Gap Inc Q4 FY2023 Earnings Call

Good afternoon, ladies and gentlemen. My name is Krista, and I'll be your conference operator today. I would like to welcome everyone to Gap Inc.'s Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. I would now like to introduce your host, Emily Gacka, Director of Investor Relations. Emily, please go ahead.

Good afternoon, everyone, and welcome to Gap Inc.'s Fourth 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 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, March 7, 2024, 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 will turn the call over to Richard.

Thank you for joining our call today, where I'll provide an update on our performance and progress in the context of our four strategic priorities. Then I'll pass the call to Katrina to walk you through our detailed financial results as well as our 2024 outlook before we take questions. As a reminder, our four strategic priorities are, first, maintaining and delivering financial and operational rigor; second, the reinvigoration of our brands; third, strengthening our platform; and fourth, energizing our culture. Before I start, I'd like to highlight three recent additions to our leadership team, each of whom will contribute meaningfully to the ongoing execution of our strategic priorities. Eric Chan has joined us as Chief Business and Strategy Officer, Amy Thompson as Chief People Officer, and Zac Posen as Creative Director of Gap Inc. and Chief Creative Officer of Old Navy. I've been purposeful and thinking about the talent and skill these executives bring and how they complement our existing institutional knowledge. These new leaders will play critical roles in unlocking our full potential and solidifying our foundation as we redefine Gap Inc. for a new era, one where our financial and operational rigor is a cornerstone of strength bolstered by best-in-class talent and a culture of creativity, all paving the way for brand reinvigoration and greater cultural relevance. We are pleased with the results of the quarter as we exceed expectations on several key metrics driven by our strategic priorities. Maintaining and delivering financial and operational rigor strengthened our financial footing in 2023, showing that we can drive more efficiency and productivity, enabling us to focus on brand reinvigoration. We've made a lot of progress, delivering cost-savings and gross margin expansion, and this work helped us deliver meaningful improvement in adjusted operating margin of 410 basis points for 2023. Our focus on controlling the controllables also resulted in better working capital and a stronger balance sheet at year end. This includes reducing our inventory levels by 16% year-over-year, building a strong cash balance of $1.9 billion, and generating over $1.1 billion in free cash flow. These proof points put us on strong financial footing as we begin 2024. Our results in the fourth quarter demonstrate strong progress, not only in terms of improved margins and well-controlled expenses but also with more stability in net sales. Net sales grew by 1% and comps were flat with Gap Inc., gaining market share. The sequential improvement, which is noteworthy in a declining apparel market reflects the team's responsiveness and nimbleness as we begin our brand reinvigoration work. Old Navy comps increased 2%, and we were pleased to gain share in women's for the fourth quarter, building on the success we saw in the third quarter. We are also encouraged that we increased our foothold in two key categories, Active and Bottoms. As the number five player in the active space, we are excited for Old Navy to accelerate in this leading category. The all-important bottoms category creates additional opportunities because it's the gateway to the full wardrobe. Gap brand's comps were up 4% driven by strength in Women's, where we delivered our fifth consecutive quarter of market share gains. This result was amplified by good performances in denim and sweaters, supported by new marketing campaigns. Banana Republic comps were down 4% as we conduct deliberate and ongoing work to reestablish the brand and Athleta's comps were down 10% as we lapped a period of heavy discounting that we previewed last quarter, but improved sequentially, driven by new holiday product, updated marketing, and improved in-store presentation. We expanded our company gross margin by 530 basis points, ahead of expectations, driven by more effective sourcing strategies and lower commodity costs combined with improved promotional activities, leaner inventories, and better assortments. We also increased our operating margin by 570 basis points to 5%. Our team is demonstrating the ability to do what we say we're going to do and in some cases even more. However, we're not where we need to be. Our ongoing focus on financial and operational rigor will allow us to continue to elevate our performance, improve execution consistency, and set the foundation for our exciting brand reinvigoration work. Turning to our next priority, brand reinvigoration is about driving both relevance and revenue inspired by our brand's incredible heritage. As a reminder, this strategic priority begins with strengthening the identities and purpose of each of our brands. We are striving for each brand to have trend-right product assortments rooted in customer-centric design thinking and a clear point-of-view that delivers on both wants and needs. From there we need to execute several key ingredients. We must consistently deliver product storytelling that excites our customers, supported by compelling merchandise. We need to drive demand with innovative marketing to regain a powerful voice in the cultural conversation, and we must create better, more engaging omnichannel experiences with a clear and compelling pricing strategy. Most importantly, we must execute with excellence along every touchpoint and interaction. These elements form the basis of our brand reinvigoration playbook. While specific execution will differ by brand, we are working with each of our brand teams to implement this playbook holistically and consistently. Now I'd like to provide an update on the progress of each brand. Let's start with Old Navy. We are encouraged by the sales performance we saw in the back half of 2023 and the growth we delivered in the quarter. We are re-asserting Old Navy's authority as the number two apparel brand in the U.S. We delivered on-trend products, particularly in women's, active, bottoms, and knit, which performed well in the quarter, supported by our campaign with Natasha Lyonne. We showcased and leveraged our authority in the bottoms business and saw great response, especially to the tailor pant, the refreshed Pixie pant, and the cargo. We're celebrating fashion, family, and fun