Please standby. Good afternoon, ladies and gentlemen. My name is Justin, and I will be your conference operator today. At this time, I'd like to welcome everyone to The Gap, Inc., First Quarter 2021 Conference Call. [Operator Instructions] I'd now like to introduce your host, Steve Austenfeld. Please go ahead.

Thanks, Justin. Good afternoon, everyone, and thanks for joining us today. Welcome to Gap, Inc.’s first quarter 2021 earnings conference call. Before we begin, I'd just like to remind you that the information made available on this webcast and earnings call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from any forward-looking statements as well as a description and reconciliation of any financial measures not consistent with generally accepted accounting principles, please refer to Page 2 of the slides provided today on the Investors section of our website, gapinc.com, which supplement today's remarks as well as today's earnings release. The company's annual report on Form 10-K filed with the SEC on March 16, 2021, and any subsequent filings with the SEC all of which are available on gapinc.com. These forward-looking statements are based on information as of today May 27, 2021, and we assume no obligation to publicly update or revise our forward-looking statements. So joining me on the call today are Chief Executive Officer, Sonia Syngal and Chief Financial Officer, Katrina O'Connell. So with that, I’ll turn it over to Katrina.

Thank you, Steve and thank you everyone for joining us today. We're very pleased with our first quarter results and especially pleased that our performance is giving us confidence to raise our full year outlook on sales, operating margin and earnings per share. Our four purpose-led billion dollar lifestyle brands are competing well, gaining share and expanding gross margins driven by strong product and creative execution and digital dominance. And we're making progress on our transformation initiatives that are critical to our goal of growing sales profitably and expanding operating margins. We're optimistic that the consumer will remain strong particularly in the U.S., and that our iconic brands, well-located stores and digital advantage will remain relevant as consumers transition back to work and school. And while our business did benefit from stimulus spending in Q1, as well as a faster recovery due to accelerated vaccine deployment, we're very pleased with the way we leveraged our competitive advantages our brands, our portfolio and our platform to win this quarter. With that, let me share a few highlights from the quarter that demonstrate our continued progress against our Power Plan 2023 strategy. Starting with delivering sales growth. First, our revenue grew 8% versus 2019. We're pleased with this strong performance, recognizing it includes nearly five points of impact from our strategic North America store closure plan over that time period, as well as roughly two points of impact from COVID-related store closures outside of the U.S. Our U.S. market share is the highest we've seen in recent years at 5.5%, up 90 basis points versus last year. At nearly $4 billion, this was the largest Q1 revenue in the company's history. We're happy with the standout performance of Old Navy and Athleta, which grew net sales 27% and 56% respectively in Q1…

Thank you, Katrina and good afternoon, everyone. I'm happy to be here today to share our first quarter results and as Katrina mentioned, our sales were up significantly year-over-year and exceeded our 2019 results. Our strong performance in Q1 can be attributed to two things. First, and most importantly, our Power Plan 2023 is taking hold. And second, the macro tailwinds which included a third round of stimulus checks and increased vaccine distribution created an inflection point. Our teams are maniacally focused on growing our purpose-led billion dollar lifestyle brands and our customers are responding. The marketing investments we've made over the last several quarters to fuel demand, coupled with the macro tailwinds are supercharging our business. The share we strategically took in 2020, during the consolidation in the apparel market, drove outsized momentum in Q1, especially in Old Navy and Athleta. And we're feeling great about the health adapt business in North America. According to NPD, our market share gains outpaced the industry average and as Katrina shared, the highest we've seen in recent years. Customers are emerging from the pandemic with a newfound appreciation for social connections and a chance to express their style. At the same time, customers are holding on to the comfort they found in the spaces and rituals created over the last year. As stores traffic rebounded, we sustained our digital dominance, with online growth up 61% year-over-year, and 82% when compared to 2019. Growth in Active and Fleece continue to rise, showing customers hesitance to let go of the cozy mentality. While, we saw a resurgence in dresses and summer fashion as customers also wish for a spring awakening. While these trends benefited the entire industry, we are uniquely positioned to take advantage of the end factor, joggers and dresses, digital and in-store,…

Thank you. [Operator Instructions] And our first question come from in Adrienne Yih with Barclays.

Good afternoon, congratulations. It's been a tough road but well done. Sonia, couple questions. I guess my first question is on advertising spend, I know that you're moving from kind of non-customer facing SG&A shifting into kind of demand creation. And we should think about that as probably being in the 6% of sales range. And I'm just wondering how you think about that number relative to other companies that have brands, they tend to be a little bit higher than that. And then of that spend, how are you thinking about proportioning it among the different brands? And then, for Katrina, can you give us either a line of sight of where Gap and BR are trending now for operating margin or alternatively, when you get to the 10% margin, what is the target for those two pieces of the business? Thank you very much.

Thank you. So we are pleased with our two top investments, which are technology and marketing and the marketing investments have allowed us to expand our product margins, reduce discount, et cetera. So we're learning as we go, yes, you're correct that 6% is roughly where we're planning, but we're learning and we'll continue to see what we hear back from customers and some of those investments. Right now we're seeing a really great virtuous cycle, with the investments in marketing allowing us to improve our price realization across all of our brands.

