The Gap, Inc. (NYSE:GPS) Q4 2022 Earnings Call Transcript

The Gap, Inc. (NYSE:GPS) Q4 2022 Earnings Call Transcript March 9, 2023

Operator: Good afternoon, ladies and gentlemen. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to the Gap Inc. Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. I would now like to introduce your host, Cammeron McLaughlin, Head of Investor Relations.

Cammeron McLaughlin: Good afternoon everyone. Welcome to Gap Inc.’s fourth quarter fiscal 2022 earnings conference call. Before we begin, I’d like to remind you that information made available on this webcast and conference call contains forward-looking statements that are subject to risks that could cause our actual results to be materially different. For information on factors that could cause our actual results to differ materially from any forward-looking statements, as well as the description and reconciliation of any financial measures, not consistent with Generally Accepted Accounting Principles, please refer to the cautionary statements contained in our latest earnings release; the information included on page two, of the slides shown on the Investors section of our website, gapinc.com, which supplement today’s remarks; the risk factors described in the company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15th, 2022 and any subsequent filings with the Securities and Exchange Commission, all of which are available on gapinc.com.

These forward-looking statements are based on information as of today, March 9th, 2023 and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Interim Chief Executive Officer, Bobby Martin; and Chief Financial Officer, Katrina O’Connell; and Old Navy Chief Executive Officer, Haio Barbeito With that, I’ll turn the call over to Bobby.

Bobby Martin: Thank you, Cammeron, and good afternoon, everyone. When I first spoke with you in August of last year, we discussed the need and bias for action. In that time, we moved quickly and effectively at clearing excess inventory improving assortment balance, particularly at Old Navy, while removing costs across our business and improving our balance sheet and as a result, we entered fiscal 2023 in a more competitive position. In parallel, we’ve wasted no time in shoring up the foundation of our company to get back to a place where we are delivering what our customers, employees, and shareholders expect. In my time as interim CEO, I’ve spent many hours listening to our people across every area of the business, especially those closest to our customers.

What I have found is incredible talent and creative muscle that has been varied, dampened by a complicated organizational structure, bureaucracy, and outdated processes. That’s why we are hard at work to remove barriers, simplify how we work, and empower our teams to embrace and drive change that will enable the future for Gap Inc. really is a healthier company at its core. I will share more on this in a moment. But before I do that, I’m sure you are all looking for an update on our search for Gap Inc.’s permanent Chief Executive Officer. The Board has narrowed its search, and we are getting close to naming a new CEO. The Board and I remain determined to land the right leader. An external candidate, one with an unwavering commitment to leading brands with a point of view, delivering relevant products and experiences for our customers and above all, a strong leader who sets the right tone, one with heightened accountability and operating rigor.

Final candidates have been provided appropriate insight to the work underway and are aligned on our approach. We believe this will enable the next CEO to have a quicker ramp, and I will remain a dedicated support through the transition. In our pursuit to become fit for the future, today we announced a simplified leadership and operating structure to further optimize cost and organizational effectiveness while enabling a return to the cultural relevance and creative focus that has always been the heartbeat of Gap Inc. We are flattening the organization by increasing spans of control and decreasing management layers to improve the quality and speed of decision-making, starting with our leadership team. Each of our brands now have consistent leadership structures focused on delivering excellence for our customers by elevating design and brand creative, focusing on merchandising end-to-end and providing better oversight to the customer experience across all markets and channels.

We estimate that these actions will result in $300 million of annualized savings, of which roughly half is expected to be realized in fiscal 2023. Over the past six months, we’ve identified $550 million of annualized savings, and these actions are just the first steps in an ongoing plan to drive meaningful change in our operating model and continue to drive financial gains. With the right organizational structure and foundation in place, we are assessing our go-forward plans to rationalize our technology investments and to further optimize our marketing, so that brand messaging is closely integrated from product, creation to customer. As a result of our new operating structure, we will be eliminating the role of Chief Growth Officer, held by Asheesh Saksena.

Equally important to simplifying how we work is ensuring that we have the right talent in the right roles to drive long-term results. We believe Athleta has incredible potential, but has suffered product acceptance issues over several quarters now. As we look to seize the potential and remain competitive amidst the dynamic landscape, we believe now is the right time to bring in a new leader who can position Athleta for long-term success. With that, Mary Beth Laughton will be leaving her role as President of Athleta. I will lean in, while we search for a new leader supported by a strong leadership team inside Athleta, who will continue to drive the business in the interim. Additionally, we just hired a new Head of Brand Creative, who is scheduled to join in May, known for bringing vision, voice and a clear point of view to brands of all sizes.

We are eager to have her join the Athleta team. I would not miss taking this opportunity in a moment to express my gratitude to Asheesh and Mary Beth for all their many contributions to Gap Inc. during their tenures. Okay. Let’s pivot to performance across brands. We made great progress across brands to rebalance and reduce inventory, ending the year with inventories 21% below the prior year. As I hope you would expect, I am really pleased with the progress the teams have made to start the year clean and we anticipate sales and inventory growth to be much more closely aligned as we progress through fiscal 2023. Gap brand exited fiscal 2022 in a better position than it entered the year with the women’s business rebounding, thanks to cleaner inventory and product that is much more relevant.