through more precise marketing and storytelling. Another example of re-asserting our authority is Jingle Jammies. We took our famous Jingle Jammies and created Jingle Glamies, supporting it through a compelling social media campaign, where influencers paired Jammies with going outwear. This demonstrates how we take a product and make it a trend by dialing it up in a relevant way through storytelling. Old Navy is reinforcing value by communicating to customers with more clarity on price and quality, both in stores and online, highlighting the brand's value proposition. We're starting to see the strength of the brand identity evolving and coming alive through online and visual communications. The progress we are making at Old Navy gives us confidence in our ability to build consistency while we deliver against our priorities. Let's turn to Gap brand. We are driving continuous improvement and Gap has exciting potential as we focus on reigniting the brand dialog. Gap was built on strong product narratives with brilliant marketing, expressed through big ideas. Gap in its best days was a storyteller who can take a product and create a trend using culturally relevant marketing. During the fourth quarter, our team took Cashsoft, Gap's innovative washable fabric that feels like cashmere and turned it into a big idea through creative storytelling supported by elevated marketing and in-store design and digital presentation. We amplified this innovative product idea and it became a key contributor to the strength and sweaters we saw during the quarter. Its success is an important proof point that shows we can reignite Gap with big ideas and deliver improved results. Now we're going to build on that example with relentless repetition. Our Linen campaign, which launched in late February, is the big idea for spring. The campaign is running now and I encourage you to take a look. This is a great example of the brand taking trend-right product and amplifying it, turning it into a big idea expressed through compelling in-store merchandising and strong digital execution with an innovative and culturally relevant marketing campaign entitled Linen Moves, featuring Musical Artist Tyla and Jungle. We struck a cultural record on Instagram and TikTok. Linen Moves was Gap brand's highest-performing video on both platforms ever and we're just getting started. Regarding Banana Republic, we are focused on re-establishing this brand to thrive in the premium lifestyle space. As I dug in with the Banana Republic team, I realized that we are behind on the fundamentals, having the right product in the right place with the right price. 2024 will be about getting back to the basics, both for product and execution. This includes a focus on go-to-wardrobe pieces and BR Classics like sweaters, Oxfords, suit separates, and khaki, those products that Banana Republic has been known for and will be again. We're encouraged by the brand aesthetic, but it will take some time to get this right and unlock the potential of this business. Turning to Athleta, as we shared with you last quarter, the brand had missteps in prior years, and as a result, net sales for the brand remained muted in Q4 as we lapped markdowns, a challenge that we will continue to face through the first half of 2024. Athleta is a brand with significant growth potential and a clear and distinct positioning rooted in the Power of She. Early holiday ideas like cold weather train and our Shine Set sold well. These great ideas were ultimately bought too small, but they are good proof points that we are on the right track at Athleta. We're making progress in resetting this brand, returning to the core of Athleta's positioning. We started the new year with a cleaner palette and we've seen early successes in new arrivals, although the changes are small, we are learning and encouraged by the customers' early reactions. We're focused on resetting the brand for success and putting Athleta back at the center of the cultural wellness conversation while re-engaging the brand's performance roots. Moving to the third strategic priority, strengthening our platform. We're focused on building and sharpening our operational capabilities to improve effectiveness and efficiency, and in turn drive cost leverage and demand generation. I recently returned from a two-week trip to Asia, during which I immersed myself in our supply chain infrastructure. I spent time listening, learning, and understanding the facets of our supply chain network, and I've gained insight into the incredible longstanding partnerships that we have built over the years. I also spent time in our Hyderabad office in India, studying our technology tools and capabilities. While encouraging, this is an area that we will be focused on elevating as part of our path to becoming a high-performing apparel company. We are still in the assessment days, but my intent is to cultivate a digital-first organization and mindset that uses technology to enable business strategy, enhance the customer experience, and capture future opportunities. We are also beginning to evaluate how we can better leverage our media and marketing with the goal of developing more compelling creative and more innovative media to support growth across the portfolio. I believe our platform gives us meaningful differentiation and has the potential to unlock additional value creation, and we will work to further build out our capabilities to drive efficiency and effectiveness. The fourth priority is culture. Energizing our culture will fuel creativity and connectivity while driving accountability across our organization. As I mentioned earlier, the recent appointment of Amy Thompson has bolstered our leadership team and underscored our investment in building a culture where employees show up every day with purpose and a sense of belonging. Amy is a builder of highly effective cultures that integrate purpose, vision, mission, and values throughout an end-to-end employee experience, all dedicated to driving business success. This includes igniting a growth mindset with empowered leaders and aligned incentives. I'm confident she will help us build a winning culture at Gap Inc. Today, our company is on strong financial footing. In 2024, we will continue to strengthen our fundamentals as we focus on our four strategic priorities. While there is a lot of work to do, I'm energized by the progress we have made so far, and I'm inspired by the team's commitment and talent. I want to take a moment to recognize our global team for their ongoing dedication, and I look forward to continuing this work in partnership with them as we drive towards becoming a high-performing apparel company. And now I will turn the call to Katrina for a closer look at our financials and our outlook for 2024.

