# GAP INC (GAP) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from GAP INC's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/39911/000003991123000015/gps-20230128.htm
Accession: 0000039911-23-000015
Filing date: 2023-03-14
Report date: 2023-01-28
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/GAP/
All MD&A years: /company/GAP/mda/
Previous year: /company/GAP/mda/fy2022/ (FY 2022)
Next year: /company/GAP/mda/fy2024/ (FY 2024)

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. As of January 28, 2023, we had Company-operated stores in the United States, Canada, Japan, China, and Taiwan. Our products are available to customers online through Company-owned websites and through third party arrangements. We also have franchise agreements 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

Financial results for fiscal 2022 are as follows:

•Net sales for fiscal 2022 decreased 6 percent to $15.6 billion compared with $16.7 billion for fiscal 2021.

•Store sales for fiscal 2022 decreased 6 percent compared with fiscal 2021 and online sales for fiscal 2022 decreased 7 percent compared with fiscal 2021.

•Gross profit for fiscal 2022 was $5.4 billion compared with $6.6 billion for fiscal 2021. Gross margin for fiscal 2022 was 34.3 percent compared with 39.8 percent for fiscal 2021.

•Operating loss for fiscal 2022 was $(69) million compared with operating income of $810 million for fiscal 2021.

•Effective tax rate for fiscal 2022 was negative 45.3 percent compared with 20.7 percent for fiscal 2021.

•Net loss for fiscal 2022 was $(202) million compared with net income of $256 million for fiscal 2021.

•Diluted loss per share was $(0.55) for fiscal 2022 compared with diluted earnings per share of $0.67 for fiscal 2021.

•Merchandise inventory for fiscal 2022 decreased 21 percent compared with fiscal 2021.

During fiscal 2022, we made progress improving our inventory levels and inventory composition to meet changing consumer preferences; however, our gross margins were impacted by higher levels of promotional activity as well as macroeconomic challenges including global inflationary pressures. To right-size our inventory levels, we also reduced inventory orders, primarily at Old Navy, and we continue to have select seasonal product being stored at distribution centers for expected introduction into the market through fiscal 2023. In light of continued uncertain consumer preferences and the challenging macroenvironment, we will continue to take steps to improve inventory category, size, and assortments.

In the second quarter of fiscal 2022, due to difficulty managing the timing of seasonal inventory flows amidst global supply chain disruptions, the Company recorded pre-tax inventory impairment costs of $58 million, primarily related to delayed seasonal product and extended size product at Old Navy. The costs were recorded in cost of goods sold and occupancy expenses on the Consolidated Statement of Operations.

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In fiscal 2022, the Company began to take steps to drive long-term improvements across our business. These steps include reducing open and existing corporate roles, renegotiating our advertising agency contracts, reducing technology operating costs, and rationalizing digital investments. The Company did not incur material charges in connection with these steps during fiscal 2022. On March 9, 2023, the Company shared plans to further simplify and optimize its operating model and structure, including actions such as increasing spans of control and decreasing management layers to improve quality and speed of decision making, as well as creating a consistent organizational structure across all four brands. The Company also believes there are opportunities to further optimize its marketing spend and rationalize its technology investments over the next few years.

During the third quarter of fiscal 2022, the Company ended its Yeezy Gap contract and recorded pre-tax impairment costs of $53 million, primarily related to inventory, as a result of the decision. The costs were recorded in costs of goods sold and occupancy expenses on the Consolidated Statement of Operations.

The Company is also continuing 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 28, 2023, we have closed, net of openings, 304 Gap and Banana Republic stores in North America since the beginning of fiscal 2020.

We completed the transition of our United Kingdom and Ireland online operations to a franchise partner through a joint venture with Next Plc on August 10, 2022. We also completed the transition of our Gap France operations to Hermione People & Brands and Gap Italy operations to OVS S.p.A. ("OVS") on October 1, 2021 and February 1, 2022, respectively. As our European partnership model transition is now complete, we sold the distribution center in Rugby, England for $125 million and recognized a pre-tax gain on sale of $83 million within operating expenses on the Consolidated Statement of Operations during the 52 weeks ended January 28, 2023.

On March 1, 2023, the third party that operates our Gap France franchise business was placed into receivership. We do not expect this to have a material impact to our Consolidated Financial Statements.

