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Presentation

The Gap, Inc. beats earnings expectations. Reported EPS is $0.59, expectations were $0.2.

Operator: Good afternoon, ladies and gentlemen. My name is Brianna, and I will be your conference operator today. I would like to welcome everyone to The Gap, Inc. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to introduce your host, Emily Gacka, Director of Investor Relations.

Emily Gacka: Good afternoon, everyone. Welcome to Gap Inc.’s third quarter fiscal 2023 earnings conference call. Before we begin, I’d like to remind you that the information made available on this 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 press release. The risk factors described in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2023 and any subsequent filings with the Securities and Exchange Commission, all of which are available on gapinc.com.

These forward-looking statements are based on information as of today, November 16, 2023, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Chief Executive Officer, Richard Dickson; and Chief Financial Officer, Katrina O’Connell. With that, I’ll turn the call over to Richard.

Richard Dickson: Thank you for joining our third quarter earnings call. In the nearly three months since I joined Gap Inc. as CEO, I’ve hit the ground running, immersing myself in the business, assessing brands and functions, and meeting people in every corner of the Company. I’ve met many of our customers and employees, visiting stores across the country. I’ve also met with many of you, our shareholders, to hear your views and understand your perspectives, and all of this has been incredibly insightful. Today, I’ll share my initial observations and priorities. Then, I’ll hand it off to Katrina, who will walk you through more detailed financial results, before we take questions. The four areas I’ll discuss today are: one, maintaining and delivering operational and financial rigor; two, the reinvigoration of our brands; three, the strength and continued evolution of our operating platform; and four, reviving our culture.

Let’s start with maintaining operational and financial rigor. As you know, this has been a core priority, and we’ve made significant progress which has strengthened our financial footing. Examples of this work include, actioning over $550 million in expected annualized cost savings, realizing margin expansion through lower air costs, improved discounting and more effective sourcing strategies combined with recovery of commodity costs, and we’ve reduced our inventory by nearly $800 million versus last year’s peak. Our efforts to date have resulted in better working capital and a stronger balance sheet, and this discipline of controlling the controllables will continue to be a priority for us as we aim to increase the consistency of our performance both near- and long-term.

Our focus on operational and financial rigor benefited our third quarter results, particularly in terms of improved margins, expenses, and cash flow, and I’ll briefly review highlights for the quarter. Revenue was down 7% versus last year with comp sales down 2%, ahead of expectations. We grew market share both overall and at Old Navy and Gap brand. We expanded adjusted gross margin by 260 basis points, driven in part by improved promotional activity, enabled by leaner inventory and better assortments. We maintained well-controlled expenses, resulting in an improved adjusted operating margin at 6.8% and we ended the quarter with a strong cash balance of $1.4 billion, generating free cash flow of over $500 million year-to-date. Old Navy delivered a positive 1% comp for the quarter with momentum in women’s, driven in part by our active business combined with strength in kids and baby during the back to school season.

Gap brand saw strength in women’s and baby. Comp sales for Gap were down 1% in the quarter, despite anniversarying the final quarter of Yeezy sales last year. Banana Republic comps were down 8% for the quarter as the brand undergoes deliberate and ongoing repositioning. Athleta’s performance in the quarter was disappointing with comps down 19% as we lap a period of heavy discounting last year. I will provide a more detailed update on our brands in a few minutes. Looking out to the full year, as we enter the fourth quarter, we have a balanced view of the holiday season. Inventories are well controlled and our financial position is strong. However, we remain mindful of the uncertain consumer environment. We know that great brands can win regardless of the environment, and execution is everything.

I’m working with our teams to react and respond in real time to consumer and competitive dynamics, ensuring our brands break through this season with relevant campaigns and touch points that matter. With the progress we achieved in the third quarter and our measured expectations for the holiday season, we are comfortable reaffirming our full year revenue outlook and expect strong progress in our margin recovery. Katrina will provide more detail on the outlook in a moment. Let’s turn to brand reinvigoration. Brand reinvigoration is about driving both, relevance and revenue. Now, it’s early days and our playbook is still in development, but I will give you some insight into how we’re thinking and where we are headed brand-by-brand. Old Navy, Gap, Banana Republic, and Athleta are all brands with incredible heritage.

Brand reinvigoration will build on that heritage and will include a number of priorities. We need to strengthen our portfolio of brands with crisp, identities and purpose. We need to create trend right product assortments with a clear point of view to deliver beyond just needs to also deliver on wants. We must consistently deliver merchandising presentations and product storytelling that excites our customers. We have to create a better, more engaging omnichannel experience with a clear and compelling pricing strategy. We have to communicate through innovative marketing to regain a powerful ongoing voice in the cultural conversation, and we need to do this, while consistently executing with excellence at every touch point and interaction. I’ve seen areas where our brands do this well, but I’ve also seen opportunities where they can do significantly better.

