Q3 2022 Gap Inc Earnings Call
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I would now like to introduce your host Cameron Mclaughlin head of Investor Relations.
Good afternoon, everyone. Welcome to Gap, Inc. Third quarter fiscal 2022 earnings conference call before we begin I'd like to remind you that information made available on this webcast and conference call contains forward looking statements that are subject to risks that could cause our actual results to be materially different.
For information on factors that could cause our actual results to differ materially from any forward looking statements as well as the description and reconciliation of any financial measures not consistent with generally accepted accounting principles. Please refer to the cautionary statements contained in our latest earnings release.
Information included on page two of the slide shown on the investors section of our website <unk> Dot com, which supplement today's remarks. The risk factors described in the company's annual report on Form 10-K filed with the Securities and Exchange Commission on March 15th 2022, and any subsequent filings with the Securities and Exchange Commission all of.
Which are available on <unk> dot com.
These forward looking statements are based on information as of today November 17, 2022, and we assume no obligation to publicly update or revise our forward looking statements joining.
Joining me on the call today are interim Chief Executive Officer, Bobby Martin and Chief Financial Officer Katrina O'connell with that I'll turn the call over to Bobby Thank you Cameron and good afternoon, everyone. Thank.
Thank you for months as interim CEO I have even deeper conviction that we have a portfolio of iconic brands that our customers love.
And increased confidence in our platform to drive leverage and economies of scale and belief in this team's ability to deliver.
We know we've got some things wrong.
Jim and I are at work to correct it.
Told you last quarter, we can and we should win in any environment and the management team and I continue to hold the company accountable to deliver on that.
We think can actually optimize profitability and cash flow, while rebalancing and reducing inventory to drive near and long term improvements across our entire business.
Sharpened our focus on execution are bringing more rigor to our operations and are responding to what our customers are telling us with respect to trend.
Well our efforts drove sequential improvement during the quarter, our expectations are set on the consistency of execution quarter after quarter year. After year that we know with crucial to delivering sustainable profitable growth and value that our people and shareholders expect.
Let me provide an update on our progress during the quarter, starting with actions taken on cost.
Ill last shared meter of aggressively managing cost and have taken distinct action in this quarter alone, resulting in roughly $250 million in estimated annualized savings. These actions include the elimination of 500 existing and open roles in our corporate offices and a pause on hiring and contractor spend.
For the remainder of the year, resulting in a $125 million estimated annualized savings. Additionally, the renegotiation of our advertising agency contracts, resulting in approximately $75 million in annualized savings and a reduction in new technology operating cost and rationalize the investor.
That's resulting in an estimated 50 million of annualized savings beginning in fiscal 2023.
We are early in our work here and you had already these savings are expected to help offset higher incentive compensation and increasing labor cost and physical 2023.
However, there is still work to be done to transform our cost structure and improve overall efficiency. So that we are fit for the future.
Next let me share more on our inventory actions and assortment rebalancing efforts.
We continue to rely heavily on markdowns of discounting to sell through a viable styles this quarter and have reduced receipts in Q4.
These actions will allow us to enter physical 2023, and an improved inventory position and beginning in Q1, our brands will benefit from our reinstated responsive capabilities to chase into product demand.
We're seeing an improved balance in the assortment across the portfolio compared to the first half of the year.
And each of our brands were better positioned in the categories that resonate with today's consumer preferences, and our customers rewarded us for that.
We saw consistent category strength in dresses sweaters pants, and woven tops across the portfolio with access underperforming across the board as consumers continue to shift away from the cozy at home lifecycle.
While escalator isn't a managers with changes in consumer preferences.
Despite a moderation of growth in the women's active market. The brand is showing strength in our lifestyle categories like dresses and accessories that are demonstrating disproportionate growth in today's current environment.
Now, let me take a moment and speak to each of our brands starting with old Navy.
<unk> delivered net sales growth of 2% over last year, showing early signs of improvement and the brand continues its efforts to rightsize inventory.
Balanced assortment relevance and sizing across its channels.
And the brand saw strength when its women's business.
Categories, including pants, outerwear, sweaters and woven tops.
All of this was offset however by softness in active and kids and baby as we lapped last year's strong demand, which we believe was driven in part by the U S child tax credits and of course, the heightened post COVID-19 back to school spending old Navy customers still have a propensity to buy that being said it continues to experience.
Softness in spending and shopping frequency from its lowest income consumers.
As we continue to attract a wide range of consumers, we still believe old Navy is well positioned in the marketplace, particularly as consumers become more value conscious next gasoline.
Gas delivered net sales flat to last year and is seeing signs of strength in its core with a significant shift in trend performance across its women's business.
Thank you Axel ramp toward delivering and traded REIT fabrics like faux leather and occasion based categories like dresses woven tops sweaters and pants, all drove comparable sales growth.
Many of the old Navy gap brand experienced softness in kids and baby and Activewear overall.
Over the last 18 months <unk> has successfully transitioned its France, Italy and UK businesses.
And franchise partners as part of our partner to amplify strategy.
And last week, we signed agreements to transition to gas greater China business to boat show Nate Haynesville operators are in market sites and stores under our franchise agreement.
In closing conditions and regulatory approval early next year. This.