In addition to these changes to our European operating model, on August 1, 2022, we completed the transition of our Old Navy Mexico operations to a third party, Grupo Axo, to operate Old Navy Mexico stores as a franchise partner. As a result of this transaction, the Company recognized a pre-tax loss of $35 million within operating expenses on the Consolidated Statement of Operations during the 52 weeks ended January 28, 2023.

On November 7, 2022, we signed agreements to transition our Gap Greater China operations to a third party, Baozun, to operate Gap Greater China stores and the in-market website as a franchise partner, subject to regulatory approvals and closing conditions. On January 31, 2023, the Gap China transaction closed with Baozun. The Gap Taiwan operations will continue to operate as usual until regulatory approvals and closing conditions are met.

In fiscal 2023 and through the global macroeconomic challenges, we will continue to manage these transitions with our partnerships in order to transform our international footprint, grow our brands, and amplify our reach.

On July 11, 2022, Sonia Syngal stepped down as President and Chief Executive Officer and resigned from the Company's Board. On the same date, Bob L. Martin, the Executive Chair of the Board, began serving as President and Chief Executive Officer on an interim basis.

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We remain focused on the following strategic priorities in the near term:

•managing inventory to support a healthy merchandise margin;

•reducing and optimizing our fixed cost structure to improve profitability and manage through current macroeconomic challenges;

•driving sales through assortment improvements and a balanced and relevant category mix;

•driving creative excellence and delivering product that offers value to our customers through a combination of fit, quality, brand, and price;

•rationalizing the Gap and Banana Republic store fleet;

•prioritizing asset-light growth through licensing, online, and franchise partnerships globally;

•optimizing investments in our four purpose-led lifestyle brands to drive relevance and market share;

•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 identify our operating segments according to how our business activities are managed and evaluated. As of January 28, 2023, our operating segments included Old Navy Global, Gap Global, Banana Republic Global, and Athleta Global. 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.

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 Janie and Jack and Intermix until the divestitures of those brands in fiscal 2021. Comp Sales also included the results of our European operations and Old Navy Mexico operations until the respective transitions to third party franchise partners in fiscal 2021 and 2022.

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.

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For the 52 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.

As a result of the extensive temporary store closures during the first quarter of fiscal 2020 due to the COVID-19 pandemic, Comp Sales are not a meaningful metric for the 52 weeks ended January 30, 2021.

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

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

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

[[GREPCENT_TABLE]]
[["","","January 29, 2022","","Fiscal 2022","","January 28, 2023"],["","","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)","","1,252","","","30","","","20","","","1,238","","","19.8"],["Gap North America","","520","","","10","","","37","","","493","","","5.2"],["Gap Asia","","329","","","5","","","102","","","232","","","2.0"],["Gap Europe (2)","","11","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Banana Republic North America","","446","","","2","","","29","","","419","","","3.5"],["Banana Republic Asia","","50","","","3","","","7","","","46","","","0.2"],["Athleta North America","","227","","","40","","","10","","","257","","","1.1"],["Company-operated stores total","","2,835","","","90","","","205","","","2,685","","","31.8"],["Franchise (1) (2)","","564","","","138","","","70","","","667","","","N/A"],["Total","","3,399","","","228","","","275","","","3,352","","","31.8"],["Decrease over prior year","","","","","","","","(1.4)","%","","(4.5)","%"],["","","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 (3)","","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 (4)","","31","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Janie and Jack North America (4)","","119","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Company-operated stores total","","3,100","","","97","","","191","","","2,835","","","33.3"],["Franchise (3)","","615","","","78","","","150","","","564","","","N/A"],["Total","","3,715","","","175","","","341","","","3,399","","","33.3"],["Decrease over prior year","","","","","","","","(8.5)","%","","(3.8)","%"]]
[[/GREPCENT_TABLE]]

__________

(1)The 24 Old Navy Mexico stores that were transitioned to Grupo Axo during the period are not included as store closures or openings for Company-operated and Franchise store activity. The ending balance for Old Navy North America excludes these stores and the ending balance for Franchise includes these stores.

(2)The 11 Gap Italy stores that were transitioned to OVS 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.

(3)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.

(4)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 2022 decreased $1.1 billion, or 6 percent, compared with fiscal 2021, driven primarily by Old Navy Global as a result of inventory delays related to global supply chain disruptions, as well as size and assortment imbalances in the first half of fiscal 2022. The decrease in net sales was also driven by strategic store closures which was partially offset by an increase in net sales related to our franchise business as well as Banana Republic Global. There was also an unfavorable impact of foreign exchange of $162 million. The foreign exchange impact is the translation impact if net sales for fiscal 2021 were translated at exchange rates applicable during fiscal 2022.

