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(Exact name of registrant as specified in its charter)
iDelaware
i94-1697231
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
iTwo Folsom Street
iSan Francisco,
iCaliforniai94105
(Address of principal executive offices)
Registrant’s telephone number, including area code: (i415) i427-0100
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
iCommon
Stock, $0.05 par value
iGPS
iThe 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. iYes☑No ☐
Indicate by check mark whether the
registrant has submitted electronically every Interactive Data File required to be submitted 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). iYes☑ 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.
iLarge
accelerated filer
☑
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
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 i☐ No ☑
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 potential impact of COVID-19 on the assumptions and estimates used when preparing the quarterly financial statements, and on our results of operations, financial position, and liquidity;
•the potential impact if economic
conditions caused by COVID-19 were to worsen beyond what is currently estimated by management;
•the impact of recent accounting pronouncements;
•recognition of revenue deferrals as revenue;
•compliance with applicable financial covenants under the 2023 Notes, 2025 Notes, 2027 Notes, and the ABL Facility;
•the expected tax impact of our participation in the Coronavirus Aid, Relief and Economic Security Act;
•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, including the impact of such actions on our financial results;
•the ability of our new capital structure to provide sufficient liquidity to continue to navigate the COVID-19 pandemic;
•the ability to supplement near-term liquidity, if necessary, with our $1.8675 billion asset-based revolving credit facility or other available market instruments;
•current cash balances and cash flows from our operations and from issuance of the 2023 Notes, 2025 Notes, 2027 Notes being sufficient to support our business operations;
•the
impact of the seasonality of our operations;
•offering product that is consistently brand-appropriate and on-trend with high customer acceptance;
•the impact of adopting the accounting standards update No. 2019-12 on January 31 2021;
•growing and operating our global online business and our newly introduced business-to-business program;
•realigning inventory with customer demand;
•increasing focus on improving operational discipline and efficiency by streamlining operations and processes and leveraging scale;
•managing inventory to support a healthy merchandise margin;
•the
expected timing, cost and scope of the strategic review of our operating model in Europe;
•the expectation that we will reach additional agreements with our landlords regarding suspended rent payments for our temporarily closed stores;
•rationalizing the Gap and Banana Republic brands, with emphasis on the specialty fleet globally, to create a healthier business while prioritizing asset-light growth through licensing and franchise partnerships in international markets;
•the impact of our expected lease buyouts related to a small population of stores in the future;
•continuing to integrate social and environmental sustainability into business practices;
•increased
interest expense on future borrowings caused by any future reductions in our credit ratings; 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 overall global economic environment and risks associated with the COVID-19 pandemic;
•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 changes in global economic conditions or consumer spending patterns could adversely impact our results of operations;
•engaging in or seeking to engage in strategic transactions that are subject to various risks and uncertainties;
•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 manage key executive succession and retention and to continue to attract qualified personnel 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 risks to our business, including our costs and supply chain, associated with global sourcing and manufacturing;
•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 efforts to expand internationally, including our ability to operate in regions where we have less experience;
•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 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 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 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 position or our business initiatives;
•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 (similar to and including the ongoing COVID-19 pandemic), 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 this Quarterly Report on Form 10-Q 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 November 25, 2020, 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 1, 2020.
(1)
On March 4, 2020, the Company declared a first quarter fiscal year 2020 dividend of $0.2425 per share. On March 26, 2020, the Company announced that the dividend will be payable on or after April 28, 2021 to shareholders of record at the close of business on April 7, 2021. The dividend payable amount was estimated based upon the shareholders of record as of October 31, 2020.
See Accompanying Notes to Condensed Consolidated Financial Statements
5
THE
GAP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Adjustments
to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization
i381
i417
Share-based
compensation
i55
i64
Impairment
of operating lease assets
i361
i1
Impairment
of store assets
i127
i9
Loss
on extinguishment of debt
i58
i—
Amortization
of debt issuance costs
i8
i1
Non-cash
and other items
i—
(i4)
Gain
on sale of building
i—
(i191)
Deferred
income taxes
(i74)
i42
Changes
in operating assets and liabilities:
Merchandise inventory
(i590)
(i559)
Other
current assets and other long-term assets
i37
i8
Accounts
payable
i1,120
i129
Accrued
expenses and other current liabilities
i98
i28
Income
taxes payable, net of receivables and other tax-related items
(i206)
i89
Lease
incentives and other long-term liabilities
i54
i19
Operating
lease assets and liabilities, net
(i131)
(i60)
Net
cash provided by operating activities
i399
i528
Cash
flows from investing activities:
Purchases of property and equipment
(i288)
(i523)
Purchase
of building
i—
(i343)
Proceeds
from sale of building
i—
i220
Purchases
of short-term investments
(i237)
(i235)
Proceeds
from sales and maturities of short-term investments
i348
i231
Purchase
of Janie and Jack
i—
(i69)
Other
i2
i—
Net
cash used for investing activities
(i175)
(i719)
Cash
flows from financing activities:
Proceeds from revolving credit facility
i500
—
Payments
for revolving credit facility
(i500)
i—
Proceeds
from issuance of long-term debt
i2,250
i—
Payments
to extinguish debt
(i1,307)
i—
Payments
for debt issuance costs
(i61)
i—
Proceeds
from issuances under share-based compensation plans
i16
i22
Withholding
tax payments related to vesting of stock units
(i8)
(i21)
Repurchases
of common stock
i—
(i150)
Cash
dividends paid
i—
(i274)
Net
cash provided by (used for) financing activities
i890
(i423)
Effect
of foreign exchange rate fluctuations on cash, cash equivalents, and restricted cash
i4
i—
Net
increase (decrease) in cash, cash equivalents, and restricted cash
i1,118
(i614)
Cash,
cash equivalents, and restricted cash at beginning of period
i1,381
i1,420
Cash,
cash equivalents, and restricted cash at end of period
$
i2,499
$
i806
Supplemental
disclosure of cash flow information:
Cash paid for interest during the period
$
i41
$
i75
Cash
paid for income taxes during the period, net of refunds
$
i8
$
i117
See
Accompanying Notes to Condensed Consolidated Financial Statements
6
THE GAP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
i
Note
1. Accounting Policies
Basis of Presentation
The Condensed Consolidated Balance Sheets as of October 31, 2020 and November 2, 2019, and the Condensed Consolidated Statements of Operations, the Condensed Consolidated Statements of Comprehensive Income (Loss), and the Condensed Consolidated Statements of Stockholders' Equity for the thirteen and thirty-nine weeks ended October 31, 2020 and November 2, 2019, and the Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 31, 2020 and November 2, 2019, have been prepared by The Gap, Inc. (the “Company,”“we,” and “our”). In the opinion of management, such statements contain all normal and recurring adjustments (except as otherwise disclosed) considered necessary to present fairly our financial position, results of operations, comprehensive income (loss), stockholders' equity, and cash flows as of October 31, 2020 and November 2, 2019 and for all periods presented. The Condensed Consolidated Balance Sheet as of February 1, 2020 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 1, 2020.
