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Text: The company's annual report on Form 10-K filed with the Securities Exchange Commission on March 16, 2021, and any subsequent filings with the Securities Exchange Commission, all of which are available on gapinc.com.
Joining me on the call today are chief executive officer, Sonia Syngal; and chief financial officer, Katrina O'Connell.
As I reflect on the last 18 months, I'm inspired by the incredible transformation our teams have made in such a short time despite an ongoing pandemic-related disruption to our business and the broader economy.
Coming off record sales performance in Q2, we had accelerated momentum heading into the back half before facing disruption to our supply chain, driven by the two-and-a-half-month closure of our top manufacturing country, Vietnam, as well as port congestion, both of which affected our ability to fully meet strong customer demand.
While we had planned into the known supply chain constraints as we entered the quarter, including COVID-related closures in Vietnam, the shock to our business persisted longer than anticipated as weeks turned into months.
We have been all hands on deck to address these headwinds and the resulting impact on our business, proactively navigating holiday and beyond, ensuring that the customer is at the center of every decision we make.
To secure our supply and meet the needs of our customers, we chose airfreight over ocean vessel for a significant portion of our assortment, taking on extreme transitory cost.
We're disappointed in the short-term impact on earnings, but we made the choice to invest in our customer promise and build loyalty that will help sustain growth over the long term.
Katrina will go into greater detail on our mitigation efforts later.
Overall, we continue to believe the scale of our supply chain is the material advantage.
We have deep relationships with our manufacturers across multiple countries of origin optimized for cost, speed, and expertise.
And we have strong transportation partners, offering speed advantage and industry-leading rate.
That said, learnings from this crisis will not go to waste.
We're using them as an opportunity to accelerate digitization efforts that were already underway across our product-to-market process.
There was a sizable increase in the enterprise clock speed on transformative initiative as we combated the current crisis with an eye on a better future faster.
For example, we're adding supply chain capabilities that will allow us to better anticipate the unexpected.
We've made significant progress digitizing core operating processes with a targeted focus on inventory management, loyalty, and personalization.
And we're transforming product creation by using digital tools to unlock speed and efficiency.
All of this work will pay forward in 2022 and beyond.
These near-term pressures have not distracted us from our core strategy.
We have an acute focus on what really matters, our unique, ownable asset.
It's because of the simple, consumable, and executable strategy we shared in October of last year, our Power Plan 2023, the Gap Inc. is in a stronger, more resilient position today than we were entering this fiscal year.
Even in the face of current headwinds, I'm confident this is true.
Our brands are healthy, demand for our product is strong, and we have pricing power with average unit retail contributing to the highest gross margins in over a decade.
We are becoming digitally led.
Online sales grew 48% in the quarter compared to 2019, representing 38% of total sales, and our migration to the cloud has unlocked innovation in our tech portfolio.
We will strategically shed an estimated 1 billion in sales by year-end versus 2019 by closing unproductive stores, divesting smaller brands, and partnering our European business to drive focus and profitability.
Nearly three-quarters of active customers are loyalty shoppers, and they are spending twice as much as nonloyalty customers.
And we have fortified our strong balance sheet by restructuring long-term debt, allowing us to invest for growth while continuing to return cash to shareholders.
I have watched you navigate, persevere, and accelerate through these needs -- near-term challenges while executing a long-term strategy.
Despite the supply chain disruption, comp sales were up 5% on a two-year basis, with three of our four brands delivering positive two-year comps.
Net sales were down 1% to 2019, which includes an estimated 8%-point impact due to supply chain headwinds.
Our strategy is on track and is working.
Let me walk you through how our Power Plan came to life in Q3.
Starting with the power of our brand.
Each of our billion-dollar brands is finding new and relevant ways to expand reach and cut through to the consumer.
This is driving an increase in brand power and a decrease in discounting.
Let me start with Old Navy.
Old Navy delivered 8% sales growth versus 2019, a deceleration from the first half as the brand was disproportionately affected by inventory lateness during the quarter.
Old Navy maintained its No.
1 rank in kids market share according to NPD and sustained its kids and baby growth trend from the first half with strong back-to-school performance.
BODEQUALITY, Old Navy's inclusive sizing integration launched successfully in August.
The brand more than doubled its extended size customer files since launch.
Fifteen percent of customers who shopped extended sizes are new to the brand, and more than a third have shopped Old Navy before but are new to the category.
We are seeing strong extended-sized demand across fashion categories, a clear signal that our customer is craving trend choice lacking in the market.
