GAP INC (GAP) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. 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 have Company-operated stores in the United States, Canada, Japan, Italy, China, Taiwan, and Mexico. In fiscal 2021, we signed an agreement with a third party to operate Gap Italy stores as a franchise partner beginning in fiscal 2022. Our products are available to customers online through Company-owned websites and through the use of third parties that provide logistics and fulfillment services. We also have franchise agreements with unaffiliated franchisees to operate Old Navy, Gap, Banana Republic, and Athleta throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate, or will operate, stores and websites that sell apparel and related products under our brand names. In addition to operating in the specialty, outlet, online, and franchise channels, we 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.
Overview
We unveiled our Power Plan strategy during fiscal 2020, which reflects long-term plans to strengthen the Company and pave the foundation for sustainable growth. Since then, we have focused on our key initiatives, including growing Old Navy and Athleta, repositioning and transforming Gap and Banana Republic, and scaling strategic partnerships to amplify our brands across product categories, markets, and channels. Each of our purpose-led, lifestyle brands are finding new and relevant ways to expand customer reach. Since the beginning of fiscal 2021, we have executed on this strategy in various ways such as launching Gap Home at Walmart, and BODEQUALITY at Old Navy. We also launched AthletaWell, an immersive digital health and wellness platform designed to build loyalty, engagement, and a community of empowered women. Additionally, we launched the Athleta website in Canada and opened the first Athleta stores in the Canadian market in fiscal 2021.
In order to attract new customers and create enduring relationships by turning customers into lifelong loyalists, we launched a new integrated loyalty program across the U.S. and Puerto Rico. We also entered into agreements with Barclays and Mastercard relating to a new long-term credit card program that is expected to begin in the second quarter of fiscal 2022. Accordingly, our private label credit card program with Synchrony Financial will be discontinued upon the launch of the new long-term credit card program.
During the second half of fiscal 2021, global supply chain disruption, including COVID-19 related factory closures and increased port congestion, caused significant product delays resulting in brands being unable to fully meet customer demand. The Company continues to work with its suppliers to minimize the ongoing disruption and has employed increased air freight and port diversification. While the supply chain disruption resulted in lost sales in fiscal 2021 due to constrained inventory, and increased air freight expenses, we have prioritized increased investments in technology to build out our digital and supply chain capabilities and are beginning to optimize manufacturing which includes proximate sourcing and digital product creation. These investments are intended to drive automation, speed, and efficiency within our fulfillment network to help mitigate future disruption.
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We implemented actions during fiscal 2021 to reduce our interest on long-term notes. On September 27, 2021, the Company completed the issuance of 3.625 percent senior notes due 2029 (“2029 Notes”) and 3.875 percent senior notes due 2031 (“2031 Notes”) (the 2029 Notes and the 2031 Notes, collectively, the "Senior Notes") in an aggregate principal amount of $1.5 billion. The Company used the net proceeds from the offering of the Senior Notes, together with cash on hand, to complete tender offers and purchase an aggregate principal amount of $1.9 billion of the 8.375 percent senior secured notes due 2023 (the "2023 Notes"), 8.625 percent senior secured notes due 2025 (the "2025 Notes"), and 8.875 percent senior secured Notes due 2027 (the "2027 Notes") (the 2023 Notes, the 2025 Notes, and the 2027 Notes, collectively, the "Secured Notes"). On October 27, 2021, the Company redeemed the remaining outstanding Secured Notes that were not tendered in the tender offers and paid the related make-whole premiums. In conjunction with these transactions, we incurred a loss on extinguishment of debt of $325 million, which was recorded on the Consolidated Statement of Operations and primarily consisted of tender premiums, make-whole premiums, and unamortized debt issuance costs relating to the Secured Notes. See Note 6 of Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K for further details related to our debt and credit facilities.
In line with our strategic review of our operating model in Europe, we completed the transition of our Gap France operations to Hermione People & Brands to operate Gap France stores as a franchise partner in the third quarter of fiscal 2021 and signed an agreement with OVS to operate Gap Italy stores as a franchise partner beginning in fiscal 2022. In addition, we entered into a joint venture agreement in September 2021 with Next Plc ("Next") where the joint venture will serve the United Kingdom and Ireland as a franchise partner beginning in early 2022. We believe these transformations of our European business model will streamline our operations by using strong local partnerships to grow our brands and amplify our reach. As a result of these strategic changes, we incurred net pre-tax costs of $41 million during the fiscal year ended January 29, 2022, primarily consisting of employee and lease costs related to the closure of the Company-operated stores in the United Kingdom and Ireland. These costs were recorded within cost of goods sold and occupancy expenses and operating expenses on the Consolidated Statement of Operations.
