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

The Gap, Inc. (NYSE:GPS) Q4 2023 Earnings Call Transcript March 7, 2024

The Gap, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, ladies and gentlemen. My name is Krista, and I’ll be your conference operator today. I would like to welcome everyone to [Technical Difficulty] Incorporated Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to introduce your host, Emily Gacka, Director of Investor Relations. Emily please go ahead.

Emily Gacka: Good afternoon, everyone, and welcome to Gap Inc.’s Fourth Quarter Fiscal 2023 Earnings Conference Call. Before we begin, I’d like to remind you that the information made available on this 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 risk factors described in the company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2023, 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 7, 2024, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Chief Executive Officer, Richard Dickson, and Chief Financial Officer, Katrina O’Connell. With that, I will turn the call over to Richard.

Richard Dickson: Thank you for joining our call today, where I’ll provide an update on our performance and progress in the context of our four strategic priorities. Then I’ll pass the call to Katrina to walk you through our detailed financial results as well as our 2024 outlook before we take questions. As a reminder, our four strategic priorities are, first, maintaining and delivering financial and operational rigor; second, the reinvigoration of our brands; third, strengthening our platform; and fourth, energizing our culture. Before I start, I’d like to highlight three recent additions to our leadership team, each of whom will contribute meaningfully to the ongoing execution of our strategic priorities. Eric Chan has joined us as Chief Business and Strategy Officer, Amy Thompson as Chief People Officer, and Zac Posen as Creative Director of Gap, Inc., and Chief Creative Officer of Old Navy.

I’ve been purposeful and thinking about the talent and skill these executives bring and how they complement our existing institutional knowledge. These new leaders will play critical roles in unlocking our full potential and solidifying our foundation as we redefine Gap, Inc., for a new era. One, where our financial and operational rigor is a cornerstone of strength bolstered by best-in-class talent and a culture of creativity, all paving the way for brand reinvigoration and greater cultural relevance. We are pleased with the results of the quarter as we exceed expectations on several key metrics driven by our strategic priorities. Maintaining and delivering financial and operational rigor strengthened our financial footing in 2023, showing that we can drive more efficiency and productivity, enabling us to focus on brand reinvigoration.

We’ve made a lot of progress, delivering cost-savings and gross margin expansion, and this work helped us deliver meaningful improvement in adjusted operating margin of 410 basis points for 2023. Our focus on controlling the controllables also resulted in better working capital and a stronger balance sheet at year end. This includes reducing our inventory levels by 16% year-over-year, building a strong cash balance of $1.9 billion, and generating over $1.1 billion in free cash flow. These proof points put us on strong financial footing as we begin 2024. Our results in the fourth quarter demonstrate strong progress, not only in terms of improved margins and well-controlled expenses but also with more stability in net sales. Net sales grew by 1% and comps were flat with Gap Inc., gaining market share.

The sequential improvement, which is noteworthy in a declining apparel market reflects the team’s responsiveness and nimbleness as we begin our brand reinvigoration work. Old Navy comps increased 2% and we were pleased to gain share in women’s for the fourth quarter, building on the success we saw in the third quarter. We are also encouraged that we increased our foothold in two key categories, Active and Bottoms. As the number five player in the active space, we are excited for Old Navy to accelerate in this leading category. The all-important bottoms category creates additional opportunities because it’s the gateway to the full wardrobe. Gap brand’s comps were up 4% driven by strength in Women’s, where we delivered our fifth consecutive quarter of market share gains.

This result was amplified by good performances in denim and sweaters, supported by new marketing campaigns. Banana Republic comps were down 4% as we conduct deliberate and ongoing work to reestablish the brand and Athleta’s comps were down 10% as we lapped a period of heavy discounting that we previewed last quarter, but improved sequentially, driven by new holiday product, updated marketing, and improved in-store presentation. We expanded our company gross margin by 530 basis points, ahead of expectations, driven by more effective sourcing strategies and lower commodity costs combined with improved promotional activities, leaner inventories, and better assortments. We also increased our operating margin by 570 basis points to 5%. Our team is demonstrating the ability to do what we say we’re going to do and in some cases even more.

However, we’re not where we need to be. Our ongoing focus on financial and operational rigor will allow us to continue to elevate our performance, improve execution consistency, and set the foundation for our exciting brand reinvigoration work. Turning to our next priority, brand reinvigoration is about driving both relevance and revenue, inspired by our brand’s incredible heritage. As a reminder, this strategic priority begins with strengthening the identities and purpose of each of our brands. We are striving for each brand to have trend-right product assortments rooted in customer-centric design thinking and a clear point-of-view that delivers on both wants and needs, from there we need to execute several key ingredients. We must consistently deliver product storytelling that excites our customers, supported by compelling merchandise.

We need to drive demand with innovative marketing to regain a powerful voice in the cultural conversation, and we must create better more engaging omnichannel experiences with a clear and compelling pricing strategy. And most importantly, we must execute with excellence along every touch point and interaction. These elements form the basis of our brand reinvigoration playbook, while specific execution will differ by brand, we are working with each of our brand teams to implement this playbook holistically and consistently. Now I’d like to provide an update on the progress of each brand. Let’s start with Old Navy. We are encouraged by the sales performance we saw in the back half of 2023 and the growth we delivered in the quarter. We are re-asserting Old Navy’s authority as the number two apparel brand in the U.S. We delivered on-trend products, particularly in women’s, active, bottoms, and knit, which performed well in the quarter, supported by our campaign with Natasha Lyonne, we showcased and leveraged our authority in the bottoms business and saw great response, especially to the tailor pant, the refreshed Pixie pant, and the cargo.

