per average square foot are as follows:



	13 Weeks Ended				26 Weeks Ended
($ in millions)	August 3, 2019		August 4, 2018		August 3, 2019		August 4, 2018
Net sales per average square foot (1)	$	83	$	90	$	158	$	169

__________


(1)	Excludes net sales associated with our online and franchise businesses. Online sales includes both sales through our online channels as well as ship-from-store sales.

Store count, openings, closings, and square footage for our stores are as follows:



	February 2, 2019	26 Weeks Ended August 3, 2019		August 3, 2019
	Number of Store Locations	Number of Stores Opened	Number of Stores Closed	Number of Store Locations		Square Footage (in millions)
Old Navy North America	1,139	28	1	1,166		19.0
Old Navy Asia	15	2	—	17		0.2
Gap North America	758	3	28	733		7.6
Gap Asia	332	29	19	342		3.1
Gap Europe	152	1	2	151		1.3
Banana Republic North America	556	5	7	554		4.7
Banana Republic Asia	45	3	1	47		0.2
Athleta North America	161	10	—	171		0.7
Intermix North America	36	—	1	35		0.1
Janie and Jack North America (1)	—	—	—	140		0.2
Company-operated stores total	3,194	81	59	3,356		37.1
Franchise	472	66	17	521		N/A
Total	3,666	147	76	3,877		37.1
Increase over prior year				6.9	%	1.4	%

	February 3, 2018	26 Weeks Ended August 4, 2018		August 4, 2018
	Number of Store Locations	Number of Stores Opened	Number of Stores Closed	Number of Store Locations		Square Footage (in millions)
Old Navy North America	1,066	30	2	1,094		18.1
Old Navy Asia	14	—	—	14		0.2
Gap North America	810	4	14	800		8.2
Gap Asia	313	9	3	319		3.1
Gap Europe	155	5	5	155		1.3
Banana Republic North America	576	3	9	570		4.8
Banana Republic Asia	45	2	3	44		0.2
Athleta North America	148	7	1	154		0.6
Intermix North America	38	—	1	37		0.1
Company-operated stores total	3,165	60	38	3,187		36.6
Franchise	429	47	37	439		N/A
Total	3,594	107	75	3,626		36.6
Increase (decrease) over prior year				(0.4	)%	0.3	%

__________


(1)	On March 4, 2019, we acquired select assets of Gymboree, Inc. related to Janie and Jack. The 140 stores acquired were not included as store openings for fiscal 2019; however, they are included in the ending number of store locations as of August 3, 2019.

Gap and Banana Republic outlet and factory stores are reflected in each of the respective brands.

Net Sales

Our net sales for the second quarter of fiscal 2019 decreased $80 million, or 2 percent, compared with the second quarter of fiscal 2018 primarily driven by a decrease in net sales at Gap Global, as well as an unfavorable impact of foreign exchange of $22 million, partially offset by an increase in net sales at Athleta, the acquisition of Janie and Jack, and higher income related to our credit card agreement. The foreign exchange impact is the translation impact if net sales for the second quarter of fiscal 2018 were translated at exchange rates applicable during the second quarter of fiscal 2019.

Our net sales for the first half of fiscal 2019 decreased $157 million, or 2 percent, compared with the first half of fiscal 2018 primarily driven by a decrease in net sales at Gap Global, as well as an unfavorable impact of foreign exchange of $56 million, partially offset by an increase in net sales at Athleta, the acquisition of Janie and Jack, and higher income related to our credit card agreement. The foreign exchange impact is the translation impact if net sales for the first half of fiscal 2018 were translated at exchange rates applicable during the first half of fiscal 2019.

Cost of Goods Sold and Occupancy Expenses



	13 Weeks Ended						26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018			August 3, 2019			August 4, 2018
Cost of goods sold and occupancy expenses	$	2,449		$	2,458		$	4,811		$	4,814
Gross profit	$	1,556		$	1,627		$	2,900		$	3,054
Cost of goods sold and occupancy expenses as a percentage of net sales	61.1		%	60.2		%	62.4		%	61.2		%
Gross margin	38.9		%	39.8		%	37.6		%	38.8		%

Cost of goods sold and occupancy expenses increased 0.9 percentage points as a percentage of net sales in the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018.


