Q3 2020 Gap Inc Earnings Call

Sure.

For gap Inc. third quarter 2020 conference call at this time.

Do we very shortly we appreciate your patience patients.

[music].

Please standby we're about to begin.

Good afternoon, ladies and gentlemen, my name is.

I'll be your conference operator today.

At this time I would like to welcome everyone to the gap Inc. third quarter 2020 conference call at.

At this time all participants are in a listen only mode.

Sure wish to participate in the question and answer session. After the presentation.

No press Star one statute acuity Q.

A reminder, please limit your questions to one per participant.

Anyone should require assistance during the call. Please press the star key followed by the jokey on the Touchtone phone.

I would now like to introduce your host Steve Austenfeld head of Investor Relations. Please go ahead.

Great. Thank you very much.

Good afternoon, everyone and welcome to gap Inc.'s third quarter 2020 earnings call.

Before we begin we'd like to remind you that the information made available on this webcast and conference call contains forward looking statements.

Factors that could cause our actual results to differ materially from any forward looking statements as.

There's also a description and reconciliation of any financial measures.

Consistent with generally accepted accounting principles.

Please refer to page two of the slides shown on the investors section of our website gap.

Thanks.

Which supplement today's remarks.

As well as today's earnings release.

Our quarterly report on form 10-Q filed with the Securities and Exchange Commission on June 19, 2020.

And any subsequent filings all of which again are available on gapping Dot com.

These forward looking statements are based on information as of November 24, 2020.

Assumes no obligation to publicly update or revise the forward looking statements.

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Moving on calls a day or Chief Executive Officer said their single.

She financial Officer Katrina.

With that I'll turn the call to Katrina. Thank you.

Thank you Stephen Thank you everyone for joining us today.

Before we get started we hope you and your loved ones are safe and healthy recognizing we continue to address the cobot Evan.

As we head into the holiday season, we recognize many people are eager to purchase guests for their family and loved ones.

Gap, Inc. We've invested year to date over $100 million in health and safety measures to make our stores I say shopping experience both for our store employees and our customers.

Additionally, we further invested in online shipping capabilities as well as curbside pickup options, enabling our customers to purchase Jeff how and when they want for themselves and their families during the upcoming holiday season.

We hope everyone remains felt safe and healthy this holiday.

For today's call I'd like to quickly connect as Dr. day Investor meeting, we held last month I'm feeling art Healthland 2023 strikes.

Following that I'll review, the company's third quarter performance Paul.

Byron thoughts on the remainder of fiscal year 2020.

So Neil will then share her perspective, followed by Q1 day.

So as mentioned before I jump into our third quarter results I want to acknowledge our investor meeting we hosted last month.

In summary, we provided perspective on the power of our brands specifically, our 4 billion dollar brands with old Navy Dinoire, just over $8 billion as of the end of last year, the power of our portfolio, noting the growth synergies that come from each brand being part of our portfolio.

Power of our platform with just two examples being the digital capabilities and extensive supply chain that all brands benefit from.

Additionally, we shared economic model with financial assumptions beginning in 2022 that we believe reflect how old drive ongoing shareholder value.

Specific to the economic model I noted that we expect to 2021 to be a year of profitable growth.

This is 2020, which has been significantly disrupted due the cobot 10 diavik.

I would call it a rebound year and we'll share our thoughts on 2021 as part of our fourth quarter earnings call in early twenties 21.

We also noted that as we emerge from 2021, beginning in 2022, we anticipate the structural changes, we're making now and into next year well set up the company to deliver on a consistent basis low to mid single digit sales growth and consistent operating margin expansion.

Well to achieve a 10% or greater operating margin by the end of 2023.

And we anticipate yielding operating cash flow of 10% of sales and achieved net we've accomplished for a number of years.

As we execute our power plant 2023 strategy, we continue to focus on a number of key initiatives. These.

These include driving growth in our highest margin brands old made yet I'll, let out both of which had double digit growth in the third quarter and when should we expect to be 70% of sales by the end of 2023.

Transitioning the gap brand into a more capital efficient model through our licensing agreement with I.M.G., the easy gap partnership as well as a strategic review our European business to improve profitability.

We also will continue closing unprofitable gap and banana Republic stores.

Which as stated during our Investor meeting will yield $100 million in EBITDA cost savings on an annualized basis by the end of 2023.

Additionally, we target to have 50% of sales by the end of 2023 being online building off the 40% of our sales that were online in the third quarter.

And beginning in 2021, returning to a normalized level of capital expenditures focused on investments to further our omni capabilities, including digital and technology capabilities and distribution capacity.

So having addressed some of our key elements of our power plant 2023 strategy, Let me turn to our third quarter results starting with top line total company net sales were flat, which included the impact of the company's decision to close unprofitable stores consistent with our store rationalization initiative, a key element of our strategy.

Importantly, comparable store sales were comparable sales were up 5% in the quarter, reflecting the fundamental health of the business.

We're also pleased to see that our strategic focus on driving our online business is paying off as online sales increased 61% in the third quarter.

The 5% increase in comp sales was driven by old Navy and that's what.

Which both delivered strong double digit comp number is as customers responded positively to their strong product offerings to relevant marketing messages.