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.

Cost of Goods Sold and Occupancy Expenses

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[[/GREPCENT_TABLE]]

Cost of goods sold and occupancy expenses increased 5.5 percentage points as a percentage of net sales in fiscal 2022 compared with fiscal 2021.

•Cost of goods sold increased 5.0 percentage points as a percentage of net sales in fiscal 2022 compared with fiscal 2021, primarily driven by higher promotional activity and increased average unit costs. Average unit costs were impacted by commodity price increases and were partially offset by a decrease in air freight costs. The increase was also due to inventory impairment which was primarily related to seasonal product and extended size product at Old Navy Global as well as the decision to discontinue the Yeezy Gap business.

•Occupancy expenses increased 0.5 percentage points as a percentage of net sales in fiscal 2022 compared with fiscal 2021, primarily driven by a decrease in Comp Sales without a corresponding decrease in fixed occupancy expenses.

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.

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Operating Expenses and Operating Margin

[[GREPCENT_TABLE]]
[["($ in millions)","","Fiscal Year"],["","2022","","2021","","2020"],["Operating expenses","","$","5,428","","","$","5,827","","","$","5,567"],["Operating expenses as a percentage of net sales","","34.8","%","","35.0","%","","40.3","%"],["Operating margin","","(0.4)","%","","4.9","%","","(6.2)","%"]]
[[/GREPCENT_TABLE]]

Operating expenses decreased $399 million, or 0.2 percentage points as a percentage of net sales in fiscal 2022 compared with fiscal 2021 primarily due to the following:

•a decrease in performance-based compensation;

•a gain of $83 million on sale of building;

•a decrease in advertising expense primarily at Old Navy Global; and

•a decrease in costs incurred related to strategic initiatives completed in fiscal 2022, which included the transition of our Old Navy Mexico business, compared with fiscal 2021, which included divestiture activity and the review of our European operating model.

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.

Loss on Extinguishment of Debt

[[GREPCENT_TABLE]]
[["($ in millions)","","Fiscal Year"],["2022","","2021","","2020"],["Loss on extinguishment of debt","","$","\u2014","","","$","325","","","$","58"]]
[[/GREPCENT_TABLE]]

On September 27, 2021, the Company completed the issuance of its 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, together with cash on hand, to complete tender offers and purchase an aggregate principal amount of $1.9 billion of its 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. 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 in an aggregate principal amount of $2.25 billion and used the proceeds to redeem its 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

[[GREPCENT_TABLE]]
[["($ in millions)","","Fiscal Year"],["2022","","2021","","2020"],["Interest expense","","$","88","","","$","167","","","$","192"]]
[[/GREPCENT_TABLE]]

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 as a result of the issuance of our Senior Notes on September 27, 2021. 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 decreased $79 million or 47.3 percent during fiscal 2022 compared with fiscal 2021 primarily due to lower interest rates and principal for outstanding borrowings.

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.

Income Taxes

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The decrease in the effective tax rate for fiscal 2022 compared with fiscal 2021 was primarily due to changes in the jurisdictional mix of pre-tax operations and divestiture activities.

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.

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.

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Liquidity and Capital Resources

We consider the following to be measures of our liquidity and capital resources:

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[[/GREPCENT_TABLE]]

As of January 28, 2023, 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 senior secured asset-based revolving credit agreement (the "ABL Facility") or other available market instruments. On July 13, 2022, we entered into an amendment and restatement of the ABL Facility. Among other changes, the amendment and restatement extended the maturity of the ABL Facility to July 2027, increased the borrowing capacity, modified the reference rate from the London Interbank Offered Rate ("LIBOR") to the Secured Overnight Financing Rate ("SOFR"), and reduced the applicable interest rate margin. As of January 28, 2023, the Company's outstanding borrowing under the ABL Facility was $350 million. See Note 7 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for disclosures on the ABL Facility.