It’s not enough to get it right in one or two of these areas. Effective brand reinvigoration is about getting it right holistically and consistently. Execution will differ brand-by-brand, but that’s a good overview of how we’re thinking. And with that backdrop, let’s take a look at where our brands are today, some of the meaningful progress we are making, and also the work ahead. Beginning with Old Navy, the number two apparel brand in the U.S. and the largest brand in our portfolio. Old Navy is a family destination with 94% U.S. brand awareness according to YouGov, a multi-billion dollars e-commerce business and an impressive retail footprint that includes more than 1,200 locations with 240 million customers entering our stores in the last year.

We have a loyal following and a great brand heritage rooted in fun, fashion and value for the whole family. Old Navy has a strong and distinctive brand positioning in the value space. However, the execution of that positioning is a significant opportunity. We need to be more deliberate and consistent about how we express the brand through bold and breakthrough narratives, something the brand is known for. We also have to improve our product assortments, balancing essentials with exciting new trends, and a pricing strategy that clearly communicates jaw-dropping value. All of this to remind customers, why they love Old Navy and give them compelling reasons to love us even more. As we begin to execute the work around these initiatives, we were encouraged to see signs of progress in the third quarter.

We created stronger product storytelling through a dedicated women’s marketing campaign, featuring on-trend product. We also improved site execution and online marketing with compelling creative and value messaging, all of which drove positive momentum and share gains in the quarter. Looking ahead to holiday, we believe the brand is ready to compete with high-quality inventory composition offering consumers great fashion at a great value. Our efforts at Old Navy come down to unlocking and reasserting a great brand. Moving on to Gap. Gap brand, as you know, has tremendous heritage as a pop culture brand that delivers, leads trends, celebrates individuality, and self expression. The brand enjoys 90% brand awareness among U.S. consumers, but lately, Gap has been far too quiet in the cultural conversation.

We need to reignite that dialogue, offering confident, trend right assortments, priced right, and expressed through big ideas and culturally relevant messaging. Our holiday campaign, which debuted October 23rd, is an early example of this. It demonstrates creative consistency, building on brand heritage, and championing originality with relevant individuals of style and substance, and I encourage you to check it out. A more inspiring and integrated creative narrative is also showing up online. And while we have much more work to do, it’s great to see progress taking place as we work to reignite this iconic brand. Now turning to Banana Republic. I’m encouraged by the team’s vision, aesthetic direction, and enhanced focus on fabrication and quality, and our cashmere and leather product offering is translating well.

While this repositioning is the right direction for the brand, there is work to do on execution. Comps are down as we continue to refine our assortment architecture, work on the brand’s price value equation, and improved marketing and merchandising effectiveness. We think Banana Republic has an opportunity to thrive in the quiet luxury space, and represents a unique position in our portfolio. This evolution will take time to manifest as we transition away from what was previously a highly promotional and transactional experience. Now, taking a look at Athleta, a brand with significant growth potential and the number five brand in the highly attractive U.S. women’s active segment. More so than any of our other brands, Athleta has a clear and distinctive brand positioning rooted in the power of she, an authentic and highly differentiated platform that plays extremely well across performance, outdoor, and travel.

As you know, the brand has gotten off track with challenged performance caused by a misfire on product, marketing that didn’t resonate, and retail execution that didn’t connect with customers. In the first half of this year, the team took action, marking down products and cleaning up the brand to pave the way for long-term success. We utilized the third quarter to reset the baseline of the brand by eliminating off-brand fashion products and focusing on our key categories. At the same time, we began to refresh store presentations and the brand’s website to better delineate our active segment with narrative-based merchandising that pulls Athleta’s focus back to its performance roots and winning platform. We are seeing early indications that customers are responding with positive NPS scores and positive sales growth in certain key products that we marketed in the new brand voice.

Despite the favorable reaction to our cleaned up brand aesthetic, lapping last year’s heavy discounting is weighing on performance. We see this headwind continuing at least through the fourth quarter. That said, I’m encouraged by the brand execution of new digital dialogue, store experience, and holiday product assortment. While we are progressing each quarter, we know that a full brand reset will require a more comprehensive approach and will take more time. Moving on to the third discussion area, we are continuing to strengthen our operating platform. We will build on and leverage operational capabilities to increase efficiency and support high-performing brands. In some areas, we are in good shape, but we have more work to do. Our supply chain is a pillar of strength at Gap Inc., where our scale gives us unique cost leverage, but we need to accelerate innovation.

Our financial strategy is driving early value, but we need to continue our focus on rigor and efficiency. In technology, we’ve made strategic investments and now it’s about optimizing those investments and driving adoption across the organization. In addition to these existing capabilities, media and marketing is another area where we can up our game, leveraging the scale of our media spend to derive greater efficiency and effectiveness overall. And let me be clear, it’s not about spending more, it’s about getting more value from what we spend. The fourth area I’d like to address today is culture. Culture is the bedrock of every successful company, particularly one that is creatively driven. And that’s why I’m laser focused on reviving a culture of creativity at Gap Inc.