This strategy allowed us to get brand operated businesses through a more asset light cost effective model and to benefit from our local expertise of our partners moving to Banana Republic.
Which saw net sales growth of 8% compared to last year.
Timber marked the one year anniversary of the brand relaunch chip.
Shifting from a highly promotional workwear brand catering to everybody Banana Republic spent the last year re imagining every element of the customer journey with a special focus on quality product differentiated experiences and relevant brand positioning it as a premier lifestyle brand that enhances people's lives.
They are.
This accessible luxury differentiates banana Republic from others at this price point and has brought in a more premium consumer we hope that youll take a look soon.
During the quarter Banana Republic experienced strong demand for suiting and expire fabrics, including sales in Kashmir.
Pandemic consumer preferences begin to balance from the current trend of occasion in workwear. It will be important that banana Republic continues to use its unique customer proposition as a lifestyle brand to differentiate itself for years to come.
Finally on <unk>.
<unk> delivered net sales growth of 6% compared to last year, while the womens activewear market has continued to be soft against the growth trajectory over the past few years Atlanta is holding share.
As I mentioned last quarter, Atlanta has made quick notice to print and pattern as well as with their performance lifestyle product to better meet the customers' preferences.
The new fall and holiday product is resonating well with the customer and has led to solid growth in both bottoms and tops the largest categories in the women's apparel market and key to the brand's long term strategy.
Before I pass the basket Katrina to share more details on our financials, let me end with how I began on the state of the business.
I have no doubt, we have world class brands that our customers love and we drive value at scale through the synergy of our platform but.
But I'm also very clear that there is work to be done to rightsize, our cost structure streamline inventory and capitalized on our creative strengths to deliver the products and experience of our customers deserve and employees and shareholders expect.
Lastly, the board remains active in our search for a permanent Chief Executive Officer.
We're focused on hands on leader and greatly increase our operating rigor, leaving us ramsar deficiencies, while in parallel enabling strong creative direction and brand architecture as they develop the vision for our portfolio should evolve over time to create a sustainable business model.
This was a great company with strong assets and one that demands a leader who can hold to its values and ensure it remains good.
Capable of scaling its omni platform and market leadership.
And with that I'll turn the call over to Katrina. Thank you Bobby and thanks, everyone for joining US. This afternoon, let me start with our third quarter results.
Third quarter net sales of four point here 4 billion increased 2% versus last year or 3% on a constant currency basis, driven by an improvement in trend relative to the first half of the year and in part due to the timing of franchise sales.
Sales in the third quarter were 1% above pre pandemic levels in 2019.
Comparable sales were up 1% on top of negative 1% comp last year and a significant sequential improvement from the negative 10 comp last quarter, primarily as our assortment rebalancing efforts at old Navy and gap are starting to take hold and.
And resonating with our customers as well as the benefit of an early holiday promotional event at old Navy in October .
So our sales increased 1% from the prior year.
Year to date, we have closed a net total of 29 gap and Banana Republic stores in North America, and now anticipate closing approximately 30 additional stores this year.
Now to close to 90% of our goal of closing 350 stores in North America by the end of fiscal 2023.
As we look to the remainder of fiscal 2022, we remain on track to open a net 30 athleta stores and now expect to open a net 10 old Navy stores this year.
Online sales increased 5% versus last year and represented 39% of total sales in the quarter compared to pre pandemic levels in 2019 online sales increased to 55%.
Turning to sales by brand.
With old Navy sales in the third quarter of $2 $1 billion were up 2% versus last year and increased 10% relative to pre pandemic levels in 2019.
Old Navy comparable sales were down 1%, representing a sequential improvement from the negative 15 comp last quarter driven by improvements in category mix and a more balanced assortment that now includes more of the product that our customers have been looking for as preferences have shifted from cozy casual to work occasion this year.
However, we do believe that old Navy did benefit from a slight pull forward of sales from the fourth quarter into October as a result of its efforts to get out earlier than typical with its first holiday promotional events.
Gap brand global sales of $1.04 billion were flat versus last year with global comparable sales up 4% driven by improved category mix and a more balanced assortment, including more occasion based in Boston driven categories.
As well as comp growth in Asia as a result of lapping the outsize negative impact of Covid related restrictions last year.
North America comparable sales were flat a sequential improvement from negative 10% last quarter.
Banana Republic sales grew 8% from last year to $517 million with comparable sales up 10% as the brand continued to capitalize on the shift in consumer preference and the relaunch and elevate the positioning of the brand last year.
Athletic sales grew 6% to $340 million or an increase of 57% compared to 2019 pre pandemic levels.
Comparable sales improved sequentially to a flat comp in the third quarter compared to negative eight comp last quarter and negative 7% in the first quarter.
As we look to sales in the fourth quarter, we continue to take a prudent approach given the uncertain macro and consumer environment as well as the competitive promotional environment.
Also as stated earlier third quarter net sales benefited in part by the timing of franchise sales as well as the October holiday events at old Navy.
In addition, GAAP ground will be up against an approximate one point headwind as we anniversary <unk> sale last year that will not be in the base. This year.
As a result of these factors and the continued uncertain environment, we anticipate that total company sales in the fourth quarter could be down mid single digits year over year.
Now to gross margin.