The results of operations for the thirteen and thirty-nine weeks ended October 31, 2020 are not necessarily indicative of the operating results that may be expected for the 52-week period ending January 30,
2021.
COVID-19
In March 2020, the World Health Organization declared the coronavirus disease ("COVID-19") a global pandemic and recommended containment and mitigation measures worldwide. As a result, we temporarily closed our North America retail stores and a large number of our stores globally. In May 2020, we began to safely reopen our temporarily closed stores in accordance with local government guidelines and most stores were open during the thirteen weeks ended October 31, 2020. Beginning in late October 2020, several European countries instituted new lockdown mandates to contain surging COVID-19 cases and as a result we have temporarily closed certain stores in Europe. We will continue to monitor regional mandates for additional temporary store closures as they arise.
During
the thirty-nine weeks ended October 31, 2020, the Company implemented several actions including completing the issuance of our Senior Secured Notes for $i2.25 billion due 2023 (“2023 Notes”), 2025 (“2025 Notes”), and 2027 (“2027 Notes”) (collectively, the “Notes”) and entering into a third amended and restated senior secured asset-based revolving credit agreement (the "ABL Facility") in May 2020. See Note 3
of Notes to Condensed Consolidated Financial Statements for further details related to our debt and credit facilities. Additionally, we suspended share repurchases and dividends and deferred the first quarter of fiscal 2020 dividend in March 2020.
As a result of COVID-19, we suspended rent payments beginning in April 2020 due to our temporarily closed stores and are continuing to work through negotiations with our landlords relating to those leases. We considered the Financial Accounting Standards Board's ("FASB") guidance regarding lease modifications as a result of the effects of COVID-19 and elected to apply the temporary practical expedient to account for lease changes as variable rent unless an amendment results in a substantial change in the Company's lease obligations. As of October 31,
2020, the impact of applying the temporary practical expedient was not material to our Condensed Consolidated Financial Statements.
In response to COVID-19, various governments worldwide have enacted, or are in the process of enacting, measures to provide relief to businesses negatively affected by the pandemic. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain payroll and income tax provisions. In connection with CARES Act and other financial relief measures worldwide, the Company has recognized $i67
million of payroll related credits for the thirty-nine weeks ended October 31, 2020. The payroll related credits are recorded as a reduction within operating expenses in the Condensed Consolidated Statements of Operations. The Company is also considering certain other beneficial provisions of the CARES Act, including the net operating loss carryback provision. See Note 7 of Notes to Condensed Consolidated Financial Statements for more information on the estimated income tax impact of the CARES Act.
/
7
We
continue to consider the impact of COVID-19 on the assumptions and estimates used when preparing these quarterly financial statements including inventory valuation, lease accounting impacts, income taxes, and the impairment of long-lived store assets and operating lease assets. These assumptions and estimates may change as the current situation evolves or new events occur and additional information is obtained. If the economic conditions caused by COVID-19 worsen beyond what is currently estimated by management, such future changes may have an adverse impact on the Company's results of operations, financial position, and liquidity.
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.
i
As of October 31, 2020, restricted cash primarily included consideration that serves as collateral for certain obligations occurring in the normal
course of business and 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:
Cash and cash equivalents, per Condensed Consolidated Balance Sheets
$
i2,471
$
i1,364
$
i788
Restricted
cash included in other current assets
i4
i—
i—
Restricted
cash included in other long-term assets
i24
i17
i18
Total
cash, cash equivalents, and restricted cash, per Condensed Consolidated Statements of Cash Flows
$
i2,499
$
i1,381
$
i806
/
Accounting
Pronouncements Recently Adopted
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 accounting standards update ("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. We adopted this ASU on a prospective basis
on February 2, 2020. The adoption of this standard did not have a material impact on our Condensed Consolidated Financial Statements or related disclosures.
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 Condensed Consolidated Financial Statements, based on current information.
ASU No. 2019-12, Simplifying the Accounting for Income Taxes
In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes. The ASU is intended to enhance and simplify aspects
of the income tax accounting guidance in ASC 740 as part of the FASB's simplification initiative. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2020 with early adoption permitted. The Company will adopt this ASU on January 31, 2021 and does not expect there to be a material impact on our Condensed Consolidated Financial Statements.
Note 2. iRevenue
The
Company’s revenues include merchandise sales at stores, online, and through franchise agreements, as well as the newly introduced business-to-business ("B2B") program. 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, the Company has elected to treat shipping and handling as fulfillment activities and not as a separate performance obligation. Accordingly, we recognize revenue for our single performance obligation related to online 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.
8
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 Operations.
We also have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic, Old Navy, and Athleta 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. There were no material
contract liabilities related to our franchise agreements for all periods presented.
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 October 31, 2020, the opening balance of deferred revenue for these obligations was $i189 million,
of which $i68 million was recognized as revenue during the period. For the thirty-nine weeks ended October 31, 2020, the opening balance of deferred revenue for these obligations was $i226
million, of which $i140 million was recognized as revenue during the period. The closing balance of deferred revenue for these obligations was $i191
million as of October 31, 2020.
We expect that the majority of our revenue deferrals as of the quarter ended October 31, 2020, will be recognized as revenue in the next twelve months as our performance obligations are satisfied.