One that embraces change is obsessed with our customer, relentlessly curious, highly collaborative and eager to imagine better led by the industry’s best talent. More than an objective, culture is an everyday pursuit, fueled by shared values and a belief system that unites us as one company. The intention is there, I see it, but we’ve got to better articulate it and then own it, building on our story past to create an even more vibrant future. In summary, it’s impossible to ignore the impressive scale of Gap Inc. We have four billion-dollar brands with nearly 2,600 company operated stores and 1.4 billion visits to our websites every year. And we have 58 million known active customers who rely on us for fashion that both functions and makes them feel good.

We also have an impressive team around the world and I want to take a moment to thank everyone for welcoming me and recognize the team’s commitment to delivering a solid third quarter performance. Among the insights I’ve gained in the last three months is a recognition that Gap Inc. has weathered a lot of disruption over the last several years, both external macro factors as well as execution missteps, and strategically well-intended initiatives have impacted the company. All that said, the opportunity is clear, and I have conviction that we can reinvigorate our portfolio of brands, while we lead a creative culture that attracts, retains, and develops the best talent in the industry. I’m encouraged by the early progress we’ve made to date, but we have a long way to go and a lot of work to do, and I’m looking forward to sharing updates with you on our progress in the quarters ahead.

Thank you. And now, I’ll pass it to Katrina. Katrina?

Katrina O’Connell: Thank you, Richard. We’re pleased to report third quarter results ahead of our prior expectations, gaining market share despite overall declines in the apparel market. We remain focused on the discipline we’ve created around margin recovery, expense actions, inventory management, and maintaining a strong balance sheet. As Richard noted, our operational and financial rigor will be foundational as we turn our attention to the reinvigoration and relevance of our storied and important brands. Let me start with some highlights of our third quarter financial performance before going into more detail. Net sales down 7% and comparable sales of minus 2% drove market share gains in a challenged apparel market and exceeded our prior expectations with recovery at Old Navy and consistent execution at Gap brand.

Old Navy drove a positive 1% comp with strength in women’s and kids and baby during back to school, meaningful improvement from the first half, resulting in market share gains. Gap brand showed underlying strength in performance with women’s resonating as the brand lapped the last quarter of the Yeezy product sales last year, with only a negative 1% comp for the quarter. We drove 260 basis points of adjusted gross margin expansion, resulting from assortments that resonated with customers, which combined with well-managed inventories, led to improved promotional activity. Margins also benefited from the beginnings of lower commodity costs. We delivered on our SG&A expectations of $1.3 billion despite sales above our prior guidance, all of which resulted in the Q3 adjusted operating margin of 6.8%, a 290 basis-point improvement versus last year.

Inventories were down 22% year-over-year and remain well-controlled, driving better profitability and working capital. We ended with $1.4 billion of cash on the balance sheet, up 99% to last year, and we are pleased to have repaid our asset-based line of credit as we previewed. Year-to-date free cash flow is $544 million and we are maintaining our competitive dividend, an important part of returning cash to shareholders. Let me now turn to our third quarter results. Net sales of $3.8 billion decreased 7% versus last year, with comparable sales down 2%. As a reminder, the sale of Gap China last year had about a $70 million or 2-point negative impact to Gap Inc. total net sales growth. Let me now provide sales results by brand. Starting with Old Navy.

Net sales in the third quarter were $2.13 billion, down 1% to last year. Comparable brand sales were up 1%. For the third quarter in a row, Old Navy gained market share, an encouraging early proof point that work to improve both product assortment and brand messaging are driving results on the path to unlocking Old Navy’s potential. Turning to Gap brand. Gap brand total sales of $887 million were down 15% versus last year. Excluding the estimated negative impact to sales of 7 points related to the sale of Gap China and 2 points due to the shutdown of Yeezy Gap, net sales were down 6% versus last year. Comparable sales were down 1%, and we believe signs of progress in building momentum at Gap are beginning to emerge. Banana Republic third quarter sales of $460 million declined 11% versus last year.

Comparable sales were down 8%. As Richard noted in his prepared remarks, Banana Republic has made progress in elevating the brand aesthetic and product offering. However, evolution takes time, and we know that there is work to be done to evaluate how to best engage and retain the premium customer. Athleta sales of $279 million declined 18% from the prior year. Comparable sales were down 19%, as we lapped elevated discount levels, while we work to reset the brand for the long term. We will continue to lap elevated discounting that took place last year for at least the fourth quarter. Now, turning to gross margin in the quarter. Gross margin was 41.3%, an increase of 390 basis points versus last year’s reported gross margin. Compared to last year’s adjusted rate, gross margin expanded 260 basis points.

Merchandise margin expanded approximately 340 basis points versus last year’s adjusted rate in the quarter, driven by approximately 180 basis points of leverage from improved commodity costs and lower air utilization, with the remaining 160 basis points of leverage, primarily driven by improved promotional activity, enabled by our better inventory position and stronger assortments. This was better than our expectations, particularly as Old Navy and Gap outperformed in the quarter. Rent, occupancy and depreciation declined on a nominal dollar basis versus last year. As a percentage of sales, ROD deleveraged 80 basis points, better than previously expected, given the stronger sales. Now let me turn to SG&A. Reported SG&A of $1.3 billion includes approximately $5 million in restructuring charges.

