The Gap, Inc. (GAP) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. My name is Karina and I will be your conference operator today. At this time, I would like to welcome everyone to The Gap, Incorporated Third Quarter 2020 Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to introduce your host, Steve Austenfeld, Head of Investor Relations. Please go ahead sir.

Great, thank you very much. Good afternoon, everyone and welcome to Gap, Inc.’s third quarter 2020 earnings call. Before we begin, we would like to remind you that the information made available on this webcast and conference call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from any forward-looking statements, as well as the description and reconciliation of any financial measures not consistent with Generally Accepted Accounting Principles please refer to Page 2 of the slides shown on the investors section of the website gapinc.com. We supplement today’s remarks as well as today’s earnings release, our quarterly report on Form 10-Q filed with the Securities and Exchange Commission on June 9, 2020 and any subsequent filings all of which are available on gapinc.com. These forward-looking statements are based on information as of November 24, 2020 and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Chief Executive Officer, Sonia Syngal; and Chief Financial Officer, Katrina O’Connell. With that, I’ll turn the call over to Katrina. Katrina O’Connell: Thank you, Steve and thank you everyone for joining us today. Before we get started, we hope you and your loved ones are safe and healthy, recognizing we continue to address the COVID pandemic. As we head into the holiday season, we recognize many people are eager to purchase gifts for their family and loved ones. At Gap, Inc., we've invested year to date over $100 million in health and safety measures to make our stores a safe shopping experience, both for our store employees and our customer. Additionally, we further invested in online shipping capabilities, as well as curbside pickup options, enabling our customers to purchase gifts how and when they want for themselves and their family during the upcoming holiday season. We hope everyone remains safe and healthy this holiday. For today's call, I'd like to quickly connect us back to the investor meeting we held last month unveiling our Power Plan 2023 strategy. Following that, I'll review the company's third quarter performance, followed by our thoughts on the remainder of fiscal year 2020. Sonia will then share her perspective followed by Q&A. So, as mentioned before I jump into our third quarter results, I want to acknowledge our investor meeting, we hosted last month. In summary, we provided perspective on the power of our brands, specifically our $4 billion brands, with Old Navy being largest at over $8 billion as of the end of last year, the power of our portfolio, noting the growth synergies that come from each brand being part of our portfolio, and the power of our platform, with just two examples being the digital capabilities and extensive supply chain that all brands benefit from. Additionally, we shared our economic model with financial assumptions beginning in 2022 that we believe reflect how we’ll drive ongoing shareholder value. Specific to the economic model, I noted that we expect 2021 to be a year of profitable growth versus 2020, which has been significantly disrupted due to the COVID pandemic. I would call it a rebound year and we'll share our thoughts on 2021 as part of our fourth quarter earnings call in early 2021. We also noted that as we emerge from 2021, beginning in 2022, we anticipate the structural changes we're making now and into next year will set up the company to deliver on a consistent basis, low-to-mid single digit sales growth and consistent operating margin expansion, as well as achieve a 10% or greater operating margin by the end of 2023. And we anticipate yielding operating cash flow of 10% of sales, an achievement we've accomplished for a number of years. As we execute our Power Plan 2023 strategy, we continue to focus on a number of key initiatives. These include driving growth in our highest margin brands, Old Navy and Athleta. Both of which had double digit growth in the third quarter, and which we expect to be 70% of sales by the end of 2023. Transitioning The Gap brand to a more capital efficient model through our licensing agreement with IMG, the YEEZY Gap partnership, as well as a strategic review of our European business to improve profitability. We also will continue closing unprofitable Gap and Banana Republic stores, which as stated during our industrial meeting will yield $100 million in EBITDA savings on an annualized basis by the end of 2023. Additionally, we target to have 50% of our sales by the end of 2023 being online, building off the 40% of our sales that were online in the third quarter. And beginning in 2021, returning to a normalized level of capital expenditures, focused on investments to further our omni capabilities, including digital and technology capabilities, and distribution capacity. So, having addressed some of our key elements of our Power Plan 2023 strategy, let me turn to our third quarter results. Starting with top lines, total company net sales were flat, which included the impact of the company's decision to close unprofitable stores, consistent with our store rationalization initiatives, a key element of our strategy. Importantly, comparable sales were up 5% in the quarter, reflecting the fundamental health of the business. We’re also pleased to see that our strategic focus on driving our online business is paying off as online sales increased 61% in the third quarter. The 5% increase in comp sales was driven by Old Navy and Athleta, which both delivered strong double-digit comp numbers as customers responded positively to their strong product offerings and relevant marketing messages. As noted during our investor meeting, Old Navy and Athleta, which are cumulatively 63% of company's sales as of the end of third quarter are both our fastest growing and highest margin businesses. We anticipate them growing to be 70% of company sales by the end of 2023 as noted during our strategy review, which will meaningfully add to company's growth rate and