We continued strengthening the power of our platform through strategic investments in our digital, loyalty, and supply chain capabilities. During fiscal 2021, we acquired two technology companies, CB4 and Drapr, that we believe will add data and science to the way we work and enhance the customer shopping experience while also streamlining operations. See Note 4 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K for further details about the Company’s acquisitions.
As part of a strategic review of the Company's brands and businesses, we made the decision to divest the Janie and Jack and Intermix brands. The divestiture of Janie and Jack was completed on April 8, 2021. The divestiture of Intermix was completed on May 21, 2021. We believe these divestitures will allow the Company to prioritize its strategic focus and resources on growing our four purpose-led, lifestyle brands. We recognized a pre-tax loss of $59 million within operating expenses on the Consolidated Statement of Operations during fiscal 2021 in conjunction with these transactions. See Note 17 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K for further details about the Company’s divestitures.
The Company remains focused on our plans 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. As of January 29, 2022, we have closed, net of openings, 250 Gap and Banana Republic stores in North America since the beginning of fiscal 2020. The majority of the selected stores had leases that expired in fiscal 2020 and fiscal 2021, which allowed us to exit underperforming stores with a minimal net impact to our Consolidated Statement of Operations.
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In January 2022, Gap brand announced the global launch of its first collection of non-fungible tokens ("NFT") to bring its brand and iconic product to new and existing customers in a rapidly evolving digital ecosystem. Additional digital experiences are planned in the future to continue to engage customers in a digitally-led world.
We remain focused on the following strategic priorities in the near term:
•creating product that offers value to our customers through a combination of fit, quality, brand and price;
•investing in our four purpose-led lifestyle brands to drive relevance and gain market share;
•growing our online business;
•reducing our fixed cost structure to fuel demand generation investments;
•leveraging our scale to navigate constraints in supply chain;
•managing inventory to support a healthy merchandise margin;
•rationalizing the Gap and Banana Republic store fleet;
•prioritizing asset-light growth through licensing, online, and franchise partnerships globally;
•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.
We believe focusing on these priorities in the near term will propel the Company to execute against its Power Plan 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 identify our operating segments according to how our business activities are managed and evaluated. As of January 29, 2022, our operating segments included Old Navy Global, Gap Global, Banana Republic Global, and Athleta. 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 one reportable segment.
Financial results for fiscal 2021 are as follows:
•Net sales for fiscal 2021 increased 21 percent to $16.7 billion compared with $13.8 billion for fiscal 2020.
•Online sales for fiscal 2021 increased 2 percent compared with fiscal 2020 and store sales for fiscal 2021 increased 36 percent compared with fiscal 2020.
•Gross profit for fiscal 2021 was $6.6 billion compared with $4.7 billion for fiscal 2020. Gross margin for fiscal 2021 was 39.8 percent compared with 34.1 percent for fiscal 2020.
•Operating income for fiscal 2021 was $810 million compared with operating loss of $(862) million for fiscal 2020.
•We incurred a loss on extinguishment of debt of $325 million during fiscal 2021, primarily related to the tender premiums, make-whole premiums, and unamortized debt issuance costs of the Secured Notes.
•Effective tax rate for fiscal 2021 was 20.7 percent compared with 39.7 percent for fiscal 2020.
•Net income for fiscal 2021 was $256 million compared with net loss of $(665) million for fiscal 2020.
•Diluted earnings per share was $0.67 for fiscal 2021 compared with diluted loss per share of $(1.78) for fiscal 2020.
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Results of Operations
Net Sales
See Note 3 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K 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 excludes the results of the franchise business. Gap Inc. Comp Sales included the results of Hill City, Janie and Jack, and Intermix until the respective closure and divestitures of those brands in fiscal 2020 and fiscal 2021.
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 fifty-two weeks ended January 29, 2022, any stores temporarily closed for more than three days as a result of the COVID-19 pandemic were excluded from the Comp Sales calculations. After 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.
