Q4 2020 Gap Inc Earnings Call
Good afternoon, ladies and gentlemen, my name is James and that'll be a conference operator today at this.
It sounds like to welcome everyone to the Gap, Inc. Fourth quarter 2020 conference call.
At this time, all participants are in a listen only mode flow.
At the analysts who wish to participate in the question and answer session. After the presentation. You May now press Star one theater of the Q&A queue at.
Michael Please limit your questions to one per participant.
If anyone should require assistance during the call. Please press the star key followed by the zero key on your Touchtone phone.
I'd now like to introduce your host Steve Austin felt head of Investor Relations.
Okay. Thanks, Jamie Hey, good afternoon, everyone and welcome to Gap, Inc. 's fourth quarter 2020 earnings Conference call.
Before we begin I'd like to remind you that the information made available on this webcast at an earnings call contains forward looking statements.
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 page two of the slides shown on the investors section of our website gap.
<unk> Dot com.
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 again, all of which are available on gap, Inc. Dot com.
These forward looking statements are based on information as of today March four 2021.
And we assume no obligation to publicly update or revise our forward looking statements.
Joining me on the call today are Chief Executive Officer, Sony of single and Chief Financial Officer of Katrina O'connell.
With that I'll turn the call over to Katrina.
Thank you Stephen Thank you everyone for joining us today, it's nice to be with you as we wrap up of 'twenty 'twenty I want to share of comments regarding the fourth quarter of the year, but more importantly provide our 2021 financial outlook as noted in our earnings release today.
Following my comments, so yeah, well there then share of her perspective, followed by Q&A.
We're very pleased with our progress on our path towards sustainable economic model, which I outlined at our Investor day in October.
Let's talk first about some key accomplishments for 2020 that put us well on our path to achieving our power plant in 2023.
First we remain very pleased with the performance of old Navy, and Athleta, which grew 5% and 29% respectively in Q4.
Old Navy gained share to become the number two apparel brand in the U S second to Nike and that's a lot of surpassed $1 billion in sales and grew 16% for the full year. Despite the pandemic.
Combined they represented 63 per cent of company sales in 2020.
The weight of our target of 70% by the end of 2023.
Their standout sales performance reflected gains in market share during the fourth quarter led by their brand strength omnichannel offerings and relevant product categories. So yeah, well talk more about how they compete to win about later.
Theres meaningful progress at gap brand, while total sales for gap brand global were down in Q4 significantly impacted by pandemic related market closures and restrictions in international markets GAAP, North America delivered of 1% comp.
This underscores the progress of the brand is making in the product and operations of its core business.
We're pleased to have new leadership at Banana Republic gap.
Andre Stangl and her team will be focused on repositioning banana Republic for a post COVID-19 world with relevant marketing and product.
We are becoming digital lead dominance our online business grew at 54% in 2020 and closed the year at about 45 per cent of total company sales up from 25% at the end of last year.
At over $6 billion, our online channel is ranked number two in U S apparel e-commerce sales and when leveraged with our well located fleet is of strategic advantage in serving our customers through the omnichannel ones.
Our fleet rationalization is on track and driving significant economic value in 2020, we closed 228, net gap and banana Republic stores globally at head of our 225 store closure target.
These closures along with lease negotiations and rent abatements settlements as well as higher online sales contributed to over 400 basis points of rod leverage in Q4.
We are progressing on our goal of improving the profitability of gap brand as we partner to amplify through asset light models.
The easy partnership is on track for launch in the latter part of the first half of 'twenty 'twenty, one and we continue to be excited by the creativity of that partnership will bring to the brand.
Our strategic review of Europe market is underway and we are in process on several of licensing deals that we believe will provide great extensions to the brand.
We have driven meaningful improvements in product margins with good pricing discipline, and more freight and shipping costs as well as pandemic headwinds have persist at this margin expansion has provided a partial offset against these rising costs.
Several expense levers strategic store closures and a reduction in force early in the year helped us weather of pandemic related costs. This year, such as meaningful of health and safety costs and allowed us to lean into demand generating investments such as marketing.
Marketing has been a strategic investment this year as we leverage the dislocated apparel market to gain market share.
We've undertaken a strategic review of our Internet business as we continue to focus on our 4 billion dollar brands to drive a more profitable portfolio.
And we have generated meaningful free cash flow in the quarter ending the year with $2 4 billion of cash on the balance sheet.
Our reliable cash generation and strong balance sheet will enable us to continue investing in growth in 2021 through capital expenditures. While also returning to our long standing practice of returning cash to shareholders through paying the previously approved dividend in the first quarter and initiating a new dividend in the second quarter.
Recognizing the Covid related challenges faced during 2020, I am very proud of our team and how we remain focused on driving these strategic initiatives to drive long term shareholder value.
As we look to 2021 despite the significant uncertainty that remains related to the Covid pandemic. We are pleased to provide of 2021 outlook today.
For 2020, one we expect to deliver earnings per share in the range of $1 20 to $1 35.
I will provide more context regarding this range at the moment, but it's important to note that the 2021 guidance range. We are providing today was fully contemplated in our power plant in 2023 and in the 'twenty two 'twenty three estimated at 10% operating margin target we provided in October investor event.
So let me move onto of Cat recap of fourth quarter results, starting with sales net sales for the quarter were $4 $4 billion down five per cent of last year at and below our previous outlook fourth quarter sales were impacted by a mid quarter resurgence in the COVID-19 pandemic that resulted in unplanned mandated store closures and restrictions.
Across Canada, Japan, China, and Europe, as well as new U S stay at home orders and select densely populated regions, such as California, and the northeast which impacted store traffic.