As noted during our Investor meeting old Navy and I've, let out which are cumulatively, 63% of company sales as of the end of third quarter, our both our fastest growing and highest margin businesses, we anticipate growing to be 70%. The company's sales by the end of 2023 as noted during our strategy review.

Will meaningfully add to the company's growth rate and margin.

Third quarter gross margin was 40.6%.

160 basis points compared to last year. This reflects margin expansion of 360 basis points from rent and occupancy savings as we continue to close unprofitable gap and banana Republic stores.

Partially offset by 200 basis points of de leverage in merchandise margin as higher shipping costs, resulting from very strong top line sales growth.

Seated higher product margins, reflecting a lower level of promotions in the quarter.

Turning to operating expenses during the quarter operating expenses increased by 270 basis points versus last year.

It's included over 175 basis points higher marketing investment across all brands with each of our billion dollar brands being advertised during the extended back to school shopping season.

As discussed during the Companys Investor meeting, we believed the challenging marketplace for many other retailers provides our brands and the opportunity to gain market share through increased marketing.

Additionally, the company continued to invest in health and safety measures in its stores as part of our sales shopping protocols.

By customers in a safe and welcome environment in which to purchase items for their family.

In the quarter and these expenses amounted to approximately 140 basis points of de leverage.

Lastly, as you know they also reflected approximately a 120 basis points of de leverage from costs associated with store closures. Although from an earnings standpoint. These costs were essentially offset in gross margin through lower rent and occupancy costs.

These cumulative increases were partially offset by a benefit of approximately 200 basis points in one time cost in a year ago quarter, primarily related to the company's previously planned separation of old Navy.

Looking forward to Q4, we intend to continue investing in brand marketing to compete during the important holiday season.

Well continue to invest in and provide a sales shopping environment for our customers as we manage through the pandemic and we expect to reflect more store closure costs, but again directly directionally offsetting growth margin.

So from an operating income standpoint, with meaningfully improved sales performance versus last quarter and improved gross margin versus last year. The company delivered third quarter operating income of $175 million or 4% of sales.

Looking at other lines of the income statement interest expense was $54 million.

The effective tax rate was 21.5%, primarily reflecting changes in the estimated benefit associated with getting back then the Corona virus aid relief and economic security or cares Act and the impact of the company's geographical mix of pre tax earnings for.

The year to date effective tax rate was 23.7%.

And lastly earnings per diluted share for the third quarter was 25 cents.

Turning to the balance sheet.

Looking at inventory on a reported basis, we ended the third quarter up 1% recall that in the face of uncertain demand earlier in the year, we implemented a pack and hold inventory approach whereby so mostly summer product is being held and will be released during next year selling season.

As a result pack and hold inventory will remain in our reported inventory numbers until released to the market in 2021.

Excluding pack and hold end of quarter inventory was down about 7%, reflecting our disciplined approach to managing inventory.

Looking forward, we anticipate Q4, ending inventory, excluding pack and hold to be down percentage wise roughly the same as Q3.

Now, let me turn to cash flow as we shared at our Investor meeting fundamentally Gap, Inc. Has a strong cash flow generator with over 10 consecutive years of at least $1 billion in operating cash flow.

Despite store closures earlier in the year due to net pandemic gap, Inc. Year to date has generated nearly 400 million operating cash flow or approximately 4% of sales driven in great part by disciplined working capital management.

Specific to capital expenditures, we have invested $288 million year to date.

We now expect to spend roughly 375 million in 2020.

The current estimate is higher than our last forecast of $300 million as the company's strong cash position has supported high ROI fee based investment in digital technology and capacity, particularly in support of our online business.

As noted during our Investor meeting, we anticipate beginning in 2021, increasing our capital expenditure spend from more traditional level of 4% to 5% of sales to continue supporting supporting our growth.

The company ended the quarter with a cash balance, including cash equivalents and short term investments of $2.6 billion. So we are well funded for 2021 and beyond to to invest for the long term health of the business.

Lastly, before I turn it over to Sonia let me share some thoughts on the final quarter of the fiscal year.

Given the high level of uncertainty in the current environment, particularly recognizing the rising rising COVID-19 cases in the U.S. and around the globe were not providing specific fiscal year 2020, our fourth quarter earnings outlook.

However, recognizing any aren't able to enjoy the usual simple pleasures of traveling to see loved ones were attending a concert or sporting event. We believe people are looking more than ever to buying gifts during the holiday season for family and friends.

Our investments in health and safety measures and our stores as well as in our online business coupled with the marketing investments were making in our brands give us cautious optimism for the fourth quarter.

We anticipate getting your perspective on 2021 during our next earnings call, but to be helpful. As we look toward Q4 here are some thoughts on the quarter.

We see the following dynamics in Q4, net sales being equal to or slightly higher than last year gross.

Gross margin rate being equal to last year, reflecting benefits continuing from store closures largely offset by higher shipping expenses.

And operating expenses being between 33, and 34% of company sales, reflecting the company's continued investment in brand marketing capitalizing on the opportunity to capture market share.

Well as the continued cost of in store health and safety measures on behalf of our customers and employees.

And importantly, cash flow performance should remain strong and.

And with that I will turn the call over to Sonia.

Thank you Katrina and good afternoon, everyone.

