Q3 2021 Gap Inc Earnings Call
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Good afternoon, ladies and gentlemen, my name is Justin and I will be your conference operator today.
At this time I would like to welcome everyone to the Gap, Inc. Third quarter 2021 earnings Conference call.
This time, all participants are in a listen only mode for those analysts who wish to participate in the question and answer session. After the presentation. You May now press star one to enter the Q&A queue.
As a reminder, please limit your questions to one per participant.
If anyone should require assistance during the call. Please press the star key followed by zero key on your Touchtone phone.
I would now like to introduce your host Joe <unk> head of corporate finance and good afternoon, everyone. Welcome to Gap, Inc. 's third quarter 2021 earnings conference call before we begin I'd like to remind you that the information made available on this webcast and conference call.
Contains forward looking statements or information on factors that could cause our actual results to differ materially from any forward looking statements as well as a description and reconciliation of any financial measures not consistent with generally accepted accounting principles. Please refer to page two of the slide shown on the investors section of our web.
Gap, Inc, Dot com, which supplement today's remarks as well as today's earnings release, the company's annual report on Form 10-K filed with the Securities and Exchange Commission on March 16, 2021, and any subsequent filings with the Securities and Exchange Commission all of which are available on GAAP in Stockholm East.
Forward looking statements are based on information as of today November 23, 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, Sonya single and Chief Financial Officer Katrina O'connell.
With that I'll turn the call over to Satya.
Thank you Joe and good afternoon, everyone. Thanks for joining us today.
I reflect on the last 18 months I'm inspired by the incredible transformation. Our teams have made in such a short time, despite an ongoing pandemic related disruption to our business and the broader economy.
Coming off record sales performance in Q2, we had accelerated momentum heading into the back half before facing disruption to our supply chain driven by the two and a half months closure of our manufacturing country, Vietnam as well as port congestion, both of which affected our ability to fully meet.
Long customer demand.
While we had planned into the nose supply chain constraints as we entered the quarter, including Covid related closures in Vietnam, the shock to our business persisted longer than anticipated as we turned into months.
We have been all hands on deck to address these headwinds and the resulting impact on our business.
We're actively navigating holiday and beyond ensuring that the customer is at the center of every decision we make.
To secure our supply and meet the needs of our customers. We chose airfreight over ocean vessel for a significant portion of our assortment taking on extreme transitory costs.
We're disappointed in the short term impact on earnings we made the choice to invest in our customer promise and build loyalty that will help sustain growth over the long term Katrina will go into greater detail on our mitigation efforts later.
Overall, we continue to believe the scale of our supply chain is a material advantage, we have deep relationships with our manufacturers across multiple countries of origin optimized for cost speed and expertise.
And we have strong transportation partners offering speed advantage and industry leading rates.
That said learnings from this crisis will not go to waste, we're using them as an opportunity to accelerate digitization effort that were already underway across our product to market process.
There was a sizable increase in the enterprise clock speed on transformative initiatives as they can.
Combated the current crisis with an eye on a better future faster.
For example, we're adding supply chain capabilities that will allow us to better anticipate the unexpected.
We've made significant progress digitizing core operating processes with a targeted focus on inventory management.
LT and personalization.
And we're transforming product creation by using digital tools to unlock speed and efficiency.
All of this work will pay forward in 2022 and beyond.
These near term pressures have not distracted us from our core strategy.
We have an acute focus on what really matters, our unique honorable assets.
Because the simple consumable and executable strategy, we shared in October of last year, our power plant in 2023. The gap Inc. Is in a stronger more resilient position today than we were entering this fiscal year.
Even in the face of current headwinds I'm confident that that's true.
Our brands are healthy demand for our product is strong and we have pricing power with average unit retail contributing the highest gross margins in over a decade.
We are becoming digitally led online sales grew 48% in the quarter compared to 2019, representing 38% of total sales.
And our migration to the cloud, it's unlocked innovation in our tech portfolio.
We will strategically shed an estimated $1 billion in sales by year end versus 2019 by closing unproductive stores divesting smaller brands and partnering our European business to drive focus and profitability.
Nearly three quarters of active customers our loyalty shoppers.
And they are spending twice as much as non loyalty customers.
And we have quantified our strong balance sheet by restructuring long term debt, allowing us to invest for growth, while continuing to return cash to shareholders.
So our team and partners around the world. Thank you I've watched you navigate persevere and accelerate through these needs near term challenges, while executing our long term strategy.
Despite the supply chain disruption comp sales were up 5% on a two year basis with three of our core brands delivering positive two year comps.
Net sales were down 1% to 2019, which includes an estimated 8% point impact due to supply chain headwinds our.
Our strategy is on track and it's working let.
Let me walk you through how our power plant came to life in Q3.
Starting with the power of our brands.
Each of our 1 billion dollar brands, it's finding new and relevant ways to expand reach and cut through to the consumer.
This is driving an increase in brand power and a decrease in discounting let.