margin. Third quarter gross margin was 40.6%, up 160 basis points compared to last year. This reflects margin expansion of 360 basis points from rent and occupancy savings as we continue to close unprofitable Gap and Banana Republic stores, partially offset by 200 basis points of deleverage in merchandise margin, as higher shipping costs resulting from very strong online sales growth exceeded higher product margins, reflecting the lower level of promotions in the quarter. Turning to operating expenses. During the quarter operating expenses increased by 270 basis points versus last year. This included over 175 basis points in higher marketing investment across all brands, with each of our billion-dollar brands being advertised during the extended back to school shopping season. As discussed during the company's investor meeting, we believe the challenging marketplace for many other retailers provides our brands an opportunity to gain market share through increased marketing. Additionally, the company continued to invest in health and safety measures in its stores as part of our safe shopping protocols to provide customers a safe and welcome environment in which to purchase items for their family. In the quarter these expenses amounted to approximately 140 basis points of deleverage. Lastly, SG&A also reflected approximately 120 basis points to deleverage from costs associated with store closures. Although from an earnings standpoint, these costs were essentially offset in gross margin through lower rent and occupancy costs. These cumulative increases were partially offset by a benefit of approximately 200 basis points in one-time costs in the year ago quarter, primarily related to the company's previously planned separation of Old Navy. Looking forward to Q4, we intend to continue investing in brand marketing to compete during the important holiday season. We'll continue to invest in and provide a safe shopping environment for our customers as we manage through the pandemic, and we expect to reflect more store closure costs, but again directionally offsetting gross margin. So, from an operating income standpoint with meaningfully improved sales performance versus last quarter and improved gross margin versus last year, the company delivers third quarter operating income of $175 million or 4% of sales. Looking at other lines of the income statement, interest expense was $54 million. The effective tax rate was 21.5%, primarily reflecting changes in the estimated benefit associated with the enactment of the coronavirus aid relief and economic security or CARES Act and the impact of the company's geographical mix of pre-tax earnings. The year-to-date effective tax rate was 23.7%. And lastly, earnings per diluted share for the third quarter was $0.25. Turning to the balance sheet, looking at inventory on a reported basis, we ended the third quarter up 1%. Recall that in the face of uncertain demand earlier in the year, we implemented a pack and hold inventory approach, whereby mostly summer product is being held will be released during next year’s selling season. As a result, pack and hold inventory will remain in our reported inventory numbers until released to the market in 2021. Excluding pack and hold, end of quarter inventory was down about 7%, reflecting our disciplined approach to managing inventory. Looking forward we anticipate Q4 ending inventory, excluding pack and hold to be down percentage wise roughly the same as Q3. And let me turn to cash flow, as we shared at our investor meeting, fundamentally Gap, Inc. is a strong cash flow generator, with over 10 consecutive years of at least $1 billion in operating cash flow. Despite store closures earlier in the year, due to this pandemic, Gap, Inc. year-to-date has generated nearly $400 million operating cash flow or approximately 4% of sales driven in great part by disciplined working capital management. Specific to capital expenditures, we've invested $288 million year-to-date. We now expect to spend roughly $375 million in 2020. The current estimate is higher than our last forecast of $300 million, as the company's strong cash position has supported high ROIC based investments in digital technology and capacity, particularly in support of our online business. As noted during our investor meeting, we anticipate beginning in 2021, increasing our capital expenditure spend to a more traditional level of 4% to 5% of sales to continue supporting our growth. The company ended the quarter with a cash balance, including cash equivalents and short-term investments of $2.6 billion. So, we are well funded for 2021 and beyond to invest for the long-term health of the business. Lastly, before I turn it over to Sonia, let me share some thoughts on the final quarter of the fiscal year. Given the high level of uncertainty in the current environment, particularly recognizing the rising COVID-19 cases in the U.S. and around the globe, we're not providing specific fiscal year 2020 or fourth quarter earnings outlook. However, recognizing many aren't able to enjoy the usual simple pleasures of traveling to see loved ones, or attending a concert or sporting event, we believe people are looking more than ever to buy gifts during the holiday season for family and friends. Our investments in health and safety measures in our stores, as well as in our online business, coupled with the marketing investments we're making in our brands give us cautious optimism for the fourth quarter. We anticipate giving you perspective on 2021 during our next earnings call, but to be helpful as we look towards Q4, here are some thoughts on the quarter. We see the following dynamics in Q4: net sales being equal to or slightly higher than last year.; gross margin rate being equal to last year reflecting benefits continuing from store closures largely offset by higher shipping expenses; and operating expenses being between 33% and 34% of company sales, reflecting the company's continued investment in brand marketing, capitalizing on the opportunity to capture market share, as well as the continued cost of in-store health and safety measures on behalf of our customers and employees. And importantly, cash flow performance should remain strong. And with that, I will turn the call over to Sonia.