The pandemic related impact of fourth quarter sales is estimated to be approximately four percentage points in.
In addition, the sales decline related to strategically planned permanent store closures had an estimated impact of about five percentage points.
Overall store sales in Q4 were down 28% as a result of slower traffic in select U S markets Covid related closures and the strategic closures related to the company store rationalization initiative at.
Online sales grew 49% and contributed <unk> 46 per cent of the sales in the quarter, we leveraged our omnichannel capabilities, such as both of US and ship from store to serve the customer even as the pandemic searched.
Comparable sales were flat in the quarter comp sales by brand or in our earnings press release.
Turning to gross margin on a reported basis fourth quarter gross profit totaled totaled $1 $7 billion and gross margin rate was 37.7% nearly 200 basis points ahead of both last year and the guidance, we provided last quarter our year over year margin expansion is as follows.
Rod leveraged 400 basis points from rent and occupancy savings as online sales increased and as we continued to close unprofitable stores favorably settle lease liabilities and derive benefit from rent negotiations and rent abatement resolutions.
Merchandise margin Deleveraged 210 basis points, driven by 300 basis points of higher shipping costs associated with the increased online sales and carrier surcharges of.
All set by higher product margin due to lower promotional activities despite increases in air freight costs.
Air costs were incurred in the quarter to navigate the port delays that mounted because of COVID-19 imposed restrictions.
Turning to SG&A fourth quarter operating expenses were $1 $5 billion and $34 seven per cent of sales leveraging 640 basis points versus last year.
Recall that last year had 501 million in one time of SG&A costs, primarily related to flagship impairment as well as costs for previously planned separation from old Navy.
We have initiated a strategic review of our Internet business as we reshaped the profitability of our portfolio of brands as a result fourth quarter operating expenses include of $56 million trademark and long term asset impairment charge related to the internet business.
Excluding this impairment charge on an adjusted basis fourth quarter total operating expenses were $33 four per cent of sales in line with our previous guidance for SG&A for the quarter of 33 to 34 per cent of sales.
When normalizing for the intermix impairment this year and the flagship impairment charges last year fourth quarter, SG&A dollars increased $60 million versus last year, notably store expense savings largely offset the investment in demand generation, but nominal increase of expenses over last year being mostly driven.
Real estate termination fees and higher distribution center costs.
Consistent with our strategy, we generated store expense savings of approximately $133 million related to store closures and productivity efforts, partially offset by $40 million and higher health and safety costs to keep our employees and customers safe.
These safety costs are likely to stay with us for the first half of 2020, one, but we are closely monitoring vaccination progress in infection rates and we'll continue to invest in the safety of our customers and employees as long as necessary.
We invested in marketing as we pursue market share growth. During this highly disruptive time in the apparel market marketing dollars were up $66 million year over year end Deleveraged 150 basis points. As a result, GAAP, Inc. Gained seven tenths of a point in market share in Q4, ending the quarter at 6% of.
Of total U S market share for the company.
And we grew our customer file to 183 million global known customers.
We incurred $19 million of costs in the quarter associated with the strategic store closures, although from an earnings standpoint. These costs were essentially offset in gross margin through lower rent and occupancy.
Turning to EBIT on a reported basis fourth quarter operating income totaled 104 $34 million operating margin of 3% leverage 820 basis points versus last year's reported operating margin due to the material year ago flagship store impairments at impairments and costs associated with the previously planned old Navy separate.
Ration at.
On an adjusted basis fourth quarter operating income totaled $190 million with operating margin of four 3%.
Moving to taxes and interest the effective tax rate was negative 204 per cent for the quarter tax.
Taxes were highly favorable in the quarter, reflecting changes in the estimated benefit associated with the enactment of the cares Act and the impact of the nonrecurring income tax benefit related to legal entity structure changes. These tax items in the quarter delivered an EPS benefit of approximately 45 cents.
For the year of the effective tax rate was 40% and fourth quarter net interest expense was $57 million.
Turning to EPS for the fourth quarter, our fourth quarter reporting reported earnings per share was 61 cents versus a loss of 49 cents in the prior year, including of current year of benefit of approximately 45 cents from nonrecurring tax items, and approximately 12% and charges related to the impairment of the at.
Our next business as a result of the strategic review.
Now, let me provide some perspective on inventory.
Total inventory was up 14% versus the fourth quarter of last year. Despite the higher year over year inventory Mark down inventory is below last year and we're pleased with the current inventory composition.
We are confident that first half of Assortments and the quality of the inventory composition will enable product margins in the first half of 'twenty 'twenty, one to be above last year's levels.
There were three main drivers of the year over year increase with the first two associated with the timing of inventory ownership.
First about 10 percentage points of the increase resulted from inventory the company strategically held back in the first half of fiscal year 2020, due to COVID-19 related store closures that will be reintroduced per sale during the first half of fiscal year 2021.
This does drive a temporary increase in our inventory balance it was contemplated in our first half receipt plans, which were adjusted accordingly.
Second new Covid related U S port congestion and impacts on shipping lanes were unforeseen and contributed to higher year over year in transit inventory levels.
And third we continue to sell Covid related safety products, such as masks and hand sanitizers in the near term and Owen to this new category of inventory at year end.
We also ended the year with inventory levels above our prior guidance. In addition to the impact from Port congestion. The second driver of this increase is from longer living seasonal styles and basics that we purposely held at shallow promotions within Q4 to improve product margins, while we balance deeper discounts on seasonally light.
Of all products.
Well this did increase our year end inventory levels of non liable and basic products, we will leverage our responsive supply chain to adjust replenishment within the first half of fiscal year 'twenty, one and believe this strategy will enable us to maximize gross margin over the life of these products.