We’re celebrating fashion, family, and fun through more precise marketing and storytelling. Another example of re-asserting our authority is Jingle Jammies. We took our famous Jingle Jammies and created Jingle Glamies, supporting it through a compelling social media campaign, where influencers paired Jammies with going outwear. This demonstrates how we take a product and make it a trend by dialing it up in a relevant way through storytelling. Old Navy is reinforcing value by communicating to customers with more clarity on price and quality, both in stores and online, highlighting the brand’s value proposition. We’re starting to see the strength of the brand identity evolving and coming alive through online and visual communications. The progress we are making at Old Navy gives us confidence in our ability to build consistency, while we deliver against our priorities.

Let’s turn to Gap brand. We are driving continuous improvement and Gap has exciting potential as we focus on reigniting the brand dialog. Gap was built on strong product narratives with brilliant marketing, expressed through big ideas. Gap in its best days was a storyteller, who can take a product and create a trend using culturally relevant marketing. During the fourth quarter, our team to took Cashsoft Gap’s innovative washable fabric that feels like cashmere and turned it into a big idea through creative storytelling, supported by elevated marketing and in-store design and digital presentation. We amplified this innovative product idea and it became a key contributor to the strength and sweaters we saw during the quarter. Its success is an important proof point that shows we can reignite Gap with big ideas and deliver improved results.

And now we’re going to build on that example with relentless repetition. Our Lenin campaign, which launched in late February is the big idea for spring. The campaign is running now and I encourage you to take a look. This is a great example of the brand taking trend-right product and amplifying it, turning it into a big idea expressed through compelling in-store merchandising and strong digital execution with an innovative and culturally relevant marketing campaign entitled Linen Moves, featuring Musical Artist Tyla and Jungle. We struck a cultural record on Instagram and TikTok. Linen Moves was Gap brand’s highest-performing video on both platforms ever and we’re just getting started. Regarding Banana Republic, we are focused on re-establishing this brand to thrive in the premium lifestyle space.

As I dug in with the Banana Republic team, I realized that we are behind on the fundamentals, having the right product in the right place with the right price. 2024 will be about getting back to the basics, both for product and execution. This includes a focus on go-to-wardrobe pieces and BR Classics like sweaters, Oxford’s suit separates, and khaki, those products that Banana Republic has been known for and will be again. We’re encouraged by the brand aesthetic but it will take some time to get this right and unlock the potential of this business. Turning to Athleta, as we shared with you last quarter, the brand had missteps in prior years, and as a result, net sales for the brand remained muted in Q4 as we lapped markdowns, a challenge that we will continue to face through the first-half of 2024.

Athleta is a brand with significant growth potential and a clear and distinct positioning rooted in the Power of She. Early holiday ideas like cold weather train and our Shine Set sold well. These great ideas were ultimately bought too small, but they are good proof points that we are on the right track at Athleta. We’re making progress in resetting this brand, returning to the core of Athleta’s positioning. We started the new year with a cleaner pallet and we’ve seen early successes in new arrivals, although the changes are small, we are learning and encouraged by the customers’ early reactions. We’re focused on resetting the brand for success and putting Athleta back at the center of the cultural wellness conversation while reengaging the brand’s performance roots.

Moving to the third strategic priority, strengthening our platform. We’re focused on building and sharpening our operational capabilities to improve effectiveness and efficiency, and in turn drive cost leverage and demand generation. I recently returned from a two-week trip to Asia, during which I immersed myself in our supply chain infrastructure. I spent time listening, learning, and understanding the facets of our supply chain network, and I’ve gained insight into the incredible longstanding partnerships that we have built over the years. I also spend time in our Hyderabad office in India, studying our technology tools and capabilities. While encouraging, this is an area that we will be focused on elevating as part of our path to becoming a high-performing apparel company.

We are still in the assessment days, but my intent is to cultivate a digital-first organization and mindset that uses technology to enable business strategy, enhance the customer experience, and capture future opportunities. We are also beginning to evaluate how we can better leverage our media and marketing with the goal of developing more compelling creative and more innovative media to support growth across the portfolio. I believe our platform gives us meaningful differentiation and has the potential to unlock additional value creation, and we will work to further build out our capabilities to drive efficiency and effectiveness. The fourth priority is culture. Energizing our culture will fuel creativity and connectivity while driving accountability across our organization.

As I mentioned earlier, the recent appointment of Amy Thompson has bolstered our leadership team and underscored our investment in building a culture where employees show up every day with purpose and a sense of belonging. Amy is a builder of highly effective cultures that integrate purpose, vision, mission, and values throughout an end-to-end employee experience, all dedicated to driving business success. This includes igniting a growth mindset with empowered leaders and aligned incentives. I’m confident, she will help us build a winning culture at Gap, Inc. Today, our company is on strong financial footing. In 2024, we will continue to strengthen our fundamentals as we focus on our four strategic priorities. While there is a lot of work to do, I’m energized by the progress we have made so fa, and I’m inspired by the team’s commitment and talent.

I want to take a moment to recognize our global team for their ongoing dedication, and I look forward to continuing this work in partnership with them as we drive towards becoming a high-performing apparel company. And now I will turn the call to Katrina for a closer look at our financials and our outlook for 2024.