Thank you, Katrina and good afternoon everyone. I'm happy to talk with you today about our third quarter results within the context of our newly defined go forward strategy, our Power Plan 2023. As we shared with you at our investor event in October, we grow purpose led billion-dollar brands that shape people's way of life. So, what does that look like? It's Old Navy paying employees to serve as poll workers to show that every voice and action counts. It’s Gap delivering American optimism by encouraging people to stand up for one another in their Stand United TV spot. It's Banana Republic reissuing its iconic notorious necklace, and raising half a million dollars for the International Center for Research on Women to celebrate and honor the life and legacy of Supreme Court Justice, RBG; and its Athleta putting its brand mission into action with a $2 million pledge to establish the power of [she fund] keeping women and girls connected through movement. It starts with brands that stands for something. Brands with a distinct point of view that connects directly with how consumers are shopping, what they're wearing, and most importantly, how they're feeling. And in today's landscape, this means more than ever. Since the beginning, we have led the casualisation of American wardrobe were comfort, fit, and quality matter. Whether it was introducing khakis and the notion of casual Fridays to the New York Stock Exchange in the late 1990s or a modern version of Gap Khakis making the headlines during election coverage earlier this month. It's about more than just a pair of pants. It's about relevance. And since our recent election coverage, we saw a dramatic increase in online traffic and within a day, the number of straight fit Palomino, brown khakis, we sold online went up 90%. We connected with people. Together, our brands reach all ages, all bodies, all social economic brackets, all moments and all used occasions and target approximately 80% of the very large addressable apparel market. The majority of our assortment is pointed at the youth occasions that are most relevant today. And when you couple that with the scale we have across key categories, like our nearly 3 billion active business, including fleets, and our nearly 4 billion kids and baby business, we are delivering the product consumers want and need. And we deeply know and understand our customers, enabling us to make business decisions with them at the heart of it. Fueling our brands are our powerful Omni capabilities. We are ranked Number 2 in U.S. apparel e-commerce sales. We have sharpened our real estate strategy so that our stores will be where our customers want to shop today. And we have increased focus on convenience and experience and uniquely ownable, digital, and physical spaces. These advantages give us the power to deliver. This is such a unique moment in time. In a dislocated market, we are investing in growth today to drive share gains for the long-term. While we have just built our strategy, our teams have been leveraging the power of our brands, the power of our portfolio, and the power of our platform for many months now. It's showing up in our performance. Before I dive into third quarter results, I really want to thank our teams and I can't say this enough. I'm proud to see them leading with our competitive strength, embracing our new cultural imperatives, co-creating with our customers and each other, and driving for growth. Recognizing that the effects of COVID-19 are still very much a reality for our business, our customers and our communities, this has not been easy. Their belief in Gap Inc., our purpose led brands, the values of this company, and the customer we serve has been unwavering. So, let me reflect on Q3 and bring to life the Power Plan 2023 in action. First, the power of our brands. During the quarter, our billion-dollar brands leveraged their brand power to win in a dislocated market by delivering the right product at the right time, at a time when trust matters most. Each brand lead with their values and their full campaigns. They invested dollars and increased digital marketing to drive traffic, and for the first time in 10 years, all four brands were on TV and it paid off. Let me start with Old Navy, our largest brand ranked Number 2 apparel brand in the U.S. And now the Number 5 apparel retailer on a rolling three-month basis according to NPD Group. Old Navy’s results were exceptional, driving a 50% sales growth year-over-year, while also delivering margin expansion and market share growth. They did this by focusing on the democracy of style and service, leveraging promotion strategically, and leaning into brand value. Their omni-channel offerings provided superior convenience to customers by leveraging the large online channels and well-located suites. Online sales for Old Navy grew 86% in the quarter, maintaining its momentum from Q2 even as stores fully reopened. They delivered strong product performance and relevance in advantaged categories like [active employees and Twitter baby]. According to the NPD Group, Old Navy grew market share faster than any other denim brands in the U.S. in October on a rolling three-month basis. Thanks to denim America campaign focused on inclusive sizing. Celebrating Old Navy's commitment to their quality and inclusivity is, we are we campaign delivered a positive year-over-year brand impression. The Gap brand sales declined 14% in Q3. Store sales were lower reflecting our plan to strategically shed unprofitable sales as part of our fleet rationalization efforts, while online sales grew 38% year-over-year. While we transitioned Gap brand to a capital efficient and more profitable business, the team is really focused on maximizing online demand through relevant marketing, product and quality improvements, customer engagement, and stronger execution. Gap’s Fall marketing campaigns ‘Stand United’ and ‘Be the Future’ both generated positive customer response, while store traffic beat the industry average throughout the quarter. Moving on to Banana Republic, which represents about 10% of Gap, Inc. sales, in Q3 sales declined 34% and while we are nowhere near satisfied with this result, this is an 18-point improvement from Q2. As we noted during our inventor meeting, Banana Republic continues to face challenges driven by the shift in customer preference from a more formal workwear to casual in light of work from home today. With this in mind, the brand is working hard to update product assortment, prioritizing more relevant categories like lounge, sleep, active, fleece and sweaters with a reduced focus on workwear categories like tailored suiting. And last, we're extremely proud of the results at Athleta, our fastest growing brand. In Q3, Athleta delivered 35% sales growth, with September reaching the highest sales comp in the history of the brand. This has continued evidence that Athleta is on its path to double reaching 2 billion in sales by 2023. Once again, they delivered incredible online growth, supported by investments in digital marketing with traffic and net demand both up approximately 75%. They're focused on key growth categories that will help us reach new customers, which is driving a healthy reg price business and productivity gains. And their 1x to 3x inclusive sizing pilot is delivering a strong early read ahead of a full re-launch in January 2021 and will be a major growth driver for us next year. Next, I want to talk about the power of our portfolio. We acquired over 6 million customers in Q3, and our total customer file now sits at 176 million, up 15% from last year. Our customers also spent 6% more with us on average than last year. For fueling enduring relationships through personalization, infusing the voice of the customer at every turn to create product and experiences that they need and want, and this is showing up in our net promoter score, which across all channels is up 13% from Q3 of last year. Customers continue to come to our brands from masks. And we’ve updated styles and introduce innovation across the category now representing 4% of sales across the company. It is our goal to turn every customer into a