Yes. And I'm glad you brought up the 6% because that is in fact, roughly where we still expect the year to land. I mean, we'll see where revenue is. But that is, it'll be sort of lumpy by quarter. And as we said in this speech, we are going to lean a little bit more into Q2, we actually didn't hit the 6% marketing in Q1. And so we did sort of reserve some of that money for Q2 to invest in back-to-school, as we said in the loyalty launch. So it's going to be lumpy, but I think six is about what we're thinking and we'll see. Sonia may or may not have said a lot of our marketing is digital, we can read it week-to-week, it's very flexible, and so we'll lean in as appropriate. With regards to operating margin, we haven't broken those out by brand. I think we've acknowledged that Old Navy and Athleta are the highest operating margins. But certainly the restructuring of Gap and Banana is intended to really take out the lack of profitability at those brands and bring them back up all of that's contemplated in various scenarios in the 10% operating margin goal. And we haven't really said more than that.

Our next question comes from Matthew Boss with JPMorgan.

Thanks and congrats on the performance. So maybe Sonia or Katrina, at Old Navy, maybe just help us to break down the drivers of the improvement to the 27% top-line this quarter versus 5% in the fourth quarter. Have you seen the momentum sustained post stimulus? If so, what do you think is driving it? And on the bottom-line, I guess help us to think about product margin expansion drivers, as we think about the second quarter against pretty healthy expansion a year ago?

We've got multiple strategies at play, right, Matt. So specifically to Old Navy, they're really seeing strength, from the distortion on product and the acceleration of comfort and cozy whether it's the fleece and active dominance that they've seen. And really big growth there, triple-digit growth, with the resurgence in the lifestyle products, such as dresses, and shorts. Through this power of the end, right, the family is wanting all of these choices from Old Navy to the product acceleration between those big end uses and you couple it with the kids and baby dominoes that Old Navy has, as the number one brand in the kids baby space, all of that yields really, really great execution on product. And then, they deployed excellent new pricing strategies this quarter as well, that you'll see in stores and online with everyday magic pricing, which is allowed day in, day out pricing for about 20% of the assortment, we see this as growing, we see this as something customers are really responding to. And it's enabled the margin expansion on top of the profit acceptance. And then, the innovation that's happening in the site has really maintained our ecommerce momentum. As you know, technology investment is a big deal for us, that's manifesting in a stronger momentum in the ecommerce business, the loyalty enablement. We know how much more customers spend with loyalty. So those technology and loyalty investments are paying off and building. And then lastly, I'd say the stores, recovery from the COVID times has been fantastic. And customers are loving experience, they want a physical shopping space where the family can come and really have something that is human centered. And that's what they're experiencing the stores. They are happy to be back and we're happy to have them.

Great. And then maybe just a follow up for Katrina, could you speak to gross margin progression, as we think about -- as we think about the first quarter being 400 to 500 basis points above 2019. I think you previously attributed half of the Analyst Day, even margin expansion to ROD and the other half to SG&A. I just wanted to confirm that these two pieces are at or ahead of the plan in order to get to the 10%.

Yes. So when I think about margin for the year, what I would say is the rent and occupancy leverage that we're seeing is largely on track based on the work we've done to shut the North America stores and get the lease renegotiations that we worked so hard on last year. And so I would say about 75% or 80% of that 430 bps we saw in Q1 would continue for the year and continue to add significant value to our margin expansion. And then, on the product margin side, as Sonia said, we're really pleased with the way our brands are competing. And whether that's the right product, the right creative, the right brand values, the right marketing, all of that is giving us the power to pull back on discounting, in Q1 that allowed us to offset shipping. And we'll see how that plays out for the rest of the year. But certainly we expect product margins should continue to be higher on a year-over-year basis. What we're watching honestly, on the margin side of things is what everyone I think has talked about, which is whether its supply chain issues will require air freight in order to be able to continue to get inventory here, whether there will be commodities pressures in the back half. We'll see how all that plays out. We've been navigating that closely and using our advantage supply chain to help us mitigate what we can. But certainly all of that's on our minds as we think about the back half of the year. But all those scenarios are reflected in the 6% operating margin. And I think as we said on the call, we had originally expected 5% this year, we're now guiding to six and so all of that feels like we're accelerating towards our 10% plan and we're proud of that.

And the next question comes from Lorraine Hutchinson with Bank of America.

I was hoping to just get your thoughts on the progression of the Gap brand as the year moves forward. Any timing on the Conway collaboration and then how you're thinking about planning inventory for the brand through the collaboration and as sales continue to improve?

So as you know, we've been doing the heavy work with building our creative competence and creative audacity with Gap while at the same time restructuring the business by shedding unproductive stores and the review of our international markets, looking at harder to amplify as the strategy and an important partner, as we've announced is, is the easy Gap collaboration. We love the enthusiasm. It's the number one question we get. And everyday with customers and across social media, we see the hype building, from speculation around the product supposed launch dates. Easy Gap is a work in progress and remains a significant opportunity for us and will it be Q2 or Q3 we'll see. But I can tell you is that the creativity is through the roof. And it's spilling over us the brand. And it's inspiring our teams more broadly. So we are very energized by what we're seeing and we know our customers will be too -- we're planning for a multi-year effect here, multi-year business. So we're confident that potential. As we think about Gap for the rest of the year, continuing to drive for health and margin expansion is something that we are committed to. And so the inventory will be commensurate with that. I don’t know if Katrina, you want to add anything on the inventory side?