Katrina O’Connell: Thank you, Richard, and thanks, everyone, for joining us this afternoon. We’re pleased to report fourth quarter and full-year 2023 results ahead of our expectations with market share gains. We remain focused on the discipline we’ve created around margin recovery, expense actions, inventory management, and maintaining a strong balance sheet. As Richard noted, our financial and operational rigor continues to be foundational as we turn our attention to the reinvigoration of our brands in 2024. Before we begin, I’ll note that all results reported today are inclusive of the 53rd week, except for comparable sales metrics. Some of the key highlights from fourth quarter and fiscal 2023 include the following. Fourth quarter comparable sales were flat and net sales were up 1%, ahead of our expectations driven by Old Navy and Gap brand sales results during the important holiday season.

And while full-year 2023 comparable sales were down 2% and net sales declined 5% year-over-year, this performance was in-line with the outlook we provided at the beginning of the year, as our financial and operational rigor begins to deliver more consistent performance. Old Navy drove a positive 2% comparable sales in the quarter, building increased confidence in consistent delivery of net sales growth. For the year, Old Navy comparable sales were down 1%, with positive comp performance in the second-half of the year and market share gains in all four quarters. Gap brand drove 4% quarterly comparable sales growth with a positive 1% comp for the year, outpacing the market. We delivered 530 basis points of gross margin expansion in Q4 and 380 basis points of expansion for the year versus last year’s adjusted gross margin, resulting from trend-right product, which when combined with well-managed inventories led to improved promotional activity.

Margins also benefited from lower commodity costs. We reduced fiscal 2023 SG&A by over $300 million year-over-year on an adjusted basis, as a result of our commitment to financial discipline, all of which resulted in an operating margin of 5% for Q4 and an adjusted operating margin of 4.1% for the year, a 410 basis point improvement versus last year’s adjusted operating margin, demonstrating meaningful progress on our path towards profitable sales growth. Inventories ended down 16% year-over-year and remained well-controlled, driving better profitability and working capital, and we ended the year with $1.9 billion of cash on the balance sheet, delivering $1.1 billion of free cash flow for the year. While we enter fiscal 2024 encouraged by the financial progress we’ve made, we’re taking a balanced view of 2024 while we shore up the foundation of our brands.

I will discuss our outlook in more detail in a moment. Let me start with fourth quarter results. Net sales for the quarter were up 1% to last year at $4.3 billion, exceeding our previously communicated guidance range and comparable sales were flat. The 53rd week added approximately 4 percentage points of sales growth in the quarter. Also, the sale of Gap China last year had an estimated 2 point negative impact to Gap Inc.’s total net sales growth. Now let me provide fourth quarter sales results by brand. Starting with Old Navy, net sales were $2.3 billion, up 6% versus last year, with comparable sales up 2%. This represented the second consecutive quarter of positive comps at the brand. Turning to Gap brand. Gap brand net sales of $1 billion were down 5% versus last year.

Excluding the estimated negative impact to sales of 8 percentage points related to the sale of Gap China, net sales would have been up 3% versus last year. Comparable sales inflected positively, increasing 4% driven by continued strength in Women’s, which gained market share for the fifth quarter in a row. Banana Republic net sales of $567 million declined 2% year-over-year, with comparable sales down 4%. Reestablishing Banana Republic will take time and we know there is work to be done to better execute many of the fundamentals in 2024. Athleta net sales of $419 million declined 4% versus last year. Comparable sales were down 10%, while the sales trend improved versus the prior quarter, net sales performance was still challenged due to tougher comparisons as we anniversary a period of elevated discounting, a dynamic which we expect will continue through the first-half of fiscal 2024.

While Athleta sales remain negative from the headwinds related to lapping last year’s significant promotions, we’re encouraged by the positive customer reaction to our new assortments, cleaner store presentations, improved online experiences, better marketing execution, and innovative new customer activations, which gives us confidence that the brand’s efforts are driving underlying benefits. Now turning to gross margin in the quarter. Gross margin of 38.9% expanded 130 basis points versus last year. Merchandise margin increased 500 basis points in the quarter compared to last year, driven by an estimated 300 basis points of leverage from lower commodity and air freight costs. With the remaining leverage primarily driven by improved promotional activity ahead of expectations, as strong holiday assortments and well-controlled inventory enabled lower discounting during the season.

Rent, occupancy, and depreciation modestly declined on a nominal dollar basis versus last year. As a percentage of sales, ROD leveraged 30 basis points. Now let me turn to SG&A. SG&A was $1.46 billion in the quarter, largely in-line with our prior outlook. As a percentage of sales, SG&A of 33.9% leveraged 40 basis points versus last year. Operating income was $214 million, up $244 million versus last year. Fourth quarter operating margin of 5% improved 570 basis points versus last year, driven primarily by gross margin expansion. Fourth quarter net interest income was $4 million, as higher interest earned on cash balances offset interest expense. Our fourth quarter tax rate was 15.1% and benefited from the release of certain reserves. Earnings per share in the quarter were $0.49.

Now turning to full-year fiscal 2023 results. Net sales were down 5% to last year at $14.9 billion and comparable sales were down 2%. The addition of the 53rd week contributed approximately one point of sales growth to the full year. And the sale of Gap China in fiscal 2022 had an estimated 2 point negative impact to Gap Inc.’s total net sales growth. Gross margin was 38.8%, expanding 450 basis points versus last year’s reported gross margin and 380 basis points versus last year’s adjusted gross margin. Merchandise margin increased 420 basis points versus last year on an adjusted basis, driven by 200 basis points of benefit from lower air freight expense, with the remaining expansion primarily driven by improved promotional activity. Inflationary impacts from commodity costs were relatively neutral for the year.