loyalist. One of the things I'm most energized about is the strong launch of our multi tender loyalty program and the enhanced value this program can unlock since the rollout on September 22, just two months in, we have enrolled 3.5 million new members to double digit conversion in stores and online enrollment. We're excited to build on this as we move into 2021 and fully leverage all customer touch points to market the program. We now have more than 50% of our sales coming from loyalists, meaning they have a credit card with us or they're part of our loyalty program. This is more than double where we were able to deliver with card alone and is an important enabler to our personalization imperatives. Lastly, I'd like to talk about the power of our platform. As we shared in October, the strength of our platform, including our Omni capabilities and scale operations enables us to serve our customers the way they're shopping today, whether it's online, safely in stores, via partnerships, or combination of all three. Our agile network also allows us to be nimble as customers shopping preferences change. In Q3, we saw strong performance online, even when stores reopened, with 61% growth versus last year, comprising about 40% of total sales in the quarter and to fuel the online growth and drive site conversion, we developed new functionality this quarter to make it easier for customers to shop, including quick add to bag features redesign navigation on our mobile experience and improved usability of product review, and our product is coming to life across our site better than ever with elevated product photography that is more emotional and more aspirational. Our partnership with PayPal and AfterPay went live this quarter, with strong conversion in mobile and attractive new customer acquisition with demographic skewing towards millennial and Gen Z. Across both, we expect to deliver approximately 2% lift in revenue per visitor, compared to customers using other payment methods. I really want to celebrate the work of the digital team. I've seen a massive collaboration and acceleration of both talent and innovation as they work to deploy functionality and creative cut through, big and small to make the site more engaging for our customers. One of the biggest value drivers of our Power Plan 2023 is our real estate restructuring strategy, largely pointed at closing select stores across Gap and Banana Republic. Our strategy is rooted in moving away from traditional malls and focusing on more advantageous locations to better meet customer needs. As Katrina mentioned, the work is on track and delivering substantial savings, and will continue to do so in the future. That being said, we believe there are profitable opportunities to open stores in both Old Navy and Athleta. In fact, Athleta opened eight new stores in Q3, including their 200th store. Our stores remain a very important part of the shopping journey for our loyalists. We're making investments to deliver standout moments across our Omni experiences, whether in store, on mobile, or through one of our new capabilities like curbside pickup or virtual styling. In Q3 alone, overall net sales volume across BOPIS and curbside increased over 50%, proving that our customers are voting for convenience and safety this brings. And on November 19, just in time for holiday shopping, we've launched convenience hubs across the entire fleet of Old Navy and Athleta stores. These stations will streamline the in-store process and create a single destination to expedite BOPIS orders curbside pickups to return, reducing customer pain points and congestion at the cash register. This is one way we're leveraging our lean and advantage operations to make customer facing improvements that will also help improve operating costs across the fleet. Before we turn to Q&A, I'd like to comment on Q4. As you look at the remainder of the year, we're encouraged that according to NRF, the National Retail Federation, retail sales have largely recovered from the pandemic heading into the holiday season, which points to the resiliency of the consumer. In some ways this doesn't surprise us, if people aren't spending money on things like travel or sporting events and concerts. So, with more disposable income available, heading into the holidays, research suggests people will be more likely to buy products across our brands. Showing your love for family and friends at a time of gifting means more than ever. At the same time, consumers still face uncertainty with rising COVID cases, higher unemployment, and uncertainty around any incremental stimulus, and ambiguous operating environment that poses some risk to store operation. To head against these challenges, we are doubling down on initiatives that nurture deeper relationships and trust with our customers. We're seeing strength in key indicators, such as a 15% increase in stores Net Promoter Score versus last year, especially as customers appreciate the safety measures we have committed to, ensuring they can shop without worries in our stores, and as you've heard, our online business is going faster than it ever was, enabling our customers to purchase our products regardless of the pandemic. And to support the unprecedented channel shift online, we have scaled and deepened relationships with existing parcel carriers, and added new shipping partners. We ramped up automation and staffing in our distribution centers or as we like to call them our customer experience centers and pull forward demand to reduce pressure on fulfillment. Recognizing the increasing online shopping we have seen year to date, we have invested in having the right capabilities to address the possible surge in online demand. Big picture, I'm proud of the company's ability to improve sales performance during the unique pandemic related challenges. It's a once in a generation opportunity right now. With the holidays upon us, we feel confident in our preparedness and the trust we’ve built with our customers through strong execution and safe shopping practices. We believe in the power of our brands and that product, experiences, and capabilities we deliver to our customers will enable us to grow sales profitably and generate meaningful cash flow to invest in the long-term growth, all consistent with our Power Plan 2023 strategy. Before I wrap up, I want to share the exciting news that we have two new leaders joining our Gap Inc. senior leadership team. Asheesh Saksena will join our team this January as our Chief Growth Officer, a newly created position that will focus on executing against our strategic agenda, as well as leading growth initiatives for the future. Asheesh joins us most recently from Best Buy, where he served as President of Best Buy Health and prior to that Chief Strategic Growth Officer. He's also lead strategy and growth organizations at Cox Communications, Time Warner Cable, and as Partner at Accenture. Asheesh is an agent of change with 30 years of experience as a growth igniter. Once on board, I look forward to his assessment of value creation opportunities to ensure consistent growth for the company. And Sandra Stangl will step into the role of President and CEO of Banana Republic, as the brand continues to redefine affordable luxury. With more than 25 years of experience, Sandra is a strong creative leader known for delivering design, vision, brand expansion, and outstanding financial results. Sandra has held numerous leadership positions, including President of Pottery Barn, where she was part of a team that envisioned and launched Pottery Barn Kids and Pottery Barn Teen, as well as President of Restoration Hardware. And most recently, she co-founded with Chief Merchant of MINE, a disruptive pure-play home business. She will join Banana Republic in December. I'm pleased to have Asheesh and Sandra join the team, both strong industry veterans and visionary leaders known for driving growth through creativity. As we steered Gap Inc. in our purpose driven billion-dollar brands into the future, this gives me even greater confidence in our ability to deliver against our Power Plan 2023. With that, why don't we open it up for Q&A?