As a result of the extensive temporary store closures during the first quarter of fiscal 2020 due to the COVID-19 pandemic, comparable sales are not a meaningful metric for the fifty-two weeks ended January 30, 2021 and we have not included a discussion within our Results of Operations. The percentage change in Comp Sales by global brand and for The Gap, Inc., as compared with the preceding year, is as follows:
| 52 Weeks Ended | ||
|---|---|---|
| January 29, 2022 | ||
| Old Navy Global | — | % |
| Gap Global | 8 | % |
| Banana Republic Global | 24 | % |
| Athleta | 12 | % |
| The Gap, Inc. | 6 | % |
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Store count, openings, closings, and square footage for our stores are as follows:
| January 30, 2021 | Fiscal 2021 | January 29, 2022 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number of Store Locations | Number of Stores Opened | Number of Stores Closed | Number of Store Locations | Square Footage (in millions) | ||||||||||
| Old Navy North America | 1,220 | 44 | 12 | 1,252 | 20.1 | |||||||||
| Gap North America | 556 | 2 | 38 | 520 | 5.5 | |||||||||
| Gap Asia | 340 | 12 | 23 | 329 | 2.8 | |||||||||
| Gap Europe (1) | 117 | 1 | 86 | 11 | 0.1 | |||||||||
| Banana Republic North America | 471 | 2 | 27 | 446 | 3.7 | |||||||||
| Banana Republic Asia | 47 | 6 | 3 | 50 | 0.2 | |||||||||
| Athleta North America | 199 | 30 | 2 | 227 | 0.9 | |||||||||
| Intermix North America (2) | 31 | — | — | — | — | |||||||||
| Janie and Jack North America (2) | 119 | — | — | — | — | |||||||||
| Company-operated stores total | 3,100 | 97 | 191 | 2,835 | 33.3 | |||||||||
| Franchise (1) | 615 | 78 | 150 | 564 | N/A | |||||||||
| Total | 3,715 | 175 | 341 | 3,399 | 33.3 | |||||||||
| Decrease over prior year | (8.5) | % | (3.8) | % | ||||||||||
| February 1, 2020 | Fiscal 2020 | January 30, 2021 | ||||||||||||
| Number of Store Locations | Number of Stores Opened | Number of Stores Closed | Number of Store Locations | Square Footage (in millions) | ||||||||||
| Old Navy North America | 1,207 | 32 | 19 | 1,220 | 19.6 | |||||||||
| Old Navy Asia | 17 | — | 17 | — | — | |||||||||
| Gap North America | 675 | 2 | 121 | 556 | 5.8 | |||||||||
| Gap Asia | 358 | 16 | 34 | 340 | 2.9 | |||||||||
| Gap Europe | 137 | 4 | 24 | 117 | 1.0 | |||||||||
| Banana Republic North America | 541 | 3 | 73 | 471 | 4.0 | |||||||||
| Banana Republic Asia | 48 | 5 | 6 | 47 | 0.2 | |||||||||
| Athleta North America | 190 | 11 | 2 | 199 | 0.8 | |||||||||
| Intermix North America | 33 | — | 2 | 31 | 0.1 | |||||||||
| Janie and Jack North America | 139 | — | 20 | 119 | 0.2 | |||||||||
| Company-operated stores total | 3,345 | 73 | 318 | 3,100 | 34.6 | |||||||||
| Franchise | 574 | 67 | 26 | 615 | N/A | |||||||||
| Total | 3,919 | 140 | 344 | 3,715 | 34.6 | |||||||||
| Decrease over prior year | (5.2) | % | (6.5) | % |
__________
(1)The 21 Gap France stores that were transitioned to Hermione People & Brands during the period are not included as store closures or openings for Company-operated and Franchise store activity. The ending balance for Gap Europe excludes these stores and the ending balance for Franchise includes these stores.
(2)On April 8, 2021, the Company completed the divestiture of the Janie and Jack brand. On May 21, 2021, the Company completed the divestiture of the Intermix business. The 150 stores divested are not included as store closures or in the ending balance for fiscal 2021.
Outlet and factory stores are reflected in each of the respective brands.
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Net Sales Discussion
Our net sales for fiscal 2021 increased $2.9 billion, or 21 percent, compared with fiscal 2020, driven primarily by temporary closures across our fleet during fiscal 2020 due to the COVID-19 pandemic, as well as a favorable impact of foreign exchange of $93 million; partially offset by supply chain disruptions that constrained inventory and negatively impacted sales in the second half of fiscal 2021. The foreign exchange impact is the translation impact if net sales for fiscal 2020 were translated at exchange rates applicable during fiscal 2021.