The brand has already begun to reinstate its responsive capabilities, which will continue to enable them to further chase into the categories consumers are looking for. And I hope you have gotten a chance to see Gap brand’s most recent collaboration with Brooklyn Circus. It’s truly an example of how product partnerships can work when vision and values align. On the full year, Banana Republic delivered market share gains as its elevated brand positioning and strong expression of occasion and workwear resonated with consumers. As some holiday misses dampened the quarter’s overall results. We remain confident in the long-term strategy for Banana Republic and know that it takes time to transform a brand and build strong relevance. As we look to fiscal 2023, we are expecting more moderated growth at BR relative to fiscal 2022 as consumer preferences rebalance post-COVID.

On Athleta, we know that the brand can and will do better. It’s foundational brand health is intact and its power of sheet positioning continues to resonate. But at the end of the day, it all comes down to product. Core bottom silhouettes continue to perform true to Athleta’s performance DNA and remain stable in our customers’ wardrobe. However, print and color misses are examples of where we are not meeting her expectations fully. And finally, Old Navy was a key driver of our inventory improvement in the quarter. And again, I’m really proud of the work this team is doing to improve execution and consistency of results. Katrina will share more with you on specifics around brand performance, but where I wanted to take a little more time today and spend with you is talking about Old Navy.

As you know, Haio Barbeito joined us in August of the last year, bringing an authentic leadership style, backed by a strong track record of delivering results through challenging times. I’ve asked him to join us today to share his observations since joining Old Navy and how he is approaching bringing the brand back to winning again. So I gladly present to you Haio Barbeito. Haio?

Haio Barbeito: Thank you, Bobby. It is nice to speak to all of you today. Old Navy has always been around that delivers on the idea that great quality fashion and an unbelievable prices where we delightful experience should be accessible to everyone. This was true differentiator in the apparel industry when Old Navy reached $1 billion in sales in just four years. And it still rings true today as Old Navy maintains its position as one of the largest apparel brands in the US, delivering not only sales in excess of 8 billion, but also serving more than 45 million customers and nearly 50,000 associates globally. And I am confident that our unique customer value proposition is well suited for an environment where consumers are increasingly seeking value.

I am pleased to report that Old Navy has delivered significant improvements in performance relative to the first half of the year. But in order to unleash Old Navy’s full potential long-term and further amplify its market leadership, we have spent considerable time focusing on stabilizing the core and elevating execution across our entire organization. Let me provide some more specifics on where we have been focused. First, we took decisive action to rightsize the historic high levels of inventory in the second half of fiscal 2022, which had arisen from the supply chain disruptions and also some execution issues that impacted Old Navy in late 2021 and early 2022. At the end of the fiscal 2022, liable inventory for Old Navy store hit one of the lowest levels in brand’s history, abate at expensive margin, which made room for newness and seasonally the right assortment that you can see these days across our fleet and online.

And it’s now making it even easier for our customers to find and discover the product they are looking. Second, we improved balance and relevance in the assortment, pivoting from narrow end use over dialed a little bit on comfort to a more versatile occasion-based assortment in response to our customers’ need for return to routine. This has resulted in improvement in our performance as we exit fiscal 2022. After losing share in the first half of fiscal 2022, all maybe maintain share in the second half of the year, primarily driven by market share gains in women’s. We are pleased to report that Old Navy’s women’s business showed positive momentum in the fourth quarter, which is a significant improvement and very important for the health of our brand.

This was offset by weakness in kids and baby as noted by many others in the industry. But the good news is that, we renewed assortment in the new kids and baby flow, we’re seeing early improvement in sales trend. Third, with our now leaner inventory position and balanced assortment, we have been focused on getting our responsive capabilities back in order to buy more efficiently and remain dynamic and flexible to chase into demand or pivot, if the consumer needs shift. And finally, we have been focusing on execution discipline. We have been deep in the work of identifying areas of opportunities for organizational efficiency, in order to streamline processes and elevate execution and experience for our customers. In our efforts to elevate execution, Old Navy’s store leadership rolled out a comprehensive operational excellence plan, elevate operating standards, optimizing associate coverage and overall omni-customer experience.

As a result, we are experiencing consistent improvement in Old Navy stores NPS that we expect to cement going forward. Now with a more solid foundation from which to build, I can focus my attention towards the long term and defining the future of Old Navy. One that is rooted in overall Old Navy has always been known for offering style, fit, quality and cultural relevance at a great value, but with an even sharper focus on how we can better serve our customers today and very importantly, to win with the omni customer of tomorrow. This forward-looking work is just kicking off, and I look forward to speaking to you more about it, once it is complete. With that, I will turn the call back to Bobby.

Bobby Martin: All right. Thanks, Haio and thanks again for the great leadership you’re providing. To wrap up, let me take you back to where I began. We are in the midst of transformative change. We are on a journey to build a healthier Gap, Inc. at its core, and the actions we shared today are just the beginning. Again, I believe we have taken the right short-term actions to boost performance at Old Navy, clear excess inventory, removed cost from the business and improve our balance sheet, which is allowing us to begin the year in a much stronger position. The true payback will be far greater than the cost savings we’ve discussed. The payback will come when we show up as a more informed, faster and more creative company, delivering brand and cultural relevance to our customer.