I'm happy to talk with you today about our third quarter results within the context of our newly defined go forward strategy, our power plant 2023.

As we shared with you at our Investor event in October we grow purpose led billion dollar brands that shape People's way of life. So what does that look like.

It's old Navy paying employees to serve as Paul workers to show that every boys action count.

It's gap delivering American optimism by encouraging people to stand up for one another in their stand United TV spot.

It's banana Republic, we issuing its iconic notorious necklace and raising half a million dollars for the International Center for research on women to celebrate and honor the lights on legacy of Supreme Court Justice RPG.

So let us putting its random mission into action with a $2 million pledge to establish the power of she fund keeping women and girls connected through movement.

It starts with brands that stands for something brands with a distinct point of view that connect directly with how consumers are shopping what they're wearing and most importantly, how they are feeling and in today's landscape. This means more than ever.

Since the beginning we have led to the casualization of the American wardrobe, where comfort fit and quality matter.

Whether it was introduced in khakis and the notion of casual Fridays to the New York stock exchange in the late Ninetys or a modern version of you've got khakis, making the headlines during the election coverage earlier this month.

It's about more than just a pair path, it's about relevance and since our recent election coverage. We saw a dramatic increase in online traffic and within a day a number a straight fit palomino Brown khakis, we sold online went up 90% we connected with people.

Together, our brands reach all ages, all bodies, all social economic brackets, all moments and all use occasions and target approximately 80% of the very large addressable apparel market.

The majority of our assortment is pointed at the usage occasions that are most relevant today and when you couple that with the scale we have across key categories.

Like our nearly 3 billion active business, including fleets and are nearly 4 billion kids and baby business, we are delivering the product consumers want and need and we deeply know what I understand our customers, enabling us to make business decisions with them at the heart of it.

[noise] fueling our brands are powerful omni capabilities. We are ranked number two in U.S. apparel ecommerce sales, we have sharpened our real estate strategy, so that our stores will be where customers want to shop today.

We have increased focused on convenience and experience and uniquely ownable digital and physical spaces.

These advantages give us the power to deliver.

This is such a unique moment in time and in a dislocated market. We are investing in growth today to drive share gains for the long term.

Well, we adjusted and be able to us price strategy. Our teams have been leveraging the power of our brands the power of our portfolio and the power of art platform for many months now and it's showing up in our performance.

Before I dive into third quarter results I really want to thank our teams and I can't say this enough I'm proud to see them, leading with our competitive strength embracing our new cultural imperative co, creating with our customers on each other and driving for growth.

Recognizing that the effects of COVID-19 are still very much a reality for our business our customers and our communities. This has not been easy there.

Their beliefs in gap Inc., our purpose, let brands the values of this company and the customer movies, we serve has been unwavering.

So let me reflect on Q3 and bring to life the power plant 2023 in action.

First the power of our brands.

During the quarter our billion dollar brands leveraged their brand power to win in a dislocated market by delivering the right product at the right time at a time when cost matters most.

Each brand lead with our values and their fall campaigns day.

<unk> dollars increased digital marketing to drive traffic and for the first time in 10 years, all four brands were on TV and it paid off.

Let me start with old Navy, our largest brand ranked number two apparel brands and the U.S. and now the number five apparel retailers on a rolling three month basis. According to NPD.

Old made these results were exceptional driving.

Driving a 15% sales growth year over year, while also delivering margin expansion and market share growth.

They did this by focusing on the democracy of style and service leveraging promotion strategically and leaning into brand value.

Their omni channel offerings provided superior convenience to customers by leveraging their large online channel and well located sweet online.

Online sales for old Navy grew 86% in the corner maintaining its momentum from Q2, even as stores fully reopened.

They delivered strong product performance and relevant advantaged categories like active in fleece and kitchen basics. According to NPD group old Navy grew market share faster than any other denim brands in the U.S. and October on a rolling three month basis. Thanks to its denim America campaign focused on inclusive sizing.

Celebrating old Navy commitment to quality and includes somebody is we are are we campaign delivered positive year over year brand impressions.

Gap brand sales declined 14% in Q3 store sales were lower reflecting our plan to strategically shed unprofitable sales as part of our fleet rationalization efforts.

On line sales grew 38% year over year.

We transition gap brand to a capital efficient and more profitable business. The team is really focused on maximizing online demand through relevant marketing product and quality improvements customer engagement and stronger execution.

Yes, Paul marketing campaigns stands United and be the future both generated positive customer response, Paul store traffic beat the industry average throughout the quarter.

Moving onto the Banana Republic, which represents about 10% of gapping sales in Q3 sales declined 34% and while we are nowhere near satisfied with this result. This is an 18 point improvement from Q2 I.

As we noted during our Investor meeting Banana Republic continues to face challenges driven by the shift in customer preference from a more formal workwear to cash all in light of work from home trends.

With this in mind the brands working hard to update its product assortment prioritizing more relevant categories like lounge sleep active fleece sweaters with a reduced focus on work wear categories like Taylor Citi.

And last we are extremely proud of the results at Atlanta, our fastest growing brand in Q3 I plan to deliver 35% sales growth was September we change the highest sales comp and the history of the brand.