The momentum continues at Gap brand, particularly North America, with comparable sales up 13% versus 2019, and net sales nearly flat despite the almost 18 percentage points of revenue we shed through strategic store closures.
This marks the third consecutive quarter of positive comparable twp-year sales growth in North America as Gap brand improves the core health of the business from tighter assortments and better quality product to an increase in digital penetration and lighter and brighter stores.
Gap reached a critical milestone in our Power Plan, concluding its strategic review of the European market, driving a more profitable business model by shuttering our U.K. stores and working with local partners to amplify growth.
We have identified strong partners in the U.K., Ireland, France, and Italy, and together, are committed to serving and growing our Gap customers in Europe.
Our newest Yeezy Gap icon, the Perfect Hoodie, delivered the most sales by an item in a single day in gap.com history.
With over 70% of the Yeezy Gap customers shopping with us for the first time, this partnership is unlocking the power of a new audience for Gap, Gen Z plus Gen X men from diverse background.
We've successfully launched new brand positioning focused on acceptable luxury.
Through unique storytelling and experiences, the brand is going back to its roots, igniting the adventure in all of us.
Banana Republic reported a net sales decline of 18% versus 2019, and a negative 10% two-year comp.
Like Gap, we walked away from about 10 percentage points of unprofitable revenue due to strategic store closures.
Product margins expanded during the quarter as luxury products like merino, leather, cashmere, and silk resulted in increased average transaction, drawing higher-value customers willing to pay for great quality.
And finally, Athleta delivered an outstanding quarter with 48% net sales growth versus 2019, using its unique and ownable mission to empower women and girls through the power of she.
The brand is investing in new touchpoints that increased awareness and drove new customer acquisition, which has more than doubled versus Q3 2019.
Athleta grew brand awareness of 33% versus 27% last year, according to YouGov, by embracing celebrity partnerships, Simone Biles and Allyson Felix, who took to the world stage in Tokyo.
The brand expanded into Canada with the launch of its online business and its first company-operated store in Vancouver and Toronto.
And customers are quickly embracing Athleta well, their new immersive digital community rooted in well-being with the active user base growing 50% every month since launch.
We believe this platform has tremendous potential over the coming years to revolutionize how we monetize vulnerable brand experiences.
Next, the power of our platform and portfolio.
We leveraged our size and scale to drive advantage for our four purpose-led, billion-dollar brands.
Our leading omni platform provides customer convenience and engaging experiences, whether in-store, on mobile, or through curbside pickup.
Our online sales grew 48% in the quarter compared to 2019, and we maintained our rank as No.
Our sizable active customer file sits at 64 million, and those customers are spending more on average than they were two years ago.
But the more important is that the health of our customer file is improving.
Compared to 2019, newly acquired customers are spending more with us than our existing customers with increased average transactions, average unit retail, and basket size.
We're pleased with the launch of our innovative rewards program and our ability to build customer lifetime value.
Now, with more than 45 million members, our loyalists are two times more likely to shop across brands, and three times more likely to shop across channels.
We fuel our brands through our scale technology advantage operations.
We are investing capital to drive growth, reduce costs, and increase speed and agility.
To diversify and strengthen our business, we are also seeding new capabilities that will unlock additional value.
For example, we acquired Drapr, which we expect will power new e-commerce tools with 3D fit technology; and we acquired CB4, our machine learning and AI acquisition with broad potential across sales, inventory, and consumer insights.
We have plans to scale these solutions in 2022 to build our core digital capability.
This will help our brands lower return, boost in-stock levels, increase margins, and deliver better customer experiences online and in-stores across all four brands.
The power of our portfolio comes to life through our leadership in key categories.
Our strong active and fleece business and our Denim business are expected to generate revenue of 4 billion and 2 billion, respectively, this year; and our kids and baby business owns 9% market share across Old Navy, Gap, and Athleta.
Even as occasions and wear-to-work categories have strengthened, it's clear comfort and style will sustain.
We're extending our customer reach across every age, body, and occasion from value to premium through category expansion and new addressable markets.
We can test and pilot in one brand and then leverage learnings to scale across the rest.
For example, starting our inclusive sizing rollout in Athleta and scaling at Old Navy with BODEQUALITY, or using Old Navy, Gap, and Banana Republic's strong presence and infrastructure in Canada to enable Athleta's quick and seamless entry into the market.
It's the collective power of our brand that gives us scale advantage.
We continue to innovate in sustainable sourcing with a focus on empowering women, enabling opportunity, and enriching community.