I have found great talent across the company, great creative talent. And I’m confident that they are ready to embrace change, unlock value and strengthen our core capabilities and the talent waiting in the wings is more than capable of becoming the future leaders of our company. As I hand the reins over to a new permanent CEO for Gap Inc. in the near future. I am confident that the work our team is doing now to restructure for €“ the long term will enable them to join a healthier organization on day 1, an organization ready to pursue creative excellence and to deliver for our customers, our people and our shareholders. And with that, I will turn the call now over to Katrina. Katrina?

Katrina O’Connell: Thank you, Bobby, and thanks, everyone, for joining us this afternoon. We moved swiftly in fiscal 2022 to manage the levers in our control and took action to drive immediate and long-term improvements across our business during what proved to be a challenging year. Most notably, we significantly reduced excess inventory, exceeding our year-end goal and driving merchandise inventories down 21% versus the prior year. We improved category, size and assortment balance at Old Navy, which helped drive an improvement in total company trends in the second half of the year, resulting in second half sales down 2% year-over-year, compared to down 11% in the first half. We aggressively managed costs, identifying $550 million in annualized savings with a significant majority expected to impact fiscal 2023 earnings and we further fortified our balance sheet, ending with $1.2 billion of cash, an increase of almost 40% from last year.

While we are better positioned as we enter fiscal 2023, we continue to take a prudent approach to planning and managing our business in light of the continued uncertain consumer and macro environment. Let me turn to our fourth quarter results.Net sales decreased 6% to $4.24 billion or 5% on a constant currency basis and in line with our expectations of mid-single-digit declines for the quarter. Compared to pre-pandemic levels in 2019, sales in the fourth quarter were down 9%, driven by the closure of more than 300 nonproductive Gap and Banana Republic stores, the transition to international partnerships and the divestitures of Janie and Jack and Intermix since 2019. Absent closures and divestitures, fourth quarter net sales would be flat compared to 2019.

Comparable sales in the fourth quarter were down 5% on top of a positive 3% comp last year. Comp trend in the second half of fiscal 2022 has improved meaningfully as compared to the first half of the year, primarily as a result of our assortment rebalancing efforts at Old Navy and Gap. Store sales decreased 3% from the prior year, a trend improvement as consumers appeared to be shifting back to in-store shopping. Online sales were down 10% from last year and represented 41% of total sales in the quarter. Compared to 2019, online sales are up 29%. Turning to sales by brand. Starting with Old Navy, sales in the fourth quarter of $2.2 billion were down 6% versus last year and down 4% relative to 2019. Old Navy comparable sales were down 7%, driven by weakness in kids and baby, offset by strength in women’s.

As discussed last quarter, we believe that Old Navy pulled forward some sales from the fourth quarter to October as a result of its efforts to get out earlier than typical with its first holiday promotional event, which impacted growth in the fourth quarter. In addition, we believe that Old Navy continues to experience demand softness from its lower income consumers. After losing share in the first half of the year, Old Navy maintained share in the second half of the year, driven by market share gains in women’s. As we look to fiscal 2023, we believe that Old Navy remains well-positioned given its value positioning in the marketplace. Gap brand total sales of $1.1 billion were down 9% versus last year. Gap global comparable sales were down 4% and outpaced North America comparable sales as a result of lapping the outsized negative impact of COVID-related restrictions last year in Asia.

Gap North America comparable sales were down 5%. The shutdown of Yeezy Gap negatively impacted growth in North America by approximately 2 points. Gap brand experienced continued weakness in the kids and baby and active categories during the quarter, which was offset by strength in women’s. Gap brand maintained share in the second half of the year after losing share in the first half, driven by share gains in women’s. While Banana Republic delivered comparable sales growth of 9% and gained market share in fiscal 2022 as the brand continued to capitalize on the shift in consumer preference and its relaunch and elevated positioning of the brand last year, fourth quarter results were below our expectations. In the fourth quarter, Banana Republic sales were down 6% to $578 million, with comparable sales down 3%.

We believe Banana Republic had some holiday product misses, including over-assorted sweaters and outerwear and a gifting assortment that didn’t resonate with the consumer. While dresses and suiting drove comp growth in the quarter, we do remain mindful of the fact that BR has been a beneficiary of the shift in consumer preferences to occasion and work-based categories, as people go back to work and events post COVID. Athleta sales of $436 million were down 1%, however, up 51% compared to 2019 pre-pandemic levels. Comparable sales were down 5%. We expect the brand to be delivering market share gains. We acknowledge that there have been broader product misses at Athleta. While the team is focused on course correcting, this could continue to impact growth in the near term.

That being said, we’re confident that the brand will get back to driving growth and profitability over the long term. Now, to gross margin in fourth quarter. Gross margin in fourth quarter decreased 10 basis points to 33.6%. Merchandise margin increased 20 basis points, driven by 540 basis points of leverage, as we lapped last year’s elevated air freight expense, offset by approximately 200 basis points of deleverage due to continued inflationary cost headwinds. The remaining 320 basis points of deleverage was primarily driven by discounting, resulting from our efforts to better position and clear excess inventory. ROD as a percentage of net sales deleveraged 30 basis points versus last year. Now let me turn to SG&A. As you know, during the third quarter of fiscal 2022, we acted on approximately $250 million in annualized savings, stemming from the reduction of corporate roles, the renegotiation of advertising agency contracts and the reduction of technology operating costs and rationalization of digital investments.

