In this series of posts we are exploring examples of COVID-19’s impact on Form 10-Q disclosures for the first quarter of 2020.  This fourth post draws examples from Gap’s  Form 10-Q for their first quarter ended May 2, 2020.

Gap, as do many retailers, has a January fiscal year-end.  As a result, their first quarter 10-Q includes more of the period where COVID-19 is disrupting their business.

Gap’s financial statements present the facts surrounding the actions they have taken in response to COVID-19.  As you can see below, these disclosures are extensive.  They include information about store closings, impairments and financing transactions.

But Gap does not stop with disclosure of the facts.  In their MD&A they weave the facts into an overall picture of how they are dealing with COVID-19.  The MD&A disclosures are, as you would expect, also lengthy.  In this post,  you can review the financial statement disclosures first, and then read Gap’s MD&A summary and review how they relate to and complement each other.

To begin, Gap includes this lengthy overall summary of COVID-19 issues in the first note to their interim financial statements:

COVID-19

In March 2020, the World Health Organization declared the coronavirus disease (“COVID-19”) a global pandemic and recommended containment and mitigation measures worldwide. To date, COVID-19 has surfaced in nearly all regions around the world and resulted in restrictions and shutdowns implemented by national, state, and local authorities. As a result of the pandemic, we temporarily closed our North America retail stores and a significant number of our stores in Asia and Europe, causing a significant reduction in net sales in the first quarter of fiscal 2020. The Company also implemented several actions during the first quarter of fiscal 2020 to enhance liquidity and financial flexibility. These actions included the draw-down of the entire $500 million available on our revolving credit facility as defined in Note 3 of Notes to Condensed Consolidated Financial Statements, suspending share repurchases, and deferring the record and payment dates for our previously announced first quarter of fiscal 2020 dividend. In addition, on May 7, 2020, we announced new debt financing as described in Note 12 of Notes to Condensed Consolidated Financial Statements.

Beginning in April 2020, we suspended rent payments under the leases for our temporarily closed stores in North America. We considered the Financial Accounting Standards Board’s (“FASB”) recent guidance regarding lease modifications as a result of the effects of the COVID-19 pandemic and have elected to apply the temporary practical expedient to account for changes. We have recorded accruals for rent payment deferrals and accounted for deferred rental payments as though no changes to the lease contract were made.

During the thirteen weeks ended May 2, 2020, the Company recorded inventory related impairment costs of $235 million, primarily related to seasonal inventory that was stranded in stores when closures occurred or seasonal inventory in distribution centers that was planned for store sales. The costs also include impaired garment and fabric commitment costs for future seasonal product.

Additionally, on March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law in the United States. The CARES Act provides relief to U.S. Corporations through financial assistance programs and modifications to certain payroll and income tax provisions. The Company is considering certain beneficial provisions of the CARES Act, including the net operating loss carryback provision. See Note 7 of Notes to Condensed Consolidated Financial Statements for more information on the income taxes impact of the CARES Act.

The Company also considered the impact of COVID-19 on the assumptions and estimates used when preparing these quarterly financial statements including the impairment of long-lived store assets and operating lease assets, inventory valuation, income taxes, sales return allowance, and future compliance with debt covenants. These assumptions and estimates may change as the current situation evolves or new events occur, and additional information is obtained. If the economic conditions caused by COVID-19 worsen beyond what is currently estimated by management, such future changes may have an adverse impact on the Company’s results of operations, financial position, and liquidity. See the following Notes to the Condensed Consolidated Financial Statements for further detail of the impact of these assumptions and estimates.

GAP includes disclosures in various notes about specific COVID-19 issues, including this discussion of impairments in Note 4:

Nonfinancial Assets

Long-lived assets, which for us primarily consist of store assets and operating lease assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The asset group is defined as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of other groups of assets, which for our retail stores, is at the store level. 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, which is recorded in operating expenses on the Consolidated Statements of Operations. For operating lease assets, the Company determines the fair value of the assets by discounting the estimated market rental rates over the remaining term of the lease. These estimates can be affected by factors such as future store results, real estate demand, store closure plans, property specific discount rate and economic conditions that can be difficult to predict. These fair value measurements qualify as level 3 measurements in the fair value hierarchy.