For the thirteen weeks ended November 2, 2019, the opening balance of deferred revenue for these obligations was $i195
million, of which $i78 million was recognized as revenue during the period. For the thirty-nine weeks ended November 2, 2019, the opening balance of deferred revenue for these obligations was $i227
million, of which $i161 million was recognized as revenue during the period. The closing balance of deferred revenue for these obligations was $i189
million as of November 2, 2019.
i
Net sales disaggregated for stores and online sales for the thirteen and thirty-nine weeks ended October 31, 2020 and November 2, 2019 was as follows:
(1)Store
sales primarily include sales made at our Company-operated stores and franchise sales. Fiscal 2020 store sales were negatively impacted by COVID-19. See Note 1 of Notes to Condensed Consolidated Financial Statements for further details.
/
(2)Online sales primarily include sales made through our online channels including curbside pick-up, ship-from-store sales, buy online pick-up in store sales, and order-in-store sales. Additionally, beginning in the second quarter of fiscal 2020, sales from the B2B program are also included.
See Note 10 of Notes to Condensed Consolidated Financial Statements for further disaggregation of revenue by brand
and by region.
Note 3. iDebt and Credit Facilities
i
Long-term
debt recorded on the Condensed Consolidated Balance Sheets consists of the following:
In
June 2020, we redeemed our $i1.25 billion aggregate principal amount of i5.95 percent notes due April 2021 (the "2021 Notes"). We
incurred a loss on extinguishment of debt of $i58 million, primarily related to the make-whole premium, which was recorded on the Condensed Consolidated Statement of Operations. Prior to redeeming our 2021 Notes, the aggregate principal amount of the 2021 Notes was recorded in long-term debt on the Condensed Consolidated Balance Sheets, net of the unamortized discount. Following the redemption, our obligations under the 2021 Notes were discharged.
In May 2020, we completed the issuance
of the Notes in a private placement to qualified buyers and received gross proceeds of $i2.25 billion. Concurrently with the issuance of the Notes, the Company amended the existing unsecured revolving credit facility with the ABL Facility which is scheduled to expire in May 2023. During the second quarter of fiscal 2020, we paid and recorded debt issuance costs related to the Notes and ABL Facility within long-term debt and other long-term assets on the Condensed Consolidated Balance Sheet, which
will continue to be amortized through interest expense over the life of the related instrument.
i
The scheduled maturity of the Notes is as follows:
(1)Includes an option to call the Notes in whole or in part at any time, subject to a make-whole premium.
/
As
of October 31, 2020, the estimated fair value of the Notes was $i2.54 billion and was based on the quoted market price for each of the Notes (level 1 inputs) as of the last business day of the fiscal quarter. The aggregate principal amount of the Notes is recorded in long-term debt on the Condensed Consolidated Balance Sheet, net of the unamortized debt issuance cost.
The ABL Facility has a $i1.8675
billion borrowing capacity and bears interest at a base rate (typically LIBOR) plus a margin depending on borrowing base availability. We also have the ability to issue letters of credit on our ABL Facility. As of October 31, 2020, we had $i48 million in standby letters of credit issued under the ABL Facility. There were ino
borrowings under the ABL Facility as of October 31, 2020.
The Notes are secured by the Company's real and intellectual property and equipment and intangibles. The Notes contain covenants that limit the Company’s ability to, among other things: (i) grant or incur liens on the collateral; (ii) incur, assume or guarantee additional indebtedness; (iii) enter into sale and lease-back transactions; (iv) sell or otherwise dispose of assets that are collateral; and (v) make certain restricted payments or other investments. The Notes are also subject to certain provisions related to default that, if triggered, could result in acceleration of the maturity of the Notes.
The ABL Facility
agreement is secured by specified assets, including a first lien on inventory, accounts receivable and bank accounts. The Notes are also secured by a second priority lien on certain assets securing the ABL Facility, which includes security interests in inventory, accounts receivable and bank accounts, subject to certain exceptions and permitted liens. In addition, the ABL Facility agreement is secured by a second lien on certain assets securing the Notes. The ABL Facility contains customary covenants restricting the Company's activities, as well as those of its subsidiaries, including limitations on the ability to sell assets, engage in mergers, or other fundamental changes, enter into capital leases or certain leases not in the ordinary course of business, enter into transactions involving related
parties or derivatives, incur or prepay indebtedness, grant liens or negative pledges on its assets, make loans or other investments, pay dividends or repurchase stock or other securities, guarantee third-party obligations, engage in sale and lease-back transactions and make changes in its corporate structure. There are exceptions to these covenants, and some are only applicable when unused availability falls below specified thresholds. In addition, the ABL Facility includes, as a financial covenant, a springing fixed charge coverage ratio which arises when availability falls below a specified threshold.
As of October 31, 2020, we were in compliance with the applicable financial covenants and expect to maintain compliance for the next twelve months.
We also maintain multiple agreements with third parties that make unsecured revolving
credit facilities available for our operations in foreign locations (the “Foreign Facilities”). The Foreign Facilities are uncommitted and had a total capacity of $i58 million as of October 31, 2020. As of October 31, 2020, there were ino
borrowings under the Foreign Facilities. There were $i19 million in bank guarantees issued and outstanding primarily related to store leases under the Foreign Facilities as of October 31, 2020.
We have bilateral unsecured standby letter of credit agreements that are uncommitted and do not have expiration dates. There were ino
material standby letters of credit issued under these agreements as of October 31, 2020.
10
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 iiiino///
purchases, sales, issuances, or settlements related to recurring level 3 measurements during the thirteen and thirty-nine weeks ended October 31, 2020 or November 2, 2019. There were iiiiiino/////
transfers of financial assets or liabilities into or out of level 1, level 2, and level 3 during the thirteen and thirty-nine weeks ended October 31, 2020 or November 2, 2019.
Financial Assets and Liabilities
i
Financial assets and liabilities measured at fair value on a recurring basis and cash equivalents are as follows:
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents
$
i238
$
i3
$
i235
$
i—
Short-term
investments
i294
i131
i163
i—
Derivative
financial instruments
i12
i—
i12
i—
Deferred
compensation plan assets
i53
i53
i—
i—
Other
assets
i2
i—
i—
i2
Total
$
i599
$
i187
$
i410
$
i2
Liabilities:
Derivative
financial instruments
$
i10
$
i—
$
i10
$
i—
/
11
We
have highly liquid investments classified as cash equivalents. 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 investments in cash equivalents are placed primarily in time deposits, money market funds, and debt securities.