SG&A in the fourth quarter was $1.45 billion, a decrease of 4% relative to last year. This decrease was driven by savings related to these cost actions, offset by higher seasonal labor costs. As a percentage of total sales, SG&A deleveraged 80 basis points from the prior year, as a result of the lower sales volume in the quarter. Fourth quarter net income was a loss of $273 million, primarily as a result of $230 million of tax expense related to quarterly earnings variability. EPS was a loss of $0.75. Share count ended at $366 million. Turning to fiscal 2022 results. Fiscal 2022 net sales of $15.6 billion are down 6% compared to last year, including a 1 point foreign exchange headwind. Compared to 2019, net sales in fiscal 2022 were down 5%.

As a reminder, we have removed close to $1.5 billion of unproductive sales since 2019 and as a result of our North America fleet rationalization, divestitures and transition to international partnerships, which represents nearly 10 points of growth versus 2019. Adjusted operating margin was 0% in fiscal 2022, down 550 basis points from last year, driven by 480 basis points of gross margin deleverage and 80 basis points of SG&A deleverage. Fiscal 2022 adjusted gross margin was 35% versus 39.8% in fiscal 2021. Merchandise margin was down 430 basis points driven by 50 basis points of air freight leverage, approximately 200 basis points of deleverage due to inflationary headwinds, and the remaining 280 basis points of deleverage, primarily from higher discounting versus last year.

ROD as a percentage of net sales deleveraged 50 basis points versus last year. Adjusted SG&A of $5.48 billion in fiscal 2022 is down 4% from last year, driven by lower incentive compensation and lower marketing spend. Now turning to balance sheet and cash flow, starting with inventory. As discussed, we made progress rightsizing inventory and exceeded our goal of inventory levels below last year by the end of fiscal 2022, and primarily driven by significant improvements at Old Navy. The 21% decline in ending inventories includes a 17 percentage point benefit related to in-transit as we lapped last year’s supply chain challenges and two percentage points of growth related to pack and hold. The remaining decline is primarily driven by a decrease in fashion inventory.

As we look to fiscal 2023, we continue to moderate buys and will further lean into our responsive levers throughout the year, which will provide flexibility to better align inventory levels with demand trends. We are planning for inventory to be down more than sales in fiscal 2023 as compared to the prior. In addition, we will continue to integrate the inventory that was placed in pack and hold in fiscal 2022 into future assortments. This will benefit working capital as we buy lower receipts and sell through the pack and hold inventory. We ended fiscal 2022 with cash and cash equivalents of $1.2 billion, an increase of 39% from last year. Net cash from operating activities in fiscal 2022 was $607 million as a result of our progress on improving inventory levels and composition coupled with our receipt cuts and leaner buys.

Capital expenditures were $685 million, slightly above our expectations, largely as a result of timing. Free cash flow was an outflow of $78 million and should begin to normalize throughout fiscal 2023. As we look to fiscal 2023, we expect to be positioned to pay down the $350 million draw on our asset-backed line of credit later this year. We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns. During the quarter, we paid a dividend of $0.15 per share and on March 2nd, our Board approved maintaining that $0.15 dividend for the first quarter of fiscal 2023. We completed our goal of offsetting dilution in fiscal 2022, repurchasing 10.6 million shares at an average price of about $12 per share.

We anticipate very modest dilution in fiscal 2023 and therefore, do not anticipate meaningful share repurchase activity. We continue to have $476 million available under our current share repurchase program authorization. Now, turning to our outlook. We continue to take a prudent approach to planning in light of the continued uncertain consumer and macro environment. Starting with Q1, let me first provide an overview of factors impacting year-over-year sales comparisons in the first quarter. The sale of Gap China to Baozun was completed in the beginning of the quarter. Gap China represented approximately $60 million of sales last year in Q1, representing a two-point headwind to Gap, Inc. for the quarter. These sales need to be adjusted out of current Gap brand and Gap, Inc.

sales assumptions. We are assuming a continued one-point foreign exchange headwind in the first quarter. While quarter-to-date, first quarter net sales are trending better than the fourth quarter. It’s important to note that we have yet to reach the important March, April shopping period, which will be a significant volume period in the quarter. As I stated earlier, we also remain mindful of the uncertain consumer environment and are planning for sales to be down in the mid-single-digit range year-over-year for the quarter. As it relates to first quarter gross margin, we expect significant year-over-year improvement compared to the 31.5% gross margin in the first quarter last year. This will be driven by approximately 550 basis points of leverage as we lap last year’s elevated air freight.