Our net sales for fiscal 2020 decreased $2.6 billion, or 16 percent, compared with fiscal 2019, reflecting a 39 percent decline in store sales, partially offset by a 54 percent increase in online sales. The decrease in net sales was primarily driven by mandatory store closures and stay-at-home restrictions related to the COVID-19 pandemic as well as permanent store closures as a result of our strategic store rationalization initiatives for Gap Global and Banana Republic Global.
Cost of Goods Sold and Occupancy Expenses
| ($ in millions) | Fiscal Year | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||
| Cost of goods sold and occupancy expenses | $ | 10,033 | $ | 9,095 | $ | 10,250 | ||||
| Gross profit | $ | 6,637 | $ | 4,705 | $ | 6,133 | ||||
| Cost of goods sold and occupancy expenses as a percentage of net sales | 60.2 | % | 65.9 | % | 62.6 | % | ||||
| Gross margin | 39.8 | % | 34.1 | % | 37.4 | % |
Cost of goods sold and occupancy expenses decreased 5.7 percentage points as a percentage of net sales in fiscal 2021 compared with fiscal 2020.
•Cost of goods sold decreased 3.1 percentage points as a percentage of net sales in fiscal 2021 compared with fiscal 2020, primarily due to lower promotional activity, a decrease in online shipping costs due to lower ship-from-store fulfillment, and higher inventory impairment recognized during fiscal 2020 due to the COVID-19 pandemic; partially offset by higher air freight costs especially in the fourth quarter of fiscal 2021.
•Occupancy expenses decreased 2.6 percentage points as a percentage of net sales in fiscal 2021 compared with fiscal 2020, primarily driven by an increase in net sales largely due to temporary store closures as a result of the COVID-19 pandemic during fiscal 2020 as well as a decrease in fixed occupancy expenses due to strategic store closures.
Cost of goods sold and occupancy expenses increased 3.3 percentage points as a percentage of net sales in fiscal 2020 compared with fiscal 2019.
•Cost of goods sold increased 4.1 percentage points as a percentage of net sales in fiscal 2020 compared with fiscal 2019, primarily driven by higher shipping costs as a result of growth in online sales as well as higher inventory impairment due to store closures in the first half of the year and decreased retail traffic as a result of the COVID-19 pandemic; partially offset by lower promotional activity.
•Occupancy expenses decreased 0.8 percentage points as a percentage of net sales in fiscal 2020 compared with fiscal 2019, primarily driven by growth in online sales with minimal impact on fixed occupancy expenses; partially offset by decrease in net sales largely due to store closures as a result of the COVID-19 pandemic without a corresponding decrease in occupancy expenses.
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Operating Expenses and Operating Margin
| ($ in millions) | Fiscal Year | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | |||||||||
| Operating expenses | $ | 5,827 | $ | 5,567 | $ | 5,559 | |||||
| Operating expenses as a percentage of net sales | 35.0 | % | 40.3 | % | 33.9 | % | |||||
| Operating margin | 4.9 | % | (6.2) | % | 3.5 | % |
Operating expenses increased $260 million, but decreased 5.3 percentage points as a percentage of net sales in fiscal 2021 compared with fiscal 2020 primarily due to an increase in net sales as well as the following:
•an increase in advertising expense to support demand generation across all purpose-led lifestyle brands;
•an increase in performance-based compensation;
•an increase in store payroll and benefits and other store operating expenses due to COVID-19 temporary store closures during fiscal 2020 which was partially offset by additional costs incurred during fiscal 2020 to support health and safety measures as stores reopened;
•an increase related to fiscal 2021 strategic initiatives including divestiture activity and the review of our European operating model; and
•an increase related to digital innovation costs to fuel the growth priorities of the business;
partially offset by
•a decrease due to impairment charges of $557 million during fiscal 2020 primarily due to the impact of the COVID-19 pandemic and a strategic review of the Intermix business; and
•a decrease in lease termination fees.
Operating expenses increased $8 million or 6.4 percentage points as a percentage of net sales in fiscal 2020 compared with fiscal 2019 primarily due to the following:
•impairment charges of $557 million incurred during fiscal 2020 primarily due to the impact of the COVID-19 pandemic and a strategic review of the Intermix business compared with impairment charges of $337 million incurred during fiscal 2019 primarily related to global flagships;
•a gain on the sale of a building that occurred during fiscal 2019 of $191 million;
•an increase in advertising expenses due to higher investment in marketing support across all purpose-led lifestyle brands;
•an increase in lease termination fees incurred in fiscal 2020;
partially offset by
•separation-related and specialty fleet restructuring costs of $339 million incurred in fiscal 2019;
•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.