Let me start with old Navy.
Old Navy delivered 8% sales growth versus 2019, a deceleration from the first half as the brand was disproportionately affected by inventory lateness during the quarter.
Navy maintained its number one ranking kids market share according to NPD and sustained its kids and baby growth trend from the first half with strong back to school performance.
Bought a quality old Navy is inclusive sizing integration launch successfully in August the brand more than doubled its extended type customer file since launch.
15% of customers, who shopped extended sizes are new to the brand and more than a third have shopped old Navy before but are new to the category.
We are seeing strong extended size demand across fashion categories, a clear signal that our customer is craving trend choice locking in the market.
Moving to get.
The momentum continues a gap brands, particularly North America with comparable sales up 13% versus 2019, and net sales nearly flat. Despite the almost 18 percentage points of revenue, we shed through strategic store closures.
This marks the third consecutive quarter of positive comparable to your sales growth in North America as gap brand improves the core health of the business from tighter assortments and better quality product to an increase in digital penetration and lighter and brighter stores.
Yup reached a critical milestone in our power plant concluding its strategic review of the European market.
Driving a more profitable business model by shuttering, our UK stores and working with local partners to amplify growth.
We have identified strong partners in the U K, Ireland, France, and Italy, and together are committed to serving and growing our DAP customers in Europe.
Our newest easy GAAP icon the perfect Hoodie delivered the most sales by an item in a single day in GAAP Dot Com history.
With over 70% of easy GAAP customers shopping with us for the first time. This partnership is unlocking the power of a new audience for GAAP Gen Z plus Gen X men from diverse backgrounds.
Next banana Republic, which successfully launched new brand positioning focused on acceptable luxury.
Through unique storytelling experiences the brand is going back to its roots.
Igniting the adventure and all of us.
But then our public reported a net sales decline of 18% versus 2019, and a negative 10% two year comp.
GAAP, we walked away from about 10 percentage points of unprofitable revenue due to strategic store closures.
Product margins expanded during the quarter as luxury products like Marino leather cashmere and silk resulted in increased average transaction.
Going higher value customers willing to pay for great quality.
And finally, Athleta delivered an outstanding quarter with 48% net sales growth versus 2019 used.
Using its unique an honorable mission to empower women and girls to the power of she the brand is investing in new touch points that increased awareness and drove new customer acquisition, which has more than doubled versus Q3 2019.
I thought our group brand awareness of 33% versus 27% last year. According to you Gov by embracing celebrity partnerships Simone Biles analysis, Felix who took to the world stage and Tokyo.
The brand expanded into Canada with the launch of the online business in its first company operated store in Vancouver and Toronto.
Customers are quickly embracing athleta well their new immersive digital community alluded and wellbeing with the active user base growing 50% every month since launch we believe this platform has tremendous potential over the coming years to revolutionize how we monetize vulnerable brand experiences.
Next the power of our platform and portfolio.
We leveraged our size and scale to drive advantage for our for purpose led billion dollar brands.
A leading omni platform provides customer convenience and engaging experiences whether in store on mobile or through curbside pickup.
Online sales grew 48% in the quarter compared to 2019, and we maintained our ranking as number two in U S apparel E Commerce sales.
Our sizable active customer file system $64 million and those customers are spending more on average than they were two years ago.
But more important is that the health of our customer file is improving.
Compared to 2019 newly acquired customers are spending more with us that are existing customers with increased average transactions average unit retail and basket size.
We're pleased with the launch of our integrated rewards program and our ability to build customer lifetime value.
Now with more than 45 million members. Our loyalists are two X more likely to shop across brands and three X more likely to shop across channels.
We feel our brands through our scale technology advantage operation.
We are investing capital to drive growth reduce costs and increase speed and agility.
To diversify and strengthen our business. We are also seeing new capabilities that will unlock additional value. For example, we acquired Graper, which we expect will power new e-commerce tools with <unk> technology, and we acquired C. Before our machine learning and AI acquisition with broad potential across.
Loss sales inventory and consumer insights we.
We have plans to scale. These solutions in 2022 to build our core digital capability.
This will help our brands lower return boost in stock levels increased margins and deliver better customer experiences online and in store across all four brands.
The power of our portfolio comes to life through our leadership in key categories.
Our strong active and fleece business and our denim business are expected to generate revenues of 4 billion and 2 billion, respectively. This year, and our kids and baby business, one 9% market share across old Navy gap in Athleta.
Even as occasion and wear to work categories have strengthened its clear comfort and style will sustain.
We're extending our customer reach across every age body in occasion from value to premium through category expansion and new addressable markets. We can test and pilot in one brand and then leverage learnings to scale across the rest for example, starting our inclusive sizing rollout in Athleta and scaling at old Navy.
With product quality.
Are using old Navy gap, and Banana Republic strong presence and infrastructure in Canada to enable athletic quick and seamless entry into the market.
It's the collective power of our brands that gives us scale advantage.