Approximately 360 basis points of deleverage due to inflationary cost headwinds as we are now selling product locked in at last year’s peak cotton prices. These inflationary headwinds are expected to moderate and become a tailwind in the back half of the year. At least half of this 360 basis point inflationary headwind is expected to be offset by less discounting and promotional activity, particularly at Old Navy. And ROD is expected to be roughly flat as a percentage of sales. We are planning to manage SG&A of approximately $1.2 billion in the first quarter largely reflecting the continued benefit of last year’s savings actions, offset by higher incentive compensation. Now turning to full year 2023. Starting with factors impacting year-over-year comparisons, Gap China represented approximately $300 million in net sales last year, representing a two-point headwind to Gap Inc.

in fiscal 2023. These sales need to be adjusted out of current Gap brand and Gap Inc. sales assumptions. Fiscal 2023 will have a 53rd week, estimated to add approximately $150 million to net sales or one-point of growth. Assuming a continuation of current trends, and taking a prudent approach in light of the continued uncertain environment, we believe fiscal 2023 net sales could be down in the low to mid-single-digit range. And as stated earlier, we are planning for inventory to be down more than sales in fiscal 2023. Turning to gross margin. We expect to make progress towards getting back to pre-pandemic gross margins compared to the 35% adjusted gross margin in fiscal 2022, gross margin in fiscal 2023 is expected to be driven by approximately 200 basis points of leverage as we lap last year’s elevated air freight.

This will only be a tailwind in the first half of the year as airfreight expense normalized in the back half of fiscal 2022. Approximately 100 basis points of deleverage versus last year due to inflationary cost headwinds. This is driven by approximately 300 basis points of deleverage in the first half of the year, shifting to a tailwind of approximately 100 basis points of leverage in the back half as we benefit from improved product costs and freight rates. We believe the 100 basis points of inflationary headwind for the year could be more than fully offset as a result of our better inventory position and more normalized promotional activity relative to last year. And ROD is planned to be roughly flat as a percentage of sales compared to last year.

We are targeting fiscal 2023 SG&A to be down low to mid single digits from the prior year or approximately $5.2 billion. We are planning for higher incentive compensation and wage inflation in fiscal 2023, which we expect will be fully offset by the cost savings initiatives implemented in fiscal 2022. In addition, we expect to realize roughly half of the $300 million in annualized savings that Bobby spoke to earlier in the back half of fiscal 2023. These savings will incur severance and other related costs, which will be adjusted out of fiscal 2023 reported operating and net income. We are planning capital expenditures in the range of $500 million to $550 million, largely reflecting lower technology project investments as well as fewer store openings.

This year, we’re planning to open 30 to 35 Old Navy and Athleta stores in total and plan to close 50 to 55 Gap and Banana Republic stores. We remain on track to achieve our goal of closing 350 non-strategic Gap and Banana Republic stores in North America by the end of 2023 and ended fiscal 2022 having achieved close to 90% of that goal. So in closing, during what proved to be a challenging year, we moved swiftly to manage the levers in our control. We significantly reduced inventory, improved category size and assortment balance at Old Navy, aggressively manage costs, including identifying $550 million in annualized savings to-date and fortified our balance sheet. While we remain mindful of the continued uncertain consumer and macro environment, we are confident in the actions we’re taking and believe we’re taking the right steps to position Gap, Inc.

back on its path towards sustainable, profitable growth and delivering value for our shareholders over the long-term. With that, we’ll open the line for questions. Operator?

Q&A Session

Operator: Thank you. Our first question will come from the line of Brooke Roach with Goldman Sachs.

Brooke Roach: Good afternoon. Thank you so much for taking the question. My question is on Old Navy. Based on the improvements that you’ve made to the brand to-date, what do you see as a reasonable time line to returning to consistent positive comparable sales growth for the brand? And maybe as a follow-up for Katrina, along those lines, can you help contextualize the outlook for 1Q sales down mid single digits, I guess that commentary of Old Navy product improvement as you cycle some of the assortment issues from last year. How was the Old Navy brand been comping quarter-to-date? Thank you.

Katrina O’Connell: Haio, do you want to go ahead and start a little bit with your view, and then I can jump in.

Haio Barbeito: Yes. I think on the green shoots, we’re seeing maybe women’s strength, the inventory cleanup, as we said in the prepared remarks, some of the green shoots we’re seeing in NPS scores in the stores are giving us confidence that even though we don’t call it a trend, but we are in the right direction, addressing some fundamentals of the business.

Katrina O’Connell: And I think, Brooke, the way I would think about the quarter is, we did say that Q1, we expect revenues to be down mid singles. We gave some context around how China and foreign exchange are headwinds of about three points when taken together. And then really, the balance is the current trend and some macro conservatism potentially, but maybe it’s really more uncertainty about sort of how the consumer will play out through the important March, April timeframe, which we know is spring break and Easter. As far as by brand, I’m not going to give you the quarter to date trend by brand, but our commentary, I think, would talk to the fact that we’re mindful of the fact that Athleta has some maybe product acceptance issues that might meet their performance in the near term, and that we’re carefully watching the Banana Republic consumer for whether or not they are moderating a little bit in their work wear and sort of how to think about that.

So it’s fair to say that Banana and Athleta are sort of more muted in the near term based on what we’re seeing with momentum building at Old Navy. But again, I want to be clear, — it’s good to see the trend, but March and April are really important for that brand in particular as we head into spring break and Easter.

Brooke Roach: Thank you so much. I’ll pass it on.