This is continued evidence that Atlanta is honest path to double reaching 2 billion in sales by 2023.

Once again, they delivered deliberate income line growth supported by investments in digital marketing, what traffic and net demand both up approximately 75%.

They're focused on key growth categories that will help us reach new customers, which is driving a healthy Brent price business and productivity gains and there are one and the three assets inclusive sizing pilot is delivering a strong early we'd had about Paul we launched in January 2021, and will be a major growth driver for us next year.

Next I want to talk about the power of our portfolio.

We acquired over 6 million customers in Q3, and our total customer file now sits at 176 million up 15% from last year.

Our customers also spent 6% more with us on average the last year.

Fueling enduring relationships through personalization infusing the voice of the customer at every turn to create products and experiences that they need and want.

And this is showing up in our net promoter score which across all channels is up 13% from Q3 of last year.

Customers continue to come to our brands for masks and we updated styles and introduce innovation across the category now representing 4% of sales across the company.

[noise]. It is our goal to turn every customer into old loyalist.

One of the things I most energized about is a strong launch of our multi tender loyalty program and the enhanced value. This program can unlock.

Since the rollout on September 22nd just two months and we haven't rolled 3.5 million new members to double digit conversion in stores and online enrollment works.

We're excited to build on this as we move into 2021 and fully leverage all customer touch points to mark at the program.

We now have more than 50% of our sales coming from loyalist, meaning they have a credit card with us or they are part of our loyalty program.

This is more than double where we were able to deliver with card alone.

It is an important enabler to our personalization imperatives.

Lastly, I'd like to talk about the power of our platform.

As we shared in October the strength of our platform, including our omni capabilities and scale operations enables us to serve our customers the way they're shopping today, whether it's online safely in stores via partnerships or a combination of all three.

Our agile network also allows us to be nimble as customers shopping preferences change.

In Q3, we saw strong performance online even when stores, we opened but 61% growth versus last year, comprising about 40% of total sales in the quarter.

And to fuel the online growth and drive site conversion, we developed new functionality this quarter to make it easier for customers to shop, including quick add Tabak features redesigns navigation on our mobile experience and improved usability a product reviews and.

And our price is coming to life across our site better than ever with elevated product photography, but as mark emotional and more operational.

Our partnership with pay Pal an after pay went live this quarter with strong conversion in mobile and attractive new customer acquisition, what demographic skewing towards millennial and Gen Z.

Across both we expect to deliver approximately 2% lift in revenue per visitor compared to customers using other payment methods.

I really want to celebrate the work of the digital team I've seen a massive collaboration and acceleration of both talent and innovation as they work to deploy functionality and creative cut through big and small to make the site more engaging for our customers.

One of the biggest value drivers of our power plant 2023, it's a real estate restructuring strategy.

Largely pointed at closing select stores across gap and Banana Republic. Our strategy is rooted in moving away from traditional malls and focusing on more advantageous locations to better meet customer needs.

As Katrina mentioned the work is on track and delivering substantial savings and we'll continue to do so in the future.

That being said, we believe there are profitable opportunities to open stores in both old Navy and athletic in fact, that's what up opened eight new stores in Q3, including their 200 store.

Our stores remain a very important part of the shopping journey for our loyalists.

We're making investments to deliver stands out moments across our omni experiences whether in store or online.

Bull or through one of our new capabilities like curbside pickup or virtual skylake.

In Q3 alone overall net sales volume across BOPUS and curbside increased over 50% proving that our customers are boating for convenience and safety the spreads.

And on November 19th just in time for holiday shopping we launched convenience hubs across the entire fleet of old Navy in outlet stores. These.

These stations will streamline the install process and create a single destination to expedite BOPUS orders curbside pickup some returns reducing customer pain points and congestion at the cash Register.

This is one way we are leveraging our lean and advantage operations to make customer facing improvements that will also help improve operating cost across the fleet.

Before we turn to queuing I'd like to comment on Q4 as.

As we look at the remainder of the year, we're encouraged that according to NRF. The National retail Federation retail sales have largely recovered from the pandemic heading into the holiday season.

Which points to the resiliency of the consumer.

In some ways this doesn't surprise us as people aren't spending money on things like travel or sporting events and concerts.

So with more disposable income available heading into the holidays research suggests that people will be more likely to buy product across our price showing.

Showing a love for family and friends at a time and gifting means more than ever.

At the same time consumers still face uncertainty with rising commodity cases high unemployment and uncertainty around any incremental stimulus and ambiguous operating environment that poses some rest to store operation.

The hedge against these challenges we are doubling down on initiatives that nurture deeper relationships and trust with our customers well.

We're seeing strength in.

Key indicators, such as a 15% increase in stores net promoter score versus last year.

Especially as customers appreciate.

The safety measures, we have committed to ensuring they can shop without worries in our stores.

And as you heard our online business is growing faster than it ever was enabling our customers to purchase our products regardless of the pet debt.

And to support the unprecedented channel shift online, we have scale and deepen relationships with existing parcel carriers and it had new shipping partners.

We wrapped up automation and staffing in our distribution centers or as we like to call them our customer experience centers.

And pulled forward demand to reduce pressure on fulfillment.

Recognizing the increasing online shopping we've seen year to date, we have it.