And ROD as a percentage of sales deleveraged 40 basis points versus last year. Reported SG&A was $5.22 billion for the year, or 35% of sales. Excluding restructuring costs and a gain related to the sale of an office building, adjusted SG&A was $5.17 billion, down 6% versus last year, primarily driven by cost savings as a result of strategic actions. Reported operating margin was 3.8%. Excluding $93 million in restructuring costs and $47 million related to the gain on sale of an office building, adjusted operating margin of 4.1% expanded 410 basis points versus last year. Fiscal year 2023 net interest expense was $4 million as interest expense was largely offset by interest earned on cash balances. The reported effective tax rate was 9.7% for the year and the adjusted effective tax rate was 11%.

During the year, we received discrete tax benefits from the impact of foreign operations, a transfer pricing settlement related to sourcing activities, and the release of certain reserves. Share count ended at 372 million. Reported earnings per share was $1.34. Excluding the impact of restructuring and the gain on sale of the office building, adjusted earnings per share was $1.43. Adjusted earnings per share includes $0.29 of discrete tax benefits and a $0.05 benefit related to the 53rd week. Now turning to the balance sheet and cash flow. Inventory levels were meaningfully below last year in all quarters, with fiscal 2023 ending inventory declining 16% year-over-year. We ended the year with cash and equivalents of $1.9 billion, an increase of 54% from last year.

Full-year net cash from operating activities was $1.5 billion as a result of our improved operating profit and lower inventory buys. Free cash flow was an inflow of $1.1 billion. We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns. During the year, we returned $222 million to shareholders in the form of dividends, representing annual dividends of $0.60 per share. On February 27, our Board approved maintaining a dividend of $0.15 per share for the first quarter of fiscal 2024. In summary, as I reflect on 2023, I’m proud of the discipline and rigor we’ve brought back into our foundation, which has resulted in meaningful recovery and profits, as well as strong free cash flow. I’m also encouraged by the progress we made in the second-half of the year with sales stabilizing in the fourth quarter led by progress at Old Navy and Gap, early proof points of brand reinvigoration.

We remain committed in 2024 to delivering continued improved performance through maintaining our financial and operational rigor. Now let me turn to our 2024 Outlook. Our attention in 2024 remains on controlling the controllables — gross margin recovery, expense discipline, inventory management, and maintaining a strong balance sheet, while we continue the foundational work-related to our brands as we aspire to drive relevance and revenue. We expect this rigor to deliver roughly flat sales excluding the 53rd week while delivering low-to-mid-teens operating income growth. Let me provide some details on our outlook, starting with the full year 2024. Our outlook of flat net sales year-over-year, excluding the 53rd week assumes continued performance at Old Navy and Gap, offset by challenging comparison for Athleta in the first-half of the year as the brand laps elevated discounting from 2023 and a longer recovery timeline at Banana Republic.

This net sales outlook also contemplates the following unique dynamics. First, as a reminder, 2024 is a 52-week year, but will be compared in total to a 53-week year in 2023. The loss of the 53rd week result in a detrimental impact of approximately $160 million to fiscal 2024 net sales. It’s worth noting that the timing shifts associated with the 53rd week are expected to be impactful to both Q1 and Q4 in 2024. In the first quarter, we expect to benefit from the timing shifts as we lose a lower-volume week in February and add a modestly larger week in May. Additionally, the fourth quarter is expected to be negatively impacted by the loss of the 53rd week. Second, we have embedded multiple scenarios that contemplate modest headwinds in the first-half of the year related to late deliveries, as a result of geopolitical issues in the Red Sea.

We currently expect that impact will moderate in the second-half of 2024, but we will monitor the situation closely as we move through the year. And third, we’re not anticipating major changes to consumer dynamics and macroeconomic pressures in 2024. In addition, I’d like to comment on the potential impact of the recent CFPB ruling on late fees for credit card holders. Our outlook assumes a mid-year implementation of the ruling, which we expect to be largely offset in 2024 by other levers within our credit card program. Now moving to gross margin. We anticipate gross margin expansion of at least 50 basis points for the full year compared to fiscal 2023’s gross margin of 38.8%. Our gross margin outlook is driven by the following factors. We expect commodity cost tailwinds in the first-half of the year, which we anticipate will become largely neutral in the second-half of the year.

We expect ROD to deleverage modestly on the lower sales volume resulting from the loss of the 53rd week, and we continue to take a measured view of the consumer environment in fiscal 2024, particularly as we lap significant improvements we delivered in promotional activity during 2023. Regarding SG&A. SG&A of $5.1 billion is expected to decline year-over-year as we benefit from $150 million in reductions related to last year’s strategic actions and lower costs from the loss of the 53rd week, which are partially offset by wage inflation. We are committed to strong financial discipline and we will continue to identify and pursue efficiencies as we drive our strategic plan. Considering the above dynamics regarding sales, gross margin, and SG&A, we see a clear path towards delivering low-to-mid-teens operating income growth in fiscal 2024 versus the $606 million of adjusted operating income in 2023.