Looking forward, we expect inventory levels to decrease as we reached the end of the first half end to end Q2, Q2 with inventory up high single digits.
Inventory outlook includes the expectation of continued port delays, causing higher in transit balances as well as set of inventory to support the Q3 launch of old Navy plus product of strategic growth initiatives. The brand is proud to launch move.
Moving to real estate and store closures regarding our previously announced real estate restructure program, our discussions with landlords have progressed quite well and we are making quick and effective progress on our real estate goals. During the year, we closed 228 gap and banana stores globally in line with our guidance of 225.
In fiscal 2020, we incurred cash outlays of about $75 million related to closures.
In 2020, one we expect to meet our closure target of 75 gap and Banana Republic stores in North America, and estimate net cash outlays of about $135 million.
We are still targeting to close about 350 gap and Banana Republic stores in North America by the end of 2023, and we continue to expect total cash outlays of the program of shared during our October investor meeting to be about $210 million.
For the full program as of the end of 2023, we continue to expect annualized pre tax savings of about $100 million.
This estimate does not include our strategic review of our Europe market.
Fiscal 2020 capital expenditures were $392 million below our normal levels of investment as we responded to the pandemic impact on cash flows.
Regarding the balance sheet and cash flow for fiscal year 2020 free cash flow was negative 105 at $55 million compared with positive $709 million last year.
Notably following the challenges of the Covid pandemic earlier in the year free cash flow during the last three quarters of the year was approximately $900 million.
We ended the quarter with $2 $4 billion of cash we are committed to the uses of cash we laid out at our Investor day number one invest in growth through capital expenditures number to return cash to shareholders largely through a competitive dividend and number of three evaluate how we use excess cash to delever of.
Over time.
In light of the continued pandemic uncertainty we remain prudent in our approach to cash management with a balance between return of capital to shareholders, while maintaining financial flexibility to invest in the business.
And our ending share count was 374 million shares.
So before I turn it over to Sonya, Let me touch on our financial outlook for 'twenty 'twenty, one while the biggest impact from the pandemic is likely to largely behind us we expect the lingering impacts as seen in the fourth quarter of international market closures and stay at home restrictions, including in Canada, China, Japan and Europe.
As well as U S. Covid case counts to persist, particularly in the first half of 2020 one.
However, as vaccines rollout and stimulus checks begin we currently view the second half of 2021 favorably reflecting of likely return to a more normalized pre pandemic levels.
With that in mind I would like to provide the following guidance for fiscal year 2021.
Excluding costs associated with strategic reviews, we are conducting in Europe or with our intermix business, we expect earnings per share to be in the range of $1 20 to $1 35.
Now let me provide you with some additional guidance metrics for 2021, we anticipate full year net sales growth to be in the range of mid to high teens versus fiscal year 2020.
We expect to deliver an operating margin of approximately 5% in 2021 day.
Outlook for 'twenty or 'twenty, one is consistent with the company's powerplay in 2020 three objective of achieving at least 10 per cent EBIT margin by the end of 2023.
We expect to open 30 to 40 old Navy stores, and 20 to 30, Athleta stores and consistent with our strategy. We plan to close approximately 100 gap and banana Republic stores globally, including 75 closures in North America. This will put us at 75 per cent of our targeted North America closures by the end of fiscal 'twenty one.
We expect the annual effective tax rate to be about 25%.
Our reliable cash generation of balance sheet remains strong as we look to 'twenty 'twenty, one of our capital allocation philosophy and priorities remain consistent.
First and foremost we plan to invest adequately, but responsibility responsibly in the business to drive growth.
With that we expect capital expenditures for the year to be about $800 million.
We'll shift our capital spend of higher Rois see projects as we just store our investments towards higher returning customer facing growth initiatives, such as digital customer acquisition programs like loyalty D. C capacity to accommodate online growth and store growth for old Navy and Athleta.
Second we remain committed to returning to paying a dividend with that we will pay the previously declared in deferred Q1 fiscal 'twenty dividend of just over 24 cents per share in Q1 of fiscal 'twenty one.
In addition, the company expects to initiate a new dividend in Q2 of 2021 at a level that balances the return of capital of shareholders with the financial flexibility to face continued uncertainty and invest in growth.
In light of the current uncertainty related to the pandemic recovery, we do not anticipate share repurchases in the first half of 2021.
We believe this outlook reflects the company's progress even amidst the challenging 2020 and as we transition to a strong 2021 and most importantly is consistent with the strategic objectives and long term goals. We shared with you during our October investor meeting, including improving our cost structure, particularly through store fleet rationalization.
John.
Strongly supporting the growth of our brands and returning cash to shareholders.
Looking forward, we remain on track to delivering our 2023 EBIT margin target of about 10%.
Gross in 2020, and our guidance for 2021 continue to provide important milestones of progress on our journey towards that goal.
Continued improvements beyond 2021 will be accomplished by progressing the following initiatives one completing our North America store closure plan too.
Two sunsetting COVID-19 costs, such as health and safety three completing strategic reviews of select international markets and domestic businesses for making meaningful progress on engineering fixed operating costs fall.
Five launching sourcing logic and inventory of initiatives targeted at growing gross margins as we look to defray growing pressures from the continued shift into online and fix leveraging increases in marketing from 'twenty to 2020 'twenty, one we made to proactively gained share.
And so with that I will turn the call over to solar.
Thank you Katrina and good afternoon, everyone.
Before we look ahead I want to take a minute to reflect on 2020.