We continue to innovate and sustainable sourcing with a focus on empowering women.
Enabling opportunity intermission community.
The industry will be impacted by climate change and we are doing our part to mitigate its impact both on our supply chain and on the communities where we operate.
Earlier this month the U S. H gapping women in water Alliance and now that we have empowered 1 million people to improve their access to clean water and sanitation already halfway to our goal of reaching 2 million by 2023.
Looking ahead, we anticipate robust apparel and accessory retail sales across the industry for the remainder of the year and into the next that said we are balancing the favorable consumer climate against current supply constraints as.
As I mentioned earlier, we are doing everything we can to improve our on hand inventories versus call. It still we remain cautious given the current environment.
One last thought before I hand, it over to Katrina.
While the near term headwinds and resulting impact on our performance are difficult. We remain focused on executing our strategy for long term sustainable growth we.
We are focused on what matters.
Demand generating investments and a $1 billion brands fueled by cut through creative.
Deploying data and science to drive efficiency in the way, we work and restructured our business to reduce costs.
All of this allows us to emerge from the crisis growing share increasing brand health and delivering profitable growth long term.
With that I wish you and your families a happy Thanksgiving.
Katrina.
Thanks, Tony and good afternoon, everyone and Sonya said, we're deeply proud of the progress we're making to transform gap Inc. Through our power plan 2023, we have strong demand for our brands and our fleet optimization through store closures international partnerships and divestitures is progressing well and adding value.
Our operating margin remains on track to hit 10% by 2023 in line with our plan even as we navigate these near term disruptions our balance sheet fortified with our recent debt restructuring enables us to invest in our business to drive growth, while returning cash to shareholders.
The core tenants of our power plant in 2023 strategy are well underway in delivering value.
Well, we're confident with our strategy widely reported worsening global supply chain issues meaningfully impacted our third quarter performance, we lost approximately $300 million of revenue or eight percentage points of sales growth on a two year basis due to longer transit times in last weeks of production, which led.
The on hand inventory shortages in the quarter.
Our backlog at U S ports deteriorated meaningfully from the first half of the year, resulting in up to three continuous weeks of unanticipated delays to fall product deliveries throughout the quarter.
In addition, while our production capacity is largely globally diversified.
Approximately 30% of our product is produced in Vietnam, where factory closures extended to over two and a half months significantly longer than initially anticipated.
Our average on hand inventory in Q3 was 11% below fiscal year 2019, so despite strong sell through trends, we lost volume as a result of limited supply.
While our brands all experienced delays in styles and sizes that limited their ability to fully meet strong demand old Navy was disproportionately impacted.
We believe these supply chain disruption impacts to our sales and margins are transitory, although will persist in Q4 and potentially into early next year.
With that we've taken some near term actions to proactively improve supply for holiday and we're using the learnings from acute supply crisis to accelerate new capabilities for 2022 that we believe will help to better mitigate logistics challenges and more profitably increase speed to market go forward, Let me touch on some efforts.
First in the near term, we have secured incremental air capacity to support holiday inventory.
In addition to an estimated $100 million of air costs incurred in Q3, we've also invested approximately $350 million in Q4 airfreight to further expedite holiday deliveries and second where possible. We have rounded a modest portion of our inventory to east coast ports to bypass the congest.
And in the L. A long beach port.
While we aspire to improve our on time deliveries for holiday by adding air capacity and utilizing alternate ports the supply chain situation continues to be volatile.
<unk> opened Vietnam factories are behind on holiday production ramping up slowly ongoing port delays are worsening in air charters are causing new airport congestion.
Our mitigation efforts are driving significant transitory costs.
We're focused on the long term impact that delighting, our customers with the products. They love during the holiday season has on preserving market share and maintaining customer loyalty.
We remain cautious in our outlook for the balance of the year and are updating our full year 2021, EPS guidance range to 45 to.
To <unk> 60 per share on a reported basis.
And $1 25 to $1 40 per share on an adjusted basis.
We are updating our guidance solely based on the acute revenue and margin impacts from supply chain disruptions.
This range now reflects the estimated loss sales from supply disruptions in the second half of 2021 to be $550 million to $650 million.
In addition, our updated guidance range reflects approximately $450 million of transitory airfreight costs, we have chosen to incur as we seek to meet as much customer demand as possible.
And we are confident that when adjusting for these substantial disruptive impacts to 2021, our underlying business is ahead of plan and we will emerge strong and 2022 and beyond.
As we look to 2022 we are adding new capabilities that will enable us to navigate these disruptions with more flexibility and significantly less airfreight.
Beginning with summer 2022, our teams have added expected longer port delay times into product booking deadlines, which we believe will enable us to ship goods largely by ocean for on time deliveries.
In addition old Navy has now accelerated its use of digital product creation for the majority of its fall orders with vendors.
This is added speed to the pipeline as a breakthrough inefficiency for the brands.