We expect full year net interest expense to be similar to fiscal 2023 with interest expense being largely offset by interest on cash balances, however, we will be watching Fed actions to determine if lower interest rates over time might impact this dynamic in the year. We are planning for a more normalized tax rate of 28% in 2024. This compares to 9.7% in fiscal 2023 as we benefited from several discrete tax items, which as previously noted, added approximately $0.29 to fiscal 2023 earnings per share. We are planning capital expenditures of about $500 million for the year. Now let me share some color on your outlook for the first quarter of fiscal 2024. We’re pleased with the trends quarter-to-date and are planning for net sales in Q1 to be roughly flat versus Q1 2023.

Consistent with our full year view, our first quarter outlook assumes continued performance at Old Navy and Gap, offset by challenging comparison for Athleta and a longer recovery timeline at Banana Republic. As it relates to first quarter gross margin, we expect at least 100 basis points of expansion compared to the adjusted gross margin of 37.2% in the first quarter of fiscal 2023, driven by commodity cost tailwinds. We continue to take a prudent approach in relation to the promotional environment in the first quarter, and we’re planning SG&A of approximately $1.2 billion in the first quarter of fiscal 2024. In closing, we’re pleased to deliver strong financial results during both the fourth quarter and the full year demonstrated through gross margin expansion, expense discipline, lean inventory, and strong cash generation.

The financial and operational rigor that we’ve worked to develop and will continue to pursue is enabling us to focus on reinvigorating our brands with the goal of generating sustainable profitable growth and delivering value for our shareholders over the long term. With that, we’ll open up the line for questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Adrienne Yih from Barclays. Please go ahead.

Adrienne Yih: Great, thank you very much, good afternoon, and congratulations to everybody on the Gap team. Richard, my first question is, the hiring of Zac Posen as Chief Creative of Gap Inc., but also Chief Creative of Old Navy, the number one, sort of where — his focus obviously is going to be on Old Navy, but how are you expecting him to be used more broadly across Gap, Inc. And then historically, Gap has had designers in the fold before, and we always say you design for the one in merchandise for the masses, so I just want to get your philosophy on how you kind of expect to keep the guardrails on that. And then, Katrina, if you could just help us with the $5.1 billion OpEx, it seems very flattish, but you had mentioned that there was — there were opportunities. It seems a little bit high, I guess is the way I would put it, so any color there would be great. Thank you very much.

Richard Dickson: Sure, thanks, Adrienne. I appreciate the question, and we’re very excited to welcome Zac to the company, and in particular, to our largest brand, Old Navy, where he is going to be serving as Chief Creative Officer. Zac is one of America’s most celebrated designers. His creative expertise, his cultural clarity, has consistently evolved American fashion, making him really a great fit for the company as we engage our culture and look to reinvigorate our story brands. Zac’s role as Chief Creative Officer at Old Navy is really designed to harmonize, orchestrate, and dial up the storytelling across product and marketing. Looking at how we create brand relevance and charade experiences that ultimately celebrate the brand’s ownable attributes, fun, fashion, and value for the whole family.

Now, as Zac gets more immersed in the business, his influence will be really well considered to enhance the continuity of the brand’s reinvigoration which we’ve already started to see show up on the scoreboard, and his leadership across the portfolio will add a new dimension of relevance, and I’m really looking forward to Zac on the team and having him get immersed in our portfolio at our brands.

Adrienne Yih: Fantastic.

Katrina O’Connell: And then, Adrienne, let me take on the SG&A question. It’s a great one, and I think you’d agree that we’re committed to maintaining financial and operational rigor, which has really strengthened our financial footing. 2023 reflected the benefits of the ongoing work, particularly in terms of margins, expenses, inventory, cash flow, and we just delivered a year with SG&A reductions of approximately $300 million. The outlook we provided today does reflect another $70 million of reductions, that’s really driven by the remaining $150 million reduction from last year’s strategic actions, partially offset by inflationary pressures from wages and other headwinds. I believe we can make our cost structure more efficient and drive operating margin expansion, but we have work to do to get back to historical levels.

So our outlook today reflects our current point-of-view, but we’ll continue to assess the efficiency of our investments and look for opportunities for reduction or redeployment, where it makes sense, so more to come as we move through the year.

Adrienne Yih: Fantastic. Best of luck. Thank you.

Operator: Your next question comes from the line of Bob Drbul from Guggenheim Securities. Please go ahead.

Bob Drbul: Hi, good afternoon. Richard, I was wondering if you could spend some more time on the marketing initiatives that are underway. I’ve seen some changes within Athleta but I’ve also seen the Gap campaign, has been really highly visible, so I guess, if you could just talk about how you’re approaching it, and I guess, the level of expense that you’re there and sort of the commitment to sort of reinvesting in the marketing, I think that will be pretty helpful for us. Thanks.

Richard Dickson: Sure. Yes. Bob, thank you for the question. Look, marketing is a much more complex function today than it was in the past and our brands need to show up where consumers are, but they need to show up in relevant ways, and the media mix to create relevant demand creation has changed fastly and we’re approaching it very differently than in the past. There really is an art and science to creating demand today and Gap Inc.’s brands have been behind, but we are working on delivering more efficiency with our marketing and media dollars to have more specific and significant impact. And what I would say is, while we don’t share marketing spend by brand, it’s really not about spending more, it’s about spending more efficiently.

And I think you can take the Gap Linen campaign, as you mentioned, as an example. Gap is probably furthest along in this new approach — using a holistic approach, social, influencers, streaming, linear throughout all the way through our stores, site to amplify this big idea. And I think as you’ll see, you need to be driving a message consistently from the top to the bottom of the marketing funnel, and historically, we’ve not done a good job of keeping the message consistent throughout the funnel, and this is a great example of our new marketing methodology. Now, on Athleta, which you mentioned specifically, which again is another great example, we have a really significant opportunity with this important brand, the Power of She, is a compelling brand platform.