Loss on Extinguishment of Debt
On September 27, 2021, the Company completed the issuance of the Senior Notes in an aggregate principal amount of $1.5 billion and used the net proceeds from the offering, together with cash on hand, to complete tender offers and purchase an aggregate principal amount of $1.9 billion of the Company’s Secured Notes. On October 27, 2021, the Company redeemed the remaining outstanding Secured Notes that were not tendered in the tender offers and paid the related make-whole premiums. We incurred a loss on extinguishment of debt of $325 million, which was recorded on the Consolidated Statement of Operations during fiscal 2021, primarily related to the tender premiums, make-whole premiums, and unamortized debt issuance costs of the Secured Notes.
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On May 7, 2020, the Company completed the issuance of the Secured Notes for $2.25 billion and used the proceeds to redeem the 5.95 percent notes due April 2021 (the "2021 Notes"). We incurred a loss on extinguishment of debt of $58 million, primarily related to the make-whole premium, which was recorded on the Consolidated Statement of Operations during fiscal 2020.
Interest Expense
| ($ in millions) | Fiscal Year | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | |||||||||
| Interest expense | $ | 167 | $ | 192 | $ | 76 |
Interest expense decreased $25 million or 13.0 percent during fiscal 2021 compared with fiscal 2020 primarily due to the lower interest rates and principal as a result of the issuance of the Senior Notes. The total outstanding principal related to our Notes decreased from $2.25 billion as of January 30, 2021, to $1.5 billion as of January 29, 2022. Additionally, the Senior Notes bear interest at 3.625 percent and 3.875 percent compared with 8.375 percent, 8.625 percent, and 8.875 percent with our previous Secured Notes.
Interest expense increased $116 million or 152.6 percent during fiscal 2020 compared with fiscal 2019 primarily due to higher total outstanding debt and higher interest rates as a result of the May 2020 issuance of the Secured Notes. The total outstanding principal related to our Notes increased from $1.25 billion as of February 1, 2020, to $2.25 billion as of January 30, 2021. Additionally, the Secured Notes bear interest at 8.375 percent, 8.625 percent, and 8.875 percent compared with our previous 5.95 percent 2021 Notes.
Income Taxes
| ($ in millions) | Fiscal Year | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | |||||||||
| Income taxes | $ | 67 | $ | (437) | $ | 177 | |||||
| Effective tax rate | 20.7 | % | 39.7 | % | 33.5 | % |
The decrease in the effective tax rate for fiscal 2021 compared with fiscal 2020 was primarily due to benefits from the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), foreign entity structure changes related to fiscal 2020, and the recognition of certain tax benefits associated with divestiture activity occurring in fiscal 2021, partially offset by the tax impact of foreign operations.
During fiscal 2021, we recorded a $18 million benefit related to finalization of the net operating loss carryback prescribed in the CARES Act. We also recorded a $21 million benefit related to recognition of certain tax benefits associated with divestiture activity.
The increase in the effective tax rate for fiscal 2020 compared with fiscal 2019 was primarily due to the benefit associated with the enactment of the CARES Act and the recognition of certain tax benefits associated with foreign entity structure changes, partially offset by the tax impact of foreign operations.
During fiscal 2020, we recorded a $122 million benefit related to the CARES Act carryback provisions and a $113 million benefit related to recognition of certain tax benefits associated with foreign entity structure changes.
See Note 8 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for further details.
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Liquidity and Capital Resources
On September 27, 2021, we completed the issuance of the Senior Notes in an aggregate principal amount of $1.5 billion. The Company used the net proceeds from the Senior Notes offering, together with cash on hand, to complete tender offers and purchase an aggregate principal amount of $1.9 billion of the Secured Notes. On October 27, 2021, the Company redeemed the remaining outstanding Secured Notes that were not tendered in the tender offers and paid the related make-whole premiums. Our obligations under the Secured Notes were discharged following their redemption. See Note 6 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for further details about the Company’s debt and credit facilities.
The Senior Notes are guaranteed on a senior unsecured basis, jointly and severally, by each of the Company’s existing wholly owned domestic subsidiaries that is a borrower or guarantor under the Company’s senior secured asset-based revolving credit agreement (the "ABL Facility").