The impact of the COVID-19 pandemic resulted in a qualitative indication of impairment related to our store long-lived assets. For store locations, we analyzed our store asset recoverability. During the thirteen weeks ended May 2, 2020, the Company recorded an impairment of store assets of $124 million, and impairment of operating lease assets of $360 million. The impairment of the store assets reduced the carrying amount of the applicable long-lived assets of $127 million to their fair value of $3 million. The impairment of the operating lease assets reduced the carrying amount of the applicable long-lived assets of $1,358 million to their fair value of $998 million. The impairment charges were recorded in operating expenses on the Condensed Consolidated Statement of Operations.

During the thirteen weeks ended May 4, 2019, there were no material impairment charges recorded for long-lived assets.

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

There were no impairment charges recorded for goodwill or other indefinite-lived intangible assets for the thirteen weeks ended May 2, 2020 or May 4, 2019.

Gap also included this disclosure in its Debt and Credit Facilities note:

We also had a $500 million, five-year, revolving credit facility, which was scheduled to expire in May 2023. On March 25, 2020, we drew down the entire amount under the revolving credit facility resulting in a total of $500 million outstanding as of May 2, 2020. The borrowings accrued interest at a base rate (typically LIBOR) plus a margin based on our long-term senior unsecured credit ratings and our leverage ratio. The draw-down proceeds were recorded in revolving credit facility on the Condensed Consolidated Balance Sheet. There were no material outstanding letters of credit under the revolving credit facility as of May 2, 2020.

On May 7, 2020, we completed the offering of $500 million aggregate principal amount of 8.375 percent Senior Secured Notes due 2023 (the “2023 Notes”), $750 million aggregate principal amount of 8.625 percent Senior Secured Notes due 2025 (the “2025 Notes”) and $1 billion aggregate principal amount of 8.875 percent Senior Secured Notes due 2027 (the “2027 Notes” and, with the 2023 Notes and the 2025 Notes, the “Notes”) in a private placement to qualified buyers. Concurrently with the issuance of the Notes, the Company amended the existing unsecured revolving credit facility with a third amended and restated senior secured asset-based revolving credit agreement (the “ABL Facility”). Additionally, on May 7, 2020, we repaid the $500 million that was outstanding under our existing unsecured revolving credit facility and did not borrow any funds under the ABL Facility. The amended ABL Facility has a $1.8675 billion borrowing capacity and includes revised financial covenant requirements. See Note 12 of Notes to Condensed Consolidated Financial Statements for further information regarding subsequent events.

To weave all these disclosures into a comprehensive story Gap included this summary in their MD&A:

OVERVIEW

Effective March 23, 2020, Sonia Syngal became the Company’s chief executive officer after previously serving as the president and chief executive officer of Old Navy Global. Also effective March 23, 2020, Katrina O’Connell became the Company’s executive vice president and chief financial officer.

In March 2020, the World Health Organization declared COVID-19 a global pandemic and recommended containment and mitigation measures worldwide. To date, COVID-19 has surfaced in nearly all regions around the world and resulted in restrictions and shutdowns implemented by national, state, and local authorities. As a result, during the quarter we temporarily closed our North America retail stores and a significant number of our stores in Asia and Europe, causing a significant reduction in net sales in the first quarter of fiscal 2020. However, our e-commerce business remains open and is supported by the employees in the distribution centers. We have also closed many of our corporate offices and other facilities, including our corporate headquarters in San Francisco, and have implemented a work-from-home policy for most of our corporate employees.

Beginning in May 2020, the Company started to reopen stores in select states and countries. When the Company reopened these stores it did so in accordance with local government guidelines. As of June 4, 2020, the Company has reopened more than 1,500 of its stores worldwide.