Our available-for-sale securities are comprised of investments in debt securities and are recorded in both short-term investments and cash and cash equivalents on the Condensed Consolidated Balance Sheets. These securities are recorded at fair value using market prices. As of October 31, 2020 and November 2, 2019, the Company held $i178
million and $i294 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 October 31, 2020 and November 2, 2019, the Company held $i222
million and $i17 million 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 Sheet. Unrealized gains and losses on available-for-sale debt securities included within accumulated other comprehensive income were not material as of October 31, 2020 and November 2, 2019.
The
Company regularly reviews its available-for-sale debt securities for other-than-temporary impairment. For the thirteen and thirty-nine weeks ended October 31, 2020 or November 2, 2019, 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 Notes to 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 to defer base compensation and bonus up to a maximum percentage, and non-employee directors to defer receipt of a portion of their Board fees. 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, including recently shared strategic plans. 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 at the store level.
The impact of COVID-19 resulted in a qualitative indication of impairment related to our store long-lived assets. For store locations, we analyzed our store asset recoverability. There were ino
material impairment charges recorded for long-lived assets during the thirteen weeks ended October 31, 2020. During the thirty-nine weeks ended October 31, 2020, the Company recorded impairment of store assets of $i127 million and impairment of operating lease assets of $i361
million. The impairment of the store assets reduced the carrying amount of the applicable long-lived assets of $i131 million to their fair value of $i4 million. The impairment of the operating
lease assets reduced the carrying amount of the applicable long-lived assets of $i1,369 million to their fair value of $i1,008 million. The impairment charges were recorded in operating expenses
on the Condensed Consolidated Statement of Operations.
There were ino material impairment charges recorded for long-lived assets during the thirteen weeks ended November 2, 2019. During the thirty-nine weeks ended November 2, 2019, the Company recorded impairment of store assets of $i9
million and impairment of operating lease assets of $i1 million. The impairment of the store assets reduced the carrying amount of the applicable long-lived assets of $i10 million to their
fair value of $i1 million. The impairment of the operating lease assets reduced the carrying amount of the applicable long-lived assets of $i61 million to their fair value of $i60
million. The impairment charges were recorded in operating expenses on the Condensed Consolidated Statement of Operations.
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 iiiiiiiino///////
impairment charges recorded for goodwill or other indefinite-lived intangible assets for the thirteen and thirty-nine weeks ended October 31, 2020 or November 2, 2019.
12
Note 5. iDerivative
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 dollar, Japanese yen, British pound, Euro, Mexican peso, Taiwan dollar, and Chinese yuan. 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 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; (2) forward contracts used to hedge forecasted intercompany royalty payments denominated in foreign currencies received by entities whose functional currencies are U.S. dollars; and (3) 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, intercompany royalty payments, 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 net income (loss) during the period in which the underlying transaction impacts the Condensed Consolidated Statements of Operations.
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 Operations in the same period and generally offset each other.
Outstanding Notional Amounts
i
We
had foreign exchange forward contracts outstanding in the following notional amounts:
Derivatives
not designated as hedging instruments:
Other current assets
i4
i4
i4
Accrued
expenses and other current liabilities
i6
i8
i8
Total
derivatives in an asset position
$
i6
$
i10
$
i12
Total
derivatives in a liability position
$
i7
$
i10
$
i10
/
Substantially
all of the unrealized gains and losses from designated cash flow hedges as of October 31, 2020 will be recognized into net income (loss) within the next twelve months at the then-current values, which may differ from the fair values as of October 31, 2020 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 not material for all periods presented.
See Note 4 of Notes to Condensed Consolidated Financial Statements for disclosures on the fair value measurements of our derivative financial instruments.
i
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:
(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 $i1.0 billion share repurchase authorization (the "February 2019 repurchase program"). The February 2019 repurchase program had $i800
million remaining as of October 31, 2020. On March 12, 2020, the Company announced its decision to suspend share repurchases through fiscal 2020.
All of the share repurchases were paid for as of February 1, 2020 and November 2, 2019. All common stock repurchased is immediately retired.
Note 7. iIncome
Taxes
On March 27, 2020, the CARES Act was signed into law in the United States. The CARES Act includes certain provisions that affect our income taxes, including temporary five-year net operating loss carryback provisions, modifications to the interest deduction limitations, and the technical correction for depreciation of qualified leasehold improvements.
The effective income tax rate was i21.5 percent
for the thirteen weeks ended October 31, 2020, compared with i33.0 percent for the thirteen weeks ended November 2, 2019. The decrease in the effective tax rate is primarily due to changes in the mix of pretax income between domestic and international operations, partially offset by the impacts of the net operating loss carryback provisions of the CARES Act.
The effective income tax rate was i23.7
percent for the thirty-nine weeks ended October 31, 2020, compared with i31.6 percent for the thirty-nine weeks ended November 2, 2019. The decrease in the effective tax rate is primarily due to changes in the mix of pretax income between domestic and international operations and the fiscal 2019 impact of an adjustment for additional guidance issued regarding the Tax Cuts and Jobs Act of 2017 ("TCJA"), partially offset by the impacts of the net operating
loss carryback provisions of the CARES Act.
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 2010.
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 October 31, 2020, it is reasonably possible that we will recognize a decrease in gross unrecognized tax benefits within the next twelve months of up to $i3 million, primarily due to the closing of audits. If we do recognize such a decrease, the net impact on the Condensed Consolidated Statements of Operations would not be material.
15
Note
8. iEarnings (Loss) Per Share
i
Weighted-average number of shares used for earnings (loss) per share is as follows:
(1)For
the thirty-nine weeks ended October 31, 2020, the dilutive impact of outstanding options and awards was excluded from dilutive shares as a result of the Company’s net loss for the respective period.