Invested and having the right capabilities to address the possible surge in online demand.

Big picture I'm proud of the company's ability to improve sales performance during the unique pandemic related challenges. It's a once in a generation opportunity right now with the holidays. Upon us we feel confident in our preparedness and the trust, we've built with our customers through strong execution and save shopping practice.

Yes.

We believe in the power of our brands and that product experiences and capabilities, we deliver to our customers will enable us to grow sales profitably and generate meaningful cash flow to invest in the long term growth all consistent with our power plant 2023 strategy.

Before I wrap Bob I want to share the exciting news that we have two new leaders, joining our gapping senior leadership team.

She is that set up well join our team. This January as our chief growth officer, a newly created position that will focus on executing against our strategic agenda as well as leading growth initiatives for the future and.

She joins US most recently from best buy where he served as president of best buy health and prior to that she strategic growth officer.

He has also led strategy and growth organizations at Cox Communications time, Warner cable and a partner at Accenture.

She is an agent of change with 30 years of experience as a growth igniter. Once on board I look forward to his assessment of value creation opportunities to ensure a consistent growth for the company.

And Sandra Stangl will step into the role of President and CEO of Banana Republic as the brand continues to redefine affordable luxury but.

With more than 25 years experience Sandra it's a strong creative leader known for delivering design vision brand expansion and outstanding financial results.

Sandoz has held numerous leadership positions, including president of pottery barn, where she was part of the team that envisioned and launch pardon pottery barn kids and pottery barn teen.

As well as president of restoration hardware.

And most recently she co founded and was chief merchant of mine disrupted pure play home business.

He joined Banana Republic in December.

I'm pleased to have Ashish and Sandra joined the team both strong industry veterans and visionary leaders known for driving growth through creativity.

As we steered gap, Inc, and our purpose driven.

Billion dollar brands into the future. This gives me even greater confidence in our ability to deliver against our power plant 2023 with that why don't we open it up for acuity.

Thank you once again, if youd like to ask a question on todays call. Please press star one on your telephone Keypad. We'll go ahead and take our first question from Kimberly Greenberger with Morgan Stanley. Please go ahead.

Okay, great. Thank you so much a very nice results Tonight I wanted to ask specifically about old Navy the really impressive 15% bounce back in revenue here would seem to suggest that old Navy delivered some margin expansion as well.

During the third quarter I'm, just wondering if you can laser in on on old Navy margin performance in particular and I I know after.

Financially to challenging third quarters in a row the old Navy business, what was sort of off the levels that had delivered back in 2017 margins.

I'm wondering if you make progress towards recovering back to 2017, and what are the sort of key drivers old Navy a margin expansion or let's say, but turning back to those 2017 margins in the future. Thanks, so much.

Yeah, I don't know if you want to start with sort of the sales performance and I'm happy to wrap up what kind of art, maybe had a standout quarter and we're really pleased with the results strong response to product offering we saw great increase in digital and traditional marketing with more to come with high return on that investment.

Strong active business the kids and baby achieved the number one brand in that segment and in terms of sustainability. We know it speaks to the brand positives and we referenced in our Q4 sales outlook that we expect to be equal or slightly higher than old wise. So we're we're confident about their business and their momentum then.

You know the product margin expansion. So we saw this quarter and you know I think that the the yield management that they drove in combination with their strong product, it's something that bill continue to focus on.

I mean, Kimberly what I would do it.

Oh the team has done really a tremendous job between the lean inventories that we had when we sort of cut the inventories heading into the pandemic and then chasing back into the categories that really have resonated active Suisse Knits kids and baby.

Better Oh, they've done a tremendous job managing the inventory and then the promotions on those inventories so you're right. The team did see expanded gross margins in the quarter based on that and as it relates to historical levels, you know well all see longer term, but we're very pleased with the way that team is.

Executing on all fronts.

Thank you.

Well go ahead and take our next question from Mike.

With Wells Fargo. Please go ahead.

Hi, good afternoon, everyone.

Two questions Katrina, just one quick one sorry, if I missed it did you break out the merchandise margin versus occupancy in the third quarter as I, just said that albeit a stream day I guess at a higher level can you kind of talk to accelerate investments you guys are making up that we saw in the third quarter, but you're talking about for the fourth quarter is this a sign.

Your.

Your expectations on growth going forward or higher or just you know it's an interesting dynamic that we're not really seeing clear there are a lot of other retailers out there. So it was kind of curious how you're thinking about going forward.

Really means to your ultimate trajectory to get the margins back to or 10% over the next couple of years.

Yeah. Thanks, Mike So on the margin question.

You're right. So our third quarter margin was up 160 basis points, what I have said is that.

Run to the occupancy was 360 basis points of expansion and that was partially offset by 200 basis points of de leverage in merchandise.

Merchandise margins, which was the result of higher shipping, which largely offset the lower level of promotions. So higher product margin. So that was the margin dynamics.

You brought up the US today, it's really an important point because we see this time is a very unique time for us to really drive market share gains ahead of other competition. In this dislocated time, we still remain committed to what we said less than a month ago or a month ago, which is.

We're going to continue to invest in demand generation expenses, and we're going to re engineer the fixed cost structure of the company and that's going to be everything from the store closures to the evaluation of some of our international markets for partnership.