Gross margin in the third quarter was 37, 4% deleveraging 470 basis points versus last year inclusive of 130 basis points of deleverage related to a $53 million easy GAAP impairment charge.
On an adjusted basis gross margin was 38, 7% deleveraging 320 basis points versus last year as we continued to experience higher levels of markdowns.
In order to better position our inventory.
Excluding the impairment related to easy gap merch margin deleverage 370 basis points as a result of higher discounting due to the previously communicated assortment imbalances as well as more aggressive focus on better positioning and clearing excess inventory as we exit fiscal 2022.
Okay.
Airfreight contributed approximately 200 basis points of leverage and spend levels normalized during the quarter and we lapped the $70 million of incremental air freight expense last year equally offsetting this was approximately 200 basis points of deleverage due to inflationary and commodity costs related headwinds.
Turning to Rod we continued to benefit from our fleet restructuring efforts through lower raw costs, which were relatively in line with last year on a nominal basis.
Excluding <unk> and impairment charge rod as a percentage of sales leveraged approximately 50 basis points.
As we look to gross margin in the fourth quarter, we will lap last year's $245 million and incremental air freight which is expected to add approximately 540 basis points to gross margin versus last year.
We continue to anticipate an approximate 200 basis point inflationary and commodity cost headwinds and that rod will likely be about flat as a percentage of sales versus last year.
As we communicated last quarter, while we are taking actions to right size inventory in an increasingly promotional environment. We continue to expect significant variability in discount rate.
As a reminder, gross margin in the second and third quarters were impacted by approximately 370 basis points of deleverage stemming from higher discounting.
Turning to SG&A reported SG&A was $1 3 billion or 32, 8% of sales leveraging 540 basis points from the prior year and includes an $83 million net benefit from the sale of our UK DC now.
Now that our European partnership model transition is complete.
In addition, we recorded an immaterial amount of severance related to the overhead reductions taken in the third quarter adjusted SG&A, excluding the UK DC benefit decreased 5% versus last year to $1 4 billion.
As a percentage of sales adjusted SG&A leverage 280 basis points from the prior year adjusted rate, primarily as a result of higher sales volumes lower bonus accrual and lower marketing spend as compared to last year.
As Bob discussed we have begun to take actions to rightsize, our cost structure and improve profitability focusing acutely on areas, where we may have invested without commensurate returns in.
As it relates to overhead marketing and technology.
We've already acted on approximately $250 million in annualized savings stemming from the reduction of approximately 500 existing and open corporate rolled in the quarter.
Our renegotiation of advertising agency contract and the reduction of technology operating costs and rationalization of digital investments.
These actions will not have a material impact on SG&A as we look to the fourth quarter as a result of timing and severance offsets. In addition to headwinds in the quarter related to higher seasonal labor costs relative to last year.
However, these actions will provide a significant offset to the higher incentive compensation and wage inflation headwinds, we anticipate in fiscal 2023.
Yeah.
Reported operating income increased 22% to $186 million or four 6% as a percentage of sales.
Adjusted operating income decreased 8% from the prior year to $156 million.
Adjusted operating margin of three 9% was 40 basis points lower than last year's adjusted rate, reflecting the elevated promotional activity and higher inflationary costs.
Offset by the airfreight leverage on the SG&A leverage relative to last year.
Moving to interest and taxes, we recognized $18 million and net interest expense of $25 million savings versus last year due to the refinancing of our long term debt last fall.
During the quarter, we recorded an income tax benefit of $114 million on pre tax income of $168 million, which.
Wanted in a negative effective tax rate of 68%.
This income tax benefit was related to the cumulative impact of a change in the estimated annual tax rate as a result of quarterly earnings variability.
This year to date tax benefit is expected to reverse and result in at least $200 million of tax expense in the fourth quarter offsetting the tax benefit on a fiscal year basis.
Reported EPS was <unk> 77.
Adjusted EPS, which excludes an approximate 18% net benefit related to the <unk> sale and a <unk> 12 negative impact due to the GAAP impairment charge was 71.
Adjusted EPS includes 33 related to the tax benefit in the quarter.
Share count ended at $365 million.
Turning to balance sheet and cash flow starting with the inventory we are making initial progress on our plan to rightsize inventory and moved to levels below last year by the end of the first full year.
Our more aggressive markdowns combined with moderated holiday receipts drove a sequential improvement in the inventory growth during the quarter.
Total ending inventory was up 12% versus last year, a sequential improvement from 37% inventory growth in the second quarter.
The 12% year over year growth in the third quarter includes a 13 percentage point benefit related to in transit.
As we lapped last year's supply chain challenges nine.
<unk> nine percentage points of growth related to pack and hold and close to two thirds of the remaining increase is attributable to elevated levels of slow turning basics and the remainder of seasonal product.
Compared to pre pandemic levels in the third quarter of 2019, ending inventory was up 12%.
While an improvement in trend versus the first half as we expected we are entering the fourth quarter with overall elevated inventory level and some carryover of fall product. Despite the increased markdown activity in the third quarter.
Although we did take action earlier this year to reduce holiday receipts, we continue to anticipate a competitive promotional environment given the increased inventory levels industry wide and plan to continue to take aggressive action to clear inventory in order to enter fiscal 2023 better positions.