Thank you, Richard, and thanks, everyone, for joining us this afternoon. We're pleased to report fourth quarter and full-year 2023 results ahead of our expectations with market share gains. We remain focused on the discipline we've established around margin recovery, expense management, inventory control, and maintaining a strong balance sheet. As Richard noted, our financial and operational rigor continues to be foundational as we turn our attention to revitalizing our brands in 2024. Before we begin, I'd like to mention that all results reported today include the 53rd week, except for comparable sales metrics. Some key highlights from the fourth quarter and fiscal 2023 include the following. Fourth quarter comparable sales were flat, and net sales increased 1%, exceeding our expectations driven by Old Navy and Gap brand sales during the important holiday season. While full-year 2023 comparable sales decreased 2% and net sales fell 5% year-over-year, this performance aligns with the outlook provided at the beginning of the year as our financial and operational rigor begins to yield more consistent results. Old Navy achieved a positive 2% comparable sales increase in the quarter, boosting confidence in ongoing net sales growth. For the year, Old Navy comparable sales were down 1%, but it showed positive performance in the second half and gained market share across all four quarters. Gap brand achieved 4% quarterly comparable sales growth and 1% for the year, outperforming the market. We delivered 530 basis points of gross margin expansion in Q4 and 380 basis points for the year compared to last year's adjusted gross margin, thanks to trend-right products, which, combined with well-managed inventories, resulted in improved promotional activity. Margins also benefited from lower commodity costs. We reduced fiscal 2023 SG&A by over $300 million year-over-year on an adjusted basis due to our commitment to financial discipline, leading to an operating margin of 5% for Q4 and an adjusted operating margin of 4.1% for the year, a 410 basis point improvement compared to last year's adjusted operating margin, signifying significant progress towards profitable sales growth. We ended the year with a 16% reduction in inventories year-over-year, which remained well-controlled, enhancing profitability and working capital. We closed the year with $1.9 billion in cash on the balance sheet, generating $1.1 billion in free cash flow for the year. While entering fiscal 2024 with optimism about our financial progress, we're maintaining a balanced view while we strengthen the foundation of our brands. Now, let’s discuss our outlook in more detail. First, looking at fourth quarter results. Net sales for the quarter increased 1% to $4.3 billion compared to last year, surpassing our previously communicated guidance, and comparable sales were flat. The 53rd week contributed roughly 4 percentage points to sales growth in the quarter, while the sale of Gap China last year negatively affected Gap Inc.’s total net sales growth by an estimated 2 points. Now for brand-specific fourth quarter sales results. Old Navy's net sales were $2.3 billion, up 6% versus last year, with comparable sales up 2%, representing the second consecutive quarter of positive comps for the brand. Gap brand net sales were $1 billion, down 5% year-over-year. Excluding the estimated negative impact from the sale of Gap China, net sales would have increased by 3% compared to last year. Comparable sales turned positive, increasing by 4%, fueled by continued strength in Women's, which gained market share for the fifth consecutive quarter. Banana Republic's net sales of $567 million declined 2% year-over-year, with comparable sales down 4%. Reestablishing Banana Republic will take time, and we recognize the need to improve several fundamentals in 2024. Athleta's net sales of $419 million fell 4% compared to last year, with comparable sales down 10%. Although sales trends improved from the prior quarter, the net sales performance was challenged by tough comparisons due to significant discounting from the previous year, a trend we expect will persist into the first half of fiscal 2024. Despite negative sales impacted by previous promotions, we are encouraged by the positive reactions from customers toward our new assortments, improved store presentations, enhanced online experiences, better marketing execution, and innovative customer activations, which instill confidence that our brand efforts are fostering underlying benefits. Moving on to gross margin in the quarter, it reached 38.9%, an increase of 130 basis points compared to last year. Merchandise margin rose 500 basis points, attributed to an estimated 300 basis point benefit from