Operator: Your next question comes from the line of Bob Drbul with Guggenheim Securities.

Bob Drbul: Hi. Good afternoon. I guess, just if I could stick with the Old Navy question, Haio when you think about the environment that’s out there, just in terms of pricing and the competitive positioning, how do you feel like you guys are positioned to capitalize on the environment today around the prices and the promotional cadence that you’ve seen? And if I could just ask a question on Old Navy €“ I’m sorry, in Athleta as well. Bobby, when you think about where Athleta is today, when you look at the leadership or the search for the leadership, can you just talk about exactly what you think does need to be repositioned around the brand overall as you look forward? Thanks.

Haio Barbeito: Thank you for the question. I think on the importance of starting this year, cleaner in inventories giving room to newness, a little bit of scarcity some novelty and work forward. So we foresee a lower level of promotional aggressiveness. We may see intensity, but not aggressiveness. And I think when you see the initial product acceptance around spring, for example, is a good indication that we’re having a healthy balance. And that was something that we wanted to remove from last year as we were having big areas of clearance and some product challenges. So we’re monitoring very, very close after the big effort of reducing the inventory to current levels.

Bobby Martin: Bob, this is Bobby. On Athleta, just to address your question. I think we really double underlined it in my remarks, and I said, it all comes down to product. And I think the acceptance issues that, we’ve seen from customers is really where I think we’ve not really hit the right stride with them in performance. We’ve lost a little bit of the franchise really around our basics in that area and where clearly, we always have to be on top of it, whether it’s color or style or whatever. We just had too many misses in there. And right now, we’re plagued with some execution issues, I would say, around BIP. Those things have really kind of dampened, I think, the recovery as we have moved back towards performance. There’s strong points in the assortment.

So I don’t want to miss that. I mean, today, low and bottoms, knit bottoms are performing pretty well. Everything in our basic assortments, jumpsuits right now are trending well. And we’ve hit some of those items, but the consistency of performance against our customer who she is, the style that she’s looking for; we are just not on target yet. So it really comes around to, I think, getting that design, that styling right and get it where it’s delivered to her in an experience that she’s looking for.

Bob Drbul: Thank you.

Operator: Your next question will come from the line of Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson: Thank you. I wanted to hear a little bit more about the inventory planning for this year. It sounds like you’re able to return to using responsive capabilities. And I was just curious what percentage of the assortment does that apply to at Old Navy? And then are you able to use that in your other brands as well?

Katrina O’Connell: Lorraine, maybe I’ll start off. Just talking a little bit again about some of the numbers and what the commentary today was, and then I’ll let Haio talk maybe more conceptually about how they’re leveraging responses. We are really, really pleased that we use the opportunities in fourth quarter to clear albeit at lower margins, the markdown inventory that has plagued us through the last three quarters to start off this year, which what we would consider to be well-positioned liability inventory heading into the quarter. So we’re happy to have achieved that. I think that not only gives us the opportunity to pull back on the discounting and markdowns, but it really gives us the opportunity to have room to bring in newness through these responsive capabilities.

And that’s an important thing, we did not have enough newness in fourth quarter, which really muted some of the performance because we had so much markdown carryover that we had to get through. So this gives us the opportunity to showcase our new products and then also bring in new products as we see things trending. So we feel like we’ve got a lot more breathing room. As we look forward, we will not only have lower initial buys, but we will be chasing into trends. And so this should give us, again, a much better stock-to-sales ratio as we move forward and we expect that overall inventory will be lower than sales, as we said. So with that, we’ve not quantified how much response is, but it’s in the form of chase, it’s in the form of vendor-managed inventory, which allows us to reflow in-stock levels and then some reorder capabilities, all of which should give us opportunities.

I don’t know, Haio, if he wants to talk?

Haio Barbeito: I think, it’s well said, with supply chain being less disruptive and variability coming to normal levels. I think responsiveness is not going to be — the main focus is a contingency mechanism and we want to get it right in the in our assortment, and that’s where the focus is. But the supply chain stability will really help us on leveraging our strength.

Lorraine Hutchinson: Thank you.

Operator: Your next question comes from the line of Alex Straton with Morgan Stanley.

Alex Straton: Great. Thanks so much for taking the question. I wanted to just drill down those $550 million in annualized savings you all were speaking about on the call. I just want to understand, what is the base that this is off of? And then can you also help us understand what’s offsetting it with that severance piece? Do you get a sense for like the net savings you’re speaking to? And any color you can give us in terms of like the breakdown of that $550 million, like what the buckets are there, that are comprising it? Thanks so much.

Katrina O’Connell: Hi, Alex, this is Katrina. So we did say that we expect full year 2023 SG&A to be about $5.2 billion. So hopefully, that helps you with the number we’re aiming for. How we get there is — we did talk last year about $250 million of annualized savings. That broke out into three buckets. It was $125 million of headcount that was really early actions on closing open roles and really tightening our belt immediately as we realize that the cost structure was just too high. We had $75 million of marketing expense that we were able to pull back on based on contract negotiations and about $50 million of savings that was really tech. And again, that was primarily headcount. So all of those actions we nodded to last year, and those will largely be annualized in the base of 2023.