As we look to fiscal 2023, we continue to moderate buys and expect to begin to lean into our responsive levers this spring, which.
Which will provide further flexibility to better align inventory levels with demand trends next year.
In addition, we are releasing some of last year's holiday pack and hold inventory and we will continue to integrate our pack and hold inventory into future Assortments.
As you know while pack and hold as a use of cash in the short term, we are able to optimize our margin in the near term and benefit working capital next year, as we buy lower receipts and sell through the pack and hold inventory.
Quarter end cash and equivalents were $679 million.
Net cash from operating activities was an inflow of $95 million in the quarter driven by a moderation in working capital usage as a result of our progress on improving inventory levels and composition, coupled with our receipt cuts and leaner buys as.
As we stated last quarter, we anticipated beginning to see more normalized cash flow in the back half of the year and we are seeing that play out.
We continue to focus on fortifying, our balance sheet and cash positions.
As discussed last quarter, we've cut our deferred some capital spending and reduced the number of old Navy stores slated for back half of this year and continue to expect capex of approximately $650 million for the year.
We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns.
During the quarter, we paid a dividend of <unk> 15 per share and on November eight our board approved a 15% dividend for the fourth quarter of fiscal 2022.
We repurchased one 2 million shares early in the quarter.
As discussed last quarter, we have completed our goal of offsetting dilution in fiscal 2022, and do not anticipate repurchasing additional shares. This year, we continue to have $476 million available under our current share repurchase program authorization.
Before closing we understand that there has been increased focus on freight and commodity related tailwind in fiscal 2023 across the industry as we have all begun to see favorability in rates.
As a reminder, we have experienced a more modest freight headwind throughout fiscal 2022 as compared to many other retailers as a result of our long term ocean contracts, which were locked in at favorable rates.
These negotiated rates remained below current ocean container rates.
As a result, as the ocean container rates come down this will not represent a significant tailwind to our margin as it made for other retailers as we looked at fiscal 2023.
In addition, as it relates to cotton and commodity costs, we have already made purchases through the first half of fiscal 2023.
And therefore, we will not begin to benefit from advantaged pricing until we enter the back half of next year.
In closing, while we continue to navigate an uncertain consumer environment and promotional and competitive environment. We are confident in the actions. We're taking and believe we are taking the right steps to position gapping back on its path towards sustainable profitable growth and delivering value to our shareholders over the long term with.
With that we'll open the line for questions operator.
Thank you as a reminder, for those analysts who wish to participate in the question and answer session. You May now press star one to enter the Q&A queue. Our first question comes from Lorraine Hutchinson with Bank of America. Your line is open.
Thank you good afternoon Katrina.
Katrina. Thanks for the gross margin puts and takes I just had a question about.
The promotional piece of that you mentioned the $3 70 in the past two quarters.
Just given where your inventories are where your receipts are in the macro environment would you expect the promotional pressure to be in line with that.
Or better maybe if you could give us some guardrails there. Thank you.
Sure Lorraine and thanks for the question I think that's.
The real open part of the margin that we sort of left for you to model.
Giving you guys the known things, which are the airfreight benefit in the quarter for fourth quarter of 540 basis points, partially offset by the inflationary pressure up 200.
We're prepared to keep promoting to get ourselves clean both fall and holiday inventories.
We enter into next year and so there is a wide range of possibilities as to what that discount amount could be I think if you see Q2 at $3 70 in Q3 at $3 70, it's rational to think Thats, a possibility, but we're not guiding to that number given there is such a wide range of possible outcomes. So.
We will let you guys take a look at what you think that will look like knowing that we will we will be committed to getting our inventories cleaned up so that we don't continue to carry the excess inventory into next year.
Thank you and then related to that as you look into the first half of next year, what proportion of your inventory will be will take.
Just some of the responsive capabilities.
We haven't said and we'll certainly consider it will say more on a future call, but I think what's important to know about responsive as we said is that it can take many different formats. So whether it's getting our basics loaded onto vendor managed inventory, which allows us to.
Take advantage of their replenishment capabilities or whether it's leaving overall inventory open to chase into Ccs or just give us an ability to range up our range down total inventory based on demand. It really is a capability that we're looking forward to having back with the manufacturing disruption that we saw.
Starting with India closing, and then Vietnam closing and many of the other jurisdictions.
<unk> closing down during COVID-19 really loss to those capabilities, which caused us to have to lean too far forward into total inventory as well as category inventory and so having those with those levers back will all give us so much more flexibility, but we haven't said, it's different by brand and certainly more.
We're happy to talk more about it as we get closer and if appropriate.
Thank you.
Your next question is from the line of Bob <unk> with Guggenheim. Your line is open.
Hi, good afternoon.
I guess the first question I have is is on old Navy.
Can you maybe just talk to some of the operational improvements and where you think.
Any of the early reads are on old Navy under <unk> as he has taken over and then.
Bobby I just curious if are you thinking of staying on as CEO .
Given the delay in naming a permanent CEO .
Maybe I'll start do you want to go ahead. Bobby go ahead. No go ahead I can't wait to find to my answer on that last one. So I'll go ahead and start with old Navy.
I think we're really pleased to see playing out at old Navy and what we have been talking about which is sequentially improving.