Thank you. [Operator Instructions] We'll go ahead and take our first question from Kimberly Greenberger with Morgan Stanley. Please go ahead, ma’am.

Okay, great. Thank you so much. Very nice results tonight. I wanted to ask specifically about Old Navy. The really impressive 15% bounce back in revenue here would seem to suggest that Old Navy delivered some margin expansion as well here in the third quarter. I'm just wondering if you can laser in on Old Navy's margin performance in particular. And I knew after potentially two challenging third quarters in a row, the Old Navy business was sort of off of the level that had delivered back in 2017 margins. I'm wondering if you made progress towards recovering back to 2017, and what are the sort of key drivers for Old Navy margin expansion, or let's say returning back to those 2017 margins in the future? Thanks so much. Katrina O’Connell: Sonia, I don't know if you want to start with sort of the sales performance, and I'm happy to wrap up with the [quarantine suggestion].

Old Navy had a standout quarter and we're really pleased with their results, strong response to product offerings, we saw a great increase in digital and traditional marketing with more to come with high return on that investment, strong active business, the Kids & Baby achieved the number one brand in that segment. And in terms of sustainability, we know it speaks to the brand positive and we have referenced in our super sales outlook that we expect to be equal or slightly higher than [indiscernible]. So, we're confident about their business and their momentum, and, you know, the product margin expansion that we saw this quarter, and you know, I think that the yield management that they drove in combination with their strong product is something that they'll continue to focus on. Katrina O’Connell : Yeah, I mean, Kimberly, what I would add is, the team has done really a tremendous job between the lean inventories that we had when we sort of cut the inventories heading into the pandemic, and then chasing back into the categories that really have resonated active fleas, knits, Kids & Baby etcetera. They've done a tremendous job managing the inventory, and then the promotions on those inventories. So, you're right, the team did see expanded, gross margins in the quarter are based on that. And that relates to historical levels, you know, we'll see longer-term, but we are very pleased with the way that team is executing on all fronts.

Thank you

We’ll go ahead and take our next question from Ike Boruchow with Wells Fargo. Please go ahead.

Hey, good afternoon, everyone. Two questions. Katrina, one quick one, I'm sorry, if I missed this, did you pick up the merchandise margin versus occupancy dynamic in the third quarter? And then on the SG&A, I guess on a higher level, can you kind of talk to the accelerated investments you guys are making that we saw in the third quarter, and you're talking about for the fourth quarter, is this assignment, you know, your expectations on growth going forward are higher just, you know, it's an interesting dynamic that we're not really seeing from the other, a lot of other retailers out there. So, I’m just kind of curious how you're thinking about pulling forward that investment and what that really means to your ultimate, you know, to get through to get the margins back to 10% over the next couple years? Katrina O’Connell: Yeah. Thanks, Mike. So, on the margin question, you're right, so our third quarter margin was up [160 basis points], what I said is that the rent and occupancy was 360 basis points of expansion. And that was partially offset by 200 basis points of deleverage in merchandise margins, which was a result of higher shipping, which largely offset the lower level of promotion. So, higher product margin. So that was the margin dynamics. I'm glad you brought up the SG&A, it's really an important point, because we see this time as a very unique time for us to really drive market share gains ahead of other competition in this dislocated time. We still remain committed to what we said less than a month ago, or a month ago, which is, we're going to continue to invest in demand generation expenses. And we're going to re-engineer the fixed cost structure of the company, and that's going to be everything from the store closures to the evaluation of some of our international markets for partnership to some of the work that I know Shawn talked about in our Investor Day around driving down operating expenses, like store, labor, etcetera. And so that's all important for us achieving the 10% and beyond operating margin in 2023. But in 2020, with this COVID environment, and really a lot of the weaker players seeing significant amount of disruption, we see this as an important time to be investing in our brands or demand generation. And as the quality of the consumers we're going to gain now will pay dividends in the future. And so, it is a strategic shift that we have chosen to make.