No, I think that's right. I mean, we were really pleased with the health of the North America core, I think you saw the 9% comp here in North America is a really good indicator that the brand is on track. They're becoming digitally dominant. And we're making the progress we need on shuttering stores. And then as Sonia said, we're continuing to make progress on negotiating our international markets, to partner and all that feels like we're making good progress. We have a lot of flexibility in inventory. So we'll keep managing that appropriately. But for now, I don't think there's anything specific to report as it relates to the Gap versus the rest of the brands.

Yes. Even though we gained a lot of speed and agility in our inventory management through COVID and that is being applied to all of our brands to respond as needed to customer stop references, the inventory needs. So it's a new day in inventory and Gap brand like all of our brands is focused on the inventory transformation, so that there's more ubiquity across the two channels. And that's also another lever that we can apply.

And moving on to Kimberly Greenberger with Morgan Stanley.

Katrina, my question is on gross margin, you got really nice leverage here in ROD, I wanted to know if you could break down the 430 basis points of leverage between any -- between what you expect to be sort of permanent and more lasting, as compared to temporary if there were any rent abatements or other assistance that benefited in the quarter. And then, if you could provide some insight on how you're thinking about shipping costs? I don't know how much advance visibility you get on that. But are you expecting shipping costs to remain elevated through the year? Thanks so much.

Thanks, Kimberly. So on rent and occupancy, we actually didn't have a lot of totally unusual items happen in the quarter, I would say it's safe to assume about 75% of that 430 bps level of leverage will continue for the year. And so we'll see, the negotiations, as you know, can be sort of lumpy. So we'll update you as we go. But if you think about the year, that's a good way to think about that leverage amount. And then, as far as shipping costs, we disclosed that we experienced about 200 basis points of shipping headwinds in the quarter. I think that's a reasonable amount to assume for the rest of the year. Honestly, what we don't know is, as the vendors are more impacted by the COVID outbreaks in India and Southeast Asia and as those orders transpire, and we start to see what happens there. We don't know yet how much we will or won't have to air in order to get that here or if there will be freight implications. So I can't say honestly, we're again, we're looking closely at all of that and working hard to do what we've been doing, which is use our pricing power to offset all of those issues. But, again, we're watching all of that closely like everyone and doing our best, I can say but the normal operations I think that 200 bps is a good estimate.

And we have a question from Mark Altschwager with Baird.

This is Sarah Goldberg on for Mark. Thanks for taking our question. Was the intimate launch at Old Navy, it looks like some early signs there. I was just wondering, has this been capturing a new customer or has it largely been an add-on project at this stage? And then, how you see the scaling over time?

Yes. Look, we're excited between the Old Navy launch between Gap [indiscernible] sleep and intimates as well as Banana Republic a true fuse that all four of our brands have permission under the guise of their lifestyle positioning to lean into the intimate space. If you add them all up, it's a fairly sizable business now. Old Navy has seen some great success, particularly their unique aesthetic. They've introduced these great colorful undergarments that really stand out in the market. And I think we're seeing customer response to that. The average transaction volume in Old Navy has really grown. So that implies that we're not only expanding the basket for existing customers, but also the customer growth is there. So it's both, I would say it's the ends that we spoke about in the script. We're seeing more customers and they're spending more of which -- intimates being one of the drivers.

And Justin, why don't we take one more call and we have to break.

Thank you, sir. Our last question will come from the line of Marni Shapiro with The Retail Tracker.

Hey, guys, congratulations. Great improvement. I think the source looks fantastic and to your point, very optimistic. Could you just touch on a little bit about Old Navy sticking there because the intimate line was something but I've also noticed the active line looks a little bit -- looks change different in the stores, broader in the stores? And then, the balance of active into lounge, into intimate how that should look in the stores? And are there other segments that you feel are missing in Old Navy that the customer is interested in buying from Old Navy?

Thanks, Marni, good to hear from you. Thanks for your notes earlier. Listen, Old Navy has a lot of permission to play across categories. And they have leaned into intimates as their latest foray and they have our -- we have our extended sizing or body positivity launched in the fall is another example of expansion and authority. And what I would say to your point active is, yes, the active business has been one of the biggest growth categories, if not the biggest growth category for Old Navy, we've given them more space in the store, more space online, it's attracting a much younger customer. We're seeing moms and a lot of teenagers join us -- join the brand for the first time through the active of business. So we are seeing a more new and younger customers, we are seeing the natural growth because this is a category. This is the space, the active space is the fastest growing within apparel. And so it's all converging to benefit Old Navy.

Well, fantastic. Best of luck for the summer season, stores look great.

Thank you, Marni. And thank you all of those for joining us today. We look forward to speaking with you at the end of the second quarter.

Thank you. And that does conclude our conference. You may now disconnect.