Now, we did say that, that’s almost fully offset by the bonus reset, as we didn’t pay management incentives last year, as well as some inflationary pressure. So I would think of those two as largely offsetting. And then the new news is that, we’ve now identified $300 million of incremental savings, that is related to some of the management changes we talked about today, but also a broader reorganization that we are embarking on to really unlock the potential of the company. That will hit partially this year, because we’ve announced it today. And as you can imagine, we’re embarking on the work. And that will probably get done in order to benefit the back half of the year, but then that will also anniversary into next year.

Alex Straton: Great. Thanks so much.

Operator: Your next question comes from the line of Dana Telsey with Telsey Group.

Dana Telsey: Hi. Good afternoon, everyone. As you think about the cost structure and the opportunity where you mentioned rationalized technology investments, optimized marketing, what are we talking about there? How big of a benefit could that be? And what do you see about the operational go forward from there? And then, just on the real estate portion of the business, what are you seeing in terms of shrinkage? How is that looking? And the investment and what we’re all hearing about higher crime and shrinkage, things like that? How are you thinking of that? And does it at all influence the cadence of store openings or closings? Thank you.

Katrina O’Connell: Yes. Thanks, Dana. So on the cost restructuring we agree that we have more to do on costs than what we’ve announced today. So we’re really happy that we’ve identified the $550 million. What we’d like to do is, get through this fairly large organizational change and then, from there, have the operating leaders in place and the operating model in place to really evaluate the next levers, which you just identified, marketing and technology to see the right level of where those will land. So more to come, but we agree there is more in the cost structure of the company that needs to get unlocked. And as we identify that, we’ll let you know. On the shrink side of things, we’re hearing that, too, and we’ve certainly been watching what competitors have said.

We’re sort of in the middle of our current full annual shrink. And so far, we don’t have anything to preview that would indicate that there’s anything materially changing. But certainly, if we see something, we’ll absolutely report it out. But right now, we’re not seeing that trend at capping.

Dana Telsey: And just lastly, what’s your overall view on the health of the consumer? How is it different now than maybe going into the fourth quarter? And is it different by brand of what you’re seeing from the income level status that you spread to? Thank you.

Katrina O’Connell: Sure. I mean I’m happy to take that. And then certainly, as Bobby and Haio want to jump in. When we look at the data, we still see that the lowest income consumer is impacted. Now, what we see is that, that took a pretty big leg down in the middle of last year, but it stayed about where it is now as we move through Q4 and again, that primarily impacts Old Navy and then some of our outlet consumers. We’ve seen a little softening throughout the rest of the consumer base, but nothing material. I think, Dana, we’re just watching the news and the economic levers that everyone else is and trying to be prudent about whether or not we will see weakness once the savings that are still accumulated start to spend down. But I think beyond that, I don’t know, if Bobby or Haio if there’s anything else you’d add.

Bobby Martin: No, I think — I mean, again, it’s really it’s only too speculative to really point to very much. It is interesting as I know you’re hearing from others. You see signs of customers going back to store. That’s an interesting trend to watch. We obviously are tracking units per transaction on visits to really just kind of judge that. But it’s certainly, I’d say, a cautious outlook to stay on top of, and Old Navy, probably we would have our better read what we’re seeing there as you may comment.

Haio Barbeito: Yes, acknowledging that there is — the outlook is somewhat concerning the state of the consumer, but nothing to call out specifically other than to say that our value proposition position us well for whatever may come our way. So, as I mentioned, there are some things that depend on us to be a better Old Navy despite of the context.

Dana Telsey: Thank you.

Operator: Your next question will come from the line of Matthew Boss with JPMorgan.

Matthew Boss: Great. Thanks. So, Katrina, on the topline, could you just help bridge the drivers embedded between the mid-single-digit decline in 1Q and the low to mid-single-digit decline for the year? And then at Old Navy, just the confidence on peeling back some of the promotional activity despite the demand softness that you cited from the lower-income consumer at the concept over holiday would be helpful.

Katrina O’Connell: Yes. So, hi Matt, on the revenue side of things, for first quarter, again, we said negative mid-singles with about three points being China and foreign exchange. And then really, the rest is about a view on what the trend coming out of fourth quarter and maybe conservative macro outlook is. On the full year, the low to mid-singles really has two points of China, but then a point of the 53rd week. So, about a point impact to a year-over-year growth. And then really, it’s about taking a position on the trend plus the macroeconomic environment, which, again, we’re really trying to take a prudent approach because I think we’re all watching what’s happening and not 100% clear where the consumer will go as we move through the year.

I think as it relates to Old Navy in the promotional environment, I think what’s really important for us to recognize is a significant portion of the margin drain whether it was at Old Navy or our other banners last year was because we just had too much inventory for the demand and so the quality of that pricing and margin was really poor because we were focused on clearing it. Now, what we have is better inventory, but with what we think is a good value proposition that we think will still serve the Old Navy consumer, but with better balance on what we like to compete on, which is fashion, style, price, fit, all the things that matter, so I think we’ll still have a good value proposition for the lower-income consumer. We just won’t have that glut of markdown inventory.

So I just see it as better quality of value for them.

Matthew Boss: Great color. Best of luck.

Katrina O’Connell: Thank you.