We consider the following to be measures of our liquidity and capital resources:
| ($ in millions) | January 29, 2022 | January 30, 2021 | |||||
|---|---|---|---|---|---|---|---|
| Cash and cash equivalents | $ | 877 | $ | 1,988 | |||
| Short-term investments | — | 410 | |||||
| Debt | |||||||
| 8.375 percent 2023 Notes | — | 500 | |||||
| 8.625 percent 2025 Notes | — | 750 | |||||
| 8.875 percent 2027 Notes | — | 1,000 | |||||
| 3.625 percent 2029 Notes | 750 | — | |||||
| 3.875 percent 2031 Notes | 750 | — | |||||
| Working capital | 1,088 | 2,124 | |||||
| Current ratio | 1.27:1 | 1.55:1 |
As of January 29, 2022, the majority of our cash and cash equivalents 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, lease and occupancy costs, personnel-related expenses, purchases of property and equipment, air freight and shipping costs, and payment of taxes. The seasonality of our operations may lead to fluctuations in certain cash inflows and outflows between fiscal year-end and subsequent interim periods.
We are party to many contractual obligations involving commitments to make payments to third parties. These obligations impact our short-term and long-term liquidity and capital resource needs. Certain contractual obligations are reflected on the Consolidated Balance Sheet as of January 29, 2022, while others are considered future obligations. Our contractual obligations primarily consist of operating leases, purchase obligations and commitments, long-term debt and related interest payments, and income taxes. See Notes 6 and 12 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K for information related to our debt, including our ABL Facility, and operating leases, respectively.
Purchase obligations and commitments consist of open purchase orders to purchase inventory as well as commitments for products and services used in the normal course of business. As of January 29, 2022, our purchase obligations and commitments were approximately $6 billion. The increase compared with the purchase obligations and commitments as of January 30, 2021 is primarily due to starting the merchandise booking process earlier to proactively mitigate supply chain delays. We expect that the majority of these purchase obligations and commitments will be settled within one year.
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Our contractual obligations related to income taxes are primarily related to unrecognized tax benefits. See Note 8 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K for information related to income taxes.
We believe our existing balances of cash and cash equivalents, along with our cash flows from operations, and instruments mentioned above, provide sufficient funds for our business operations as well as capital expenditures, dividends, share repurchases, and other liquidity requirements associated with our business operations over the next 12 months and beyond.
Cash Flows from Operating Activities
Net cash provided by operating activities increased by $572 million during fiscal 2021 compared with fiscal 2020, primarily due to the following:
Net income (loss)
•Net income compared with net loss in prior year;
Non-cash items
•a decrease of $517 million due to lower non-cash impairment charges for operating lease assets and store assets during fiscal 2021 compared with fiscal 2020; and
•an increase of $267 million due to higher loss on extinguishment of debt during fiscal 2021 compared with fiscal 2020;
Changes in operating assets and liabilities
•an increase of $219 million related to income taxes payable, net of receivables, and other tax-related items resulting from the taxable loss carryback recorded in fiscal 2020 as well as timing of tax-related payments;
•an increase of $186 million related to accrued expenses and other current liabilities in part due to an increase in deferred revenue due to the new integrated loyalty program and an increase in performance-based compensation during fiscal 2021 compared to fiscal 2020;
•a decrease of $378 million related to accounts payable primarily due to the suspension of rent for stores closed temporarily during fiscal 2020 as well as changes in payment terms as a result of the COVID-19 pandemic; and
•a decrease of $288 million related to merchandise inventory in part due to higher air freight cost and timing of receipts as a result of the global supply chain disruptions during fiscal 2021 compared to fiscal 2020.
Net cash provided by operating activities decreased $1,174 million during fiscal 2020 compared with fiscal 2019, primarily due to the following significant changes:
Net income (loss)
•Net loss compared with net income in prior comparable period;
Non-cash items
•an increase of $189 million due to non-cash impairment charges for operating lease assets and store assets during fiscal 2020 compared with fiscal 2019; and
•$191 million increase due to a gain on the sale of a building during fiscal 2019;
Changes in operating assets and liabilities
•a decrease of $390 million related to income taxes payable, net of receivables and other tax-related items, resulting from the taxable loss carryback estimated for fiscal 2020 as well as timing of tax-related payments;
•a decrease of $309 million related to merchandise inventory primarily due to timing of receipts as a result of shipping delays and port congestion as well as seasonal inventory stored at our distribution centers; and
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•a decrease of $124 million related to accrued expenses and other current liabilities primarily due to separation-related costs incurred in fiscal 2019; partially offset by
•an increase of $498 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 pandemic.