Two on some of the work that I know John talked about in our Investor day around driving down operating expenses like store labor et cetera, and so that fall are important for us achieving the 10% and beyond operating margin in 2023, but in 2020 with this cogan environment and really a lot of the week.

Her players seeing significant amount of disruption we see this as an important time to be investing in our brands for demand generation and not the quality of the consumers were going to gain now will pay dividends in the future and so it is a strategic shift.

That we have chosen to make yeah, I'll just add on to that it is quite intentional thanks for pointing it out if I get it and so as we said at Investor Day, a parallel you know 200 billion end market sales.

Hi, guys and a unique moment to consolidate share with whether it's the share donors or it's the weaker players and using both the power of our brand and the scale advantage. We have a we are playing to win in this unique time and we're very committed to the healthy top and bottom lines that we articulate.

Got it and our power plant 2023 last month with the growth and profitable sales and that growth plan.

Deliberate on quarter over quarter.

Thank you.

And well go ahead of moving on to our next question from Matthew Boss with JP Morgan.

Great. Thanks, Bob maybe to follow up on SGN, a is there a way to maybe help quantify the threeq coupon debt. If we think about store closure cost coal cost and marketing expense interest.

Maybe those same buckets whats embedded in your fourth quarter for cash and just larger picture as we think about the timeline when is it best for us to think about the inflection to operating margin expansion as you outlined at the analyst day.

Yeah, So hi, Matt in my speech I tried to break out the basis points of deleverage associated with each one so I'm happy to go through that but.

We said that the 270 basis points of operating increase operating expense increased 175 basis points was attributable to higher marketing.

And then 140 basis points is attributable to the same shopping.

And then we have this dynamic in essence, you day also where any cost but that we have to incurred to close the stores that were strategically closing that falls into SG day, and that was 120 basis points of de leverage so that's.

That's hopefully helpful to you guys.

That 120 basis point to de leverage is.

Basically offset in gross margin, though through a one time savings in rent and occupancy. So that's the one unique dynamic there as we think about Q4, you know we were trying to be helpful. In our guidance around how were thinking about operating expenses. We said, we expect them to be 33% to 34% of company sales when you look at all.

Our as reported last year, you'll see this is a meaningful improvement to last year, that's mostly because we had an almost $500 million.

<unk> expense last year attributable to some store impairments and separation costs. When you isolate for that we expect that the marketing and the store closures or excuse me the store Bob.

Safety costs will be about the same impact as what you saw in Q3 and so hopefully that's helpful. For you as you look at your model you know longer term, let's see what happens we've got a vaccine coming in and we don't know how long that covered a pandemic will last.

But hopefully that's helpful is that we've tried to let you guys know, we think it'll be a profitable sales growth year next year and we'll provide more details on exactly how we see that play out when we get to our fourth quarter earnings call and to build on what chance that had two of the three line items are you know because of the.

Environment, we're in right, whether it's the store safety costs or the cleanup of the real estate, that's been a long time coming and the marketing investment is to play to win and play aggressively to consolidate share and we'll continue to learn and we have a lot of rigor around the returns that those invested dollars with marketing effectiveness mechanisms and so we feel very good about that but.

Two of the three or are not not long term cost that we expect to.

You know to occur and so we'll be out of that at some point and linked to the vaccine et cetera.

That's helpful. Thanks.

Well.

Hi.

Hi, Mark.

Please.

Hi, Good afternoon. Thanks for taking my question with respect to the fourth quarter was hoping you could talk about the the plan shipping headwinds there maybe relative to what you saw in the third quarter and then what are the controllable drivers you have to offset some of these pressures.

So along those lines, maybe hoping you could talk about the trends split shipments.

But how that trended in the fall relative to what you experienced in the in the spring. Thanks.

Yeah, I mean, the good news is that as we expected shipping while still a headwind in Q3 was meaningfully improved from Q2 and that was based on what you just said mark which is that dynamic.

Being able to buy our inventory is more strategically back into the online channel and reduce mostly that that ship from store a dynamic and so we did see a meaningful improvement there now as we look to Q4, our guidance does sort of reflect a multitude of possible outcome, but largely similar to maybe.

Increasing pressure on shipping and a little bit of airfreight associated with art either airing in product when we changed products for the pandemic or the port issues, we've been having the levers we have whether it's.

The merchandise margins that you saw us deliver higher product margins in Q3, and let's see how Q4 plays out but we can see similar.

Execution that would be great. We would see merchandise margins offset some of that but I would say some of the shipping is a shift that we're seeing and we'll see a lot of that benefit offsetting rod with a lot of the store closures and then longer term I'm working through some algorithmic ways to start.

To reduce splits as you say and I was just going to be some of the longer term capital investments.

But I also think we have said before our supply chain is advantage just so I don't know Sonia if you want to talk about that yeah listen I think we have the most automated gecs first sector and that gives us an advantage versus the competition for us is more labor intensive environments and in terms of shipping we have focus quite a bit on what.

Theres order logic improvements, whether it's reducing split shipments all the drivers that though that our control, but as you say, whether it's multi packs in the volume space with old Navy spent many many levers that we are deploying and as you noticed that hopefully is execution for us it set up very heightened premium.

