The Gap, Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 and 26 weeks ended August 1, 2020, with comparisons to the periods ended August 3, 2019. Although the request identifies 2019 Q2, the supplied filing is for fiscal 2020 Q2.
Business context and results
Gap operates Old Navy, Gap, Banana Republic, Athleta, Intermix, Janie and Jack, and Hill City through stores, online channels, and franchisees. COVID-19 prompted temporary store closures; by August 1, approximately 90% of stores worldwide had reopened. Online sales rose sharply, supported by curbside pickup and ship-from-store. The company also launched a business-to-business cloth-mask program.
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net sales | $3.275bn | $4.005bn | $5.382bn | $7.711bn |
| Gross profit | $1.149bn | $1.556bn | $1.417bn | $2.900bn |
| Gross margin | 35.1% | 38.9% | 26.3% | 37.6% |
| Operating income (loss) | $73m | $282m | $(1.171)bn | $598m |
| Net income (loss) | $(62)m | $168m | $(994)m | $395m |
| Diluted EPS | $(0.17) | $0.44 | $(2.66) | $1.04 |
Q2 sales declined 18%; online sales increased 95% while store sales fell 48%. Company comparable sales increased 13% in Q2, but temporarily closed stores were excluded from the comparable-sales calculation. First-half sales fell 30%.
Cash flow, liquidity, and debt
- First-half operating cash flow was negative $87m, versus positive $583m a year earlier. Capital expenditures were $208m; free cash flow, a non-GAAP measure, was negative $295m versus positive $259m.
- At August 1, cash and cash equivalents were $2.188bn and short-term investments were $25m. The company reported $2.213bn of immediately available cash and investments. Its $1.8675bn asset-based revolving facility had no borrowings; $48m of standby letters of credit were issued under it.
- Long-term debt was $2.212bn net of issuance costs ($2.25bn principal). In May, Gap issued secured notes totaling $2.25bn, with coupons of 8.375%–8.875%, and used proceeds to redeem $1.25bn of 5.95% notes due 2021. The redemption generated a $58m extinguishment loss. Interest expense was $58m in Q2 and $77m for the first half.
- Operating lease liabilities totaled $6.035bn, including current and long-term portions. The company said it was complying with applicable debt covenants and expected to remain compliant for the next 12 months.
Material changes, outlook, and risks
- First-half operating expenses included $488m of store and operating-lease asset impairments ($127m and $361m, respectively), primarily reflecting COVID-19 effects and lower store cash-flow estimates. The first quarter also included $235m of inventory-related impairment; no material inventory impairment was recorded in Q2.
- Q2 gross margin fell 3.8 percentage points year over year, reflecting higher online shipping and fulfillment costs and fixed occupancy costs against lower store sales. First-half margin was further affected by inventory impairments and store closures.
- Management said current cash balances and operating cash flows should support operations for the next 12 months and that the new capital structure provided sufficient liquidity to navigate the pandemic. It also said future COVID-19 effects on demand, supply chain, results, cash flows, and liquidity could not be reasonably estimated. No specific financial guidance was provided.
- Rent payments for temporarily closed stores were suspended beginning in April; negotiations with landlords were ongoing, with additional agreements anticipated. The company deferred its previously declared first-quarter dividend until on or after April 28, 2021, subject to possible further deferral, and suspended regular dividends and share repurchases through fiscal 2020.
- Credit ratings were downgraded in March and April 2020, with negative outlooks; further downgrades could increase borrowing costs. Other cited risks include persistent pandemic impacts, consumer demand and store reopenings, inventory management, supply-chain disruption, and litigation. Management said current legal-action liabilities were not material.
Important facts for investors to verify
- Whether store reopenings, online growth, and comparable-sales trends translate into sustained revenue and margin recovery.
- Cash burn, seasonal working-capital needs, access to the ABL facility, and compliance with debt covenants.
- Landlord rent agreements, lease-related estimates, and potential further asset or inventory impairments.
- The timing and terms of the deferred dividend, and any change to the suspension of regular dividends or repurchases.
- The ongoing impact of the high-coupon secured notes, credit ratings, and any further pandemic-related changes to liquidity or operations.