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, in addition to the impact of the COVID-19 pandemic and global supply chain disruption, 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 fiscal 2021 decreased $64 million compared with fiscal 2020, primarily due to the following:
•$529 million higher net proceeds from available for sale securities during fiscal 2021 compared with fiscal 2020; partially offset by
•$302 million more purchases of property and equipment during fiscal 2021 compared with fiscal 2020; and
•$135 million in cash payments for acquisitions in fiscal 2021.
In fiscal 2021, cash used for purchases of property and equipment was $694 million primarily related to information technology, including our ongoing cloud transformation, and supply chain to support our omni and digital strategies.
Net cash used for investing activities during fiscal 2020 decreased $384 million compared with fiscal 2019, primarily due to the following:
•$310 million fewer purchases of property and equipment during fiscal 2020 compared with fiscal 2019; and
•an increase of $123 million due to the net activity related to the purchase and sale of buildings during fiscal 2019; partially offset by
•$120 million lower net proceeds from available-for-sale securities during fiscal 2020 compared with fiscal 2019.
In fiscal 2020, cash used for purchases of property and equipment was $392 million primarily related to information technology and supply chain to support our omni and digital strategies.
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Cash Flows from Financing Activities
Net cash used for financing activities was $1,471 million during fiscal 2021 compared with $895 million of cash provided by financing activities during fiscal 2020, primarily due to the following:
•$2,546 million for payments related to the extinguishment of long-term debt during fiscal 2021 compared with $1,307 million paid during fiscal 2020;
•$1,500 million in proceeds received for the issuance of long-term debt for fiscal 2021 compared with $2,250 million in proceeds received for fiscal 2020;
•$226 million in payments of dividends during fiscal 2021 compared with no dividends paid during fiscal 2020 as a result of the COVID-19 pandemic; and
•$201 million in repurchases of common stock during fiscal 2021 compared with no repurchases during fiscal 2020 as a result of the COVID-19 pandemic.
Net cash provided by financing activities was $895 million during fiscal 2020 compared with $560 million of cash used for financing activities during fiscal 2019, primarily due to the following:
•$2,250 million proceeds received related to the issuance of long-term debt during fiscal 2020; and
•No payments of dividends and repurchases of common stock during fiscal 2020 as a result of the COVID-19 pandemic compared with $564 million in payments of dividends and repurchases of common stock during fiscal 2019; partially offset by
•$1,307 million payment for the extinguishment of long-term debt during fiscal 2020.
Free Cash Flow
Free cash flow is a non-GAAP financial measure. We believe free cash flow is an important metric because it represents a measure of how much cash a company has available for discretionary and non-discretionary items after the deduction of capital expenditures. We require regular capital expenditures including technology improvements to automate processes, engage with customers, and optimize our supply chain in addition to building and maintaining stores. We use this metric internally, as we believe our sustained ability to generate free cash flow is an important driver of value creation. However, this non-GAAP financial measure is not intended to supersede or replace our GAAP results.
The following table reconciles free cash flow, a non-GAAP financial measure, from net cash provided by operating activities, a GAAP financial measure.
| Fiscal Year | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| ($ in millions) | 2021 | 2020 | 2019 | ||||||||
| Net cash provided by operating activities | $ | 809 | $ | 237 | $ | 1,411 | |||||
| Less: Purchases of property and equipment (1) | (694) | (392) | (702) | ||||||||
| Free cash flow | $ | 115 | $ | (155) | $ | 709 |
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(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 headings "Debt and Credit Facilities" in Note 6 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
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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.
During fiscal 2020, the Company suspended its regular quarterly cash dividend in order to preserve liquidity in the context of the ongoing and uncertain duration and impact of the COVID-19 pandemic on its operations. On April 28, 2021, the Company paid the previously declared first quarter of 2020 dividend to shareholders of record at the close of business on April 7, 2021. The Company resumed its quarterly dividend in fiscal 2021 and paid a quarterly dividend of $0.12 for each of the second, third, and fourth quarters of fiscal 2021. We plan to pay a dividend of $0.15 per share in the first quarter of fiscal 2022.
Share Repurchases
During fiscal 2021, the Company resumed its share repurchase activity, which was suspended in fiscal 2020 due to the economic uncertainty stemming from a number of factors, including the COVID-19 pandemic.