The BARDA quality inventory, which has finally been cleaned up and more rationalized and stores back towards what is an appropriate level of inventory for that customer still having that inventory and fully available online to serve that customer, but really getting that.
Markdown inventory out of stores that on top of that being able to finally pivot the inventories towards the categories that are selling well.
And then on top of that starting to really get back to pulling down inventory more in line with demand.
All of that sequentially has started to show real improvement I know Bobby you also have a view on some of the execution will work for all that you've talked about.
Yes look I think.
Looking at Io, although he has only been here just a little over 100 days.
He's taken decisive steps, particularly around the inventory inventory.
If you get in our stores right now they are full.
We brought a lot of that inventory forward, but it's being merchandise as well.
His focus has been.
Very very very strong that we do.
Don't lose sight of.
Good merchandising. So we've got good product that is resonating with the customer and we should never.
Get confused even in the excess of inventories youre not merchandise that well so that because the customer comes in right now we've really tightened up under his leadership, particularly in old Navy, but it's across the other brands.
To really know what the customers' AMC knows that we have no issues there.
She comes in until she leaves the engagement with the customers It was really high.
And being able to again capitalize on some of the current trends.
Maybe clearly even in this given the assortment we serve a wide range of customer.
We commented on it during.
Our opening remarks that.
One of the lower income customer, we're seeing some transition there, but thats just meaning.
They are really moving to opening price point in denim a little bit more but.
But on the other side, we've got big strengths that are showing up in categories like back back to office and even into some of our basic fashion.
Where she is really responding well so.
Those strengths right now through the team and I would say that we're really pleased with what we're seeing happen.
It's really getting the inventory right sized cleaned up.
Operationally, we're executing to get the maximum.
Conversion and driving the <unk>.
Knowing as soon as we can get or committed to the checkout, we have a greater opportunity to see additional transactions with the basket.
That's kind of the work of the work.
Right now, we're pretty pleased with what we're seeing and again a lot more to come.
I will address your second question I'm flattered I guess that you would ask but there is really only two messages that you really sit here.
Here you have heard the really strong focus.
Around operational improvements getting things right.
Knowing where we've got it wrong and stepping up to those things. So the message you really have to hang on to there is.
We're not in time out.
It's very clear to me what the board has asked me today in terms of <unk>.
Wrapping in and assessing where we are capitalizing on our strengths improving and responding quickly to to make things move in the direction, we want them to go.
But the board is very very diligent.
Around getting our CEO in <unk>.
In place and so we're very active at that but the board is also very determined to make sure we take the time to get it right.
And as I said in my closing remarks, not just casually, but this is a great company my confidence has gone way up being inside the strength of these brands are iconic we're seeing right now in our results customers are responding that when we get it right.
They do bring exactly on what they trust us for.
We will find the right leader and that can do the kind of job that I've described relative to being strong operationally and getting past some of those efficiencies whether they're cost other execution right sizing, but more than anything also being able to double down on what you know in <unk>.
Spectrum, we expect of ourselves and that is <unk>.
Returning ourselves to really really strong creative strengths brand architecture, because I believe in the portfolio strategy.
And so not sure exactly when we will finish there, but we will land the CEO for the future of this company.
Thank you very much.
Your next question comes from the line of Alex <unk> with Morgan Stanley . Your line is open.
Great. Thanks, so much for taking my question and congrats on a good quarter I just wanted to drill down on the traffic or sales trends that you saw throughout the quarter did things how did things kind of developed by month, we have been hearing some October and November weakness at select retailers. So I was wondering if you saw.
Our exit rate.
As they did thanks.
Yes, Thanks, Alex I think in line with others commentary, we did see strong volume in October slow a bit in the end and a little bit of a slow start to November .
But that trend is fully contemplated in the outlook that we described today.
And a little bit of why we remain prudent on the outlook for fourth quarter revenue.
But that said, it's early days and we know that.
Some of that was weather and potentially some other.
Disruption happening out there so we'll see what plays out but certainly we did we did see a little bit about similar trends.
Great. That's helpful. Maybe I could also describe your outlook on holiday I know last year customers kind of had a call to action to shop earlier. It seems like maybe shopping could be later and then our surveys are also saying that customers have been waiting for deals maybe what are your thoughts on that as we head into the holiday.
<unk> period.
Yeah, I mean, I've heard those various points of view as well and so we're just prepared to compete when the customer is ready to shop and so.
We know we have to get out ahead of.
Ensuring that were early enough that we're promoting at a time when she is willing to.
To buy and were not waiting too late to clear the merchandise and on the flipside, if theyre not going to shop till later, if we don't we don't want to be too far out ahead of it. So we're remaining vigilant in our view on what's happening competitively as well as taking a prudent approach to understanding where our inventory movement is and where our customer shopping.
So I guess I'll have to say that we've seen we haven't heard a lot of those dynamics and we're just watching it carefully day to day.
Thanks, so much.
Your next question is from the line of Paul <unk> with Citi. Your line is open.
Hey, Thanks, guys.
Thank you you mentioned.
Seeing commodity costs higher.
Higher than the first half of 'twenty, three any quantification of that relative to what you've been seeing.