COVID-19 presented the biggest crisis, our company our industry has ever faced and alongside of our employees our customers our communities and the rest of the world. We say challenges that defined a new paths for every one of us.
It's also true that every crisis is an opportunity and this one net gap Inc. At a crucial pivot point we.
We use this opportunity to lead with our competitive advantages while embracing the values of company was founded on.
Emerge in a place of strength and with a clear path forward.
Our teams showed resiliency and the ability to try fast learn fast and think big to meet customers' needs.
First we gained meaningful market share quarter over quarter by investing in growth across our purpose led brands. During this period of market dislocation.
We grew our global known customer file by 14% in 2020 to over $183 million and introduced convenient new ways for them to shop with us by expanding our buy online pick up in store capabilities to curbside pickup and launching new payment methods like after paid and introducing.
Our loyalty program.
Our online business reached over 6 billion in sales and delivered 54% annual sales growth leveraging our powerful omni channel platform.
Following the shutdown, we reopened our fleet of more than 3000 stores quickly while permanently closing of group of over 22 of 200 of unprofitable stores as part of our fleet rationalization strategy.
With the increased casualization of style, we played into our product category strength with disproportionate sales coming from active and sleep sleep and kids and baby.
We also quickly pivoted to produce masks of new top category, which represented 3% of sales in 2020 and drove new customer growth.
We met our economy of our customers' e-commerce shipping expectations at scale with on time delivery of approximately 130 million products well above the industry average.
And finally, we help to develop the gold standard in health and safety practices, allowing employees and customers to feel confident working and shopping at our stores.
Now as we turn the page to 'twenty 'twenty, one we're pleased with the traction we're seeing in the business. However, we understand retail is highly volatile and we will continue to face challenges that we will remain agile in the face of.
I recently had the honor to speak with President Biden, Vice President Harriss and other members of the New administration alongside several other Ceos.
I represented of our business and broader industry discussing the urgent actions required to recover from this crisis and rebuild and equitable and inclusive of economy.
And while uncertainty remains I'm confident in our agility and gapping speed and flexibility and that's all of that will serve us well.
So at all we understand this is a long game and are squarely focused on executing against our power plan 2023, and delivering profitable growth in 2021.
Let me walk you through how our strategy will show up this year, starting with the power of our brands.
Each of our brands are poised to deliver growth through world class branding relevant product and unbeatable experiences that will inspire our customers to become loyalists.
Each with a distinct point of view deeply rooted in value.
Let me first talk about old Navy old.
Maybe its results were very strong in Q4, driving 5% sales growth year over year, while also delivering margin expansion.
According to NPD group Old Navy has made continuous market share gains each quarter year to date on a trailing 12 month basis, the brand's strong value proposition leadership in key categories like active in fleets and kids and baby and commitment to leading with values because of lot of old Navy to win in today's dislocated market.
And they will lean on the strength of moving forward.
The future looks bright for old Navy and we're confident in their ability to grow to $10 billion over the next three years. This year old Navy will deliver on the democracy of style through its commitment to inclusivity and the rollout of plus to the entire store fleet later this year.
They will focus on democratizing service through a differentiated experience powered by new and highly scaled omni capabilities as well as their navias loyalty program that will accelerate value creation for both of our customers and for our business.
Next GAAP GAAP.
<unk> stands for most of the American optimism and we have seen customers respond well over the last year to a more consistent point of view as we've leaned into relevant product and culture of defining conversations and creative.
We are positioning gap to win for the long term by creating a profitable store fleet of shift to digital and by delivering effortless style and quality and market share gaining categories and partnering to amplify brand reach.
This transformation is well underway and we're excited to build upon at this year.
The number one question Mark gets asked and I as well is about our use of GAAP partnership we're on track to launch at in the first half of this year and I'm impressed with how the team is unleashing their creativity and innovation in both the development of the product and the experience for the customer we cannot wait to share with you.
Additionally, we're excited about the licensing work underway with IMG and are set to deliver new categories like gap home and baby gap gear later this year.
Moving to Banana Republic since the appointment of Sandra Stangl inside of Banana Republic in December the team is moving fast to position the brand per house by redefining of affordable luxury and building a road map for growth that meets customer needs today and in the future. We're excited to see how this comes to life later this year.
In January we launched B, our standard a collection of Lux performance were at an elevated essentials for every day more in line with current customer trends as well as creative repositioning of February that is beautiful and right per brand.
The team is off of highly focused on the store experience from transforming allocation of inventory to better align with our customer improving visual merchandising and transforming our field culture from operational to one of style of service.
And finally athletic with 29% sales growth in Q4, yes, 29%, we have never been more confident and that's let us pass forward and its ability to reach 2 billion by 2023 at.
Letter is our highest margin business and like old Navy has made continuous market share gains each quarter year to date the brand position in the growing active category and at the powerful mission to support confident women and girls gives the team permission to grow in multiple directions across product categories digital and physical.
<unk> internationally and through of distributed commerce by leveraging the power of our platform and portfolio.
That's a lot of had to exciting product launches in January per.
They brought three parts of the market using of rapid customer centric product innovation approach that they will apply to other opportunities going forward. This looked at Gulf with a customer at the center.
Next to bring life to its mission of Inclusivity athletic.
That's a lot of announced expansion into inclusive sizing.
For spring 'twenty 'twenty 170 per cent of the athletic collection will be available in sizes onex to three X now.
As part of the eye palette of launched a new holistic brand campaign entitled All powerful.
Multiplatform celebration of the beauty of empower and all of women. We believe both of these part of expansions would of major growth drivers in 2021.