On an adjusted basis, SG&A declined 7% compared to last year, as a result of our organizational changes and other cost actions. As a percent of sales, adjusted SG&A of 34.5% improved 30 basis points versus last year’s adjusted rate. Reported operating income was $250 million. Adjusted operating income, which excludes restructuring charges, was $255 million in the quarter, up $99 million versus last year. Adjusted operating margin improved 290 basis points from last year to 6.8% in the quarter, driven primarily by the improvement in adjusted gross margin. Third quarter net interest was flat, as interest expense was offset by higher earned interest on cash deposits, which we expect to continue in the fourth quarter. Our third quarter tax rate of 13% included a benefit from the impact of foreign operations.

Reported EPS was $0.58. Adjusted EPS, which excludes restructuring charges, was $0.59. Share count ended at 371 million. Turning to balance sheet and cash flow, starting with inventory. Ending inventories declined 22% in the third quarter versus last year. We will maintain this inventory discipline, utilizing our responsive levers to chase trends and continue to expect that we will end the year with inventories down roughly 15% from the prior year. Quarter-end cash and equivalents were $1.4 billion, an increase of 99% from the prior year. Year-to-date net cash from operating activities was $832 million, driven primarily by lower inventory levels. Capital expenditures were $288 million. We are pleased to have generated free cash flow of $544 million year-to-date.

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 $0.15 per share. On November 7, 2023, our Board approved maintaining that $0.15 dividend for the fourth quarter of fiscal 2023. And finally, we’re pleased to have paid down the remaining $150 million balance and are now undrawn on our asset based line of credit. Now, turning to our outlook for the remainder of fiscal 2023. Starting with sales, the following factors are considered in our outlook: one, we are mindful of the mixed economic data and uncertain consumer trends in the marketplace, and as a result, we continue to take a prudent approach to planning the business. Two, while we are encouraged by the improvement in performance at Old Navy and Gap, we now anticipate a longer recovery time line for Athleta and Banana Republic.

At Athleta, we’re lapping elevated discounting and believe net sales for the brand could be down in the low double-digit range for the fourth quarter. And three, as a reminder, we expect the 53rd week to be worth approximately $150 million in sales. These factors, along with November month-to-date sales trends which have modestly improved versus Q3 results, have been contemplated in our outlook, and we are estimating fourth quarter total company net sales growth inclusive of the 14th week to be flat to slightly negative. We remain confident in and are maintaining our prior sales outlook for fiscal 2023 of down mid single digits compared to last year’s net sales of $15.6 billion. Turning to gross margin. We expect gross margin expansion for the fourth quarter compared to the 33.6% gross margin in fiscal 2022, driven by merchandise margin expansion of approximately 280 basis points due to improved commodity costs and lower air utilization, with ROD deleverage of approximately 40 basis points.

We expect promotional levels to be roughly in line with last year as we take a measured view given the uncertain consumer environment. For fiscal 2023, we expect gross margin expansion to exceed our prior expectations. And compared to the 35% adjusted gross margin in fiscal 2022 to be driven by an estimated 200 basis points of leverage as we lap last year’s elevated airfreight, approximately 10 basis points of inflationary cost deleverage versus last year, at least 170 basis points of leverage from improved promotional activity versus last year enabled by lower inventories and better assortments, and ROD as a percentage of sales is now planned to deleverage roughly 60 basis points compared to last year. Turning to SG&A and capital. We continue to expect fiscal 2023 adjusted SG&A of approximately $5.15 billion and estimate fourth quarter SG&A of approximately $1.4 billion.

We now expect fiscal 2023 capital expenditures of about $475 million for the year, below our prior range of $500 million to $525 million, due in part to fewer store openings. In closing, we are pleased to deliver solid financial results during the third quarter, demonstrated through gross margin expansion, expense discipline, lean inventory and strong cash generation. The operational and financial rigor that we’ve worked to develop and will continue to pursue is enabling us to focus on reinvigorating our brands with the goal of generating sustainable profitable growth and delivering value for our shareholders over the long-term. With that, we’ll open up the call for questions. Operator?

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Operator: Thank you. [Operator Instructions] Our first question comes from Adrienne Yih with Barclays. Please go ahead.

Adrienne Yih: So, Richard, here’s a question I have for you. I get where the brands are pretty well established or maybe Banana, Athleta. But the one that really, for 20 years, has sort of wandered, I would say, like, kind of moving up, moving down is Gap. But, you’ve been there a 100 days or three months or so, can you give your sort of like initial kind of feeling on what Gap stands for? And how do you corral sort of the entire Gap for an organization to get to that 10-point target? And then, for Katrina, are your inventory turns back to pre-pandemic levels? If you are going to end the year at down 15%, can you structurally comp all year, just by turning faster? Is that how we should think about that? Thank you very much.