And we know the Athleta brand resonates with consumers, but our missteps in executing product, marketing, experience has ultimately weighed heavily on the performance of the brand in recent years. Chris, as you know, Blakeslee joined us in 2023, leading a team that is driving the brand reinvigoration and I think as you start to see some of that reinvigoration playbook through marketing, great storytelling, executed through social media and our stores, we’re very excited about really the tremendous potential of Athleta, and Gap as well, as I mentioned before, incredible storytelling brand, historically, a pop culture brand that truly does more than sell clothes, and today, we’re really moving again. The current campaign, Linen Moves, it is a great example of Gap having a voice again in the cultural conversation taking Linen as an amplified big idea and doing it and owning it only the way Gap can.

Music leverage always been synonymous with Gap. We’ve teamed up with Grammy Award winner Tyla and the recent BRIT award winner Jungle and created a credible storytelling campaign that’s culturally relevant and resonating. And my last point, particularly in the marketing, metrics that matter places like TikTok and Instagram are new platforms for Gap in the context of being more relevant to our consumer. Linen Moves is currently Gap brand’s highest-performing video on both of these platforms ever. So early days, we are encouraged with the momentum that we’re seeing. The playbook is in action and there’ll be a lot more to come.

Robert Drbul: Great, thank you very much.

Operator: Your next question comes from the line of Ike Boruchow from Wells Fargo. Please go ahead.

Ike Boruchow: Hey, everyone. Congrats on the quarter. Two questions. Richard, maybe first for you, I hate to put you in a tough spot, but there’s — let’s leave Athleta and Banana alone, ongoing outperformance I think was words for the guidance for Old Navy and Gap. If you have to look at both of those brands, which one do you feel like you have your arms around the best in terms of branding, marketing, and sustainable — sustainability of positive comps? And then just the follow-up question would be for Katrina. I think based on your guidance, you around 4.5%, 5% margin, if we kind of go back pre-COVID, you were kind of consistently in the high-single-digits. How are we thinking about multi-year, the building and the foundation that you guys are doing if you can sustain low-single-digit growth? How should we think about the ultimate margin structure of the company over time?

Richard Dickson: Thanks, Ike. Well, first off, I’d say my arms are everywhere in the context of what we’re trying to achieve here. And I think, again, speaking for the quarter results, we exceeded expectations on both top- and bottom-line, gaining market shares and the strength was really driven by the two largest brands in our portfolio, Old Navy and Gap. And more specifically, Old Navy, it’s the largest brand in our portfolio and we’ve been working on re-asserting the brand’s authority as the number two apparel brand in the country. We have a strong retail presence. We have over 1,200 stores and an incredible online presence, which I would encourage you to take a look at today in the context of its clarity and new relevant persona.

We did have a strong quarter. Our sales were up 6% with comps up 2%. We gained share in all segments, but we did particularly well in women’s, which we dialed up from a marketing perspective, and I will say the team has done a great job driving the financial and operational rigor, and Old Navy is really starting to see early signs of that brand reinvigoration. In particular, we know Old Navy has a reference reinforcing style authority, but with more clarity on price and quality, both in stores and online, and again, we’re very encouraged with those early results, and the consistency that we expect to have throughout the year in 2024 as we build upon that discipline. I talked about Gap in the previous question, but similar. We’ve had a great quarter with Gap and year.

We’re very happy with the positive comps and we’ve been working to reignite Gap, and drawing on what made this brand so special in the first place. And ultimately, I think this campaign that you’re seeing in market today, again, go online, take a look, I think it’s a great example of the playbook in action and Gap having a voice and culture again, taking an idea in our storytelling and amplify in a way that only Gap can.

Katrina O’Connell: And then, Ike, to talk more specifically to the margin structure, I would say, I do see a path to delivering operating margin expansion in the long term. We have work to do to get back to historical levels. I think, first and foremost, this business leverages nicely when we get the top-line moving and it hasn’t been growing regularly, and that’s really what the brand reinvigoration work that Richard has been referencing is all about, getting our business back to relevance and revenue and driving the top-line, that unto itself will drive operating merchant expansion. And in the meantime, we’ve been through several years of transformation, partnering international market, closing our unprofitable stores, divesting of smaller brands, all that reduced the fixed cost base.

And then recently, we’ve been doing other cost actions, all of which — that discipline has taken out about $550 million of cost and that led to this cost structure that leverages so nicely on sales growth. And we just talked about it, we’ll consistently evaluate the cost structure to identify additional opportunities. So, again, to sort of end where I started, there is a path to delivering operating margin expansion in long term as we get back to delivering consistent sales growth.

Ike Boruchow: Thanks so much.

Richard Dickson: Thanks, Ike.

Operator: Your next question comes from the line of Matthew Boss from J.P. Morgan. Please go ahead.

Matthew Boss: Thanks, and congrats on a nice quarter.

Richard Dickson: Thank you.

Matthew Boss: So, Richard, could you elaborate on the market share gains that you cited that you’re seeing at Old Navy and the Gap if you break down maybe by some of the destination categories for each of those brands? And any change in momentum that you’re seeing at Old Navy or Gap as we think about early spring and some of the maybe early trends? And then, Katrina, so you’re coming off 500 basis points of merchandise margin expansion, inventories are down mid-teens, I guess how best to think about the magnitude of merchandise margin opportunity in 2024 just considering some of the product cost tailwinds and maybe your view on the promotional landscape?