Our vision is to grow our purpose led billion dollar lifestyle brands and as Katrina mentioned earlier in line with our strategy. We have performed at a strategic review of our Intermix business. This moves allow allows us to prioritize our strategic focus and resources behind the brands of the most potential and that generate the most sales end.
Perfect.
Next the power of our portfolio.
Together of brands have huge reach targeting approximately 80% of of $200 billion addressable apparel market.
<unk> of our portfolio is extending our reach to new customers.
Each brand playing their part too through creative differentiation pricing segmentation and product expansions like teen plus and tweaks. It's also leveraging the brand's collect of power to make big product bets like we did last year with masks.
We're also using that collective power to grow our customer file them sort of thought about this we welcomed new customers and are building stronger relationships with the ones. We have as I've said before it is our goal to turn every customer into a loyalist relaunched our navy at gap, good Banana Republic, and Athleta rewards at the end of.
September end of Q4 alone enrolled $6 4 million, new loyalists across the company into the program.
One of the biggest value drivers for us in 'twenty 'twenty, one will be the full implementation of integration of our loyalty program across all of our brands. This summer.
We know members of our loyalty program outspend non loyalty customers by more than 80 per cent. That's integrated program will offer all of our loyalists benefits across our entire portfolio, while still providing unique and emotional brand connections.
If we can get a customer from a single transaction multiple transactions at multiple channels at the multiple brands, we see value accretion at every step.
And the other focus across the portfolio is the profitability of our store fleet.
We are on track with our fleet restructuring efforts across gap and Banana Republic, while we're opening stores across old Navy and Athleta to fuel growth. Additionally, we are moving forward with the strategic review of our Europe business and we'll have more to share at later this year.
Finally, the power of our platform.
Powering our brands at the strength of all of our platforms and capabilities at scale at number two in the U S. Apparel E. Commerce sales of 6 billion. We believe gap, Inc. Is uniquely advantaged to win in digital our online business grew 54 per cent in 2020 and closed the year at about 45% of total company sales.
To meet the rising demand of online shopping at our target of increasing digital penetration to 50% by 2023, we're focused on personalization at scale and enhancing capabilities across mobile all supported by a highly automated fulfillment network.
Mobile has become our customers preferred way to shop with us online and we know it can deliver further degrees of purpose of personalization and inspiration as well as enable the entire omni shopping journey.
We now have over 50% of traffic at 75 per cent of sales annually through mobile.
With mobile as the primary engagement platform, we're working quickly to create pictures of frictionless mobile shopping of new digital experiences of devices networks and customer preferences evolve.
Fueling the growth of our online business.
As our investment and distribution center capacity.
Last month, we announced plans to open a new state of the art D C in Texas to support old Navy's growing online business of delivering.
Inventory faster and more efficiently to customers across the country. This new campus will allow us to meet the rising customer demand for online shopping.
Key elements of our power plant will also take shape and our thousands of stores are making customer facing improvements that will also help us reduce store operating costs.
We will apply automation to key customer touch points that will enable greater levels of service and engagement with our shoppers, including exploring the introduction of self checkout later this year we.
We will begin at work on optimizing our store operating model starting with old Navy are leaning on lessons of talent from our distribution centers.
Through sort of closures strategic reviews at our focus on reducing fixed operating costs. We are building a virtuous cycle where.
Productivity compute demand generation pointedly, our investments in technology and marketing of Katrina mentioned, we're making progress against SG&A at our effort that system of lives and digitize our operations will be the rocket fuel for growth across our breadth of them.
As America's largest clothing company with reach around the world and of collection of purpose led lifestyle brands, we're proud to create product experiences of customers love well at doing right by our employees communities and the planet. We are led by our purpose inclusive by design and then the coming year our steadfast.
Cost of delivering on our commitments to racial equality and increasing representation of at all levels of the company.
We fundamentally believe the diversity of experience thought and perspective increase of creativity and innovation promote high quality decisions and enhances business growth not to mention of deeper reflection of our customers.
Today, we announced that's alarm call Ms. Smith has been elected to serve on the Gap Inc. Board of directors for Lam has a proven creator and innovator, bringing more than 20 years of leadership experience from top brands and entertainment, including Walt Disney Company, Comcast NBC, Universal and Viacom. She has the perfect blend of art and some.
Bob.
All of this and creative vision with strong business insight.
It's a long connect deeply to gap, Inc value, having hard of led one of the most diverse and inclusive management teams at her industry.
We look forward to her energy guidance and leadership as we work to serve and represent the voices of interests of millions of customers.
Now before I turn it over to Q&A I want to thank the team at <unk>.
A year ago I was asked to lead this incredible company and I could not be prouder of what our nearly 120000 employees along with the 2 million around the world and our value chain of accomplished together.
This year allowed us to unleash that potential and we're ready to deliver the next phase of work ahead.
So the power of our brands our portfolio and our platform, we are ready to deliver profitable growth value for our shell shareholders at a future. We can all be proud of.
With that I will open it up for questions.
Thank you as a reminder, for those analysts who wish to participate in the question and answer session. Next day presentation. You May now press star one to enter the Q&A queue.
First question will come from Matt boss with Jpmorgan.
Great. Thanks, So at old Navy, 7% comps.
Significant improvement in the Mark down the rates for the third straight quarter I think now so could you just speak to what you see driving the inflection at old Navy any structural changes with inventory.
Sustainability of top line growth in the mid teens margins at this concept in your view.
Yeah. Thank you for the question of we're really pleased of the trajectory of the old Navy business as it's been a strong response to the park offerings through 2020, and we think we've distorted into the winning categories with excellent execution and we're investing in digital and traditional marketing with more to come strong.