Also to increase geographic diversification and flexibility.
We expect to leverage more multinational vendors.
And we will begin to deploy AI from our recent <unk> acquisition to better drive inventory in stock in our stores.
Combined with ongoing inventory management transformation efforts and the leverage of our new loyalty program gives us confidence in the sustainability of strong average unit retail in 2022.
Yeah.
Now turning to third quarter financials before I get into specific results I'd like to note that there are select charges, we incurred in the quarter that are.
<unk> from our adjusted financials, specifically costs related to restructuring our long term debt and the transition of our European market to a partnership model I'll provide more details on these as I talk through the results.
Starting with sales net sales of $3 9 billion for the quarter were down 1% to 2019 with our Q3 sales deceleration from the first half of the year due to supply chain issues comp.
Comp sales improved 5% on a two year basis.
We're particularly pleased that three of our core brands delivered strong two year comp growth with old Navy up 6% GAAP global up 3% and North America up 13% and Athleta up 41%, all while navigating acute supply issues.
And while a banana Republic, two year comp was down 10% the brands made progress in the quarter through its product and customer experience relaunch.
Our strong E Commerce channel continues to be an advantage its online sales were up 48% compared to 2019.
Contributing 38% of sales in the quarter up from 25% of total sales in Q3 2019.
Moving to gross margin third quarter reported gross margin was 42, 1% an increase of 310 basis points versus 2019.
Excluding impacts related to the transition of Europe of our European business to a partnership model adjusted gross margin of 41, 9% for the quarter represents the highest Q3 gross margin rate in over 10 years.
Expanding 290 basis points versus 2019 gross margin.
This is primarily driven by 300 basis points and rod leverage from higher online sales and lower rent occupancy and depreciation as a result of strategic store closures and renegotiated rents.
Merchandise margins were down just 10 basis points, despite nearly 200 basis points of higher online shipping costs and about 250 basis points in short term headwinds related to air freight.
Product acceptance was strong across all brands with our overall Q3 discount rate at the lowest level in five years.
Turning to SG&A reported SG&A, which includes $26 million in charges related to the transition of our European operating model was 38, 3% of sales deleveraging 470 basis points compared to Q3 2019.
On an adjusted basis SG&A was 37, 6% of sales 610 basis points above 2019 adjusted SG&A.
We continue to execute our strategy of driving down fixed costs, while investing a portion of those costs into demand generation in the form of marketing and technology.
Fixed costs have been significantly reduced as we successfully closed stores in North America divested of two brands earlier this year and reached partnership agreements for our European markets.
Marketing up 360 basis points versus 2019 supported the rollout of our new initiatives, particularly loyalty inclusive sizing at old Navy and the brand relaunch of Banana Republic and is a major contributor to our low discount rates.
The balance of Q3 investments were primarily focused on technology to build out our digital and supply chain capabilities as well as on higher bonus accruals versus a low 2019 baseline as no meaningful incentive payouts were granted in that year based on performance.
The investments, we're making today are long term differentiators and we're committed to our strategy, while remaining prudent even in the face of near term supply headwinds.
Regarding operating margin operating margin for the quarter was three 9% on a reported basis, excluding $17 million in charges related to our European market transition adjusted operating margin was four 3%, which as I noted earlier includes the impact of an estimated $300 million in lost sales due to constrained inventory.
In addition to approximately $100 million in non structural airfreight costs.
Moving on to interest and tax during the quarter, we restructured our long term debt by retiring all of our two and a quarter billion senior secured notes and issuing $1 5 billion of lower coupon unsecured senior notes.
Through this debt restructuring, we were able to reduce our overall debt balance achieved material interest savings approximately $140 million on an annual basis, beginning in 2022 and unencumber, our real estate assets previously pledged as collateral.
We incurred a 325 million nonrecurring charge related to debt extinguishment in the quarter Q.
Q3, net interest was $43 million full year net interest is now expected to be $163 million looking.
Looking beyond 2021, we expect annual net interest expense of around $70 million.
The effective tax rate was 29% for the third quarter, excluding the impact from fees related to debt extinguishment and a charge changes to our European operating model. The adjusted effective tax rate was 20%.
We expect the full year effective tax rate to be about 23% on a reported basis.
And about 26% on an adjusted basis.
Regarding earnings on the quarter Q3 reported earnings reflect a loss of <unk> 40 per share <unk>.
Excluding fees associated with our long term debt restructuring and the transition of our European markets to a partnership model adjusted earnings per share for the quarter were 27 sets.
Turning to inventory inventory delays worsened throughout the quarter and our Q3 sales down 1% versus 2019 outpaced average on hand inventory down 11% to 2019.
Third quarter inventory ended flat to.
2019, and down 1% versus 2020 with average on hand inventory down, 7% and in transit up 16% versus last year.
On hand inventory at the end of the quarter remained seasonally relevant with markdowns below Q3 fiscal 19 quarter end levels.