•	Cost of goods sold increased 0.7 percentage points as a percentage of net sales in the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018, primarily driven by higher promotional activity at Old Navy Global, partially offset by an increase of income related to our credit card agreement classified within net sales.


•	Occupancy expenses increased 0.2 percentage points as a percentage of net sales in the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018 due to lower net sales without a corresponding decrease in occupancy expenses.

Cost of goods sold and occupancy expenses increased 1.2 percentage points as a percentage of net sales in the first half of fiscal 2019 compared with the first half of fiscal 2018.


•	Cost of goods sold increased 1.0 percentage points as a percentage of net sales in the first half of fiscal 2019 compared with the first half of fiscal 2018, primarily driven by higher promotional activity at Old Navy Global, partially offset by an increase of income related to our credit card agreement classified within net sales.


•	Occupancy expenses increased 0.2 percentage points as a percentage of net sales in the first half of fiscal 2019 compared with the first half of fiscal 2018 due to lower net sales without a corresponding decrease in occupancy expenses.

Operating Expenses



	13 Weeks Ended						26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018			August 3, 2019			August 4, 2018
Operating expenses	$	1,274		$	1,229		$	2,302		$	2,427
Operating expenses as a percentage of net sales	31.8		%	30.1		%	29.9		%	30.8		%
Operating margin	7.0		%	9.7		%	7.8		%	8.0		%

Operating expenses increased $45 million, or 1.7 percentage points as a percentage of net sales in the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018.

The increase in operating expenses for the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018 was primarily due to separation-related costs, specialty fleet restructuring costs, and operating expenses related to Janie and Jack; partially offset by a decrease in bonus expense.

Operating expenses decreased $125 million, or 0.9 percentage points as a percentage of net sales in the first half of fiscal 2019 compared with the first half of fiscal 2018.

The decrease in operating expenses for the first half of fiscal 2019 compared with the first half of fiscal 2018 was primarily driven by a $191 million gain on the sale of a building. The remaining increase in operating expenses for the first half of fiscal 2019 compared with the second half of fiscal 2018 was primarily due to separation-related costs, specialty fleet restructuring costs, and operating expenses related to Janie and Jack; partially offset by a decrease in bonus expense.

Interest Expense



	13 Weeks Ended				26 Weeks Ended
($ in millions)	August 3, 2019		August 4, 2018		August 3, 2019		August 4, 2018
Interest expense	$	19	$	17	$	39	$	33

Interest expense primarily includes interest on overall borrowings and obligations mainly related to our $1.25 billion 5.95 percent Notes.

Income Taxes



	13 Weeks Ended						26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018			August 3, 2019			August 4, 2018
Income taxes	$	103		$	91		$	178		$	146
Effective tax rate	38.0		%	23.5		%	31.1		%	24.1		%

The increase in the effective tax rate for the second quarter and first half of fiscal 2019 compared with the respective periods of fiscal 2018 is primarily due to a $30 million adjustment to our fiscal 2017 tax liability for additional guidance issued by the U.S. Treasury Department regarding the TCJA.

LIQUIDITY AND CAPITAL RESOURCES

Our largest source of cash flows is cash collections from the sale of our merchandise. Our primary uses of cash include merchandise inventory purchases, occupancy costs, personnel-related expenses, purchases of property and equipment, and payment of taxes. In addition, we may have dividend payments, debt repayments, and share repurchases. As of August 3, 2019, cash, cash equivalents, and short-term investments were $1.5 billion, the majority of which was held in the United States and is generally accessible without any limitations.

We believe that current cash balances and cash flows from our operations will be sufficient to support our business operations, including growth initiatives, Gap brand specialty fleet restructuring costs, separation related costs, and planned capital expenditures, for the next 12 months and beyond. We are also able to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility or other available market instruments.