A drag in the second half of 'twenty two and then also you've pulled back this year a bit on store openings I'm curious, how you're thinking about store growth for next year, obviously, specifically athleta and old Navy.
Sure. So Paul will provide a lot more color on 2023, as we get closer to the year, but we wanted to make sure that you guys understood is we do see.
The carton movement happening of course, it takes a while for that raw material to move through the.
The full average unit cost of our garments and so more to come on when we get to see the timing of the benefit on cotton start to flow through our Cogs.
Importantly.
We bought the first half so any raw material movement won't be flowing through Cogs materially in Q1, and Q2, but certainly we will be focused on figuring out how much of that we can get through our back half average unit cost so more to come on that dynamic we just wanted to sort of.
<unk> early thoughts on it.
And then sorry your second question.
Scott earlier thoughts on openings for next year, yet so we're going to open about 30 stores and we feel good about that pace of growth I think that's a reasonable pace of growth and so you could likely expect that.
For old Navy. The 10 stores that were opening this year was a pullback.
That was partially based on given the performance really wanting to make sure. We were staying prudent on those store openings. We did have some slip into next year, but likely will have a more moderated pace on the old Navy store openings as we move forward, but again more to come as we fully lap that pipeline of stores.
Got it. Thank you good luck.
Thank you.
Your next question comes from the line of Mark <unk> with Baird. Your line is open.
Good afternoon, Thanks for taking my question.
Yeah.
Let me back on.
Margin EBIT margin a lot of moving pieces this year a lot of temporary factors.
As you kind of right size inventory.
For some some additional sort of clearance and promotions on the holiday.
As we look forward to next year and you're past the clearance you annualize. Some of these SG&A savings that you're seeing is there a baseline level of EBIT margin that you think the business can achieve sort of regardless of kind of what the.
Revenue backdrop might look like thank you.
Okay.
Yes, I mean, there are so many moving pieces Mark and I think that we haven't issued any forward looking guidance on anything beyond sort of where we are.
Now so more to come on that I think that overall as we think about the future. While we have said is a little bit of what you've heard over the last couple of quarters, which is we feel good about the store closure activity, that's really given us a lot of benefit in <unk> and rod leverage.
We feel good about the work that the gap team has been doing about transitioning many of our international markets to partners, which will help us maybe with lower revenue, but fewer losses of operating income.
And we are committed to really deeply staring at the operating costs that we've added into the business in the form of marketing overhead and technology.
That said, we are in still a very inflationary environment and so there is headwinds on labor costs and headwinds in other inflation that we're still working through so lots of moving pieces and we'll we'll give you more of an outlook into that as we put 2023 together.
Certainly we're focused on the long term goal of getting the company back to a <unk>.
Our operating margin with profitable sales growth.
Thank you best of luck.
Thank you.
Your next question is from the line.
Roche with Goldman Sachs. Your line is open.
Good afternoon, and thank you so much for taking the question I wanted to narrow in on US, which had a nice comp improvement this quarter on both a sequential and a three year stack can you reflect a little bit more on the drivers of the sequential improvement and do you think that the three year stock trend is sustainable from here on out if that is the case what is the <unk>.
Segment profit margin that you expect for this brand ending the year and how does that compare with your view of long term segment profit operating margins for the business.
Yeah Brook I mean, we were pleased to see Athleta returned to the positive 6% growth flat comp, which was a meaningful improvement NPD came out with.
The industry growth yesterday for the quarter and the women's active market is down.
Negative seven and so athletic growth in the quarter does show that they are taking market share even as that.
Active market is slowing a bit after a few years of significant growth. So we do feel like we're starting to see a little bit of rebound in some of their performance.
Product as well as as Bobby said in his prepared remarks.
Really winning on a lot of our lifestyle product that they've been able to compete well in.
As they have been able to balance sort of performance and lifestyle as a lifestyle active brands.
As far as the three year stack going forward.
I guess, we will see but certainly our aspiration is to continue to be driving profitable sales growth.
Letter, we don't report on the operating margin segment, but certainly appreciate the question.
So with that we'll probably not comment on that at this point.
Okay. Thank you.
One more question if I, if I may as you contemplate the mid single digit sales decline that you're forecasting for <unk> can you help us a little bit with any quantification that you might be able to share about the franchise.
Impact and the holiday event pull forward impact within that thank you.
Yes, sure, we havent quantified that broken so.
I think just fair to say that the dynamics are such that we did say it was a slight impact from the October promotion in old Navy.
And then the franchise sales timing is.
<unk> impact GAAP had the easy impact at the point to them, it's probably less not more modest than that for gap, Inc. So sort of all those things together.
And then on top of that as we said, we're really just trying to remain prudent about the consumer and the environment heading into holiday. So that we do allow ourselves the ability to sell through the product as we need to as we enter into next year. So hopefully all those drivers are helpful. But I don't think it's any one single driver it is.
Everything together, that's that's adding up to that outlook.
Thank you very much I'll pass it on.
Your next question is from the line of Oliver Chen with Cowen Your line is open.
Alright, Katrina and Bobby Thank you rich.
<unk> the carryover fall product whats the nature of the product.
You still need to work through this current time and then as we zoom out a little bit on the old Navy.
Your hypothesis for a few things that needs to be done strategically just to two.
To drive more consistent.