Richard Dickson: And I do appreciate the question specifically on the Gap brand, which really is an incredible heritage brand in our portfolio, let alone a heritage brand in pop culture. And really to understand where we are with Gap, you really need to unpack all of the puts and takes. We’ve taken serious steps to meaningfully change the health of Gap brand. And over time, this has created what we believe is a much healthier core from which we’re now enabled to really reinvigorate the brand and grow. We strategically moved to a more profitable model, and we took action to optimize the retail footprint, and we’ve closed hundreds of stores. We’ve moved to a capital-light, international franchise model and partnered with our China and European markets.

We’ve also been growing our online presence, but we recognize that we have been not as prominent on top of key trends, and we need to market our core categories in a much more relevant and meaningful way. This is going to take time. The third quarter results do provide some really early proof points that our healthy core is showing signs of strength. We are going to continue to build upon this, as we reignite the brand. As we talked about and as you call out, the reignition of a brand when we sum it up, stands for relevance and revenue. And each one of our brands is in a different place of reinvigoration, but the methodology to reinvigorate our brands is similar. And in Gap’s case, we are really building upon defining a stronger, more crisp identity, working on trend right product assortments with a very clear point of view, that will deliver not just on the needs but also on wants.

Our merchandising presentations have already improved in our stores. They are starting to deliver great storytelling that excites our customers with a real edited point of view. If you go online today and if you’ve been tracking our brand, you will see a much more definitive, creatively consistent marketing story in our online experience. So, our storytelling is going to be much more prominent. And we are going to start to really infuse Gap in the cultural conversation. So stay tuned and keep watching all the touch points as we continue to reinvigorate the brand.

Katrina O’Connell: And then, Adrienne, as it relates to inventory, if we end down 15 at the end of this year, that translates to being down about 6% to 2019. So, I would say, we are back to having reasonable inventory levels for the Company. And, as I said in my remarks, our goal will be to remain very disciplined on inventory. I think, we continue to see that that enables us to grow gross margins through lower promotions, but it also allows us to utilize our responsive levers to chase trends closer into consumer demand, which also allows us to be more relevant and also allows us to then achieve higher gross margins. So, we’ll see where the inventories land for next year, but overall that inventory discipline will remain. And I think chasing trends through inventory responsiveness will be the lever that helps us turn faster.

Operator: Our next question comes from Ike Boruchow with Wells Fargo. Please go ahead.

Ike Boruchow: I guess, one for Richard and then a follow-up for Katrina, if that’s okay. So, Richard, so, you guys as a company now posted your first positive comp at Old Navy in a few years. So without being overly specific on the fourth quarter or next year in regards to guidance. Can you say at a high level, do you feel that the business has really turned a corner strategically? Do you believe this is back to a positively comping share-taking business, once again, as you look forward? And then the follow-up for Katrina. On the credit side, there’s been a lot of questions, in retail, on credit and delinquencies going up. Can you just give us some context on how you think about the potential headwinds to margins from here maybe?

I don’t know if you would be comfortable giving us what credit income was as a percent of sales in ‘19, where it’s planned to be at the end of this year, or how much margin pressure should we expect if credit trends were to fully revert to ‘19? Just something that would give us a little understanding of what that potential mean reversion could look like to the margins next year would be really helpful. Thank you.

Richard Dickson: I’ll start by saying that there’s really no denying the strength of Old Navy. This is the number two apparel brand in the U.S. We’ve got an incredibly impressive footprint with over 1,200 stores. And we’ve got a very strong brand proposition delivering on fun, fashion and value for the whole family. We were really encouraged to see the progress that we made this quarter with the brand. And the result of the learnings that we applied from a more muted first half is really what’s delivering. Specifically, we focused on a dedicated women’s marketing campaign. We included on-trend product, and it drove positive momentum and market share gains. We also spent a lot of time in the quarter improving our site execution, online marketing included in that, and have designed a much more pointed, compelling, creative point of view with value messaging.

I encourage you to go online and take a look as we’ve been tracking the brand. I think you’ll see that come across. That being said, we have work to do, and we need to continue to execute with consistency. As we look forward to the holiday, we’re going to offer a really balanced product range from, of course, Jingle Jammies to party and active. But I really do believe the brand is ready to compete. We’ve got a high quality inventory composition. We’re concentrated on creating great value presentations with great style. And look, as I noted, we are encouraged, but we’re focused on continuous improvement at Old Navy, and really for all of our brands as we look to reinvigorate our brands. So one quarter, very well done, incredible team execution, but consistency will be the name of the game.

Katrina O’Connell: And then, Ike, on your credit question, it’s a good one. We don’t disclose our credit card income, but to tell you we are actively monitoring the consumer environment, and that includes the inflationary cost pressures that are on either discretionary spending or on consumer credit. Maybe what I would say is the credit card income trends that we’re seeing today are all fully contemplated in the outlook we provided today. And of note, the biggest impact to date has been the change in interest rates, which has impacted the cost of funds. And that impact is already in the outlook we just provided. And then, as it relates to loss rates, we’re obviously looking at those carefully. We’re still better than pre-pandemic levels.