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, shipping costs, and payment of taxes. As our business typically follows a seasonal pattern, with sales peaking during the end-of-year holiday period, we fund inventory expenditures during normal and peak periods through cash flows from operating activities and available cash. Additionally, we have select seasonal product being stored at distribution centers for expected introduction into the market through fiscal 2023, which will impact inventory expenditures in future periods. The seasonality of our operations, in addition to the impact of global economic conditions such as the uncertainty surrounding global inflationary pressures, the COVID-19 pandemic, and the Russia-Ukraine crisis, may lead to significant fluctuations in certain asset and liability accounts as well as 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 28, 2023, 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 7 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 28, 2023, our purchase obligations and commitments were approximately $4 billion. The decrease compared with the purchase obligations and commitments as of January 29, 2022 is primarily due to reduced inventory orders as global supply chain challenges have improved in fiscal 2022, reducing the need to start the merchandise booking process earlier. We expect that the majority of these purchase obligations and commitments will be settled within one year.

Our contractual obligations related to income taxes are primarily related to unrecognized tax benefits. See Note 4 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.

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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, 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 decreased $202 million during fiscal 2022 compared with fiscal 2021, primarily due to the following:

Net income (loss)

•Net loss compared with net income in the prior year;

Non-cash item

•a decrease of $325 million due to a loss on extinguishment of debt during fiscal 2021;

Changes in operating assets and liabilities

•a decrease of $726 million related to accounts payable primarily due to the timing of payments for inventory during fiscal 2022 compared with fiscal 2021; and

•a decrease of $415 million related to accrued expenses and other current liabilities primarily due to a decrease in performance-based compensation for fiscal 2022 compared with fiscal 2021; partially offset by

•an increase of $1,147 million related to merchandise inventory primarily due to timing of receipts as a result of shipping delays and port congestion that occurred during fiscal 2021; and

•an increase of $502 million related to income taxes payable, net of receivables and other tax-related items, primarily due to receipt of tax refunds during fiscal 2022 related to fiscal 2020 net operating loss carryback claims.

Net cash provided by operating activities increased $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.

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Cash Flows from Investing Activities

Net cash used for investing activities during fiscal 2022 decreased $219 million compared with fiscal 2021, primarily due to the following:

•$458 million in net proceeds from sale of buildings during fiscal 2022; and

•$135 million in cash payments for acquisitions in fiscal 2021; partially offset by

•$409 million in net proceeds from available-for-sale securities during fiscal 2021.

In fiscal 2022, cash used for purchases of property and equipment was $685 million primarily related to information technology, store investments, and supply chain to support our omni and digital strategies.

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.

Cash Flows from Financing Activities

Net cash provided by financing activities was $6 million during fiscal 2022 compared with $1,471 million of cash used for financing activities during fiscal 2021, primarily due to the following:

•$2,546 million for payments related to the extinguishment of long-term debt during fiscal 2021; and

•$350 million in proceeds received from borrowing under the ABL Facility during the first quarter of fiscal 2022; partially offset by

•$1,500 million in proceeds received for the issuance of long-term debt during fiscal 2021.

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.

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.

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The following table reconciles free cash flow, a non-GAAP financial measure, from net cash provided by operating activities, a GAAP financial measure.

[[GREPCENT_TABLE]]
[["","","Fiscal Year"],["($ in millions)","","2022","","2021","","2020"],["Net cash provided by operating activities","","$","607","","","$","809","","","$","237"],["Less: Purchases of property and equipment","","(685)","","","(694)","","","(392)"],["Free cash flow","","$","(78)","","","$","115","","","$","(155)"]]
[[/GREPCENT_TABLE]]

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 7 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.

Dividend Policy

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

We paid an annual dividend of $0.60 per share in fiscal 2022 and $0.36 per share in fiscal 2021. We plan to pay a dividend of $0.15 per share in the first quarter of fiscal 2023.

Share Repurchases

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, global inflationary pressures, and other supply chain challenges worsen beyond what is currently estimated by management, our operating results could be affected.

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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.

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 8 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.

On a recurring basis, we assess the need for a valuation allowance related to our deferred income tax assets, which includes consideration of both positive and negative evidence to determine, based on the weight of the available evidence, whether it is more likely than not that some or all of our deferred tax assets will not be realized. In our assessment, we consider recent financial operating results, the scheduled expiration of our net operating losses, potential sources of taxable income, the reversal of existing taxable differences, taxable income in prior carryback years (if permitted under tax law), and tax planning strategies.

It is possible that there will be changes in our business structure, our performance, our industry or otherwise that cause results to differ materially in future periods. If the changes result in significant and sustained reductions in our pre-tax income or utilization of existing tax carryforwards in future periods, additional valuation allowances may be required with corresponding adverse impacts on results of operations. Such adverse impacts may be material.

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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 4 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.

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.