Richard Dickson: Absolutely. Matt, thanks for the question. As mentioned, Gap Inc., gained market share in the quarter year-over-year, which we were very pleased with and that is on the backdrop of a declining overall industry, so even more credit to the strength of these two particular brands at this particular time. It was driven, of course, by Old Navy and Gap as mentioned, and frankly, what we’ve seen in particular is, in Gap Inc., we gained share in literally all segments. The stores gained share driven by Old Navy and Gap and also outerwear, sleep, pants, wovens, tops also gained, kids and baby, as fair to mention, is a really important segment of our business. The Old Navy is the number one kids and baby brand in the U.S. Gap Inc owns 9% of the total market.

We have proven capabilities and brands that resonate in this category. And so over time, it’s also an opportunity for us to accelerate and become even more important of a player in this segment. And as you’ll see, and we evolve our dialogue going forward, we have opportunities in several key categories of strength, Denim, Active, Kids and baby. These will all be really good conversations for us to have as we move forward with our reinvigoration plans.

Katrina O’Connell: And then on gross margin, I just provided guidance for the full year of at least 50 basis points of margin expansion for the full year and at least 100 basis points of expansion for Q1. So let me talk to you a little bit about that. I think as you noted, the rigor we utilized in 2023 drove 380 basis points of expansion year-over-year and as we recaptured a lot of inflation in the back half of the year and we had stronger assortments with the tighter inventories that we had overall, we’re really maintaining that rigor and committed to that as we head into 2024. I think you saw that we ended with 16% less inventory year-over-year. We expect similar inventories coming out of Q1. And so that inventory rigor will allow us to lap the — about 200 basis points of improvement from less promotions last year, this year as we head into the year.

So commodity cost tailwinds in the first-half this year will become largely neutral in the back half. And we are maintaining the rigor so that we can continue to lap last year’s outsized promotion improvement.

Richard Dickson: Thanks, Matt.

Operator: Your next question comes from the line of Michael Binetti from Evercore ISI. Please go ahead.

Michael Binetti: Congrats on a great quarter. I’m just — I guess, in just following a little bit of the math here. You’ve got the merch margins up nicely to 2019 in the quarter, but I don’t know that all the brands are back above 2019 margins. So I know you were asked about merch margins a little while ago. I don’t think all the brands are above. Can you speak through a brand lens where you see the opportunity most on merchandise margin from here and how you’re attacking that opportunity? The plan you gave us today? And then I think if I heard you right, you said that, ROD — you mentioned that ROD would leverage — do you think ROD leverage is excluding the 53rd week this year and maybe the cadence of ROD through the year, please?

Katrina O’Connell: Sure. So I think if I think about the performance for 2024, our outlook includes the fact that our brands are in sort of different places as it relates to brand reinvigoration. And similar to the performance we just put up for 2023, we are seeing early proof points of the brand reinvigoration in Old Navy and Gap. Our two largest brands, which really gives us more confidence in the brand’s ability to be delivering consistent performance going forward. And so, while we don’t guide by brand, we would expect Old Navy and Gap to deliver positive sales in the year. We continue to reset Athleta. I think we talked about that. And as we lap the brand’s missteps made in the prior year, that will weigh on the revenue in the front half of the year.

But we’re encouraged, as we talked about, by the underlying progress in some of the early changes and longer term, we see lots of growth potential at that brand. And then lastly, the recovery of Banana will take more time as the brand works on better execution of the fundamentals. But we don’t disclose margins by brand, we’re just encouraged by the outlook we provided today of overall operating income growth. And we’re just going to continue to use rigor in the middle of the P&L. That will result in the low to mid-teens operating income growth that we gave today on roughly flat sales growth. As it relates to ROD, our principle for ROD generally on the year is that ROD leverages on flat to slightly positive sales. So when you think about excluding the 53rd week, ROD is very slightly deleveraging on the year, and that’s just some dynamics related to the 53rd week.

But that’s how we think about ROD.

Michael Binetti: Thanks lot.

Operator: Your next question comes from the line of Lorraine Hutchinson from Bank of America. Please go ahead.

Lorraine Hutchinson: Thank you. Good afternoon. I wanted to follow up on Bob’s question about marketing. Can you quantify how much you spent on marketing in 2023? And do you have aspirations to reduce this expense going forward or just deploy — redeploy it at current levels?

Richard Dickson: Yes. We don’t disclose how we spend or what we spend on in the context of marketing. We invest in advertising over time. And our ad spend has grown to support our brands as a result of elevated costs. But in general, ultimately, our mission is to drive more effective and more efficient use of our dollars. Marketing dollars are continuing to come down year-over-year and that is a direct function of in more innovative medium metrics that is sort of driving a more innovative approach to how we market. We are continuing to evaluate our marketing comprehensively as part of the brand reinvigoration work as well as part of media efficiency work, whether that results in lower spend in 2024 or better effectiveness of the current spend, we’re going to continue to see how that plays out.

But regardless, we have plenty of marketing investments, do not need to be spending any more and we’re going to continue to look for opportunities to be more efficient and save where appropriate.

Katrina O’Connell: And Lorraine to be helpful. As Richard said, marketing dollars were down year-over-year in 2023. On our lower sales volume, marketing was about 5.9% of sales, which is below the prior year’s 6.7%. So as we have slowly been pulling marketing down, as Richard said, we really are more focused on effectiveness and efficiency, and we’ll see how that plays out in 2024.