/
The anti-dilutive shares related to stock options and other stock awards excluded from the computation of weighted-average number of shares – diluted were i12
million and i17 million for the thirteen weeks ended October 31, 2020 and November 2, 2019, respectively, and i16
million and i14 million for the thirty-nine weeks ended October 31, 2020 and November 2, 2019, respectively, as their inclusion would have an anti-dilutive effect on earnings (loss) per share.
Note 9. iCommitments
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 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 October 31, 2020, Actions filed against us included commercial, intellectual property, customer, employment, and data privacy 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 October 31, 2020, February 1, 2020, and November 2, 2019, 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 was not material for any individual Action or in total for all periods presented. Subsequent to October 31, 2020, 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. 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 10. iSegment Information
We identify our operating segments according to how our business activities are managed and evaluated. As of October 31, 2020, 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 are aggregated into ione
reportable segment as of October 31, 2020. 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.
(1)U.S.
includes the United States, Puerto Rico, and Guam.
(2)Banana Republic Global fiscal year 2019 net sales include the Janie and Jack brand beginning March 4, 2019.
(3)Primarily consists of net sales for the Athleta, Intermix, and Hill City brands. Beginning in fiscal year 2020, Janie and Jack net sales are also included. Net sales for Athleta for the thirteen and thirty-nine weeks ended October 31, 2020 were $i292
million and $i764 million, respectively.
/
(4)Primarily consists of net sales for the Athleta, Intermix, and Hill City brands as well as a portion of income related to our credit card agreement. Net sales for Athleta for the thirteen and thirty-nine weeks ended November 2, 2019 were $i216
million and $i691 million, respectively.
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.
17
Note
11. iStore Closing and Other Operating Cost
In fiscal 2019, the Company announced plans to restructure the specialty fleet and revitalize the Gap brand during fiscal 2019 and fiscal 2020. In fiscal 2020, the Company shifted its focus towards adapting to the COVID-19 challenges and a broader scope of strategic initiatives. As a
result, restructuring costs were not material in fiscal 2020. See Overview of Management's Discussion and Analysis included in Part I, Item 2 of this Form 10-Q, for more detail on some of the strategic initiatives being undertaken by the Company.
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
OUR BUSINESS
We are a
collection of purpose-led, lifestyle brands offering apparel, accessories, and personal care products for men, women, and children under the Old Navy, Gap, Banana Republic, and Athleta brands. We also offer an assortment of products for men, women, and children through our 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. 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. We have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic, Old Navy, and Athleta 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. 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 curbside pick-up, buy online pick-up in store, order-in-store, find-in-store, and ship-from-store, as well as enhanced mobile-enabled experiences, are tailored uniquely across our collection 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
In March 2020, the World Health Organization declared COVID-19 a global
pandemic and recommended containment and mitigation measures worldwide. As a result, we temporarily closed our North America retail stores and a large number of our stores globally. In May 2020, we began to safely reopen our temporarily closed stores with industry-leading safety measures for customers and employees and most stores were open during the thirteen weeks ended October 31, 2020. Beginning in late October 2020, several European countries instituted new lockdown mandates to contain surging COVID-19 cases and as a result we have temporarily closed certain stores in Europe. We will continue to monitor regional mandates for additional temporary store closures as they arise. Although the pandemic has caused a significant reduction in store sales, our online sales have increased significantly by leveraging our omni fulfillment capabilities, including curbside pick-up and ship-from-store, to serve customer demand.
On
October 20, 2020, we shared plans to strategically review our operating model in Europe, which includes 122 Company-operated stores. As part of the review, we are considering the possibility of leveraging the strength of our franchise business model and transferring elements of the business to interested partners. We are also reviewing the strategies of our warehouse and distribution model and our Company-owned e-commerce sites for Gap and Banana Republic in Europe. While no decisions have been made, such plans could result in additional costs to the Company including charges related to leases and inventory, and employee-related costs. We are targeting early fiscal 2021 to finalize our plans.
Additionally, on October
22, 2020, the Company shared its strategic focus to reduce the number of Gap and Banana Republic stores in North America by approximately 350 stores from the beginning of fiscal 2020 to the end of fiscal 2023. The majority of the select stores being considered have leases that expire in fiscal 2020 and fiscal 2021 which allows us to exit underperforming stores with a minimal net impact to our Consolidated Statement of Operations. As of October 31, 2020, we have closed, net of openings, 143 Gap and Banana Republic stores in North America in fiscal 2020.
As a result of COVID-19, we suspended rent payments beginning in April 2020 due to our temporarily closed stores and are continuing to work through negotiations with our landlords relating to those leases. As result of the negotiations with
our landlords, the Company executed several cash buyout agreements during the third quarter of fiscal 2020 totaling approximately $57 million. The net impact of these buyouts was not material to our Condensed Consolidated Statement of Operations for the thirteen weeks ended October 31, 2020. The Company expects substantial cash lease buyout amounts in the future relating to a small population of stores we intend to close across multiple brands but we expect these buyouts to have a minimal net impact to our Consolidated Statements of Operations.
In July 2020, the Company announced the launch of a B2B program focused on offering large
organizations high-quality reusable, non-medical grade cloth face masks to supply to their employees. We have leveraged our deep supply chain relationships and agile operations to provide these masks to companies in both the private and public sector.
We implemented several actions during fiscal 2020 to enhance our liquidity position in response to COVID-19. In May 2020, the Company completed the issuance of the Notes for $2.25 billion. We also entered into the ABL Facility, with an initial aggregate principal amount of up to $1.8675 billion. Proceeds from the issuance of the Notes were used to redeem our 2021 Notes. We incurred a loss on extinguishment of debt of $58 million, primarily related to the make-whole premium, which was recorded on the Condensed Consolidated Statement of Operations. Additionally, during the second quarter of fiscal
2020, we repaid the $500 million that was outstanding under our previous unsecured revolving credit facility. Refer to the "Liquidity and Capital Resources" section for further discussion.
19
During the thirty-nine weeks ended October 31, 2020, the Company recorded impairment of store assets of $127 million and operating lease assets of $361 million, primarily due to lower cash flows from stores and the reduced estimated fair value of real estate, particularly in mall locations, as a result of COVID-19. See Note 4 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q, for further information
regarding impairments.