<unk> margins.
And balancing the assortment.
And I'm sure speed and agility and fabric platforming as an opportunity to thanks.
Yeah sure Oliver I'll take the content and then maybe Bobby I don't know if you want to speak to the old Navy Peter on the on the content side, it's different by brand, but fundamentally.
As we think about.
Summer inventory that carried into fall of that.
Our margin drain in the in the second quarter or in the third quarter and then we had saw inventory. We are clearing that now is carrying into holiday.
We do feel like with holiday by Us being down we will stop that from continuing but we need to focus on the fall alright, that's carried over its really various things. It's nothing no pockets in particular, it's really more about the overall inventory being higher than the relative demand and our ability to actually clear through.
That given sort of the customer dynamics. So we're focused on clearing through that now, though and that is part of why we do believe the margins will be pressured in the fourth quarter and again, we have a lot less holidays. So we look to have that that cycle stop as we head into first quarter of next year. So I don't know Bob if you want to comment on it.
Old Navy.
Well I mean, I think you put your finger on those things that you.
I would expect maybe as challenging as we clearly lead in the assortment get broader than it really needs to be and in some cases again were missing a great deal of depth.
So the course correction there is really just getting back to the fundamentals.
And putting the right lands on inventory. So there is a much much much greater focus.
Looking at sell through expectations.
More of a lifecycle.
Mindset around the products, so that we're continuing to keep the freshness and newness there.
Referred to IL, one of the things that he's gone through the team and again really happy right now with the things that are taking place is.
Calls with both our mills and vendor partners, where we know that we've got an opportunity for greater collaboration same responsive capabilities that right now have been helping gap brand.
Old Navy will be able to leverage.
Leverage on so.
Just a lot more creative I think.
Site from the consumer and being able to deliver on it I'll give you a good example, thats even going on right now.
And the brand that shows what happens when we do get it right.
Back to office.
The brand hopes to really own.
But even right now we have pixie and STB path.
Offered in.
Skinny leg player to hide leg.
Fabrications and patterns, all very very very popular.
Message that the consumer is telling us about the sensibility and fashion that she is looking for and again, certainly staying really sharp on our basics.
In particular being.
Being able to serve again a wide range of customers.
And then on denim and opening price point right now with a lower end, but again across the aisle.
Demand customers turn from denim too.
Athena fabric that we've got out and.
Again. These are things I think that the brand is really going to look to try and capitalize on so.
Much more rationalization around the breadth of assortment.
And really getting deep, where we know that they're looking for so then again keeping enough open so we can chase into it.
Last point on that it's not just being more responsive and having a better inventory balance the more effective we are at that those are big downpayments and steps toward localizing more effectively as well.
The inventory, we carry an increasing sell through so.
It's something I think that's a big big big opportunity of the brand and why.
<unk>.
Why we feel so strongly about the opportunity for old Navy going forward.
Thank you happy holidays.
Your next question is from the line of Mike Burrito with Wells Fargo. Your line is open.
Okay.
Hey, everyone. This is Jesse so Wilson on for Ike Thanks for taking our questions.
Just curious on this.
So first the 53 million dollar rate.
The UC products.
You kind of confirm that that was all of the product that you guys hold and just fully written down and then.
Looking out over the longer term with the real estate with your business I'm just curious on your views of the ownership there.
We should.
Specced in.
More sales in the future. Thank.
Thank you.
Yes.
Thanks Jesse.
Yes, we did take the appropriate impairment on the easy inventory.
As we are winding down that business about 53 million is reflected as appropriate.
As we think about you are talking about corporate owned real estate I'm, assuming based on your question.
Yes.
So the way I think about the corporate owned real estate is we will always look to monetize underutilized assets to the degree the assets are being fully utilized we are we are proud of the assets, we have and we feel good about them. So I'm not previewing anything else other than to say, we do try.
Look and prudently evaluate how we're utilizing our assets to make sure that that they are adding the value they need to add but at this point, we feel good with where we are today.
Michael Thank you.
Your next question is from the line of Matthew Boss with Jpmorgan. Your line is open.
Great. Thanks Katrina.
Katrina a couple of things maybe one could you help rank assortment changes that you've made at gap, which drove sequential improvement this quarter.
Old Navy is there a way to think about maybe just a reasonable timeline for optimal inventory balance that you think across categories at old Navy and then three on the $250 million of annualized expense savings I guess what percent do you see flowing through to the bottom line next year versus opportunities you see for reinvestment.
So.
In order for gap are you talking about.
Specific.
The specific assortments, what's working there is that what you're asking.
Exactly.
Yeah I think.
Funny, Bobby and I were talking about this we're really proud of the way that the gap team has come back with great current fashion.
But really its current for the modern essentials and so whether it's.
The faux leather pants that have really driven a lot of interest in the normal five pocket styles or whether it.
They are great interpretation of the basics like Jean jacket with a pop sleeve that just makes that product more current I would say overall they've.
On a really nice job of having trend right fashion, but interpreted into modern essentials and so on.
I'll answer the other two and the Bobby has anything more to add on GAAP, all I'll have him do that as far as old Navy.
Sure.