Operator: Your next question will come from the line of Jay Sole with UBS.

Jay Sole: Great, thank you. Katrina, I want to follow up on that question. I think you mentioned that in your gross margin guidance for the year, you assume RODs flat, I assume you mean that as a percentage of sales. Can you give us an idea of what the comp leverage point is for ROD?

Katrina O’Connell: Yes. I’m glad you asked that, Jay. So on the full year, you’re absolutely right, so thanks for clarifying. We did say that, I mean, RODs basically neutral to leverage on the year. And I just said that low to mid-single-digit revenue declines is what we’re expecting. So I think that’s a good benchmark for you on given how low we’ve driven the ROD structure of the company, what’s the right way to think about leverage is.

Jay Sole: So I mean, can we assume that just the way the company has negotiated leases at the year-over-year, like the comp €“ the comp and leases is actually negative that you’re seeing less rent, or is it just the store closures have led to less overall ROD expense?

Katrina O’Connell: It’s really the store closures. And I would say the partnerships of our international businesses, which had such high rent structures. So I think it’s really all the restructuring work, Jay, that we’ve done, has finally given us some relief on the rent leverage point where we can run now, not that we want to, but low to mid-single digits and still not see drag on the cost structure based on how low we brought down that portfolio of expense.

Jay Sole: Got it. Understood. Thank you so much.

Operator: Your next question will come from the line of Adrienne Yih with Barclays.

Adrienne Yih: Great. Thank you very much. A couple of questions. The first, I guess, is the comment on Banana Republic sort of moderating. And I know that there was a big return to work occasion kind of spring of last year. Would that imply that quarter-to-date is running in the negative range. And then secondarily, could you talk about your credit card penetration by brand and its ability to acquire new customers as a new customer acquisition tool. And then what was the annual income from that piece of the business? Thank you very much.

Katrina O’Connell: Sure. So Adrienne, I would say BR, we recognize that BR has been through a massive repositioning over the last 1.5 years, and we’re still really proud of the way Banana Republic is showing up to the consumer. Right now, they are lapping the massive business that they had last year based on the revenue trend change as well as the relaunch. So I’m not going to preview whether they’re negative or not, but I will say that as they lap those results, we’re watching carefully to see the sales trends might moderate. And then on the credit card data, I’m sure you can imagine, I can’t disclose the credit card income. We don’t disclose that. What I will say is we just partnered with Barclays, new credit card partner with us from Synchrony last spring.

We’ve been working hard with them to put in place new ways of being able to speak to our consumer. And we see credit card as a very important way to drive the pinnacle of lifetime value with our consumers. So I would say, credit card is more sophisticated. We launched our loyalty program. I think we have work to do now that we’ve acquired customers to better move them up through the lifetime value chain. But credit card continues to be important across all of our brands to speak to our most valuable customer.

Adrienne Yih: Okay. Thank you very much. Best of luck.

Katrina O’Connell: Thank you.

Operator: Our last question will come from the line of Paul Lejuez with Citigroup.

Paul Lejuez: Hey, thanks, guys. Can you maybe talk about your free cash flow assumptions for F 2023? Also, I think you mentioned Old Navy pulled some sales forward from 4Q to 3Q. But do you think Old Navy also maybe pulled sales into 4Q at the expense of 1Q just given how promotional you were to get your inventories clean? And then just going back to Adrienne’s question on credit. What do you expect in terms of year-over-year change in credit revenues? Are you planning for that business to be up, down, flat? Any color you can give there? Thanks.

Katrina O’Connell: Okay, Paul, that’s a triple. So on free cash flow, I think, first of all, while overall free cash flow for the year was down $78 million. I’m really pleased that we were able to see the reversion in fourth quarter that we’ve been working towards, which was free cash flow of about $600 million in fourth quarter, once we were able to really get the inventory receipts down. So, good progress on free cash flow. I would say more to come on how we see the year playing out. We did say we plan at some point during the year to repay our ABL, which means that as we continue to have lower receipts, lower expenses and release pack and hold and start generating sales off of that, we do see that we’re getting back into a much healthier cash position, more to come on whether that how free cash flow happens during the year.

On the Q4, Old Navy question, it’s funny, because it’s actually the opposite where we actually saw our December sales take a dip unlike what I think other competitors have said, because we had cut holiday receipts, and we were carrying a lot of fall inventory. So our ownership of inventory in the quarter was a little off for what the consumer wanted. But once we were able to get holiday receipts down and start clearing through the inventory at markdowns, we were able to bring in spring and really see the business rebound. So I think that actually gives us confidence that the new product is resonating. As we talked about, we have markdown behind us and so there’s room for us to be chasing. So I think Q4 was just sort of a confluence of maybe not the best content of inventory, we feel better about going forward.

And then on credit card, again, I’m not going to guide to that. I think we see similar dynamics, which is credit headwinds, right, based on interest rates and all that other stuff, but we’re working hard to offset that with aggressively looking to acquire customers. So more to come on where that program comes out, but we are pulling all levers that we have to keep that going. We know that’s a very important part of the business.

Paul Lejuez: Thank you. Good luck.

Katrina O’Connell: Thank you.

Operator: Thank you. That does conclude our conference call. You may now disconnect.