During the first quarter of fiscal 2020, the Company recorded inventory related impairment costs of $235 million, primarily related to seasonal inventory that was stranded in stores when closures occurred or seasonal inventory in distribution centers that was planned for store sales. The costs also included impaired garment and fabric commitment costs for future seasonal product. Additionally, to strategically manage inventory through COVID-19, select summer product is being stored at an off-site facility and our distribution centers and expected to be sold during fiscal 2021.
As we continue to face a period of uncertainty regarding the ongoing impact of COVID-19 on both our projected customer demand and supply chain, we remain focused on the following strategic priorities in
the near-term:
•offering product that is consistently brand-appropriate and on-trend with high customer acceptance and appropriate value perception;
•growing and operating our global online business;
•realigning inventory with customer demand;
•attracting and retaining strong talent in our businesses and functions;
•increasing the focus on improving operational discipline and efficiency by streamlining operations and processes throughout the organization and leveraging our scale;
•managing inventory to support a healthy merchandise margin;
•rationalizing
the Gap and Banana Republic brands, to create a healthier business while prioritizing asset-light growth through licensing and franchise partnerships in international markets; and
•continuing to integrate social and environmental sustainability into business practices to support long-term growth.
We believe focusing on these priorities in the near term will propel the Company to execute against the Power Plan 2023 strategy, including leveraging:
•The Power of its Brands, reflected by the Company’s four purpose-led, lifestyle brands, Old Navy, Gap, Banana Republic and Athleta;
•The
Power of its Portfolio, which enables growth synergies across key customer categories; and
•The Power of its Platform, which leverages the company’s powerful platform to both enable growth, such as through competitive omni-channel capabilities, as well as cost synergies, fueled by its scaled operations.
We continue to monitor the rapidly evolving pandemic situation and guidance from international and domestic authorities, including federal, state, and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of the situation, the
Company cannot reasonably estimate the impacts of COVID-19 on our results of operations, cash flows and liquidity in the future.
Financial results for the third quarter of fiscal 2020 are as follows:
•Net sales for the third quarter of fiscal 2020 were flat compared with the third quarter of fiscal 2019.
•Online sales for the third quarter of fiscal 2020 increased 61 percent compared with the third quarter of fiscal 2019 and store sales for the third quarter of fiscal 2020 decreased 20 percent compared with the third quarter of fiscal 2019.
•Gross profit for the third quarter of fiscal 2020 was $1.62 billion compared with $1.56 billion for the third quarter of fiscal 2019. Gross margin for the third quarter of fiscal 2020
was 40.6 percent compared with 39.0 percent for the third quarter of fiscal 2019.
•Operating income for the third quarter of fiscal 2020 was $175 million compared with $221 million for the third quarter of fiscal 2019.
•The effective income tax rate for the third quarter of fiscal 2020 was 21.5 percent, compared with 33.0 percent for the third quarter of fiscal 2019.
•Net income for the third quarter of fiscal 2020 was $95 million compared with $140 million for the third quarter of fiscal 2019.
•Diluted earnings per share was $0.25 for the third quarter of fiscal 2020 compared with $0.37 for the third quarter of fiscal 2019.
20
RESULTS
OF OPERATIONS
Net Sales
See Note 2 and Note 10 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q, for net sales disaggregation.
Comparable Sales (“Comp Sales”)
Comp Sales include the results of Company-operated stores and sales through online channels. The calculation of Gap Inc. Comp Sales includes the results of Intermix, Janie and Jack, and Hill City, but excludes the results of our franchise business.
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.
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.
For the thirteen weeks ended October 31, 2020, any stores temporarily closed for more than three days as a result of COVID-19 were excluded from the Comp Sales calculations. After temporarily closed stores reopened, subsequent sales were included in the Comp/Non-comp status they were in prior to temporary closure. Online sales continued to be included in the Comp Sales calculation for each period.
The percentage change in Comp Sales by global brand and for The Gap, Inc. is as follows:
We have historically reported net sales per average square foot, but as a result of the extensive temporary store closures due to COVID-19 and shift in focus to online, this metric is not meaningful for the first three quarters of fiscal 2020 and therefore we have omitted it.
21
Store count, openings, closings, and square footage for our stores are as follows:
(1)Represents stores that have been permanently closed, not stores temporarily closed as a result of COVID-19.
(2)On March 4, 2019, we acquired select assets of Gymboree Group, 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 November 2, 2019, net of one closure that occurred in the third quarter of fiscal 2019.
Outlet and factory stores are reflected in each of the respective brands.
22
Net Sales
Our net sales for the third quarter of fiscal 2020 were flat, decreasing $4 million, compared with the third quarter of fiscal 2019, reflecting a 61% increase in online sales, offset by a 20% decline in store sales. Net sales increased at Old Navy Global and Athleta and decreased at Gap Global and Banana Republic Global for the third quarter of fiscal 2020 compared with the third quarter of fiscal 2019.
Our
net sales for the first three quarters of fiscal 2020 decreased $2.3 billion or 20 percent, compared with the first three quarters of fiscal 2019 driven primarily by temporary store closures due to COVID-19. Although COVID-19 and resulting temporary closure of our stores negatively affected our financial results for the first three quarters of fiscal 2020, our online sales increased significantly compared with the first three quarters of fiscal 2019.
Cost of goods sold and occupancy expenses as a percentage of net sales
59.4
%
61.0
%
67.6
%
61.9
%
Gross
margin
40.6
%
39.0
%
32.4
%
38.1
%
Cost of goods sold and occupancy expenses decreased 1.6 percentage points as a percentage of net sales in the third quarter of fiscal 2020 compared with the third quarter of fiscal 2019.
•Cost of goods sold increased 2.0 percentage points as a percentage of net sales in the third quarter of fiscal 2020 compared with the third quarter of
fiscal 2019, primarily driven by higher online shipping costs as a result of growth in online sales partially offset by lower promotional activity at Old Navy and Athleta.
•Occupancy expenses decreased 3.6 percentage points as a percentage of net sales in the third quarter of fiscal 2020 compared with the third quarter of fiscal 2019 primarily driven by an increase in online sales with minimal impact on fixed occupancy expenses, as well as a decrease in fixed occupancy expenses as a result of permanent store closures and the impact of lease terminations and amendments.