And were expecting and know that the teams will continue to deliver on innovation in the technology space as well as in terms of antenna economics of.

That will help us reduce these costs in the coming months corridors.

That's great Thanks, and best of luck.

[noise] well go ahead and take our next caller Lorraine Hutchinson from Bank of America. Please go ahead.

Hi, good afternoon.

I wanted to follow up on the gross margin point to it seems as though.

Store closure was benefits will continue and for Q and into the first half of next year as we think in the first half was 21 and look at it versus 29. He do you think you'll be able to quote higher gross margins on a year over year basis.

Well.

Right and I think it'll be a good for us to have that discussion on the fourth quarter call. When we guide more specifically to 2021, but it's fair to say that the rod benefit as we discussed in our investor.

Meeting just a month ago is a significant benefit to gross margin as well as operating margin in a long time, but we can talk more specifically about 2021 and the dynamic when we guide later or actually early in 2021 and two is to build on that were more than pleased with the progress we're making on the real estate strategy.

She and execution and the compromises and the fairness appeal to be blended with now the vast majority of our landlords and you know I think.

It will be nice to close that out and really focus on you know what that's gonna then.

Positively impact on the KNL I'm excited to see that.

Complete.

Thank you.

And well go ahead and take our next question from Paul.

Citi. Please go ahead.

Hey, Thanks, guys I'm just one clarification. One question first you mentioned, Bob just trying to gauge or did they go store closing cost so that could be leveraged that was offset by I'm trying to run line I just make sure I understand the 120 that you mentioned on the store closing Todd you got one day.

On the nature or is that going to continue and I guess same question on the rent bonds wouldn't that be something that is ongoing.

Going down to help gross margin. So that was just a clarification question.

I'm, just curious about new customers, they're seeing on the athletic brand, what's customer profile of the new customer relative to your existing customer base and every day.

Chair omni spend thanks.

Yeah, Paul So the store closure costs that were referencing and maybe we're not being clear I think maybe more not but those are attributable to the buyouts. So if you remember when we were at our Investor meeting. We did indicate that there was about 210 million a buyout costs that we would incur as we try and.

It out of some of the high profile stores, it's going to be lumpy, depending on when those negotiations land. So the 120 basis points is attributable to the the cost that we use the dollars that we used to pay out some of those buyout costs with a select number of stores and then as we do those buyout costs, we're able to settle some rent.

Expense and that comes through as a one time benefit to rod now so it's a unique dynamic it doesn't repeat other than maybe in Q4, we have more buyouts as we check chunk away at that 210 million and getting that behind us, but it's kinda dot piece is going to be lumpy, depending on negotiations and then you're correct going forward.

Robert There is an ongoing rent benefit that's more associated with the monthly rents we would've been paying in those stores. So it's a little complicated, but that's what we're referencing listen we're very lucky and fortunate to have such a cash generating business.

That we are able to get some of these problems behind us that are lumpy and hard to to bottom out, but you know we can take the.

The the onetime measure. So we are taking that are showing up and get them done and continue to think about our cash to fuel organic organic growth accelerate our growth going forward.

And then Paul I think you had a customer question, but I I'm not remembering it do you mind repeating it.

The let a customer new customers, we've seen in the brand how the profile different from their existing customer base spending levels.

Oh do you want to take that Sonia the athletic customer certain other than new customers are different that the.

Yeah listen I, what I will say is masks have been a great you know wafer up many new customers being introduced to the athletic brand also.

Also it's a relevant relative.

Relevant category in the active space, which to become even more relevant sternco bid and and advantage because of its all my channel being greater than 50% of sales the relationship with the customer it's at a real builder with my with masks and the team is as innovative and introduced another fourth.

But.

Mass that that has greater and greater assets.

Staying ability at beauty and technical capabilities that customers are really flocking to and so then they get inches when they get into to the masks into some of the you know core.

Core loyalty products, such as the bottoms business. So we've been quite pleased and then you know the reason I said that they did.

You know has has had 60 million views. So the impressions that that brand is making it right now that's unique moment in time is quite high.

Thanks, guys.

Well go ahead and take our next question from Kate Fitzsimmons with RBC capital markets. Please go ahead.

Hi, Thanks, very much for taking my question I guess, just one follow up to to Paul's question. I guess, you know when you noted redness some of the marketing at Athleta I am curious just how you are viewing customer acquisition costs at that brand you know overtime and just you know relative to that superior profitability. It does.

The to the other brands you know do you expect no ongoing investment in that I don't like him to move the needle on brand awareness with perhaps offsets on the merch margin front you know that would be helpful. Just you know some of the puts and takes there and then you know next second just on the supply chain net inventories down 7%.

Actually pack away can you just remind us about some of the supply chain capabilities, perhaps by brand or category that you think in particular can help you I'm support the topline at old Navy and I'll, let Jeff. Thank you.

So.

In terms of the first question outlet. He knows we shared in our Investor day in Atlanta is our fastest growing and most profitable Brad So all of the marketing investments that we're making are contemplated in that statement and in our three year view. So while we are leaning into aggressive growth of brand awareness is mechanisms were also really pleased with the profitability.