And I would add that our file is pretty high quality. We don’t have significant subprime exposure. So, maybe all of that helps you to understand that. We are watching it carefully, but the credit outlook that we see is embedded in the outlook we provided today.

Operator: Our next question comes from Matthew Boss with JPMorgan. Please go ahead.

Matthew Boss: So Richard, on the missteps at Athleta that you cited, maybe what’s the timeline you see for stabilization when you look at that brand today? Help us to think about changes across the assortment and marketing messaging, again, relative to today. And then, Katrina, with inventory down more than 20%, just help us to think about constraints to recapturing the material headwinds tied to discounting a year ago, in the fourth quarter?

Richard Dickson: So thank you, Matthew. And specifically, look, Athleta had a disappointing quarter. It struggled recently, and the third quarter comps were very disappointing. We have begun the reset of the brand. We knew that we needed to make leadership changes in order to create a differential outcome for this powerful brand. As you know, Chris Blakeslee joined us about 90 — maybe one or two days ago, and has orchestrated appropriate changes, which we feel confident will get the brand back on track. We’re going to be progressing each quarter. We know that a full brand reset will require a more comprehensive approach. It will take more time. It is early. I can’t quite commit to a time line at this point. What I can tell you is we are confident and excited about the long-term potential of the Athleta brand.

That’s the number five brand in the U.S. women’s active segment, which is one of the largest segments in the industry. It’s got a clear and distinctive brand positioning rooted in the power of she, which is so authentic and highly differentiated as a platform. And we know that we’re lapping significant promotions and markdowns from last year, a dynamic that we expect to continue at least into the fourth quarter. But we are confident that the work that we’re doing, specifically on product has a more distinct narrative around performance based narrative measures, and we’ve also begun to refresh store presentations. The brand’s website also, I encourage you to take a look at, really pulls the Athleta’s focus back to its performance roots and of course the power of she platform.

So look, these are early days. We’re seeing early indications that customers are responding, but there is more work to do.

Katrina O’Connell: And then, Matt, on the inventory side of things and discounting, I think in third quarter, we were pleased to be able to deliver 160 basis points of margin recovery in — the margin related to discounting, which came from much less discounting than we had prior year. I think what I would say is there’s two things. First, as we said that we have brands performing at different levels right now. So, we have Old Navy and Gap that are really showing early signs of recovery, and we have a little bit of a longer recovery time line for Banana and Athleta. And so certainly, those are things to consider when thinking about margin recovery. And then, in addition to that, we are navigating a very interesting consumer environment, as we said, that has mixed consumer performance.

And so we want to remain disciplined about also providing great value to our consumers. And so, we’re also remaining prudent about that balance between inventory is down, but also being able to recover gross margins, and offer discounts.

Operator: Our next question comes from Brooke Roach with Goldman Sachs. Please go ahead.

Brooke Roach: Good afternoon and thank you for taking our question. The Company has made a lot of progress this year on recovering gross margin and driving expense discipline. Can you elaborate on the opportunity to drive further margin expansion beyond this year? And provide your thoughts on how best to balance reinvesting those wins back into the brands to drive the strategic initiatives you’ve outlined today versus flowing those through to the bottom line.

Katrina O’Connell: Sure. Brooke, I think as you say, we’ve really developed financial and operational rigor to control the controllables. And as you say, this has really showed up, both in gross margins this year with our inventory levels down, which has led to fewer promotions, the discipline around air freight and the commodity recovery in the second half. As I think about the future, we are going to remain committed to healthy gross margins and well-controlled inventories. We are also going to remain committed to the discipline that we have around SG&A, and ensuring that we have that level of inventory — or excuse me, rigor around that as well. That’s going to enable us to really turn to the brand reinvigoration that Richard articulated that is a big priority for the company, as we aspire to return to consistent profitable revenue growth over time.

So, more to come when we provide an outlook. But that discipline around the middle of the P&L, we believe is really critical so that we can really have the room to focus then on the reinvigoration of our brands.

Richard Dickson: And Brooke, I’ll just add that none of the expansion on margin and the disciplines that Katrina mentioned, compromise the integrity of the reinvigoration plan, by no means. So, I think what we are experiencing right now is that we are demonstrating the discipline of operating in financial rigor that is actually enabling the focus on the reinvigoration plan.

Operator: Our next question comes from Michael Binetti with Evercore ISI. Please go ahead.

Michael Binetti: Hey, guys. Congrats on a really great quarter out of the gate here, Richard. Can I ask you — I guess, from time-to-time, you have been willing to share where Old Navy margins are. I don’t know that we want to get into that now in much detail, but it seems like the right time to ask, if you could help us with a little bit of perspective there, as that business shifts back to positive comps, surprisingly in the quarter, pleasantly surprisingly. And then, I guess, I would ask on Athleta for a minute. I hear you on the long time frame and on the fourth quarter sales, but we did see quite a bit on sale. I mean, that banner in the quarter, seemed like a fairly heavy purchase to get a lot of inventory out. I would assume that that’s going to be — even though the sales are down, that’s going to be a positive contributor to merch margin here, as we get into the holiday.