Cost of goods sold and occupancy expenses increased 5.7 percentage points as a percentage of net sales in the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019.
•Cost of goods sold increased
4.7 percentage points as a percentage of net sales in the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019, primarily driven by higher online shipping costs as a result of growth in online sales as well as higher inventory impairment due to store closures and decreased retail traffic as a result of COVID-19.
•Occupancy expenses increased 1.0 percentage points as a percentage of net sales in the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019 primarily driven by a decrease in net sales largely due to store closures as a result of COVID-19 without a corresponding decrease in occupancy expenses, partially offset by an increase in online sales with minimal impact on fixed occupancy expenses.
Operating
expenses increased $107 million or 2.7 percentage points as a percentage of net sales in the third quarter of fiscal 2020 compared with the third quarter of fiscal 2019 primarily due to the following:
•increase in advertising expenses due to higher investment in marketing support across all purpose-led lifestyle brands;
•additional store payroll and other store related costs to support health and safety measures in stores;
•increase in lease termination fees incurred in fiscal 2020; partially offset by
•separation-related costs incurred in the third quarter of fiscal 2019.
Operating expenses increased $393 million or 11.9 percentage points as a percentage
of net sales in the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019 primarily due to the following:
•impairment charges related to store assets and operating lease assets of $488 million incurred during the first three quarters of fiscal 2020 primarily due to the impact of COVID-19;
•a gain that occurred during the first quarter of fiscal 2019 related to the sale of a building;
•increase in advertising expenses due to higher investment in marketing support across all purpose-led lifestyle brands;
•increase in lease termination fees incurred in fiscal 2020; and
•severance costs related to reductions
in headquarters workforce; partially offset by
•a decrease in store payroll and benefits and other store operating expenses as a result of COVID-19 temporary store closures across all brands which was partially offset by additional costs incurred to support health and safety measures as we reopened stores; and
•separation-related and specialty fleet restructuring costs incurred in the first three quarters of fiscal 2019.
Loss on Extinguishment of Debt
In May 2020, the Company completed the issuance of the Notes for $2.25 billion and used the proceeds to redeem our 2021 Notes. We incurred a loss on extinguishment of debt of $58 million, primarily related
to the make-whole premium, which was recorded on the Condensed Consolidated Statement of Operations.
Interest
expense increased $36 million or 189 percent during the third quarter of fiscal 2020 compared with third quarter of fiscal 2019 and increased $74 million or 128 percent during the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019 primarily due to higher total outstanding debt and higher interest rates as a result of the May 2020 issuance of the Notes. The total outstanding principal related to our Notes increased from $1.25 billion as of November 2, 2019, to $2.25 billion as of October 31, 2020. Additionally, the new Notes bear interest at 8.375 percent, 8.625 percent, and 8.875 percent compared with our previous 5.95 percent 2021 Notes.
On March 27, 2020, the CARES Act was enacted into law, which included certain provisions that affect our income taxes, including temporary five-year net operating loss carryback provisions, modifications to the interest deduction limitations, and the technical correction for depreciation of qualified leasehold improvements.
The
decrease in the effective tax rate for the third quarter of fiscal 2020 compared with the third quarter of fiscal 2019 is primarily due to changes in the mix of pretax income between domestic and international operations, partially offset by the impacts of the net operating loss carryback provisions of the CARES Act.
The decrease in the effective tax rate for the first three quarters of fiscal 2020 compared with the respective period of fiscal 2019 is primarily due to changes in the mix of pretax income between domestic and international operations and the fiscal 2019 impact of an adjustment for additional guidance issued regarding the TCJA, partially offset by the impacts of the net operating loss carryback provisions of the CARES Act.
LIQUIDITY AND CAPITAL RESOURCES
We
continue to manage through the impacts of COVID-19 in fiscal 2020 and the impact it has on our operations and liquidity. During the first three quarters of fiscal 2020, we have taken several actions to improve our financial profile and increase our liquidity, including entering into new debt financing, decreasing capital expenditures, and suspending quarterly cash dividends and share repurchases for the remainder of the fiscal year.
In May 2020, we completed the issuance of our Notes and received gross proceeds of $2.25 billion. Concurrently with the issuance of the Notes, the Company entered into the ABL Facility with an initial aggregate principal amount of up to $1.8675 billion which is scheduled to expire in May 2023. Additionally, in May 2020, we repaid the $500 million that was previously outstanding under our previous unsecured revolving
credit facility and did not borrow any funds under the ABL Facility. In June 2020, we redeemed our 2021 Notes. The Company currently believes its new capital structure provides sufficient liquidity to continue to navigate COVID-19.
As of October 31, 2020, we consider the following to be our primary measures of liquidity and capital resources:
($ in millions)
Source
of Liquidity
Outstanding Indebtedness
Total Available Liquidity
Cash and cash equivalents (1)
$
2,471
$
—
$
2,471
Short-term investments (1)
178
—
178
2023
Notes
500
500
—
2025 Notes
750
750
—
2027 Notes
1,000
1,000
—
Total
$
4,899
$
2,250
$
2,649
__________
(1)As
of October 31, 2020, the majority of our cash, cash equivalents, and short-term investments were held in the United States and are generally accessible without any limitations.
We are also able to supplement near-term liquidity, if necessary, with our ABL Facility or other available market instruments.
Our largest source of operating 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. We believe that current cash balances and cash flows from our operations will be sufficient to support our business operations for the next twelve months.
25
Cash
Flows from Operating Activities
Net cash provided by operating activities decreased by $129 million during the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019, primarily due to the following:
Net Income (Loss)
•Net loss compared with net income in prior comparable period;
Non-cash items
•an increase of $478 million due to non-cash impairment charges of store assets and operating lease assets during the first three quarters of fiscal 2020 compared with the first three quarters of 2019; and
•an increase of $191 million due to a gain that occurred during the first three quarters of fiscal
2019 resulting from sale of a building;
Changes in operating assets and liabilities
•an increase of $991 million related to accounts payable primarily due to a change in payment terms and the suspension of rent payments for stores closed temporarily as a result of the COVID-19; partially offset by
•a decrease of $295 million related to income taxes payable, net of receivables and other tax-related items, resulting from a net income tax receivable primarily due to the taxable loss carryback estimated for the first three quarters of fiscal 2020 as well as timing of tax-related payments.