Cash Flows from Operating Activities

Net cash provided by operating activities increased $37 million during the first half of fiscal 2019 compared with the first half of fiscal 2018, primarily due to the following:


•	an increase of $166 million primarily due to lower bonus payout in fiscal 2019 compared with the bonus payout in fiscal 2018, which impacts accrued expenses and other current liabilities;


•	an increase of $58 million related to merchandise inventory primarily due to the timing of receipts; and


•	an increase related to timing of payments for other current assets and long-term assets, and accounts payable; partially offset by


•	lower net income, after excluding the $191 million gain on the sale of a building, during the first half of fiscal 2019.

We fund inventory expenditures during normal and peak periods through cash flows from operating activities and available cash. Our business follows a seasonal pattern, with sales peaking during the end-of-year holiday period. The seasonality of our operations may lead to significant fluctuations in certain asset and liability accounts between fiscal year-end and subsequent interim periods.

Cash Flows from Investing Activities

Net cash used for investing activities during the first half of fiscal 2019 decreased $98 million compared with the first half of fiscal 2018, primarily due to the following:


•	$343 million purchase of a building during the first half of fiscal 2019; and


•	$69 million purchase of Janie and Jack during the first half of fiscal 2019; partially offset by


•	$220 million of proceeds received for the sale of a building during the first half of fiscal 2019; and


•	$282 million fewer net purchases of available-for-sale debt securities during the first half of fiscal 2019 compared with the first half of fiscal 2018.

Cash Flows from Financing Activities

Net cash used for financing activities during the first half of fiscal 2019 decreased $90 million compared with the first half of fiscal 2018, primarily due to fewer repurchases of common stock.

Free Cash Flow

Free cash flow is a non-GAAP financial measure. We believe free cash flow is an important metric because it represents a measure of how much cash a company has available for discretionary and non-discretionary items after the deduction of capital expenditures as we require regular capital expenditures to build and maintain stores and purchase new equipment to improve our business. We use this metric internally, as we believe our sustained ability to generate free cash flow is an important driver of value creation. However, this non-GAAP financial measure is not intended to supersede or replace our GAAP results.

The following table reconciles free cash flow, a non-GAAP financial measure, from a GAAP financial measure.



	26 Weeks Ended
($ in millions)	August 3, 2019			August 4, 2018
Net cash provided by operating activities	$	583		$	546
Less: Purchases of property and equipment (1)	(324		)	(326		)
Free cash flow	$	259		$	220

__________


(1)	Excludes purchase of building in the first quarter of fiscal 2019.

Debt and Credit Facilities

Certain financial information about the Company’s debt and credit facilities is set forth under the heading “Debt and Credit Facilities” in Note 3 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q.

Dividend Policy

In determining whether and at what level to declare a dividend, we consider a number of factors including sustainability, operating performance, liquidity, and market conditions.

We paid a dividend of $0.485 per share during the first half of fiscal 2019 and fiscal 2018. Including the dividend paid during the first half of fiscal 2019, we intend to pay an annual dividend of $0.97 per share for fiscal 2019 consistent with the annual dividend for fiscal 2018.

Share Repurchases

Certain financial information about the Company’s share repurchases is set forth under the heading “Share Repurchases” in Note 6 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q.

Summary Disclosures about Contractual Cash Obligations and Commercial Commitments

Except for presentation changes resulting from the adoption of ASC 842 during the period and Old Navy spin-off transaction costs and related obligations, there have been no material changes to our contractual obligations and commercial commitments as disclosed in our Annual Report on Form 10-K as of February 2, 2019, other than those which occur in the normal course of business. See Note 12 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q, for disclosures on commitments and contingencies.

Critical Accounting Policies and Estimates

Except for changes resulting from the adoption of new accounting standards during the period, there have been no significant changes to our critical accounting policies and estimates as discussed in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019. See Note 1 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q, for disclosures on accounting policies.


Item 3.	Quantitative and Qualitative Disclosures About Market Risk.