lower commodity and air freight costs, with the remaining leverage mainly resulting from improved promotional activity. Rent, occupancy, and depreciation costs slightly decreased in nominal terms compared to last year, and on a percentage of sales basis, ROD leveraged by 30 basis points. Now, regarding SG&A expenses, they were $1.46 billion for the quarter, aligning with our previous outlook. SG&A as a percentage of sales was 33.9%, leveraging by 40 basis points year-over-year. Operating income was $214 million, a $244 million increase compared to last year. The fourth quarter operating margin of 5% reflects a 570 basis point improvement year-over-year, primarily driven by gross margin expansion. Fourth quarter net interest income was $4 million, as higher interest earned on cash balances offset interest expenses. The quarter's tax rate was 15.1%, benefiting from the release of certain reserves. Earnings per share for the quarter were $0.49. Now, looking at full-year fiscal 2023 results, net sales decreased 5% compared to last year, totaling $14.9 billion, and comparable sales fell 2%. The 53rd week added about one point to full-year sales growth, while the sale of Gap China had an estimated 2-point negative impact on Gap Inc.'s total net sales growth. Gross margin for the year was 38.8%, expanding 450 basis points compared to last year's reported gross margin and 380 basis points compared to last year's adjusted gross margin. Merchandise margin increased 420 basis points on an adjusted basis, supported by a 200 basis point benefit from lower air freight expenses and the remainder from improved promotional activities. Inflationary impacts from commodity costs were relatively neutral for the year. ROD as a percentage of sales decreased 40 basis points year-over-year. The reported SG&A amount was $5.22 billion for the year, representing 35% of sales. Excluding restructuring costs and gains from the sale of an office building, adjusted SG&A was $5.17 billion, down 6% year-over-year, primarily due to cost savings from strategic actions. The reported operating margin was 3.8%. Excluding $93 million in restructuring costs and $47 million from the office building sale, the adjusted operating margin of 4.1% helped expand 410 basis points compared to last year. Full-year net interest expense was $4 million due to offsetting interest earned on cash balances. The effective tax rate reported was 9.7% for the year, while the adjusted effective tax rate was 11%. Throughout the year, we received discrete tax benefits from foreign operations, a transfer pricing settlement regarding sourcing activities, and the release of certain reserves. Share count concluded at 372 million, with reported earnings per share at $1.34. Excluding restructuring impacts and the office building gain, adjusted earnings per share was $1.43, including $0.29 from discrete tax benefits and a $0.05 benefit from the 53rd week. Now, turning to the balance sheet and cash flow, inventory levels significantly decreased compared to last year across all quarters, ending fiscal 2023 with a 16% year-over-year decline. We wrapped up the year with cash and equivalents totaling $1.9 billion, reflecting a 54% increase from last year. Full-year net cash from operating activities reached $1.5 billion due to improved operating profit and reduced inventory purchases. Free cash flow was an inflow of $1.1 billion. We remain committed to providing an attractive quarterly dividend as a key component of total shareholder returns. During the year, we returned $222 million to shareholders through dividends, translating to annual dividends of $0.60 per share. On February 27, our Board approved maintaining a dividend of $0.15 per share for the first quarter of fiscal 2024. In conclusion, reflecting on 2023, I'm proud of the discipline and rigor we've restored in our foundation, leading to meaningful profit recovery and strong free cash flow. I'm also encouraged by the progress made in the second half of the year as sales stabilized in the fourth quarter, driven by advancements at Old Navy and Gap, showcasing early evidence of brand revitalization. In 2024, we're dedicated to continuing improved performance by maintaining our financial and operational rigor. Now, let’s move on to our 2024 outlook. Our focus in 2024 will remain on controlling key areas: gross margin recovery, expense discipline, inventory management, and maintaining a strong balance sheet while we continue foundational work on our brands with the aim of driving relevance and revenue. We expect this diligence to lead to roughly flat sales when excluding the 53rd week, along with low-to-mid-teens operating income growth. For the full year 2024, our outlook of flat net sales