During the thirteen weeks ended May 2, 2020, the Company recorded an impairment of store assets of $124 million and operating lease assets of $360 million, primarily due to lower cash flows from stores and the reduced estimated fair value of real estate, particularly in mall locations, as a result of the COVID-19 pandemic. See Note 4 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q, for further information regarding impairments.

During the thirteen weeks ended May 2, 2020, the Company recorded inventory related impairment costs of $235 million, primarily related to seasonal inventory that was stranded in stores when closures occurred or seasonal inventory in distribution centers that was planned for store sales. The costs also include impaired garment and fabric commitment costs for future seasonal product.

In fiscal 2019, the Company announced plans to restructure the specialty fleet and revitalize the Gap brand, including closing about 230 Gap specialty stores during fiscal 2019 and fiscal 2020. The Company continues to believe that these actions will drive a healthier specialty fleet and will serve as a more appropriate foundation for brand revitalization. As a result of the COVID-19 pandemic in the first quarter, the Company shifted its focus towards adapting to the COVID-19 challenges and as a result the restructuring costs were not material in the first quarter of fiscal 2020. The Company will continue to evaluate its specialty fleet restructuring strategy as the impact of the COVID-19 pandemic on the business evolves through the remainder of the fiscal year.

We continue to face a period of uncertainty regarding the ongoing impact of the COVID-19 pandemic on both our projected customer demand and supply chain. During the first quarter, most of our Company-owned and franchise stores globally had to close due to COVID-19 mitigation efforts. During this challenging economic environment, we are focused on continuing to take the necessary steps to strengthen our financial flexibility in the face of the unprecedented and continuing impact of COVID-19. These measures include:

• the draw-down of the entire $500 million available under our revolving credit facility and new debt financing that closed subsequent to the first quarter of fiscal 2020;
• deferring the record and payment dates for our previously announced first quarter of fiscal 2020 dividend, and suspending our regular quarterly cash dividend for the remainder of fiscal 2020;
• suspending stock repurchases for the remainder of fiscal 2020;
• reducing planned capital expenditures in fiscal 2020;
• reviewing all operating expenses for opportunities to reduce spending;
• realigning inventory to expected sales trends based upon estimated timing of stores reopening;
• furloughing the majority of our store teams in North America for the period stores were closed;
• reducing headcount across our corporate functions which resulted in approximately $35 million of severance related costs during the first quarter of fiscal 2020;
• temporarily reducing pay for the entire Gap Inc. leadership team along with the Board of Directors; and
• suspending rent payments for our stores that have been closed in North America due to the COVID-19 pandemic.

In addition, we continue to be focused on the following strategic priorities:

• offering product that is consistently brand-appropriate and on-trend with high customer acceptance and appropriate value perception;
• growing and operating our global e-commerce business;
• restructuring the Gap brand, with emphasis on the specialty fleet globally, to create a healthier business;
• attracting and retaining strong talent in our businesses and functions;
• increasing the focus on improving operational discipline and efficiency by streamlining operations and processes throughout the organization and leveraging our scale;
• managing inventory to support a healthy merchandise margin; and
• continuing to integrate social and environmental sustainability into business practices to support long-term growth.

As previously noted, COVID-19 was officially declared a global pandemic by the World Health Organization in March 2020. We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, the Company cannot reasonably estimate the impacts of COVID-19 on our results of operations, cash flows and liquidity in the future.

Additionally, on May 7, 2020, the Company closed the offering of the Notes for $2.25 billion. We also entered into the ABL Facility, with an initial aggregate principal amount of up to $1.8675 billion. Proceeds from the sale of the Notes were used to redeem our 2021 Notes. We also repaid the $500 million that was outstanding under our existing unsecured revolving credit facility and did not borrow any funds under the ABL Facility. Refer to the “Liquidity and Capital Resources” section for further discussion.

Gap presents a significant amount of information in both the financial statements and MD&A.  Lastly, as you can see in the second from the last paragraph in their MD&A overview, Gap is very forthright about the uncertainty if faces surrounding COVID-19.

As always, your thoughts and comments are welcome!