Long Act of business old Navy seen phenomenal growth, there and we're very well positioned to meet the rising demand for active and casual product over last year, and kids and baby and other very bright spots of the brand as a at.
The old Navy achieved the rank of number one the kids Baby brand in this segment and this is a particularly distressed sector outside of our business and so where we are consolidating market share aggressively here.
The brand has evolved the product offering and we expect of launch extended sizing that coffee assortment. This later this year are at the test results have been really positive. So proud of the worst of the team is doing to give our customers what they're asking for is confident and the sustained momentum against our power plan 'twenty 'twenty three at I don't know if you'd like to build on that.
Not what I would add is a couple of things so as Sonya side, you know, they're advantaged in their value space and with their democracy of style positioning and then their creative execution has been excellent and they offer the products customers want like active and kids and baby and then as we look forward we are at.
Launched in the plus business in the back half of this year, which we think is really squarely are appropriate for acquiring new customers and servicing better of the existing customers and also the loyalty capability that we look to launch in the back half of the year as we.
Look forward to driving more lifetime value with our multi tender loyalty customer and then you know to add to your question about margins I would say Bob.
The right products with a relevant brands and strong execution has allowed the team to really pull back on promotions on and use the strength of the brand and marketing to drive the sell through on the inventory and structurally we feel like Theres, nothing really holding them back from continuing to the.
<unk> of that and then I think you heard Sonya say in her prepared remarks. We're also looking at the store productivity as it relates to self checkout and other mechanisms, where we can start driving more productivity in the stores. So I guess also say we have great confidence in how old Navy has executed and what the future holds for them this year.
And beyond just.
It just didn't build asks if we could talk about this forever. It's very exciting to the main capabilities that were that we know of help with driving consistency price and consistency is very very important for this business is the fashion of our loyalty program, which allows for repeat visits and a deeper relationship and the personalization journey that are tuck ins.
Estimates are fueling and so when you think about the huge reach of old Navy and at the sheer customer file and personalization continues to progress and having the ability to optimize on product on price et cetera.
Need for the historical discounting our methods of.
Driving the business are fading as we move into these more sophisticated and consistent of capability of big part of our capital investment of this coming year and we're excited to see what that will do to transform.
This very important measure that we're holding ourselves to which is consistency of growth.
Great color best of luck.
Next we'll hear from Oliver Chen with Cowen.
Hi, Thank you very much regarding their loyalty program and the innovation there how did you decide to.
It could do at as a platform versus pursuing individual brands and how would you speak to the intersection of speed speed agility and supply chain.
Relative to interaction measurement end.
Or a lower hanging fruit at your loyalty program can achieve thank you.
That's a great question and boy, we spent a lot of time on this you know we have these four amazing brands. We also one of the power of our platform and portfolio. So we're solving for the assets not be more of what we're doing with this with our loyalty design is to have really intimate emotional brand level engagement and offerings, while at the same time.
We know the customer values Cross brand shopping we know the customer value the benefit of the portfolio. So we're doing both and we've been very thoughtful about what offerings, we give our customers depending on their preferences.
As it links to supply chain to make sure I understand your question one of the things we are using loyalty for and we're designing it for us to tier of fulfillment based on if you're a bronze silver gold member of for example is about also allow us to optimize.
The speed of delivery and fulfillment based on our best customers and manage fulfillment cost effectively walked pleasing or most of them.
I'm not a valuable lifetime value customers.
Thank you and just a follow up reintroduction of inventory as you do that how does the other select with the trends that you're seeing now and also of the promotional environment in terms of optimizing our reintroducing inventory that you held back in a in a dynamic environment.
Yeah, No great question listen we love of inventory that we fall back last year, we were very thoughtful about what we hold back to make sure that it would be irrelevant now and we believe it is its already coming to life in our stores as we speak and we're seeing good acceptance. So that's all contemplated in Wisconsin played it in our inventory buys for Q1 and true.
Of seasonal relevance of integration.
Thank you very much of us regards.
Next we'll hear from Ike <unk> with Wells Fargo.
Hello, everyone I'm extremely thankful of the AR with.
Details on how it will go I was wondering if.
Some of the well the 120 to 135 I believe.
Got it excludes any reactions from your mix or the European business of golf.
Could you frame waterproof could you wrote of flow would be.
Of these drugs.
Two people from all of them on the P&L.
I can I'm glad you caught that because it's really important we're still deep in the negotiations on a potential operating model change or outlook for Europe, and we just have initiated a strategic review for Internet. So more to come and the reason why we didn't include it in our current outlook.
Because we didn't want our current outlook to be clouded by what we don't yet know the outcome of those two things will be but certainly as soon as those things start to take shape, we will provide as much detail at as possible to be able to help you understand what the impacts of those are if you think about just at the highest level of model change on Europe.
If for instance, we were to partner of franchise that model. The revenue, which is about two per cent of sales will go down right as a franchise business of our partner business, but importantly.
The SG&A, the rent and occupancy and really the cost of operating that business will be meaningfully less and so they should have a profit impact of that is favorable to the company now more to come on exactly how that gets structured when and how but that's conceptually how it could work and again, we will update you.
As soon as we know more about how how those things are progressing.
I guess, just a profile of Katrina.
Is it possible to say, what we're talking about a penny super cute at all or were talking about no recalls of Darns of I guess, just some trimming of out of it would be helpful to them.
So I mean, I guess premature because again, we are not sure even what the change will look like and so as you can imagine the model that we choose will have a wide range of outcomes and so we'll let you know, but again, we said that Europe is two per cent of sales we have about 120 wholly owned stores and.
We have an online business and so that can help you understand sort of order of magnitude.