We expect Q4, ending inventory to be up high single digits versus last year. Although at this point in time outlook may change given continued volatility in the supply chain.
Regarding the balance sheet and cash flow. We ended Q3 with $1 1 billion in cash cash equivalents and short term investments.
During the quarter, we continue to earn to return cash to shareholders paying a Q3 dividend of <unk> 12 per share and repurchasing $73 million in shares as part of our current plan to offset dilution.
And earlier this month, we announced a Q4 dividend of <unk> 12 per share.
Looking at our global store fleet, we are plan to close 350 gap and Banana Republic, North America stores is expected to be approximately 75% complete by the end of the year.
And with the recent announcement of our agreement to transition to a partner model in Italy. We've now concluded an important phase of the restructure of our European markets. All markets are expected to be transferred to our new partners in early 2022.
Now I'd like to provide an update on our full year financial outlook, which we are downwardly revising solely based on the acute impact of sales and margin of the supply chain disruptions.
Full year 2021 reported earnings per share are now expected to be in the range of 45 to 60.
Which includes net charges of $445 million comprised.
Comprised of $325 million in fees related to the restructuring of our long term debt and approximately $120 million related to divestitures and the transition of our European business model to apart European business to a partnership model.
Excluding these charges and associated tax impacts.
Full year 2021, adjusted EPS is expected to be in the range of $1 25 to $1 40.
This updated guidance now includes the following assumptions first.
We expect 2021 full year revenue growth of about 20% versus 2020.
This range now reflects the expected loss sales from supply disruptions in the second half of 2021 of approximately $550 million to 650 million.
Including an estimated $300 million from Q3, and an estimated 250 million to $350 million in Q4.
Second we expect full year non structural airfreight to be approximately $450 million.
We consciously chose to air approximately 35% of our holiday product given the two and a half months delays from Vietnam closures in Q3, and the over a three week West coast Port delays. So that we can give our customers as much holiday product as we can to deliver on their expectations.
While this is material to our profitability. We believe it is necessary to further mitigate sales losses and retained customers for the long term.
With the added air cost and the meaningful sales impact from supply constraints. We now expect full year 2021 reported operating margin to be about four 5% with adjusted operating margin at about 5% for fiscal 2021.
This is inclusive of short term air cost in the back half impacting operating margin by about 270 basis points full.
Full year capital spend is still expected to be approximately $800 million.
In summary, when adjusting for the acute impacts of supply chain disruptions, we are still expecting the year to end at or above our original plan for 2021, demonstrating that our underlying business trends are quite strong and providing real momentum.
The progress we've made on our power plan 2023 strategy in the face of these challenges highlights the strength of our core business and the health of our brands.
And we remain confident in our path as we move toward a 10% operating margin in 2023.
With that we'll open it up for Q&A.
Thank you Andrew.
A reminder, for those analysts who wish to participate.
Question and answer session. After the presentation, you May press star one to enter the queue.
And our first question will come from Rick.
Roche with Goldman Sachs.
Good afternoon, and thank you so much for taking the question.
Sonya to turnaround I was wondering if you could help us a little bit with understanding the impact of some of these inventory planning and supply chain delays as you're thinking about the inventory cadence into the fourth quarter and holiday. It sounded like there may be some shipments that may be stuck on boats in the ports right.
And the time, where those customers are really looking for that holiday season. How are you thinking about carryover inventory into January and February and perhaps the more lasting impacts of some of these supply chain delays and Vietnam slow restarts.
212 of next year. Thank you.
Hi broke its Katrina.
So as we said on the on the call we have amped up the airfreight for holiday in an effort to really navigate the lengthening port delays as well as the late opening of Vietnam.
And there's a range of possible outcomes for how that could play through the holiday season.
And so we'll we'll see where that lands with holiday inventory as it relates to the carryover into January and February the teams have been really looking at.
For Vietnam in particular, what units based on the closures do we need to cancel so that we didn't take them at all what units can get re flowed into future season, and then what units are we going to potentially pack and hold for next year. We proved this past year in the front half that pack and hold.
<unk> is a good strategy for us and so if we think that things are going to be too late for the holiday season, we won't put them in stores or online and have them generate markdowns. Instead, we'll hold them for next year or so we're using a variety of things to help really navigate the current inventory situation. So that we don't end up with a January.
Or February inventory liability issue.
Yeah.
Thanks, So much I'll pass it on.
And our next question will come from Lorraine Hutchinson with Bank of America.
Okay.
Good afternoon.
When we think about the supply chain costs, how much of these costs do you view as structural and are there any actions you can take to take price points higher to offset some of the headwinds.
Hi, Lorraine this founder here. So we do think that the Q3, Miss and the costs that we're incurring with air.
Is transitory and that's why we have made that backs. We wanted to maintain the customer promise. Our brands are resonating we have a 10 year high margins through price realization and so are our bet was to stay on the offense and have product here to service and holiday and that's what's included in our outlook.