year-over-year, excluding the 53rd week, assumes sustained performance at Old Navy and Gap, counterbalanced by challenging comparisons for Athleta in the first half due to lapping last year's high discounts and a longer timeline for Banana Republic's recovery. This sales forecast also takes into account several unique factors. Firstly, 2024 will be a 52-week year but will be compared in total to last year’s 53-week year. The loss of the 53rd week is expected to negatively impact fiscal 2024 net sales by around $160 million. It is important to note that the timing shifts associated with the 53rd week will significantly affect both Q1 and Q4 of 2024. In the first quarter, we anticipate benefiting from timing shifts, as we will lose a week of lower volume in February and gain a modestly larger week in May. Additionally, the fourth quarter is expected to be adversely impacted by the loss of the 53rd week. Secondly, we have outlined several scenarios that anticipate modest challenges in the first half of the year related to late deliveries caused by geopolitical issues in the Red Sea, with expectations for moderation in the second half of 2024, although we will closely monitor developments throughout the year. Lastly, we do not foresee major shifts in consumer behaviors and macroeconomic pressures in 2024. I would also like to address the potential effects of the recent CFPB ruling regarding late fees for credit card holders. Our outlook anticipates mid-year implementation of the ruling, which we expect will be largely balanced out by other aspects of our credit card program. Now, regarding gross margin. We expect at least 50 basis points of gross margin expansion for the entire year compared to fiscal 2023's gross margin of 38.8%. This outlook is driven by several factors. We anticipate commodity cost advantages in the first half, which we believe will trend towards neutrality in the second half of the year. ROD is expected to slightly decrease due to lower sales volume from the lost 53rd week, and we will continue to adopt a cautious stance regarding the consumer environment in fiscal 2024, especially as we compare against significant improvements achieved in promotional activities during 2023. Concerning SG&A, we expect SG&A of $5.1 billion to decrease year-over-year as we benefit from $150 million in reductions resultant from last year’s strategic actions, alongside lower costs from missing the 53rd week, partially offset by wage inflation. We are committed to maintaining strong financial discipline and will keep pursuing efficiencies within our strategic framework. Considering the dynamics related to sales, gross margin, and SG&A, we see a clear path towards achieving low-to-mid-teens operating income growth in fiscal 2024 compared to the $606 million of adjusted operating income recorded in 2023. We expect full-year net interest expense to remain at a level comparable to fiscal 2023, with interest expense mostly countered by interest earned on cash balances. Nonetheless, we will monitor Federal Reserve actions to evaluate potential impacts from lower interest rates over time. We are planning for a more normalized tax rate of 28% in 2024, in contrast to the 9.7% reported in fiscal 2023, which benefited from several discrete tax items that added approximately $0.29 to fiscal 2023 earnings per share. We're budgeting capital expenditures of around $500 million for the year. Now, let me provide details about our outlook for the first quarter of fiscal 2024. We're encouraged by the trends so far this quarter and predicting net sales in Q1 to be roughly flat compared to Q1 2023. In line with our full-year perspective, our first-quarter assessment assumes continued performance from both Old Navy and Gap, counteracted by challenging comparisons for Athleta and a lengthier recovery timeline at Banana Republic. For the first quarter's gross margin, we anticipate an increase of at least 100 basis points compared to the adjusted gross margin of 37.2% in the first quarter of fiscal 2023, driven by favorable commodity costs. We are maintaining a cautious approach concerning the promotional environment in the first quarter and plan for SG&A of approximately $1.2 billion during the first quarter of fiscal 2024. In conclusion, we are pleased to report solid financial results for both the fourth quarter and the year, as demonstrated by gross margin expansion, expense discipline, lean inventory practices, and robust cash generation. The financial and operational rigor we've strengthened will continue to support our efforts to revitalize our brands, ultimately aiming for sustainable profitable growth and delivering long-term value to our shareholders. Now, we will open the line for questions.