But again at it just is too premature without having really gotten to at any level of of structure, yet on what the future could be either be able to dimensionalize that it could be such a wide range of outcomes. So we promised as we've committed to transparency of as soon as we have line of spice of that will provide more details.
I'm just sort of bogey.
Yeah.
Okay.
Ladies and gentlemen, as a reminder, please limit your questions to one per participant. Your next question will come from the line of Kimberly Greenberger with Morgan Stanley.
Great. Thank you so much I wanted to just ask about the.
Occupancy or the rod leverage this quarter of 400 basis points Katrina items. He said how much of that was a sort of temporary savings that that might've been from rent abatements that you were able to settle and how much of that is permanent driven by the store closures.
Yeah. Good question.
So really I would say at Kimberly about half of the Rod leverage is permanent as it relates to closures and so ongoing and the other half is really the temporary nonrecurring benefits.
Okay. That's super helpful and I, just ask one follow up on a on the comp for the fourth quarter could you just help us understand a little bit of the texture of the progress through the quarter did you see improvement in comp trend from month to month did you see any sort of pickup in.
January on the back of <unk>.
Stimulus and.
I'm not sure. If you gave of comments and I missed it on sort of how Q1 has started but if you have anything you'd like to share their I'd certainly be curious about that as well.
Sure Kimberly I'll give you a little bit of insight on the fourth quarter and then maybe Sonya can talk a little bit about how the quarter has started Bob I would say you know we continue to see the dynamic that we saw all year in the midst of this turns down there at play out in the fourth quarter aware of.
On the customers just shopping differently and so the peaks art as peaky and theirs is just sort of a flatter seasonality and so overall when you think about November December January I would say.
Different flatter seasonality now of course December is also when we started to see the pandemic surge again, so that had an impact on on December <unk>.
And then I'll, let Tony talk a little bit about how we're feeling quarter today, Yeah. Let me just start by talking about the comp sales look I'm really very pleased to see three of our core brands deliver positive comps in Q4, including gap brand and I think that just shows the operating health.
Overall, though I would say is.
We had we grew our customer file by about 14% that's meaningful and those customers paid more we saw higher pricing realization and the reason we saw that was because our products resonating and our branding and marketing is more emotional and more connected which then converted these customers into loyalists.
So these are some of the underlying trends that were pleased about and we've seen that play into the start of Q1 with with more momentum in February than we had in Q4. So we're pleased with the start at.
And with these new capabilities that we're deploying and the response that we're seeing from a customer through price and acceptance and acceptance of our product.
Great very encouraging thank you.
Our next question will come from Adrienne <unk> with Barclays.
I'll be at my how pleased I end to see the progress of my congratulations to everybody.
So I guess my first question is.
On the incremental AD spend that started in the third quarter carried into the fourth quarter can you talk about how you felt about the return on that AD spend what it means that you go into this year and what we should think about either in dollars or that I guess at pushing on need of five 5% at five seven.
At this year, but at very low sales. So how we should think about total AD spend for 2021, and then Katrina could you just remind us I.
Thank you I just missed it in the prepared remarks.
<unk> sales during the fourth quarter, what percent was from store closures temporary versus permanent store closures and how should we sort of shape of sales against fiscal 19 Q1. Thank you very much.
Maybe I'll start with your last question and then some of you can talk about marketing for a second so think of in the fourth quarter. What I had said is that we attribute of about four points of sales loss in the quarter to the COVID-19 related impacts for the quarter at about five percentage points of sale.
<unk> decline related to our strategic.
Of our closures that were closing permanently because we are restructuring in gap and banana. So though that's the store closures you know as it relates to Q1 I think it was selling yes that is true which is quarter to date. We are pleased with the momentum we're seeing and certainly seeing what the trends are better than what we saw in Q4.
Sure.
Mhm and I think I'll leave it at that I was going to say you know.
There's there's pluses and minuses as you can imagine right. There is all of the momentum of Tony you spoke to as far as the underlying health of our brands the incremental growth that we're getting from our file of the margin momentum we're seeing but we're also still navigating COVID-19 and we said in our prepared remarks at the front half of the year likely have some.
Of that Sterling at whereas the back half of will return to the pre pandemic levels.
So I'll, let you sort of model Q1, and Q2 based on that but overwhelmingly feeling like.
So far so good and we certainly feel good about the mid to high teens sales growth guidance that we gave you of overall for the year.
Very helpful and let me, let me add on to that and give you a little color on marketing you know as we declared our strategy at our investor at about last year, we led with the power of our brands and so for us that meant moving to offense on branding marketing and technology investments to unleash that power and when we.
Talk specifically about marketing and the investments we do expect those investments to continue we feel good about the effectiveness of those investments I can talk about at the high end of the funnel top of the funnel at the bottom of funnel certainly at the bottom of the funnel our digital marketing investments, we manage by the hour by the day by the week and have a lot of flow.
Liberty of being able to turn that on and off based on at the turn on that investment and at the top of the funnel in terms of brand affinity and brand building. We've been really pleased with the creative clarity that we're seeing from our brands and the values based marketing its given us some of the highest AD spots that we've seen in the history of the company. This past year, so that cash.
Combination of momentum that we're building incredibly of talent that we're adding to the teams and unleashing the full.
Create of potential of our team is giving me more and more confidence that leaning into marketing in this time of dislocated disruption Ah is even more critical than ever as he looked at consolidate market share from a position of strength.
Totally agree that's good luck. Thank you.
Yeah.
Yeah.
Our next question will come from Janine Stichter with Jefferies.
Hi, Thanks, so much for taking my question and congrats on the momentum.