Our market risk profile as of February 2, 2019, is disclosed in our Annual Report on Form 10-K and has not significantly changed. See Notes 3, 4, and 5 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1, of this Form 10-Q for disclosures on our debt, investments, and derivative financial instruments.


Item 4.	Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s second quarter of fiscal 2019 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION


Item 1.	Legal Proceedings.

As a multinational company, we are subject to various proceedings, lawsuits, disputes, and claims arising in the ordinary course of our business. Many of these Actions raise complex factual and legal issues and are subject to uncertainties. Actions filed against us from time to time include commercial, intellectual property, customer, and employment claims, including class action lawsuits. The plaintiffs in some Actions seek unspecified damages or injunctive relief, or both. Actions are in various procedural stages, and some are covered in part by insurance.


Item 1A.	Risk Factors.

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended February 2, 2019.


Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.

The following table presents information with respect to purchases of common stock of the Company made during the thirteen weeks ended August 3, 2019 by The Gap, Inc. or any affiliated purchaser, as defined in Exchange Act Rule 10b-18(a)(3):



	Total Number of Shares Purchased (1)	Average Price Paid Per Share Including Commissions		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number (or approximate dollar amount) of Shares that May Yet be Purchased Under the Plans or Programs (2)
Month #1 (May 5- June 1)	—	$	—	—	$	950	million
Month #2 (June 2 - July 6)	1,550,755	$	18.09	1,550,755	$	922	million
Month #3 (July 7 - August 3)	1,165,696	$	18.83	1,165,696	$	900	million
Total	2,716,451	$	18.41	2,716,451

__________


(1)	Excludes shares withheld to settle employee statutory tax withholding related to the vesting of stock units.


(2)	On February 26, 2019, we announced that the Board of Directors approved a $1 billion share repurchase authorization, which superseded the February 2016 repurchase program and has no expiration date.


Item 6.	Exhibits.



10.1		The Gap, Inc. 2016 Long Term-Incentive Plan (as Amended and Restated Effective as of May 21, 2019), filed as Appendix A to the Company's definitive proxy statement for its annual meeting of shareholders held on May 21, 2019, Commission File No. 1-7562.
31.1		Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer of The Gap, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002). (1)
31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of The Gap, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002). (1)
32.1		Certification of the Chief Executive Officer of The Gap, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (2)
32.2		Certification of the Chief Financial Officer of The Gap, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (2)
101		The following materials from The Gap, Inc.’s Quarterly Report on Form 10-Q for the quarter ended August 3, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Stockholders' Equity; (v) the Condensed Consolidated Statements of Cash Flows; and (vi) Notes to Condensed Consolidated Financial Statements. (1)

__________


(1)	Filed herewith.


(2)	Furnished herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		THE GAP, INC.

Date:	August 30, 2019	By	/s/ Arthur Peck
			Arthur Peck
			Chief Executive Officer

Date:	August 30, 2019	By	/s/ Teri List-Stoll
			Teri List-Stoll
			Executive Vice President and Chief Financial Officer

Exhibit Index




10.1		The Gap, Inc. 2016 Long Term-Incentive Plan (as Amended and Restated Effective as of May 21, 2019), filed as Appendix A to the Company's definitive proxy statement for its annual meeting of shareholders held on May 21, 2019, Commission File No. 1-7562.
31.1		Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer of The Gap, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002). (1)
31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of The Gap, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002). (1)
32.1		Certification of the Chief Executive Officer of The Gap, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (2)
32.2		Certification of the Chief Financial Officer of The Gap, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (2)
101		The following materials from The Gap, Inc.’s Quarterly Report on Form 10-Q for the quarter ended August 3, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Stockholders' Equity; (v) the Condensed Consolidated Statements of Cash Flows; and (vi) Notes to Condensed Consolidated Financial Statements. (1)

_____________________________


(1)	Filed herewith.


(2)	Furnished herewith.

Gap Inc. - 10-Q quarterly report FY2019 Q2

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