You know, just to add on to that, it is quite intentional. Thanks for putting it out, like and – and as we said, Investor Day, apparel, you know, 200 billion in market size and a unique moment to consolidate share with whether it's the share donors, or is the weaker players and using both the power of our brands and the scale advantage we have, we are playing to win in this unique time. And we are very committed to the healthy top and bottom line. So, we articulated in our Power Plan 2023 last month, with the growth in profitable sales and that growth plan delivered on quarter-over-quarter.

Thank you.

And we'll go ahead and move on to our next question from Matthew Boss with JPMorgan.

Great, thanks. Maybe to follow up on SG&A, is there a way to maybe help quantify the 3Q buckets? If we think about store closure costs, COVID cost and marketing expense, and just know maybe those same buckets, what's embedded in your fourth quarter forecast? And just larger picture as we think about the timeline, when is it best for us to think about the inflection to operating margin expansion, as you've outlined at the analyst day? Katrina O’Connell: Yeah, so Hi, Matt. In my speech, I tried to break out the basis points of deleverage associated with each one. So, I'm happy to go through that, but you know, we said that over the 270 basis points of operating increase, operating expense increased 175 basis points was attributable to higher marketing, and then 140 basis points is attributable to the safe shopping. And then we have this dynamic in SG&A also where any cost that we have to incur to close the stores that were strategically closing, that falls into SG&A and that was 120 basis points of deleverage. So, that's hopefully helpful to you guys. That 120 basis points of deleverage is basically offset in gross margin though through a one-time savings in rent and occupancy. So, that's the one unique dynamic there. As we think about Q4, you know we were trying to be helpful in our guidance around how we're thinking about operating expenses. We said, we expect them to be 33% to 34% of company sales. When you look at our as reported last year, you'll see this is a meaningful improvement to last year. That's mostly because we had an almost $500 million expense last year attributable to some store impairments and separation costs. When you isolate for that, we expect that the marketing and the store closures – excuse me, the store safety costs will be about the same impact as what you saw in Q3. And so hopefully, that's helpful for you, as you look at your model. You know, longer-term, let's see what happens, we've got a vaccine coming and we don't know how long the COVID pandemic will last, but hopefully, what's helpful is that we've tried to let you guys know, we think it'll be profitable sales growth year next year. And we'll provide more details on exactly how we see that play out when we get to our fourth quarter earnings call.

And to build on what [Shawn said], two out of the three line items are, you know, because of the environment we're in, right, whether it's the store safety cost, or the cleanup of the real estate, that's been a long time coming, and the marketing investment is to play [indiscernible] and play aggressively to consolidate share, and we'll continue to learn. We have a lot of rigor around the return on those investment dollars with marketing effectiveness mechanisms. And so, we feel very good about that, but two of the three are not long-term cost that we expect to incur and so we’ll be out of that at some point and you know, link to the vaccine, etcetera.

That's helpful. Thanks.

We’ll go ahead and move to Mark Altschwager with Baird. Please go ahead.

Good afternoon. Thanks for taking my question. With respect to the fourth quarter, was hoping you could talk about the planned shipping headwinds there, maybe relative to what you saw in the third quarter? And then what are the controllable drivers, you have to offset some of these pressures? So, along those lines, maybe hoping you could talk about in the trends and split shipments? And how that trended in the fall relative to what you've experienced in the spring? Thanks. Katrina O’Connell: Yeah, I mean, the good news is, is that as we expected, shipping was still a headwind in Q3, it was meaningfully improved from Q2. And that was based on what you just said, Mark, which is that dynamic of being able to buy our inventory is more strategically back into the online channel, and reduce mostly that that ship from store dynamic. And so, we did see a meaningful improvement there. Now, as we look to Q4, our guidance does sort of reflect a multitude of possible outcomes, but largely similar to maybe increasing pressure on shipping and a little bit of air freight associated with either airing in product where we chase product for the pandemic or the port issues we've been having. The lovers we have whether it's the merchandise margins that you saw, deliver higher product margins in Q3, and let's see how Q4 plays out, but we can see similar execution, that would be great. We would see merchandise margins offset some of that, but I would say some of the shipping is a shift that we're seeing, and we'll see a lot of that benefit offset [and rod] with a lot of the store closures. And then longer-term, working through some algorithmic ways to start to reduce splits, as you say, and then there's going to be some of the longer-term capital investments. But I also think we have said before our supply chain is advantaged. And so, I don't know, if Sonia, you want to talk about that.

Yeah, listen, I think we have the most automated [PCs] for our sector, and that gives us an advantage versus the competition, versus more labor-intensive environments. And in terms of shipping, we have focused quite a bit on whether it's ordered logic improvements, whether it's reducing shipments, all the drivers that that are controllable, as you’d say whether it's multi-packs in the value space, but they'll maybe – we have many, many levers that we are deploying and as you noticing, hopefully it is execution for us to set up very heightened premium. And we're expecting and know that the teams will continue to deliver on innovation in the technology space, as well as in terms of intent, new economics that will help us reduce these costs in the coming months and quarters.