And then maybe just your outlook on the promotional outlook for the holiday here. We heard your thought on the promos being flat to last year, but maybe just a hint what we’re going to see as we watch the promotional environment through the holiday.

Richard Dickson: Michael, we don’t provide Old Navy margins or margins for our portfolio. But jumping to the Athleta question. Look, as I said before, we did have a disappointing quarter. Comps down 19% is not where we want to be. That being said, we had significant promotions and markdowns that we took proactively from last year to this year, to clean up the assortment that had product misfires and marketing misfires and retail execution. This dynamic, we do expect to continue at least into the fourth quarter. As you go into the stores and you look online, you will already see a more distinctive narrative in both product and brand messaging. As you go into our stores, you’re going to see a much more delineated refreshed store presentation.

The markdown assortment will get less and less as we move through it. But ultimately, we will be lapping a bit of challenge here on the misfires in product. I will say that we are seeing early indications, as I mentioned, that what we are rolling out in terms of new product, customers are responding. The work that we’ve done in marketing very quickly and the displays that we’re seeing in our digital dialogue are also encouraging, but we do have more work to do. And as I said before, out of our portfolio, this is a brand that’s operating in one of the most exciting segments in the industry, the performance segment is incredibly rich with opportunity. And while we are a number five player, we’ve got enormous potential to continue to grow this brand.

Katrina O’Connell: And then, I think, Michael, you asked about the overall promotional outlook for the holiday season. We were really pleased to enter with inventories down 22%. I think that shows discipline around controlling the inventories. We think that inventory is fresh and has good product offerings for the customer. I think what you saw in the outlook we provided was that we’re planning for our promotions to be relatively flat year-over-year. And, honestly, we want to make sure that we’re mindful of the somewhat choppy environment that we’re heading into for the fourth quarter with the consumer still feeling pressures. And so, our top priority will be about executing well for holiday and offering the right price-value equation for our customer.

Operator: Our next question comes from Lorraine Hutchinson with Bank of America. Please go ahead.

Lorraine Hutchinson: Katrina, I wanted to follow-up on Ike’s question on credit income. Would the CFPB proposal on late fees have a material effect on your operating income?

Katrina O’Connell: Well, Lorraine, I know there’s been a lot of speculation on that and sort of – we have nothing to quantify specifically at this time. At this point, I think 2024 will be the earliest impact of that, and we’re working with Barclays, who’s our credit partner on ways to mitigate the potential impact. So we’ll provide more of an update when we know more about the timing of that regulatory impact.

Lorraine Hutchinson: And then, as commodity costs go your way, is this something that you’d expect to pass through to the bottom line, or are there investments that you’ll make in product in any of the brands that might offset that?

Katrina O’Connell: I think at this point, that’s sort of a product by product discussion. I would say, universally, we don’t have plans to reinvest substantially the product cost back into the product. I’m sure, in certain brands and places where we think the customer will appreciate it, we might do that. But overall, I think just as we’ve been doing in the back half of this year, you’re seeing that with the recovery in commodity cost that’s leading to expanded gross margins. So I think it’s logical that that will likely continue.

Operator: Our next question comes from Dana Telsey with Telsey Advisory Group. Please go ahead.

Dana Telsey: With the improvement that you’ve seen in Old Navy and the focus on restoring growth to Athleta and to Banana Republic, are there any learnings from what you’ve done so far at Old Navy that harkens to Banana Republic and even Gap or the other divisions that can accelerate that turn? Thank you.

Richard Dickson: Yes. Dana, thank you for the question and the compliment on the quarter. What I would tell you is, when I speak about brand reinvigoration, I mentioned the two words that we drive from that are relevance and revenue. Each one of our brands is in a different stage of reinvigoration process. But ultimately, when I think about reinvigoration, it’s really strengthening each brand’s positioning statement and identities and purpose. In the case of Old Navy, as we’ve talked about, fun, family, fashion, and value. And I think even as an example, again, I encourage you to go online. You’ll see that crisp identity start to come through. It has to be about trend right product assortment with a clear point of view, that — I talk about delivering beyond just needs, but also deliver wants, interesting pieces, interesting segments, how we can create and amplify big ideas.

We’re going to consistently deliver merchandising presentations that tell stories with our product that excites our customers when they see it online and when they see it in our stores. And we’ll work on better and more engaging omnichannel experiences with clear and compelling pricing strategies, and again, encouraging in the early reads on some of the work that we’ve done reflected in our online presence and in our stores around a much more compelling and surgical price strategy. And last but not least, as we talk about, innovating through marketing campaigns that speak to cultural conversations, create it consistently and execute all of these touch points and interaction with excellence. You can’t do one or two of these and think we’ve got a reinvigoration on our hand.