We fund inventory expenditures during normal and peak periods through cash flows from operating activities and available cash. Our business typically follows a
seasonal pattern, with sales peaking during the end-of-year holiday period. The seasonality of our operations, in addition to the impact of COVID-19, 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 three quarters of fiscal 2020 decreased $544 million compared with the first three quarters of fiscal 2019, primarily due to the following:
•$235 million fewer purchases of property and equipment during the first three quarters of fiscal 2020 compared with the first three quarters of 2019;
•an increase of $123 million due to the net activity related to the purchase
and sale of buildings during the first three quarters of fiscal 2019; and
•$115 million higher net proceeds from available-for-sale securities during the first three quarters of fiscal 2020 compared with the first three quarters of fiscal 2019.
Cash Flows from Financing Activities
Net cash provided by financing activities during the first three quarters of fiscal 2020 increased $1,313 million compared with the first three quarters of fiscal 2019, primarily due to the following:
•$2,250 million proceeds received related to the issuance of long-term debt during the first three quarters of fiscal 2020; and
•an increase of $424 million due to the suspension of cash dividends and share
repurchases during the first three quarters of fiscal 2020; partially offset by
•$1,307 million payment for the extinguishment of long-term debt during the first three quarters of fiscal 2020.
26
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 and infrastructure. 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.
(1)Fiscal
2019 excludes the purchase of a building.
Debt and Credit Facilities
For financial information about the Company’s debt and credit facilities as of October 31, 2020 see “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.
On March 26, 2020, the
Company announced that the previously declared first quarter dividend will now be payable on or after April 28, 2021 to shareholders of record at the close of business on April 7, 2021, subject to the right of the Company to further defer the record and payment dates. Further deferral could depend upon, among other factors, the progression of COVID-19, business performance, and the macroeconomic environment. Additionally, the Company suspended its regular quarterly cash dividend through fiscal 2020. The Company determined that taking these actions was in the best interest of the
Company in order to preserve liquidity in the context of the ongoing and uncertain duration and impact of COVID-19 on its operations.
Share Repurchases
In March 2020, the Company announced its decision to suspend share repurchases through fiscal 2020 due to the economic uncertainty stemming from a number of factors, including COVID-19.
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
Other than the debt financing discussed in Note 3 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q, 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 1, 2020, other than those which occur in the normal course of business. See Note 9 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
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 1,
2020. 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.
27
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our market risk profile as of February 1, 2020, is disclosed in our Annual Report on Form 10-K and has not significantly changed other than as noted below. 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.
In May 2020, we completed the issuance of our Notes and received gross proceeds of $2.25 billion. The Notes have a fixed interest rate and are exposed to interest rate risk that is limited to changes in fair value. Changes in interest rates do not impact our cash flows. The scheduled maturity of the Notes is as follows:
(1)Includes an option to call the Notes in whole or in part at any time, subject to a make-whole premium.
In conjunction with our financings, we obtained new long-term senior
unsecured credit ratings from Moody's. On March 26, 2020, Moody's downgraded our senior unsecured rating from Baa2 to Ba1 and changed their outlook from stable to negative. On April 23, 2020, Moody's downgraded our corporate credit ratings from Ba1 to Ba2 with negative outlook, and Standard & Poor's downgraded our credit ratings from BB to BB- with negative outlook. Any future reduction in the Moody's and Standard & Poor's ratings would potentially result in an increase to our interest expense on future borrowings.
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 third quarter of fiscal 2020 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. We have not experienced any material impact to our internal controls over financial reporting despite the fact that most of our employees are working remotely due to COVID-19. We are continually monitoring and assessing the COVID-19 impact on our internal controls to minimize the impact on their design and operating effectiveness.
28
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, employment, and data privacy 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.
We cannot predict with assurance the outcome of Actions brought against us. Accordingly, developments, settlements, or resolutions may occur and impact operations 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 financial results.
Item 1A. Risk Factors.
There have been no material changes in our risk factors from those disclosed in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarterly period ended May 2, 2020.
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 October 31, 2020 by the Company 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
Month #1 (August 2 - August 29)
—
$
—
—
$
800
million
Month
#2 (August 30 - October 3)
—
$
—
—
$
800
million
Month #3 (October 4 - October 31)
—
$
—
—
$
800
million
Total
—
$
—
—
__________
(1) Excludes
shares withheld to settle employee statutory tax withholding related to the vesting of stock units.
Item 5.Other Information.
We entered into agreements to extend the existing severance provisions contained in the letter agreements with certain executive officers: on November 20, 2020 with Mr. Curran, Ms. Green, Ms. Gruber, Ms. O’Connell, and Ms. Peters and on November 23, 2020 with Mr. Breitbard and Ms. Syngal. In summary, as extended, the severance provisions provide that upon involuntary termination for reasons other than cause prior to June
30, 2024, the Company will provide, subject to a release of claims, the executive’s then-current salary for up to 18 months, payment of a portion of COBRA healthcare continuation, reimbursement for costs to maintain financial counseling the Company provides to senior executives, a prorated bonus in the year of termination if the executive worked at least three months of the fiscal year if earned based on actual fiscal results achieved in the year of termination and assuming a 100% standard for any nonfinancial component, accelerated vesting (but not settlement) of restricted stock units and performance shares or units that remain subject to only time vesting conditions scheduled to vest prior to April 1 following the end of the fiscal year of termination. Copies of the agreements extending such severance
provisions are attached hereto as Exhibits 10.4 through 10.10.
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
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
X
101
The
following materials from The Gap, Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2020, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) the Condensed Consolidated Statements of Stockholders' Equity; (v) the Condensed Consolidated Statements of Cash Flows; and (vi) Notes to Condensed Consolidated Financial Statements
X
_____________________________
(P) This
Exhibit was originally filed in paper format. Accordingly, a hyperlink has not been provided.
† Indicates management contract or compensatory plan or arrangement.
30
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.