That's great, thanks and best of luck.

And we'll go ahead and take our next caller, Lorraine Hutchinson from Bank of America. Please go ahead.

Thanks. Good afternoon. I just wanted to follow up on the gross margin point, it seemed as though some of the store closure rod benefits will continue in 4Q and into the first half of next year, I think as we look to first half of 2021 and look at it versus 2019, do you think you'll be able to post higher gross margins on a year-over- year basis? Katrina O’Connell: Well, Lorraine, I think it'll be good for us to have that discussion on the fourth quarter call when we guide more specifically to 2021, but it's fair to say that the rod benefit, as we discussed in our investor meeting just a month ago, is a significant benefit to gross margin, as well as operating margin in the long-term, but we can talk more specifically about 2021, and the dynamic when we guide later or actually early in 2021.

Just to build on that, we're more than pleased with the progress we’re making on a real estate strategy and the execution and the compromises and the fairness of deals you've landed with. Now, the vast majority of our landlords, and you know, I think it'll be nice to close that out and really focus on you know, what that's going to then positively impact on the P&L. I’m excited to see that complete.

Thank you.

And we'll go ahead and take our next question from Paul Lejuez with Citi. Please go ahead.

Hey, thanks, guys. Just one clarification. One question. First, you mentioned, [indiscernible] basis point I think of store closing costs, the deleverage that was offset by [indiscernible] line, I just want to make sure I understand that the 120 that you mentioned on the store [closing time], is that one time in nature, is that going to continue? And I guess same question on the rent line, wouldn't that be something that is ongoing and ongoing benefit that would help gross margin to those just the clarification? Question, just curious about the new customers that you are seeing in the Athleta brand, what's customer profile of the new customer relative to your existing customer base, anything to share on spend? Thanks. Katrina O’Connell: So, the store closure cost that we're referencing, and maybe we're not being clear, I think maybe we’re not, but those are attributable to the buyout. So, if you remember, when we were at our investor meeting, we did indicate that there was about 210 million of buyout costs that we would incur, as we try and get out of some of the high-profile stores, it's going to be lumpy depending on when those negotiations land. So, the 120 basis points is attributable to the cost that we use – the dollars that we use to pay out some of those buyout costs with a select number of stores. And then as we do those buyout costs, we're able to settle some rent expense. And that comes through the one-time benefit to rod. Now, so it's a unique dynamic, it doesn't repeat, other than maybe in Q4, we have more buyouts as we chunk away and that 210 million and get that behind us. But that piece is going to be lumpy, depending on negotiation. And then you're correct, going forward, there is an ongoing rent benefit that's more associated with the monthly rents we would have been paying in those stores. So, it's a little complicated, but that's what we're referencing.

Listen, we're very lucky and fortunate to have such a cash generating business that we are able to get some of these problems behind us that are lumpy and hard to bottom out, but you know, we can take the one-time measures that we are taking that are showing up and get them done and continue to think about our cash to fuel organic, organic growth, and foliar growth going forward. Katrina O’Connell: And then Paul, I think you had customer question, but I’m not remembering it, do you mind repeating it?

The Athleta customer, new customers that are seen in brand, how the profile is different from the existing customer base spending levels? Katrina O’Connell: Do you want to take that Sonia, the Athleta customer, sort of how the new customers are different than the existing one?

Yeah. Listen, what I will say is masks had been a great, you know, way for many new customers to be introduced to the Athleta brand. Also, it's a relevant category in the act space, which has become even more relevant during COVID and advantage – because of its online channel being greater than 50% of sales. The relationship with the customer has been a real builder with math and the team has innovated and introduced another fourth, you know, math that has greater and greater sustainability, beauty and technical capabilities that customers are really flocking to, and so then they get infused, and they get into to the math into some of the, you know, core loyalty products such as the bottom business. So, we've been quite pleased, and then, you know, the recent ad that they did, you know, has had 60 million views. So, the impression that that brand is making, right now is a unique moment of time that’s quite high.

Thank you guys.

We'll go ahead and take our next question from Kate Fitzsimons with RBC Capital Markets. Please go ahead.

Hi, thanks very much for taking my question. I guess just one follow up to Paul’s question. I guess, you know, Sonia you noted resonance to some of the marketing at Athleta, I am curious just how you are viewing customer acquisition costs at that brand, you know, over time, and just, you know, relative to the superior profitability, it does be to the other brands, you know, do you expect, you know, ongoing investments in that item, I think to move the needle on brand awareness, with perhaps offsets on the merchant margin front, you know, that would be helpful, you know, some of the puts and takes there. And then, you know, next, I think just on the supply chain, you know, with inventories down 7% ex-packaway, can you just remind us about some of the supply chain capability, perhaps by brand, or category that you think in particular can help you support the top line at Old Navy and Athleta? Thank you.