The brand and expect that as that grows that the greater share of the portfolio to impact the overall financial health of the company in a very good way that your second question was around the advantage supply chain and what I would say here is what we have just moved very very quickly to add speed and agility because the one thing that we do know is.

It's very hard to predict what the environment look like and we will be best served with that agility. So that our scale advantage has given us the ability to chase in a product that's working really well very quickly shed a week and one month out of our supply chain lead times, you know bring in hundreds of millions.

Of units in faster ways, you know as as we shared at Investor Day. We are I think we've got over 100, maybe hundred 15 now planes that are direct shipping into our Dcs. So that we can chase the product that is selling so lots of mechanisms in our supply chain across the portfolio too.

To enable a really driving sales growth and capitalizing on this once a month in generation opportunity for us.

Great. Thanks, so much.

Yes.

Thank you. We'll go ahead and take our next question from Susan Anderson with B. Riley.

Please go ahead.

Hi, Good afternoon, I look like on for Susan Thanks for taking our question.

So where are you are you able to provide the store productivity by brand or just overall.

Yeah.

Corporation, and how that has trended throughout the quarter and maybe in the fourth quarter and then has.

Conversion rates in store increased with.

John.

Just customer shopping more for purpose and then also as day Newsy collection still on track to launch this spring.

Yeah listen I think Katrina can go through by brand, but I will start with this we're pleased with the conversion improvements in stores, we have seen that and you know I think fueled by the 15 point improvement in our net promoter score. So we spoke about the store environment is.

That's something that the customer has really please with between the focus on safety the focus on the heightened experience.

And he'll leaner units they get a more elevated merchandising environment.

And this and the service emphasis that we've placed so I'm pleased with the in store experience and what that's doing and then your question on on easy Gap you know I think yeah. We're looking forward to the first half launch next year and what I will say is the creative that I've seen and whether it's the product or the.

The E Com site that is getting prepared it's very exciting and very in a bit of some of the most creative work weve seen and so pleased with what's ahead and we are on track for old <unk>, our launch as announced.

And then as far as store sales are concerned so net sales were flat with the 61% increase in online and our store sales down 20% now several percentage points about store sales decline was driven by closures as we said and so the remaining sort of is the average Jeff the productivity.

In Q3, and a similar to the dynamic we've articulated in the past given the results that you see at old Navy and I'm glad I think it's fair to assume that those stores have recovered more quickly, especially since they are largely off mall and strip locations as Paul is the fact that they're seeing a disproportionately.

Hi performance their online business, but then you know gap sort of more in line and then banana more disadvantaged based on the product categories, and then having a tougher time with as they look to reposition their assortment. So I would say that's what I would tell you as far as thinking about productivity in Q3.

Great and then we'll see in Q4, but as you've heard we've been investing substantially in store safety measures to make sure people feel feel comfortable and were also prepared with capacity and shipping.

Capabilities as well as you know store related capabilities to service the customers or however, they want to shop. Since we know that this will continue to be a unique environment for shoppers.

Thanks, John if you don't mind just to follow up on shipping Oh, the carriers provider. They cut off date, just to essentially guaranteed delivery by Christmas or is that something that's still being worked out on.

No listen we are in deep relationship and partnership with our carriers, then they're being very agile with us. So as demand comes in over the next you know these 11 days of of.

The Black Friday through cyber Tuesday, now I guess Ah you know very very important timeframe for US and then December shopping so we're saying in lockstep with our carriers were adding capacity as needed in order to service our customers.

Thank you.

And we'll go ahead and take our final question from Alexandra while this with Goldman Sachs. Please go ahead.

Good afternoon. Thanks, so much for taking my question Paul I.

I wanted to just ask a follow up on the fourth quarter Guide can you help us out with anything that's giving you confidence in achieving this.

Sales level, I'm, just saying that courts, it's a day.

How well then you are thinking about the timing of the holiday season. This year, it's difficult to predict but perhaps [laughter] price.

And then whether youre not when the old cuts are getting old school capacity constraint.

I'm pleased to liberate triple net.

Which culminated in the old.

But I'd love you to pull that together.

Paul.

So I think I called out let me try again, so it wasn't we think the consumer isn't a really good place we think that.

The forecast for consumer spending is up we think that apparel is a great category when when customers can't travel or spend on sporting or events those kinds of things and we believe that our voice share growth as well as our relevance makes us an ideal doesn't.

Nation for for Q4, so I am you know as we learn and shared with you in our last quarter are you.

You cannot predict when exactly the customer will make their decisions for holiday shopping back to school was much later than it had been in previous years, because the pandemic situation. We expect you know.

Dynamics to be what they are and we will be ready our whole focus is we will be ready and ready to service the customer whenever she is ready to shop with 176 million customers, they're all going to choose different types of shop or whether it's the early shoppers or the ones that flow black Friday or the ones that shop on December 24th.

And you know I think we'll be ready for all of them.

And that does conclude todays question and answer session I would like to turn the call back over to today's presenters for any additional or closing remarks.

Thank you very much it's been a pleasure I hope everyone has a safe and.

And you know time down with their families over Thanksgiving and enjoy the festive holiday season, and a lots lots of great gifts for you. Just in case you have one of the states. So talk to you next time.

Once again that does conclude today's conference. We do appreciate your participation you may now disconnect your phone lines.

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