Every industry will be impacted by climate change, and we are doing our part to mitigate this impact, both in our supply chain and on the communities where we operate.
Earlier this month, the USAID, Gap Inc., Women + Water Alliance announced that we have empowered 1 million people to improve their access to clean water and sanitation, already halfway to our goal of reaching 2 million by 2023.
Looking ahead, we anticipate robust apparel and accessory retail sales across the industry for the remainder of the year and into the next.
That said, we are balancing the favorable consumer climate against current supply constraints.
As I mentioned earlier, we are doing everything we can to improve our on-hand inventories versus fall.
And still, we remain cautious given the current environment.
One last thought before I hand it over to Katrina.
While the near-term headwinds and resulting impact on our performance are difficult, we remain focused on executing our strategy for long-term sustainable growth.
We are focused on what matters, demand-generating investments in our billion-dollar brands fueled by cut-through creative, deploying data and science to drive efficiency in the way we work, and restructuring our business to reduce cost.
All of these allow us to emerge from the crisis, growing share, increasing brand health, and delivering profitable growth long term.
As Sonia said, we're deeply proud of the progress we're making to transform Gap Inc. through our Power Plan 2023.
We have strong demand for our brands and our fleet optimization through store closures, international partnerships, and divestitures is progressing well and adding value.
Our operating margin remains on track to hit 10% by 2023, in line with our plan, even as we navigate these near-term disruptions.
Our balance sheet, fortified with our recent debt restructuring, enables us to invest in our business to drive growth while returning cash to shareholders.
The core tenets of our Power Plan 2023 strategy are well underway in delivering value.
While we're confident with our strategy, widely reported worsening global supply chain issues meaningfully impacted our third-quarter performance.
We lost approximately $300 million of revenue or eight percentage points of sales growth on a two-year basis due to longer transit times and lost weeks of production, which led to on-hand inventory shortages in the quarter.
The backlog at U.S. ports deteriorated meaningfully from the first half of the year, resulting in up to three continuous weeks of unanticipated delays to fall product deliveries throughout the quarter.
In addition, while our production capacity is largely globally diversified, approximately 30% of our product is produced in Vietnam, where factory closures extended to over two and half months, significantly longer than initially anticipated.
Our average on-hand inventory in Q3 was 11% below fiscal year 2019.
So despite strong sell-through trends, we lost volume as a result of limited supply.
While our brands all experienced delays in styles and sizes that limited their ability to fully meet strong demand, Old Navy was disproportionately impacted.
We believe these supply chain disruption impacts to our sales and margins are transitory, although will persist in Q4 and potentially into early next year.
With that, we've taken some near-term actions to proactively improve supply for holiday, and we're using the learnings from acute supply crisis to accelerate new capabilities for 2022 that we believe will help to better mitigate logistics challenges and more profitably increase speed to market go forward.
Let me touch on some efforts.
First, in the near term, we've secured incremental air capacity to support holiday inventory.
In addition to an estimated $100 million of air costs incurred in Q3, we've also invested approximately $350 million in Q4 airfreight to further expedite holiday deliveries.
And second, where possible, we have routed a modest portion of our inventory to East Coast ports to bypass the congestion in the L.A. Long Beach port.
While we aspire to improve our on-time deliveries for holiday by adding air capacity and utilizing alternate ports, the supply chain situation continues to be volatile.
Newly opened Vietnam factories are behind on holiday profits production, ramping up slowly.
Ongoing port delays are worsening and air charters are causing new airport congestion.
Our mitigation efforts are driving significant transitory costs, but we're focused on the long-term impact that delighting our customers with the products they love during the holiday season have in preserving market share and maintaining customer loyalty.
We remain cautious in our outlook for the balance of the year and are updating 2021 earnings per share guidance range to $0.45 to $0.60 per share on a reported basis, and $1.25 to $1.40 per share on an adjusted basis.
We are updating our guidance solely based on the acute revenue and margin impact from supply chain disruptions.
This range now reflects the estimated lost sales from supply disruptions in the second half of 2021 to be $550 million to $650 million.
In addition, our updated guidance range reflects approximately 450 million of transitory airfreight costs we have chosen to incur as we seek to meet as much customer demand as possible.
And we are confident that when adjusting for these substantial disruptive impacts to 2021, our underlying business is ahead of plan, and we will emerge strong in 2022 and beyond.
As we look to 2022, we are adding new capabilities that will enable us to navigate these disruptions with more flexibility and significantly less airfreight.