So, in terms of the first question on Athleta I just shared in our Investor Day, Athleta is our fastest growing and most profitable brand. So, all of the marketing investments that we're making are contemplated in that statement, and in our three-year view. So, while we are leaning into aggressive growth of brand awareness whose mechanisms, we're also really pleased with the profitability of the brand and expect that as it grows that the greater share of the portfolio to impact the overall financial health of the company in a very good way. Now your second question was around the Vantage supply chain, and what I would say here is, what we have just moved very, very quickly to add speed and agility because the one thing that we do know is that it's very hard to predict what the environment will look like, and we will be best served with that agility. So, the star scale advantage has given us the ability to chase in a product that's working really well very quickly, shed weeks, and even months out of our supply chain lead times, you know, bring in, you know, hundreds of millions of units in faster ways. As we shared in Investor Day, we are, I think we've got over 100, maybe 150 now, planes that are direct shipping into our DCs so that we can chase the positive selling. So, lots of mechanisms in our supply chain across the portfolio to enable really driving sales growth and capitalizing on this one is once in a generation opportunity for us.

Great, thanks so much.

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

Hi good afternoon. Alec Legg on for Susan. Thanks for taking our question. So are you able to provide the store productivity by brand or just overall Gap Corporation and how that has trended throughout the quarter and maybe in the fourth quarter? And then has conversion rates in store increased with just customers shopping more of a purpose and then also YEEZY Gap] collection still on track to launch this spring?

I think Katrina can go through by brand, but I will start with this. We’re pleased with the conversion improvements in stores, we have seen that and you know, having fueled by the 15 point improvement in our net promoter score that we spoke about, the store environment is something that the customer is really pleased with between the focus on safety, the focus on the heightened experience – leader unit, but give a more elevated merchandising environment and the service emphasis that we placed. So, pleased with the in-store experience and what that's doing. And then your question YEEZY Gap, you know, I think we're looking forward to first half launch next year, and what I will say is the creative that I've seen and whether it's the product or the e-com site that is getting prepared, very exciting and very innovative, some of the most creative work we've seen. And so, pleased with what’s ahead and we are on track for our launch as announced. Katrina O’Connell: And then as far as store sales are concerned, so net sales were flat with 61% increase in online and our store sales down 20%. Now, several percentage points of that store sales decline was driven by closures, as we said, and so the remaining sort of is the average of the productivity in Q3. And similar to the dynamic we've articulated in the past, given the results that you see at Old Navy, and that's what I think it's fair to assume that those stores have recovered more quickly, especially since they are largely off mall and strip locations, as well as the fact that they're seeing a disproportionately high performance in our online business. But then you know, Gap sort of more in line and then Banana, more disadvantaged based on the product categories that they've been having a tougher time with as they look to reposition their assortment. So, I would say that's what I would tell you as far as thinking about productivity in Q3. And then we'll see in Q4, but as you've heard, we've been investing substantially in store safety measures to make sure people feel comfortable. And they're also prepared with capacity, and shipping capabilities, as well as, you know, store related capabilities to service the customer wherever they want to shop, since we know that this will continue to be a unique environment for shoppers.

Thanks. And if you don't mind, just a follow up on shipping. The carriers provided a cut-off date just to essentially guarantee delivery by Christmas or it that something that's still being worked out on?

No, listen, we are in deep relationship and partnership with our carriers, and they're being very agile with us. So, as demand comes in over the next, you know, these 11 days of the Black Friday through Cyber Tuesday now, I guess, you know, very, very important timeframe for us, and then December shopping. So, we're seeing a lockstep with our carriers. We're adding capacity as needed in order to service our customers.

Thank you.

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

Good afternoon. Thanks so much for taking my question. I wanted to just ask a follow-up on the fourth quarter guide, can you help us out with anything that's giving you confidence in achieving the sales level and the [same] quarter to date. How within that you are thinking about the timing of the holiday season this year, is difficult to predict perhaps different from prior years? And then whether you're factoring anything else for capacity constants and some delivery bottlenecks, can you comment a little bit [indiscernible] pull that together which should be very helpful. Katrina O’Connell : So, I think I kind of have let me try. So listen, we think the consumer is in a really good place. We think that the forecast for consumer spending is up. We think that apparel is a great category when customers can't travel or spend on sporting or events, those kinds of things. And we believe that our voice shared growth, as well as our developments makes us an ideal destination for Q4 selling and you know, as we learn and shared with you in our last quarter, you cannot predict when exactly the customer will make their decisions for holiday shopping back to school was much later than it had been in previous years. Because of the pandemic situation we expect, you know, dynamics to be what they are and we will be ready. Our whole focus is, we will be ready and ready to service the customer whenever she's ready to shop. With 176 million customers, they're all going to choose different times to shop. Whether it's the, you know, early shoppers or the ones that love Black Friday or the ones that shop on December 24. And you know, I think we'll be ready for all of them.

And that does conclude today's question and answer session. I would like to turn the call back over to today's presenters for any additional or closing. Katrina O’Connell: Thank you very much. It's been a pleasure. I hope everyone has a safe and you know time down with their families over Thanksgiving and enjoy the festive holiday season and lots of great gifts for you in case you want to participate. So, talk to you next time.

Once again, that does conclude today's conference. We do appreciate your participation. You may not disconnect your phone lines.