Lorraine Hutchinson: Thank you.

Richard Dickson: Thanks, Lorraine.

Operator: And your next question comes from the line of Brooke Roach from Goldman Sachs. Please go ahead.

Brooke Roach: Good afternoon, and thank you for taking our question. I was hoping you could elaborate a bit more on the Athleta business. It sounds like some nice underlying proof points in some of the changes have been delivered in the fourth quarter, but you’re speaking to a tough first-half on compares. Can you talk a little bit about the outlook that you see on any key line items that we should be looking out for in the second-half across new product initiatives, marketing, and merchandise? And whether or not the underlying outlook provided today assumes an inflection back to growth this year for the brand?

Richard Dickson: Yea. Thanks, Brooke, for the question. And Athleta is a really important brand in our portfolio. We believe that it has significant long-term potential. The Power of She, as I talked about, is just an incredibly compelling brand platform, and we know the brand resonates with consumers. Our missteps are very public. We’ve executed poorly in product, marketing, and experience and that’s weighed on the performance of the brand in recent years. But resetting the brand will take time. We expect the tougher promotional volume comparisons to improve by the second-half of 2024. The team is focused incredibly well on executing the brand reinvigoration playbook. They’re leveraging the brand purpose, identity with great new products, exciting storytelling.

It’s supported by compelling marketing and really executed with excellence. I would encourage you to take a look at our sites, take a look at the social dialogue that we currently have on Athleta, even our stores that we started the new year with a very clean palette in our stores, and we’ve seen early successes in some of the new arrivals. And again, encouraged by the customers’ early reaction. I’m really liking where the team is going with the new drop strategy, innovation, color, and new customer activations and we’ll, of course, provide updates as we move through the year and assess the brand’s continued progress in executing the playbook. But suffice it to say, we are very excited about the tremendous potential of Athleta.

Brooke Roach: Great. Thanks. And just one follow-up for Katrina. Following the strong success in inventory management you’ve seen this year, can you provide an update on how you’re planning inventory for this year and your outlook for improved inventory turns going forward?

Katrina O’Connell: Sure. So for inventory, as we talked about, we ended with inventories down 16% on a year-over-year basis, and we expect end of Q1 inventories to be about similar. I would say as we start to lap the significant declines in inventory by the time we get to the end of Q2, we’ll start to see a more normalized year-over-year inventory dynamic, where inventories are down below sales growth, but still lean. We’re going to maintain the rigor we have around inventories. And I think we’re at our best. We’ve learned when we are reading and reacting to the consumer and chasing into trends. So that’s sort of how we’re thinking about inventory for the balance of the year.

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

Richard Dickson: Thank you.

Operator: Our last question will come from Alex Straton from Morgan Stanley. Please go ahead.

Alex Straton: Perfect. Thanks all for taking the question. Congrats on a nice quarter. Just on your comments for this continuation of the trend that will maybe in Gap on the top line. I’m just trying to understand what that means as it relates to sales growth? Should Gap continue to bleed or what’s the right size of that business over time? And then can Old Navy return to growth? And then I just have a quick follow-up. Thank you.

Richard Dickson: Yes. Look, I think, as we’ve said, our brands are all in different stages of reinvigoration. And ultimately, as we see the performance on Old Navy and Gap, in particular, we’re incredibly encouraged. I mean, as you’ve seen with Gap, the continuation of our reignition is working well. Again, we had a great quarter in Gap comp up 4%, Old Navy up 2%, as we described. These are not necessarily overnight fixes. It will take time. But as a high-performing company, we want to do what we say we’re going to do, and that is also setting up expectations that we believe that we can meet. We’re, of course, aspiring always to outperform and we believe that our outlook really reflects that each one of our brands is in a different point of reinvigoration.

Again, very encouraged with the comps on Old Navy and Gap. And their early work on reinvigoration, which, again, is supported by financial and operational discipline is really showing up on the scoreboard. I have noted Banana Republic has more foundational work to do to recover. The brand is a great brand. It’s got great potential. The new aesthetic is resonating. But the product architecture, pricing, in-stock really, the fundamentals need continued work and effort, and the brand will take some time to re-establish. And as mentioned, Athleta is making good underlying progress, but tougher comparisons from last year, as the brand is lapping significant promotional volume and it’s weighing on the revenue performance. Now we’re going to continue to do this probably through the first-half of 2024, and as the headwinds from the promotions last year abate in the second-half, we’re energized by the potential of the brand and its brand reinvigoration work and the ability to see that brand show up better in performance.

Alex Straton: That’s helpful. Thanks a lot. Maybe Katrina, one for you. Just on the guidance for the year, it looks like you have margin improvement following the first quarter. Can you just talk about what enables that?

Katrina O’Connell: Yes. I would say broadly, as I think about margins for 2024, we have commodity benefits that come in the first-half of the year. Those become largely neutral. And then really, we’re just anniversarying the benefits from last year in the significant improvement that we saw in promotions. So, we’ll see where everything lands, but the guidance, as you say, was 50 — at least 50 basis points of expansion versus last year for the year and at least 100 basis points of expansion for first quarter.

Alex Straton: Thanks a lot.

Operator: Thank you.

Richard Dickson: Thank you.

Operator: We’ve reached the end of the question-and-answer session. That does conclude today’s conference call. Thank you for your participation and you may now disconnect.