I wanted to ask a bit about the ports is there any mark down risk associated with kind of the product at as maybe arriving later than planned or is that mostly at smoothed out and accounted for and then on the merchandise margins of the product margins. I think you said above last year in the first half maybe you could help us contextualize, where that would be versus at pre COVID-19 levels and then more broadly just how you see.
The markdown opportunity didn't hold thank you.
Yeah as it relates to the Port I would say it really is timing and you.
You know certainly we wish everything could be here exactly on time.
But fundamentally the team has developed a on the amount of agility around of navigating.
The assortment of timing and so they are watching closely the timing of when the receipt of getting those into the stores and then if there is lateness adjusting receipts on the back end and so we feel quite good that theres no margin impact of the court issues. Its really more of all of the timing of getting things Offloaded end over here.
So that's that piece I think as you said, we set our mark down inventory was below last year heading into the year of the teams did an incredible job I've really balancing of the choices that they made around pricing to get higher AUR as lower mark down inventory levels, and then are highly focused on maximizing the <unk>.
On the inventory we have in the front half of the year, you know I'm not going to kind of specifically as it relates to 2019, but certainly our aspiration as a company is to continue to build momentum through relevance.
In our brands and better product to drive incrementally better margins year over year, especially as we look to offset some of the structural changes that happened in the business leadership in the online. So anyway, we're focused on AUR and as you said, we're focused on driving higher margin products.
Space in the first half.
Great Thanks for calling.
Our last question will come from the line of Kate Fitzsimons with RBC capital markets.
Yes, hi, thanks, very much for squeezing me in I guess at one four Sonya and then one for Katrina Sonya can you just elaborate a bit more about the inflection you saw in the gap brand in North America, and I guess as you're evaluating that brand now into 2021 and in context of your plan and you ended the year.
I think Jeff maybe brand consideration at moving in the right direction relative to awareness.
Katrina I guess.
Appreciate certainly the 5% EBIT margin target I guess some of them are just thinking about the puts and takes relative to where we were pre pandemic.
At six point for margin occupancy at certainly moving in the right direction sounds like you're feeling good about the product improvement.
Improvements here in the markdown opportunity.
And I guess, you know the all sorts of Covid costs I guess the type of piece together I guess, you know pre pandemic and now 2021 thank you.
Yeah.
Yeah happy to talk about GAAP, so listen I want to say at North America comp in Q4 is it reflects the positive momentum in the brand and they've done so much hard work this year of restructuring their unprofitable fleet segments of it while investing in there in their stores I mean, we refreshed 70 of our go forward stores, we intend to get.
The rest by mid year and he always at a store in New Jersey recently, and the customer soft and of trucks and said this is light brightened happy I mean, whats the better Stephen than that fall.
Four of to hear from our customers, we're seeing a really nice pickup in net promoter score as a result of our refreshed plan. So the restructure of the stores the improvement of the go forward fleet the leaning out of the SG&A and this is of lean mean effective team now that is wired and it has a culture oriented.
Twinning, they're attracting new customers are their team launch for example, there are is now representing about 17% of the kids business and they're centered grounded in sustainable product offering. So I'm really pleased to see their overall discounting reduced and then the partnership.
You know of partnerships are an important part of the future of the brand.
We we have the big launch coming up with easy gap and I spoke to easy last night, he's very very focused on them on.
This incredible opportunity, we're both very excited about it and he and mark and the entire GAAP team our heads down and believes it to be at a very big potential for us and look forward to sharing more with you as we launch in the first half and then our licensing program, but our plan that we signed last year, we expect some big launches.
In multi categories across our lifestyle are coming up here. A later part of this year, so lots of levers to drive the momentum in gap, while dealing with the structural issues that have plagued the brands at.
And you know what makes me happier fall asleep is to see the fact that the brand is trending it's trending with the younger customers at spending on kicked off the new spring launch is incredibly relevant and we're seeing massive impressions you know whether it was cornacchia khakis during the election or what we're seeing today.
The brand is back in the conversation at the Zeitgeist of culture, where it belongs and it's incumbent upon us to continue to deliver excellent execution with discipline in every day to live up to the promise of gap brand potential.
And then Kate as it relates to the operating margin at.
Did you say that 5% operating margin of margin guide for this year that we gave today is very much on the path to the 10% operating margin goal, we put out for 2023.
As we had said at our Investor event in 2020 with Covid 'twenty 'twenty. One has returned to profitable sales growth, but you know we do we have set at the first half so contemplate some of the COVID-19 related impacts and.
And so whether that's a little bit of weight on the sales driven by store traffic our market closures, whether it's health and safety cough or higher fulfillment costs based on.
The airfreight that we need to get around the part or whatever it is there are incremental costs still in that 5% that are associated with having to navigate the pandemic. So as we pivot to getting out of the pandemic one of the levers. We'll have is two two at sunset those as I talked about and then as you said some of the levers in our favor.
And the year are really reaping the benefits of the store closures.
As well as some of other productivity initiatives, we've already put in place and some of the impact of moving towards the old Navy and that's why the operating margin higher operating margin brands and then to calm honestly is a lot of the work we're going to do around.
Partnering markets as well as really leaning into as I said in my prepared remarks really reengineering the fixed operating costs in the business more systematically through digitizing operations.
As well as some of the margin initiatives like inventory management and such that we think will start to help offset the impact of shifting to online. So.
More to come on that but the five per cent again is very much on the path of we expected and still unfortunately, how some of the COVID-19 related costs of it.
Thanks, very much for the color at the glass.
Thank you alright, thank you for joining us today, and we look forward to speaking with you at the end of the first quarter.
Thank you that does conclude our conference you may now disconnect.
Goodbye.
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