Do think that even with the lumpiness of the quarter. We are on track to our power plant first year and as we move into next year, we will.
We'll share more at the yearend, but were confident about navigating that.
I think that through the price gains we've seen across all four of our brands.
As exemplified by the Q3 margins, we think that that can continue through a combination of the investments we've made in marketing the strong product acceptance, we're seeing as well as the enabling capabilities such as personalized pricing and inventory management optimization as key levers to continue the charge.
Over the coming years and price gains across the across the company. We're really pleased with the level of discounting we've been able to stop me and we expect that that in order to drive health and brands sequentially that that will continue.
Thank you.
And next will be Matthew boss with J P. Morgan.
Great. Thanks.
Sonya at old Navy.
If we think about the 12 point sequential deceleration in comps how much exactly was due to inventory.
What was the timeline of exactly what went wrong versus the plan that you had in late August.
<unk> seen trends improve at old Navy in November and then Katrina on the 10% operating margin target, what's the split of the 500 basis points from here, if we think between gross margin and SG&A.
Thanks, Matt So as you know we left the first half of this year with really strong momentum at old Navy with 24% sales growth and when we guided we had baked in.
Disruption from Vietnam has been seen in other countries about two to three week closures as well as a five day port delay and so because that is what we have seen that's what we had forecasted. Therefore go forward what what actualized was as you know much more dramatic we had a two and a half months shutdown of Vietnam, which is R.
Top sourcing country.
And for old Navy, a slightly higher particularly for women and so the compounding effect of that as well as the worsening port is the new news and so as we.
Thought about the health of old Navy the momentum even in Q3 the growth in the net promoter score and the growth and brand awareness through its bought a quality launch we made the decision to invest in airfreight in a substantial way to compete in holiday. So that's where we are right now we think that.
The majority of the sales force all cells, Boston factors due to supply chain.
Loss and old Navy entered the quarter quite lean and inventory because of the strong demand in the first half leaner than than the portfolio and then you exacerbate that with the out of stocks due.
Due to the supply constraints out of Vietnam, and the port and so that's really what we're navigating in the short term. We do believe its transitory. We do believe that old Navy is incredibly healthy and has had I.
I think all the indicators that price realization the brand health the net promoter score our loyalty customers the age of the customer with new customers joining that are younger.
All of that bodes to the right bet to play offense old Navy.
And then Matt as it relates to the 10% operating margin we remain confident in that for 2023. When you look at our guidance for this year with a 5% operating margin.
That includes about a 270 basis points impact from the transitory airfreight costs that we're incurring this year and then in addition to that it includes the close to 500 million of sales impact from supply constraints and so all of that gives us confidence that this year.
When you take out the supply chain impacts would have been well ahead of our original power plant in 2023 for this year and more in line with the guidance we provided back in August.
So we're confident that we will get through this as we talked about before we are looking forward. We're adding are the supply chain delays from the ports to our buying timelines for summer and then old Navy is accelerating its moved to digitizing product creation for fall all of which we think will enable.
Blessed to navigate next year with much less air freight and we can see line of sight than to recovering the lost sales with better supply. So.
You know more to come when we get into next year, but we do see that this year would've been ahead of plan and we have line of sight to mitigating these costs and sales losses going forward.
And our next question will come from Kimberly Greenberger with Morgan Stanley.
Okay.
Great. Thank you so much I wanted to ask about the level of SG&A spending that we're seeing.
Should we assume that this is the new baseline of spending going forward.
And.
When you realized during the third quarter that old Navy would be low of inventory was there any thought to perhaps cut back on marketing during the quarter. So it was not to disappoint the customer.
Because obviously with the lack of inventory and driving traffic to the stores through marketing the potential certainly would have existed. Thank you so much.
Yeah, so on the SG&A side Kimberly.
As we said the.
SG&A deleverage in the quarter was impacted partially by the drop in sales and then partially by the commitment that we had to really staying the course on marketing as you call out.
And then it was offset by pullbacks in stores expenses, which we did do in the quarter, we really targeted anything that was not customer facing.
To try to pull back on the.
The SG&A in the face of the sales declines that we were seeing from the supply constraints that emerged in the middle of the quarter I'll, let Sonya talk a little bit about the marketing piece, yeah, and I'll just add on look we pulled back on payroll and other fixed costs that don't add value in the face of lower sale as you suggest kimberly but fundamentally our strategy is working and we have a.
Fair amount of rigor around marketing effectiveness of marketing spend that gave us confidence that it was the right level of investment as we look at Q3 for old Navy in particular with net promoter score being up.
Spike the fact that we have stock outs with where we know we just we had some disappointment and with the fact that the brand awareness is up eight points for our brand of old Navy size, that's really dramatic and strong based on better quality, thereby quality launch and we think the marketing investments. We're right. We're focused on fixed cost elimination that.
<unk> our stores processes, that's removing unproductive sales through store closures.
And the transition of our.