Our first question comes from Adrienne Yih at Barclays. Please proceed.

Great, thank you very much, good afternoon, and congratulations to everybody on the Gap team. Richard, my first question is, the hiring of Zac Posen as Chief Creative of Gap Inc., but also Chief Creative of Old Navy. Where do you expect his focus to be, and how are you expecting him to be used more broadly across Gap, Inc.? Historically, Gap has had designers in the fold before, and we always say you design for the one and merchandise for the masses. I just want to get your philosophy on how you kind of expect to keep the guardrails on that. And then, Katrina, if you could just help us with the $5.1 billion OpEx, it seems very flattish, but you had mentioned that there were opportunities. It seems a little bit high, I guess is the way I would put it, so any color there would be great. Thank you very much.

Sure, thanks, Adrienne. I appreciate the question, and we're very excited to welcome Zac to the company, and in particular, to our largest brand, Old Navy, where he is going to be serving as Chief Creative Officer. Zac is one of America's most celebrated designers. His creative expertise and cultural clarity have consistently evolved American fashion, making him a great fit for the company as we engage our culture and look to reinvigorate our story brands. Zac's role as Chief Creative Officer at Old Navy is designed to harmonize, orchestrate, and dial up the storytelling across product and marketing, looking at how we create brand relevance and curated experiences that ultimately celebrate the brand's ownable attributes: fun, fashion, and value for the whole family. Now, as Zac gets more immersed in the business, his influence will be well considered to enhance the continuity of the brand's reinvigoration which we've already started to see show up on the scoreboard, and his leadership across the portfolio will add a new dimension of relevance. I'm really looking forward to Zac being on the team and having him get immersed in our portfolio at our brands.

And then, Adrienne, let me take on the SG&A question. It's a great one, and I think you'd agree that we're committed to maintaining financial and operational rigor, which has really strengthened our financial footing. 2023 reflected the benefits of the ongoing work, particularly in terms of margins, expenses, inventory, cash flow, and we just delivered a year with SG&A reductions of approximately $300 million. The outlook we provided today reflects another $70 million of reductions, that's really driven by the remaining $150 million reduction from last year's strategic actions, partially offset by inflationary pressures from wages and other headwinds. I believe we can make our cost structure more efficient and drive operating margin expansion, but we have work to do to get back to historical levels. So our outlook today reflects our current point-of-view, but we'll continue to assess the efficiency of our investments and look for opportunities for reduction or redeployment where it makes sense, so more to come as we move through the year.

Hi, good afternoon. Richard, I was wondering if you could spend some more time on the marketing initiatives that are underway. I've seen some changes within Athleta, but I've also seen the Gap campaign has been really highly visible. If you could just talk about how you're approaching it, and I guess, the level of expense that you're there and sort of the commitment to sort of reinvesting in the marketing, I think that will be pretty helpful for us. Thanks.

Thank you for the question, Bob. Marketing has become much more complex than it was in the past. Our brands need to engage with consumers in relevant ways, and the mix of media for creating demand has changed rapidly, leading us to adopt a new approach. Creating demand now involves both art and science, and while our brands have struggled, we are committed to using our marketing and media budgets more effectively for a bigger impact. While we don’t disclose marketing spending by brand, the focus is on efficiency rather than simply increasing spending. For example, the Gap Linen campaign highlights this new strategy. Gap is utilizing a comprehensive approach that includes social media, influencers, streaming, and in-store promotions to enhance our central message. In the past, we haven’t maintained consistent messaging throughout the marketing funnel, but this campaign exemplifies our new methodology. For Athleta, we see a significant opportunity with the brand's compelling platform, The Power of She. Although there have been challenges with product execution, marketing, and customer experience that have negatively affected the brand's performance, we are optimistic about its reinvigoration under the leadership of Chris Blakeslee, who joined us in 2023. As we implement our reinvigoration strategy through effective marketing and storytelling on social media and in stores, we believe in the potential of both Athleta and Gap. The current Linen Moves campaign showcases Gap's renewed voice in the cultural dialogue, with Gap taking ownership of the linen concept in a unique way. Collaborating with Grammy Award winner Tyla and BRIT award winner Jungle, we have developed a storytelling campaign that resonates culturally. Platforms like TikTok and Instagram are new avenues for Gap to connect with consumers. Linen Moves is now the highest-performing video for the Gap brand on these platforms. We are encouraged by the early momentum and will continue to execute our strategy moving forward.

Hello, everyone. Congratulations on the quarter. I have two questions. Richard, I'll direct the first one to you. I know this might be a challenging question, but if we set aside Athleta and Banana for now, it seems that there has been ongoing strong performance for Old Navy and Gap. Comparing the two, which brand do you feel you understand better in terms of branding, marketing, and maintaining positive comparable sales? For my follow-up, Katrina, based on your guidance, it looks like you're expecting margins around 4.5% to 5%. In the pre-COVID period, you were consistently achieving margins in the high single digits. How should we consider the long-term foundation you are building if you can only achieve low single-digit growth? What should we expect regarding the company's margin structure over time?

Thanks, Ike. Well, first off, I'd say my arms are everywhere in the context of what we're trying to achieve here. And I think, again, speaking for the quarter results, we exceeded expectations on both top- and bottom-line, gaining market shares and the strength was really driven by the two largest brands in our portfolio, Old Navy and Gap. More specifically, Old Navy, as the largest brand in our portfolio, has been working on re-asserting the brand's authority as the number two apparel brand in the country. We have a strong retail presence. We have over 1,200 stores and an incredible online presence, which I would encourage you to take a look at today in the context of its clarity and new relevant persona. We had a strong quarter with our sales up 6% and comps up 2%. We gained share in all segments, particularly in women's, which we dialed up from a marketing perspective. The team has done a great job driving the financial and operational rigor, and Old Navy is starting to see early signs of that brand reinvigoration. Gap, too, has had a great quarter and year. We're very happy with the positive comps, and we've been working to reignite Gap, drawing on what made this brand so special in the first place. The campaign that you're seeing in the market today is a great example of the playbook in action.