Beginning with summer 2022, our teams have added the expected longer port delay times into product booking deadlines, which we believe will enable us to ship goods largely by ocean for on-time deliveries.
In addition, Old Navy has now accelerated its use of digital product creation for the majority of its fall orders with vendors.
This has added speed to the pipeline as the breakthrough and efficiency for the brand.
Also, to increase geographic diversification and flexibility, we expect to leverage more multinational vendors.
And we will begin to deploy AI from our recent CB4 acquisition to better drive inventory in-stock in our stores.
AI, combined with ongoing inventory management transformation efforts and the leverage of our new loyalty program, gives us confidence in the sustainability of strong average unit retails in 2022.
Now turning to third-quarter financials.
Before I get into specific results, I'd like to note that there are select charges we incurred in the quarter that are excluded from our adjusted financials, specifically costs related to restructuring our long-term debt and the transition of our European market to a partnership model.
I'll provide more details on these as I talk through the results.
Net sales of 3.9 billion for the quarter were down 1% to 2019 with our Q3 sales deceleration from the first half of the year due to supply chain issues.
Comp sales improved 5% on a two-year basis.
We're particularly pleased that three of our four brands delivered strong two-year comp growth with Old Navy up 6%, Gap Global up 3%, and North America up 13%, and Athleta up 41%, all while navigating acute supply issues.
And while Banana Republic's two-year comp was down 10%, the brand made progress in the quarter through its product and customer experience relaunch.
Our strong e-commerce channel continues to be an advantage as online sales were up 48% compared to 2019, contributing 38% of sales in the quarter, up from 25% of total sales in Q3 2019.
Moving to gross margin.
Third-quarter reported gross margin was 42.1%, an increase of 310 basis points versus 2019.
Excluding impacts related to the transition of our European business to a partnership model, adjusted gross margin of 41.9% for the quarter represent the highest Q3 gross margin rate in over 10 years, expanding 290 basis points versus 2019 gross margin.
This is primarily driven by 300 basis points in ROD leverage from higher online sales and lower rent occupancy and depreciation as a result of strategic store closures and renegotiated rents.
Merchandise margins were down just 10 basis points, despite nearly 200 basis points of higher online shipping costs and about 250 basis points in short-term headwinds related to airfreight.
Product acceptance was strong across all brands with our overall Q3 discount rate at the lowest level in five years.
Reported SG&A, which includes 26 million in charges related to the transition of our European operating model was 38.3% of sales, deleveraging 470 basis points compared to Q3 2019.
On an adjusted basis, SG&A was 37.6% of sales, 610 basis points above 2019 adjusted SG&A.
We continue to execute our strategy of driving down fixed costs while investing a portion of those costs into demand generation in the form of marketing and technology.
Fixed costs have been significantly reduced as we successfully closed stores in North America, divested of two brands earlier this year, and reached partnership agreements for our European markets.
Marketing, up 360 basis points versus 2019, supported the rollout of our new initiatives, particularly loyalty, inclusive sizing at Old Navy, and the brand relaunch at Banana Republic, and is a major contributor to our low discount rates.
The balance of Q3 investments were primarily focused on technology to build out our digital and supply chain capabilities, as well as on higher bonus accruals versus a low 2019 baseline as no meaningful incentive payouts were granted in that year based on performance.
The investments we're making today are long-term differentiators, and we're committed to our strategy while remaining prudent even in the face of near-term supply headwinds.
Regarding operating margin, operating margin for the quarter was 3.9% on a reported basis.
Excluding $17 million in charges related to our European market transition, adjusted operating margin was 4.3%, which as I noted earlier, includes the impact of an estimated 300 million in lost sales due to constrained inventory in addition to approximately 100 million in nonstructural airfreight costs.
Moving on to interest and tax.
During the quarter, we restructured our long-term debt by retiring all of our 2.25 billion senior secured notes and issuing 1.5 billion of lower coupon unsecured senior notes.
Through this debt restructuring, we were able to reduce our overall debt balance, achieve material interest savings, approximately $140 million on an annual basis beginning in 2022, and unencumber our real estate assets previously pledged as collateral.
We incurred a 325 million nonrecurring charge related to debt extinguishment in the quarter.
Q3 net interest was $43 million.
Full-year net interest is now expected to be $163 million.
Looking beyond 2021, we expect annual net interest expense of around $70 million.
The effective tax rate was 29% for the third quarter.
Excluding the impact from fees related to debt extinguishment and the charge changes to our European operating model, the adjusted effective tax rate was 20%.