<unk> inventory assortment I think we're making progressive improvement through every quarter and importantly, as we move into spring. We're just very excited to have that responsive inventory back because that will start to give them the opportunity to be much closer to demand and be able to chase into the inventory trends.
As an example gap has been able to chase back into the faux leather styles as well as that gap that plus sleeve denim jacket for instance in a very short amount of time. After they saw the fall product succeed to get it back in time for holiday and.
And so just an example of how once we get that responsive inventory back I think old Navy will similarly have start to see the ability to really change the way they are able to serve their customers.
And then on the $250 million of annualized expense savings.
Right now our view is that that's expected to just offset the reset in bonus for next year. Since as you can imagine we're not likely to pay bonuses. This year based on performance.
As well as.
Some of the wage inflation that we're seeing but as Bobby said more to come we're not stopping at the $250 million I think we feel like that's a good start for where we need to be really bearing down on costs in the company, but overall, we are working hard to think about how to think longer term about more.
<unk> cost efforts that we think will right size the company's expense structure to make it more fit for purpose. So I don't know Bobby on GAAP, if you'd add anything.
No I think I would just double underlying on the costs and then we said we're really early.
In this work but.
This is work where we're taking a real comfortable position on question. The everything that we do so it's work that we'll see going on well into 2023, so a lot more to come there.
I would not Miss a chance to really go linked Katrina visit nicely, but.
I think it's a meaningful deal.
We've seen strong women specialty business term.
Ross Walmart woven bottoms sweaters, it's everything I mean, there is a.
Great oversized turtle next whether that's really really hot in there they've gotten bold enough trend right right now knowing the customer is ready to get out so whether it's party, where right now et cetera, and agenda category assumed flannel sheet of sleep and so forth so seeing that business turn.
And the way the team.
I think has geared up to keep that going.
It has my attention I've seen spring and summer.
So I think that.
Hopefully, we're going to find ourselves with some positive traction here.
Your next question is from the line of Cory <unk> with Jefferies.
Your line is open hi.
Great. Thanks, Hi, good afternoon, and thanks for taking my question so.
I wanted to touch a little bit on the gap. So I think one thing that's clear is that strategically this business has been.
Really focused on driving capital efficient growth whether it.
Franchising international selling the China business or maybe even more recently going on to launching on Amazon fashion. So could you maybe just talk a little bit about the overarching strategy at the gap brand and how that's progressing and how you see that playing out as we look to the fourth quarter and next year.
Yes Corey.
It is very much consistent with what we've put out for gap brand, which is that.
<unk>.
We have spent the last couple of years really right sizing the business model to a more modern model for the gap brand closing North America specialty stores that we potentially had over expanded back in the heyday of getting out of malls.
That are not as relevant anymore pivoting to be much more digital really focusing on ensuring that the international growth, which we think is important it's our most global brands is being done with other People's capital.
In a way that we can be in those important markets, but not be sustaining the operating losses that we were sustaining there so really focusing on a much healthier core and then really the focus on the creative health of the brand the relevance that drives the North America core through <unk>.
Product relevance and partnerships is the recipe for that brand and I think that that's what's playing out in third quarter, It's what Bobby articulated about there sort of product early signs of.
Improvement and what we remained committed to as we head into next year.
Alright, Thank you very much and best of luck.
Your last question comes from the line of Janet Kloppenburg with J J K Research. Your line is open.
Hi, everybody and congratulations on the progress.
Katrina I just wanted to flesh out the merchandise margin direction.
Fourth quarter, where it seems like there's some caution and I appreciate the inventory breakdown.
But you did a great job of bringing inventories down so I'm wondering.
With this product and a better balanced product not where you want it to be but Ellen.
<unk> balance.
There's some indication that the promotional levels will be that much more severe even though the inventory levels appear to be pretty pretty in pretty good shape or let's put it this way much better shape than they were.
And then on the SG&A. It seems like you saved a lot of marketing in the third quarter. That's my view.
And I'm just wondering.
Will you start to uptick your marketing spend in the fourth quarter and going forward into 'twenty three thank you.
Yeah sure so I think Janet.
We are glad that we have started to see the inventory levels come down.
When you adjust for the in transit in the pack and hold.
And the basics that we're carrying we do still have fashion heading into the third into the fourth quarter that is above the current revenue outlook announced what gives us the caution on the margin combined with the fact that we know others are working hard to get their inventory levels down So we'll see where the margin.
Plans, but.
We remain sort of prudent about what it might take in order to get through that so, we'll see where that lands, but again trying to be helpful. In articulating that we had to run discounts impacting the margin of about 370 basis points from Q2, and Q3 and while we certainly hope it's better in Q4 it certainly.
On our minds that it could be that.
As we head into the quarter. So we'll let you decide on SG&A.
Yes, we did save some in marketing in third quarter.
Don't believe that that we would be spending more in marketing in the fourth quarter.
We continue to try and find that right balance of marketing in the brands, but overall, our focus on marketing effectiveness, both in fourth quarter as well as we head into next year.
As we look to make sure that we're being prudent in that marketing spend after a couple of years, that's heavily investing so I wouldn't expect the marketing to go up in fourth quarter.
Okay, great. Thanks, so much and best of luck for good holiday.
Thanks, Janet E tail.
Thank you that does conclude our conference call you may now disconnect.
[music].
Yes.