I see a path toward expanding our operating margin in the long term, but we need to work on returning to our historical levels. This business benefits significantly when our top line grows, which hasn't been consistent. The brand reinvigoration efforts Richard mentioned aim to restore our business's relevance and drive revenue, which will, in turn, support operating margin expansion. We've undergone several years of transformation, including partnering in international markets, closing unprofitable stores, and divesting smaller brands, all of which have decreased our fixed cost base. Recently, we've implemented additional cost measures that have saved about $550 million, creating a cost structure that benefits from increased sales. We will continue to assess our cost structure for further opportunities. To summarize, there is indeed a path to increasing operating margin in the long term as we achieve consistent sales growth.

Thanks, and congrats on a nice quarter.

Thank you.

So, Richard, could you elaborate on the market share gains that you cited that you're seeing at Old Navy and the Gap if you break down maybe by some of the destination categories for each of those brands? Any change in momentum that you're seeing at Old Navy or Gap as we think about early spring and some of the maybe early trends?

Absolutely. Matt, thanks for the question. As mentioned, Gap Inc. gained market share in the quarter year-over-year, which we were very pleased with, and that is on the backdrop of a declining overall industry, so even more credit to the strength of these two particular brands at this particular time. It was driven, of course, by Old Navy and Gap, and frankly, what we've seen in particular is that Gap Inc. gained share in literally all segments. The stores gained share driven by Old Navy and Gap and also outerwear, sleep, pants, wovens, and tops also gained. Kids and baby, as fair to mention, is a really important segment of our business. Old Navy is the number one kids and baby brand in the U.S. Gap Inc. owns 9% of the total market. We have proven capabilities and brands that resonate in this category. It's also an opportunity for us to accelerate and become an even more important player in this segment. As you'll see, we evolve our dialogue going forward, we have opportunities in several key categories of strength: Denim, Active, Kids, and Baby. These will all be really good conversations for us to have as we move forward with our reinvigoration plans.

And then on gross margin, I just provided guidance for the full year of at least 50 basis points of margin expansion for the full year and at least 100 basis points of expansion for Q1. As you noted, the rigor we utilized in 2023 drove 380 basis points of expansion year-over-year and as we recaptured a lot of inflation in the back half of the year and we had stronger assortments with the tighter inventories that we had overall, we're really maintaining that rigor and committed to that as we head into 2024. We ended with 16% less inventory year-over-year. We expect similar inventories coming out of Q1. This inventory rigor will allow us to lap about 200 basis points of improvement from less promotions last year, this year as we head into the year. So commodity cost tailwinds in the first half of this year will become largely neutral in the back half. We're maintaining the rigor so that we can continue to lap last year's outsized promotion improvement.

Congratulations on a strong quarter. I'm trying to follow the numbers here. Merchandise margins have improved compared to 2019 this quarter, but it seems not all brands have reached margins above 2019 levels. You were asked about merchandise margins previously, and I'd like to know from a brand perspective, where you see the most potential for improving merchandise margins and how you're addressing that opportunity based on the plan you shared today. Additionally, I believe you mentioned that ROD leverage would be impacted; can you clarify if this excludes the 53rd week this year and discuss the cadence of ROD throughout the year?

Sure. I think if I think about the performance for 2024, our outlook includes the fact that our brands are in sort of different places as it relates to brand reinvigoration. Similar to the performance we just put up for 2023, we are seeing early proof points of the brand reinvigoration in Old Navy and Gap, our two largest brands, which gives us more confidence in their ability to deliver consistent performance going forward. While we don't guide by brand, we would expect both Old Navy and Gap to deliver positive sales in the year. We're resetting Athleta. We talked about that. As we lap the brand's missteps made in the prior year, that will weigh on the revenue in the front half of the year. We're encouraged by the underlying progress in some of the early changes and longer term see growth potential at that brand. The recovery of Banana will take more time as it works on better execution of the fundamentals. But, we don't disclose margins by brand. We're just encouraged by the outlook we provided today of overall operating income growth. We're going to continue to use rigor in the middle of the P&L. That will result in the low to mid-teens operating income growth that we gave today on roughly flat sales growth. As it relates to ROD, our principle for ROD generally on the year is that ROD leverages on flat to slightly positive sales. So when you think about excluding the 53rd week, ROD is very slightly deleveraging on the year, and that's just some dynamics related to the 53rd week. But that's how we think about ROD.