We expect the full-year effective tax rate to be about 23% on a reported basis and about 26% on an adjusted basis.
Regarding earnings on the quarter, Q3 reported earnings reflect a loss of $0.40 per share.
Excluding fees associated with our long-term debt restructuring and the transition of our European markets to a partnership model, adjusted earnings per share for the quarter were $0.27.
Inventory delays worsened throughout the quarter, and our Q3 sales down 1% versus 2019 outpaced average on-hand inventory of down 11% to 2019.
Third-quarter inventory ended flat to 2019 and down 1% versus 2020, with average on-hand inventory down 7% and in-transit up 16% versus last year.
On-hand inventory at the end of the quarter remained seasonally relevant with markdowns below Q3 fiscal '19 quarter-end levels.
We expect Q4 ending inventory to be up high single digits versus last year, although this point-in-time outlook may change given continued volatility in the supply chain.
Regarding the balance sheet and cash flow, we ended Q3 with $1.1 billion in cash, cash equivalents, and short-term investments.
During the quarter, we continue to earn -- to return cash to shareholders, paying a Q3 dividend of $0.12 per share and repurchasing $73 million in shares as part of our current plan to offset dilution.
And earlier this month, we announced a Q4 dividend of $0.12 per share.
Looking at our global store fleet, we are planning to close 350 Gap and Banana Republic.
North America stores is expected to be approximately 75% complete by the end of the year.
And with the recent announcement of our agreement to transition to a partner model in Italy, we've now concluded an important phase of the restructure of our European market.
All markets are expected to be transferred to our new partners in early 2022.
Now, I'd like to provide an update on our full-year financial outlook, which we are downwardly revising solely based on the acute impact of sales and margin of the supply chain disruptions.
Full-year 2021 reported earnings per share are now expected to be in the range of $0.45 to $0.60, which includes net charges of 445 million, comprised of 325 million in fees related to the restructuring of our long-term debt, and approximately 120 million related to divestitures and the transition of our European business model to a part -- European business to a partnership model.
Excluding these charges and associated tax impacts, full-year 2021 adjusted earnings per share is expected to be in the range of $1.25 to $1.40.
This updated guidance now includes the following assumptions.
First, we expect 2021 full-year revenue growth of about 20% versus 2020.
This range now reflects the expected lost sales from supply disruptions in the second half of 2021 of approximately 550 million to 650 million, including an estimated 300 million from Q3 and an estimated 250 million to 350 million in Q4.
Second, we expect full-year nonstructural airfreight to be approximately $450 million.
We consciously chose to air approximately 35% of our holiday product given the two-and-a-half-month delays from Vietnam closures in Q3 and the over three-week West Coast port delays so that we can give our customers as much holiday product as we can to deliver on their expectations.
While this is material to our profitability, we believe it is necessary to further mitigate sales losses and retain customers for the long term.
With the added air cost and the meaningful sales impact from supply constraints, we now expect full-year 2021 reported operating margin to be about 4.5%, with adjusted operating margin at about 5% for fiscal 2021.
This is inclusive of short-term air costs in the back half, impacting operating margin by about 270 basis points.
Full-year capital spend is still expected to be approximately $800 million.
In summary, when adjusting for the acute impact of supply chain disruptions, we are still expecting the year to end at or above our original plan for 2021, demonstrating that our underlying business trends are quite strong and providing real momentum.
The progress we've made on our Power Plan 2023 strategy in the face of these challenges highlights the strength of our core business and the health of our brands, and we remain confident in our path as we move toward a 10% operating margin in 2023.
With that, we'll open it up for Q&A.

user
qtrly loss per share $0.40; qtrly non-gaap earnings per share $0.27.
qtrly online sales grew 48% versus q3 2019 and represented 38% of the total busines.
sees fy earnings per share in the range of $0.45 to $0.60.
sees fy adjusted earnings per share in the range of $1.25 to $1.40.
now expects fy revenue growth to be about 20% versus fiscal year 2020.
qtrly old navy net sales were up 8% versus 2019; qtrly gap net sales declined 10% versus 2019.
qtrly comparable sales were up 5% versus 2019.
global supply chain disruption, including covid-related factory closures, continued port congestion, caused significant product delays in q3.
meaningfully reduced inventory positions throughout quarter negatively impacted sales as brands were unable to fully meet strong consumer demand.
leveraging increased air freight, port diversification to navigate ongoing delivery challenges for holiday.
qtrly banana republic net sales declined 18% versus 2019; qtrly athleta net sales were up 48% versus 2019.

assistant