Unprofitable international market. So those are areas that we've made a lot of progress on that affect broad at SG&A as well as our store operation hopefully that gives a little bit more color on SG&A, we're very very committed to digitizing our core operations. So that our fixed SG&A costs in our three year plan continues to be.
Our competitive advantage.
Great. Thanks for the color on that and I just wanted to ask a clarifying question Katrina could you just tell us what the AUR increase wasn't third quarter. Thanks, so much.
Yeah, no problem, we didn't quantify that what we did say, though kimberly is that in our merchandize margins. They were only down 10 basis points on the quarter and that was with.
200 basis points of online deleverage as well as 250 basis points of the transitory airfreight costs. So hopefully that's helpful. But so that would tell you that the AUR was up meaningfully if with that 450 basis points of headwinds, we only lost about 10 basis points of merch margin.
Understood. Thanks, so much.
Mhm.
And moving on to Ike <unk> with Wells Fargo.
Alright, Thank you Katrina.
Katrina I wanted to ask about two questions on margin.
I'm just trying to understand the airfreight dynamic.
Is this transitory in the sense that it is in your mind, one time I'm just trying to bridge the 5% margin today versus your 10% target in two years, that's 250 basis points I think for the full year. If my math is right that would get you halfway there at seven and a half.
And I guess, that's what I guess two questions. One is that the right way to think about it because at one time or someone that's going to stick and then as we build the tenant that's going to be kind of even build over the next 24 months or is this more back loaded to the 23 year just to help us think about that would be it would be great. Thanks.
Yeah.
Sure. So youre thinking about that right. Ike. This year includes 270 basis points of headwind from what we would say is airfreight costs that is solely attributable to navigating the supply crisis and so not something that we would see continue we'll see next year how much of it continues in the front.
Half of the year, but fundamentally this year would've been that 270 basis points higher without having to navigate these current issues. So youre thinking about that correctly and then we'll give you more on how it will pace out 2022 versus 2023, but I think what Sony and I would say is by the end of this.
Year, we're really proud that I would say, 75% of the core restructuring of the company is largely behind us.
When you think about closing the North America stores divesting of our two smaller brands getting our three countries in Europe partnered we do feel like we got the debt restructured in the third quarter. We do feel like we've made really good progress against the restructuring plan and so the next two years really are going to be.
Driving now the optimization of that healthy core with these digitization efforts that we think we will start to add value because we talked about through inventory management through lower return rates.
And through automation of some of our core processes to try and drive costs out, but we'll talk more about pacing when we get to the end of the year, but that's that's the way to think about that 10% operating margin. Yeah. I just add on I think fundamentally going through a quarter like this.
We have looked at our strategy and are very resolved and that it is the right strategy.
We are putting the customer at the center our commitment to sales growth driven by these four brands that are growing in health with a double digit operating return is our objective and we think we're still on plan to meet that the quarters are lumpier than we would like certainly not.
Not happy with with this quarter, but if you step back and you look at the year, we will still be on track to that plan that we communicated last October and so.
There is I think that.
To look to as well as the commitment to the next couple of years.
Okay.
Thank you so much.
And our next question will come from Adrienne <unk> with Barclays.
Thank you for taking my question.
So I'm trying to understand for the quarter, you had probably one of the biggest deltas versus other retailers on the third quarter in particular.
So I'm wondering is there something that's happening with your lead times I know that there was an initiative to shorten up and tighten up those lead times how did he come.
Two short that that these types of events can actually have a very near in impact and then.
Katrina, we didn't talk much about any.
Any average hourly rate pressure isn't that SG&A line numbers are floating out there 15 to 17 Bucks I mean, historically gap's been at the forefront of leading that HR initiatives. So how are you thinking about that and how should we think about that wage inflation annually. Thank you very much.
Well, certainly as a vertically integrated apparel retailer with about 30% of our manufacturing in Vietnam, We were disproportionately impacted and those who don't manufacture there had a natural advantage and we continue to believe that the scale of our supply chain has always been at an advantaged rate shows up in better rates and <unk>.
Our unit cost and access to last mile and so that's advantaged now that said we are using this as an opportunity to find ways to further insulate ourselves and so while we expected the shutdown to be similar to other country used a couple of weeks for example.
I think the government delayed was substantially longer in Vietnam, especially south Vietnam, where we were most exposed and an old Navy womens where we were most exposed so it was outside of our expectations.
Going forward, we're focused on multinational vendors as opposed to single point partners as well as the digitizing of the product creation process, which will really let us reduce cycle times and lead times.
In our product to market model. So you know I think we're using this crisis as an opportunity as we did last year to accelerate some of the key components of our power plant in 2023, including Digitization, including supply chain transformation and inventory management transformation, which are all up.
<unk> that we see leaning into to move us forward.
And then they are hitting on the HR pressure.
We are we are definitely seeing.
Average hourly rate pressure, primarily in our distribution centers, but in our stores as well.