Thank you. Good afternoon. I wanted to follow up on Bob's question about marketing. Can you quantify how much you spent on marketing in 2023? Do you have aspirations to reduce this expense going forward or just redeploy it at current levels?

Yes. We don't disclose how we spend or what we spend on in the context of marketing. We invest in advertising over time. Our ad spend has grown to support our brands as a result of elevated costs. But in general, our mission is to drive more effective and efficient use of our dollars. Marketing dollars are continuing to come down year-over-year and that is a direct function of more innovative medium metrics driving a more innovative approach to how we market. We are continuing to evaluate our marketing comprehensively as part of the brand reinvigoration work as well as part of media efficiency work, whether that results in lower spend in 2024 or better effectiveness of the current spend, we're going to continue to see how that plays out. Regardless, we have plenty of marketing investments, do not need to be spending any more, and we're going to continue to look for opportunities to be more efficient and save where appropriate.

As Richard said, marketing dollars were down year-over-year in 2023. On our lower sales volume, marketing was about 5.9% of sales, which is below the prior year's 6.7%. As we've slowly been pulling marketing down, we are focused on effectiveness and efficiency, and we'll see how that plays out in 2024.

Good afternoon, and thank you for taking our question. I was hoping you could elaborate a bit more on the Athleta business. It sounds like some nice underlying proof points in some of the changes have been delivered in the fourth quarter, but you're speaking to a tough first half on comparisons. Can you talk a little bit about the outlook that you see on any key line items that we should be looking out for in the second half across new product initiatives, marketing, and merchandise? Whether or not the underlying outlook provided today assumes an inflection back to growth this year for the brand?

Thanks, Brooke, for the question. Athleta is a really important brand in our portfolio. We believe that it has significant long-term potential. The Power of She, as I talked about, is just an incredibly compelling brand platform, and we know the brand resonates with consumers. Our missteps are very public. We've executed poorly in product, marketing, and experience, and that's weighed on the performance of the brand in recent years. Resetting the brand will take time. We expect the tougher promotional volume comparisons to improve by the second half of 2024. The team is focused incredibly well on executing the brand reinvigoration playbook. They're leveraging the brand purpose and identity with great new products and exciting storytelling, supported by compelling marketing and executed with excellence. I encourage you to look at our sites, take a look at the social dialogue we currently have on Athleta, even our stores, where we started the new year with a very clean palette, and we've seen early successes in some of the new arrivals. Again, I'm really liking where the team is going with the new drop strategy, innovation, color, and new customer activations. We'll provide updates as we move through the year and assess the brand's continued progress in executing the playbook. Suffice it to say, we are very excited about the tremendous potential of Athleta.

Sure. For inventory, as we talked about, we ended with inventories down 16% on a year-over-year basis, and we expect end of Q1 inventories to be about similar. As we start to lap the significant declines in inventory, we expect to see more normalized year-over-year inventory dynamics by the end of Q2, where inventories will be down below sales growth but still lean. We're going to maintain the rigor around inventories, and we're at our best when we're reading and reacting to the consumer and chasing into trends.

Perfect. Thanks all for taking the question. Congrats on a nice quarter. Just on your comments for this continuation of the trend that will maybe in Gap on the top line. I'm just trying to understand what that means as it relates to sales growth? Should Gap continue to bleed or what's the right size of that business over time?

Yes. Look, I think, as we've said, our brands are all in different stages of reinvigoration. As we see the performance on Old Navy and Gap, in particular, we're incredibly encouraged. We've seen great quarters in Gap with comp up 4% and Old Navy up 2%, as we described. These are not necessarily overnight fixes, it will take time. As a high-performing company, we want to do what we say we're going to do and that is also setting up expectations that we believe we can meet. We aspire to outperform. We believe our outlook reflects that each of our brands is in different points of reinvigoration. Again, we're very encouraged with the comps on Old Navy and Gap. Their early work on reinvigoration, supported by financial and operational discipline, is showing up on the scoreboard. Notice that Banana Republic has more foundational work to do to recover. That brand is great, it has potential. The new aesthetic is resonating, but the product architecture, pricing, and in-stock really need continued work and effort. The brand will take some time to re-establish. Athleta is making good underlying progress, but tougher comparisons from last year are weighing on the revenue performance.

Yes. I would say broadly, as I think about margins for 2024, we have commodity benefits that come in the first half of the year. Those become largely neutral. We're anniversarying the benefits from last year with the significant improvement we saw in promotions. We'll see where everything lands, but the guidance for the full year was at least 50 basis points of expansion versus last year for the year and at least 100 basis points of expansion for the first quarter.

Thank you. We've reached the end of the question-and-answer session. That does conclude today's conference call. Thank you for your participation, and you may now disconnect.