You’ve really go to work in harmony and do all of these. And so, while I’m very pleased with some of the progress that we’re making, in particular brands like Old Navy and Gap, we do have work to do across the portfolio, following this reinvigoration road map, and we will be updating you quarter-to-quarter on how we’re doing.

Operator: Our next question comes from Mark Altschwager with Baird. Please go ahead.

Mark Altschwager: I was hoping you could help us better understand or unpack the drivers of the improvement at Old Navy this quarter, down 6 to plus 1, really an impressive inflection in this backdrop. It did seem to be well ahead of your internal plans for the quarter. Was that just conservatism at the time you were guiding, or was there a bigger shift in product acceptance with the fall product that that you weren’t anticipating?

Richard Dickson: Yes. Thanks for the question. I think it’s important to note, we’ve been seeing market share gains in Old Navy every quarter this year. And certainly, we are very pleased with the progress that we’ve made in the third quarter. It’s important also to note that these are the results of learnings that we’ve applied from a more muted first half. I mentioned the dedicated women’s marketing campaign with on-trend product, and I think that shows the deliberate intent of when we market with conviction and we associate that with great trend product, and we carry through that message through online execution and in-store merchandising. These are muscles that we are going to be strengthening, and we saw it drove positive momentum and market share gains.

And so, when we look at the continuation of that reinvigoration process, we will continue to improve our site execution, work on our marketing with compelling, creative and value messaging. Again sharp price points that express great style and great value are resonating. And we continue to believe that, we’ve got the right progress and momentum, but we need to continue to deliver that consistently. And so, as we look to the back half, you are going to see a really balanced product range with offerings like Jingle Jammies and party and active, and ultimately, a high quality inventory composition that will drive to a successful year-end for Old Navy.

Mark Altschwager: That’s great. And thank you for the color there. Maybe just to follow up, I mean, the message on SG&A this year has really been about cost savings and efficiencies. What does marketing look like at Old Navy? Is that up year over year? And what do you think — how do you think about the right time line to really lean into marketing, at the Old Navy brand, given the momentum that you are seeing?

Richard Dickson: Thanks for the question. We don’t share the specifics of our brand marketing investments. What I would tell you however is we do a lot of marketing that could be more effective. And part of our operating and financial discipline applies to our marketing and media effectiveness. And you will be seeing a lot more, if you will, creative, consistent, bold narrative breakthrough marketing, that will drive conversion and compelling customer reactions in our omnichannel presentation, but it doesn’t necessarily mean that we are going to be spending more. It’s about being more effective with what we spend. Over the years, I’d argue that our marketing execution has been very, very tactical. And in some cases, on some brands, we’ve lost relevance and a narrative edge.

But when you look at our company history, we have legendary marketing. And I am very confident that we will again, it is a critical part of our reinvigoration work. And you will continue to see more effective brand presentations and communications throughout the quarters to come.

Operator: Our last question will come from the line of Alex Straton with Morgan Stanley. Please go ahead.

Alex Straton: Perfect. Thanks for taking the question, and congrats on a nice quarter. I wanted to ask a couple of follow-ups. One just on the Old Navy. I don’t think that you called out men’s as a point of strength. So I am just wondering what’s going on there, and what would you attribute it to? And then second, maybe Richard for you, you’ve been speaking about this importance of having trend right product and assortments really across the banners. Can you just speak to, like, what type of tactics or strategies you use to implement that across the organization? Thanks a lot.

Richard Dickson: So, first off, thanks for the callout on men’s. In fact, men’s had a weaker first half, and we’ve been seeing the trend actually improved in the third quarter and I think it will continue to find some strength in the back half here. When you look at, what we talk about in terms of trend right products, I think that we’ve done a good job and arguably a very good job with providing what we call the needs. And in that case, it’s providing great basics. And what we have to do a better job of is creating the wants. And that’s where sort of the interest comes as a fashion brand, complementing our assortments with interesting, various different ways that we could leverage trend. Currently, we see trends like cozy, the sweater category working.

And so, how we really prominently merchandise that in storytelling that brings, that to the highlight of a consumer experience becomes an important part of the trend presentation. The color red is trending currently, and we’re starting to react and respond in real time to make sure that we edit our assortment, both presentation wise and merchandising, to feature where we do have the color red. We’re seeing occasion work, fabrications, shine, sequin, velvet, and satin. So, you’re going to start to see reacting and responding in real time to what we see happening in the marketplace. And that may be in the kind of here and now as reaction and responsiveness. But as we look to the future, being more pronounced, driving more design and insight into our product narratives and thought process upfront is going to be part of where we head and reinvigoration for our brands.

And in this business, absolutely, product is hero, and we’re spending a lot of time ensuring that we have exceptional product with exceptional value and exceptional quality. We’ve got work to do, but I’m encouraged by early stage development.

Operator: Thank you. We’ve reached the end of the question-and-answer session. That does conclude our conference call. You may now disconnect.