And so far the teams are doing a good job navigating that and yeah, we haven't called it out because it's not sort of one of the biggest headlines but it is definitely something that we are navigating within our cost structure.
As others are and as contemplated in our outlook and then what I would say is the automation levels. We have in our Dcs are a great hedge for us that being said we are absorbing some of those.
<unk> and then our stores, we have embedded some headwind into the back half.
Okay have you given what your HR actually is.
But no we havent.
No. Thank you very much.
Thank you happy Thanksgiving.
Thanks, you too Adrian.
And we have a question from Dana Telsey with Telsey Advisory group.
Good afternoon, everyone. As you think about the supply chain obstacles that happen now and you think about going forward into 2022 and even into 2023, what are the learnings from this that adjust that how you adjust your supply chain going forward. How do you operate differently do you think that may help to manage.
The inventory even better going forward.
Yeah.
I would say first and foremost it starts with digitizing the information so that we know exactly where every unit is in our end to end supply chain, we had that information, but now we're going to a greater level of detail and more real time visibility and that all links to the technology investments we're making.
<unk> in digitizing our end to end supply chain. So I'd say, that's first and foremost second is we've always had a supply chain that has given us cost advantage.
Now, we will be putting a greater emphasis on resiliency and.
And flexibility and so whether that sourcing more near shore, whether thats multiple countries of origin. We're looking at a variety of levers to enhance our competitive advantage in our scaled supply chain.
And Dana particular to 2022 for spring, we have moved a lot of our west coast Port volume to the East Coast, which we believe will help us navigate better and in summer we've built in the much longer port delay lead times.
Into our buying cycles, and then as we said for fall.
The old Navy teams fully pulled forward the digitization of their fall lines. So that they are seeing a much better speed and flexibility. So I think sequentially next year, we feel like we've been incorporating the learnings and then as Sonya said.
Digitization has always been that next leg of power plant in 2023, but we've used this as a way to really accelerate some of that work to make sure that we're getting a more advantaged faster as we reflect on the 18 months I would say I'd much rather have a supply problem than a demand problem and on the demand side, we've been I think pleased.
With the.
The response and the customer.
Sentiment and so really it's about navigating the short term transitory issues as we lean into the pricing power of the brand helps them.
The customer acquisition into our loyalty program, which has exceeded our expectations.
Thank you so much best of luck in the holiday. Thank you.
Thank you.
And our last question will come from Paul Lajoie with Citi.
Hey, Thanks, guys.
I'm curious how you go about measuring the missed sales.
In the quarter and wondering you know on a related note can you maybe talk about bi.
By brand traffic versus conversion and how that differed in three two versus picture right.
Yeah for the Misdeal, Paul we took a pretty literal approach to really looking at what inventory wasn't here to sell and quantifying what that would have sold for you could say that there was actually a larger impact than that when you think about the fact that.
Our customers don't often by just one unit they often buy a basket of units and so there's there's what you would consider maybe a halo effect to not having those units, but the way we quantified the sales losses really that literally don't have the unit don't get the sale.
And then as it relates to brand by brand maybe Sonya can talk about brand by brand I don't know that we'll break out the components, but we're certainly happy to give you our thoughts on the Q2 trend versus Q3.
Yeah, I mean, I'd say I'm really pleased with three out of four of our brands showing comp.
With GAAP North America, showing a nice acceleration of 13 comp in North America.
And you know a great quarter for partnerships for gap, whether it's the Walmart home.
Growth or the easy gap Ike.
Icahn items are being.
Being launched and then the stores really are continuing to build momentum.
GAAP, we feel great about in terms of the momentum the bare public since we launch the positioning and ticks up the luxury we've been pleased with the momentum there with customer response, and then fled I really just had a spectacular quarter.
With a 46% sales growth over 2019, and the partnership that has been a cornerstone and a tailwind for us across the company, that's mobile and Allyson Felix partnerships, which accelerated the brand awareness for Athleta, which has been a driver of their sales momentum.
I'd say, you know for our brands and probe Navy.
I think while we had.
As I said healthy customer indicators, we simply we're just not able to meet the demand.
To the level that we wanted and we'll continue to navigate back to the back half.
Our plan to compete as best as we can in Q4.
Thanks, Tony but does that show up in lower conversion and three two versus two two or lower U P. Ts any metrics you can share to help quantify the DSL and from two 2% <unk> as a result of this lower inventory.
Yeah, Paul we don't actually break out those components.
So I think what we've said is the deceleration that we saw from Q3 was totally attributable to the lack of supply and inventory was down 11 and old Navy was down more than that so hopefully that's helpful. But we don't as a practice breakout traffic and conversion.
Okay. Thank you good luck.
Thank you.
Yeah.
Yeah.
And that does conclude the question and answer session I will now turn the conference back over to you for any additional remarks.
Thanks for joining and have a great Thanksgiving.
Thank you and that does conclude today's conference. We do thank you for your participation.
Excellent.