Certain financial information about the Company's share repurchases is set forth under the heading "Share Repurchases" in Note 10 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements.
Our significant accounting policies can be found under the heading "Organization and Summary of Significant Accounting Policies" in Note 1 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K. The policies and estimates discussed below include the financial statement elements that are either judgmental or involve the selection or application of alternative accounting policies and are material to our financial statements.
Inventory Valuation
We value inventory at the lower of cost or net realizable value (“LCNRV”), with cost determined using the weighted-average cost method. We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes or colors), and we primarily use promotions and markdowns to clear merchandise. We record an adjustment to inventory when future estimated selling price is less than cost. Our LCNRV adjustment calculation requires management to make assumptions to estimate the selling price and amount of slow-moving merchandise and broken assortments subject to markdowns, which is dependent upon factors such as historical trends with similar merchandise, inventory aging, forecasted consumer demand, and the promotional environment.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our LCNRV. However, if estimates regarding consumer demand are inaccurate, or if economic conditions including delayed shipments and other supply chain challenges worsen beyond what is currently estimated by management, our operating results could be affected.
Impairment of Long-Lived Assets
Long-lived assets, which primarily consist of property and equipment and operating lease assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Events that result in an impairment review include a significant decrease in the operating performance of the long-lived asset or the decision to close a store, corporate facility, or distribution center.
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Long-lived assets are considered impaired if the carrying amount exceeds the estimated undiscounted future cash flows of the asset or asset group over the estimated remaining useful life. 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. For our Company-operated stores, including flagships, the individual store generally represents the lowest level of independent identifiable cash flows and the asset group is comprised of both property and equipment and operating lease assets.
For impaired assets, we recognize a loss equal to the difference between the carrying amount of the asset or asset group and its estimated fair value. The estimated fair value of the asset or asset group is based on discounted future cash flows of the asset or asset group using a discount rate commensurate with the related risk. For operating lease assets, the Company determines the estimated fair value of the assets by comparing the discounted contractual rent payments to estimated market rental rates using available valuation techniques.
Our estimate of future cash flows requires management to make assumptions and to apply judgment, including forecasting future sales and gross profits and estimating useful lives of the assets. These estimates can be affected by factors such as future sales results, real estate market conditions, store closure plans, economic conditions, business interruptions, interest rates and government regulations that can be difficult to predict. If actual results and conditions are not consistent with the estimates and assumptions used in our calculations, we may be exposed to additional impairments of long-lived assets.
See Note 7 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for additional information and disclosures about impairment of long-lived assets.
Income Taxes
We are a multinational company operating in multiple domestic and foreign locations with different tax laws and regulations. The Company's management is required to interpret and apply these tax laws and regulations in determining the amount of its income tax liability for financial statement purposes. We record a valuation allowance against our deferred tax assets when it is more likely than not that some portion or all of such deferred tax assets will not be realized. In determining the need for a valuation allowance, management is required to make assumptions and to apply judgment, including tax planning strategies, forecasting future income, taxable income, and the geographic mix of income or losses in the jurisdictions in which we operate. Our effective tax rate in a given financial statement period may also be materially impacted by changes in the geographic mix and level of income or losses, changes in the expected or actual outcome of audits, and changes in the deferred tax valuation allowance or new tax legislation.
At any point in time, many tax years are subject to or in the process of being audited by various U.S. and foreign tax jurisdictions. These audits include reviews of our tax filing positions, including the timing and amount of deductions taken and the allocation of income between tax jurisdictions. When an uncertain tax position is identified, we recognize a benefit only if we believe it is more likely than not that the tax position based on its technical merits will be sustained upon examination by the relevant tax authorities. We recognize a benefit for tax positions using the highest cumulative tax benefit that is more likely than not to be realized. We establish a liability for tax positions that do not meet this threshold. The evaluation of uncertain tax positions requires management to apply specialized skill and knowledge related to tax laws and regulations and to make assumptions that are subject to factors such as possible assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolutions of tax audits. To the extent we prevail in matters for which a liability has been established or are required to pay amounts in excess of our established liability, our effective income tax rate in a given financial statement period could be materially affected.
See Note 8 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for additional information on income taxes.
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Recent Accounting Pronouncements
See "Organization and Summary of Significant Accounting Policies" in Note 1 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for recent accounting pronouncements, including the expected dates of adoption and estimated effects on our Consolidated Financial Statements.