Good afternoon, ladies and gentlemen. My name is Brianna, and I will be your conference operator today. I would like to welcome everyone to the Gap Inc. Second Quarter 2023 Earnings Conference Call. [Operator Instructions] I would now like to turn your call over and introduce your host, Emily Gacka, Director of Investor Relations.

Good afternoon, everyone. Welcome to Gap Inc.’s second 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, August 24, 2023, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Executive Chair, Bob Martin; Chief Executive Officer, Richard Dickson; and Chief Financial Officer, Katrina O’Connell. With that, I’ll turn the call over to Bob.

Thank you, Emily, and good afternoon, everyone. Before Katrina shares our second quarter results, I have the pleasure of welcoming our new CEO, Richard Dickson, to the call. There’s no denying that Richard was destined for this role at this moment. His experience as a transformational brand builder makes him a perfect fit for this great company. He is uniquely qualified to lead and carry out the transformative work already underway and more importantly, he is the right leader for tomorrow, defining the future of Gap Inc. Appointed to our Board of Directors in November of 2022, he’s had a view into how we are changing the way we work and the results we deliver. But what energizes him most is building a new legacy for our renowned portfolio of brands, one that matters to our customers, employees and shareholders. And before I hand off, I want to say thank you to our entire Gap Inc. team for their commitment to the success of this company and their tenacity and care for our brands, for embracing operational rigor and regaining the product and customer obsession with an eye on modernizing the way we work, all of which becomes a strong foundation for what’s ahead under Richard’s leadership. I have great belief that Richard and this team will define a very bright future for this company. So, with that, I want to welcome Richard Dickson, the new CEO of Gap Inc. Richard?

Well, good afternoon. This is my third official day as CEO of Gap Inc. So first, let me begin by thanking Bobby, the Board and the entire Gap Inc. organization for the opportunity to lead this incredible company. And thank you, everyone, for joining us today on our second quarter 2023 earnings call. Now many have asked me, why Gap Inc. and why now? So, let me start by saying that I have admired Gap Inc. and its brands Old Navy, Gap, Banana Republic and Athleta for decades as a customer, a brand builder, and most recently, as a Board member. Those of you who know a bit about my career know that I’ve always been drawn to companies and brands with storied legacies and powerful purposes. And in apparel, there’s no equal to Gap Inc. When Don and Doris Fisher opened the very first Gap store in San Francisco in 1969, little did they know, that they had tapped into the zeitgeist in a way that would democratize and define American style. Suddenly, great clothes were accessible, stores were experiential, self-expression could be an everyday pursuit, open to all. Talk about a game changer, Gap did that. Creating an opportunity from the currents of culture has been a hallmark of Gap Inc. for more than 5 decades. Over the years, our brands made jeans, khakis, kidswear, suits, yoga pants, you name it, into massive trends through great design, great marketing and an all-out obsession with our customer. Fast forward to today. The apparel and retail landscape has changed dramatically, evolving at an even quicker pace now it requires that great brands run at the speed of culture to maintain relevance. What has not changed is the customer’s desire for fashion they can make their own. We will take that…

[Operator Instructions] Our first question will come from Matthew Boss with JPMorgan.

Great. So maybe a two-part question. Richard, could you elaborate on the encouraging signs of progress that you see across the organization and maybe just as we think about opportunity for your concepts to take market share over time. And then Katrina, maybe just any way to elaborate on trends that you saw progress as the second quarter move forward? And maybe what you’re seeing today in terms of consumer behavior in August and into back-to-school?

Well, first off, thank you, Matthew, for the question. And I’ll start with saying again how excited I am to be here on my third day. What I can tell you in the context of where we are, first and foremost, is that these brands are incredible assets, Gap, Navy, Banana Republic, Athleta, these are truly some of the most iconic brands in the fashion industry. We serve such a broad-based consumer, which is such a strength as well, generations and backgrounds. We’ve got incredible story legacies, 54-year-old history. We created massive trends. When I look at the strength across the portfolio, as I mentioned in my opening remarks, we’re the #1 specialty apparel company in America, the scale that we operate with 600 million store visits, 1.4 billion online visits. The scaled operations we have from our DC network and logistics, our vendor partnerships, which can provide us incredible favorable rates and service, our production, we produced over 900 million units annually, the stats and strength of the fundamentals of this business are pretty incredible. Clearly, the transformation work that the team has done has put us on incredibly better financial footing. As Katrina mentioned, again, $1.4 billion in cash on hand in the balance sheet, $300 million of cash flow, 30% less inventory. These are metrics that matter and ultimately, metrics that are incredibly encouraging in the context of our ability to build upon it and continue it and go forward. As I also mentioned, part 2 to the question in terms of where are the opportunities. These are brands that truly matter. Now as I also said, they can matter more. And how to do that? I talked about reigniting the creative culture at Gap. We have extraordinary talent here. We are going to not only encourage…

Our next question comes from Paul Lejuez with Citi.

Richard, you’ve been on the Board, so obviously in touch with what’s been going on operationally to some extent. So I’m curious what you think might be the lowest hanging fruit as you think about each of the brands. Also curious, big organization, you talked about scale. Profitability doesn’t quite match the efficiencies you would expect with such scale. So I’m curious what you think are the biggest inefficiencies of the company.

Yes. Thanks, Paul. Look, broadly speaking, it’s about really reigniting Gap Inc.’s culture to really empower creativity in my experience on the Board and certainly on the ground for 3 days running fast. Our teams are incredibly creative and they’re all in on this. They’re differentiating and strengthening our brands, being design-centric, being customer-obsessed and ultimately being culturally relevant. These are not necessarily new phrases and their common language, but these are the areas that we need to work upon and reignite and ultimately, really think about how our brands show up in-store, online with consumer experiences that really excite and attract drive demand and all of the variables that go into kind of balancing wants and needs that ultimately is kind of where fashion lies. When I think about our brands in the context of opportunity, brands that have the kind of strength that we do, brands that matter can be monetized. We need to make these brands matter more. And ultimately, that is going to be the pursuit. When I look at the strengths of the business, it is incredibly encouraging. That being said, we have work to do. We’ve started this transformation work under Bobby’s leadership, and the team has worked tirelessly to make extraordinary progress. But we will continue not only the transformation that we’ve begun, but we will start to build upon it and really unlock the value of these brands. We can all agree that there is greater value in the portfolio that is showing up in the stock today. And with the consistent performance that we expect, we’re going to get rewarded for that. And ultimately, that’s going to start with really driving demand, exciting our consumers and mattering more. And we’ll be back very shortly to share how we’re going to reveal all of that and continue moving forward.

Okay. Can you just talk about what changed in your gross margin assumption for the back half of the year, which pieces moved as a result of what you’ve seen first half to date and what you’re seeing thus far in the third quarter? Katrina O’Connell : Yes, absolutely, Paul. So in second quarter, overall, the gross margin in total came in very close to, I think, the words we had used to get you guys close to the margin we just delivered. There was a little bit of a shift between the inflationary pressure, which was better, came in at about 140 basis points of headwind. We had thought it would be closer to 200. And that was really because we saw rates in the freight area get better through some negotiations we just finished with some of our big suppliers. And where we saw the margin get a little worse within ROD where we deleveraged more since we came in at the lower end of our sales range in the quarter. So that dynamic plays through to the year where, again, the overall guide on the full year margin is basically intact. Air is still about 200 basis points of benefit, but we now see less impact from inflation, so only 10 basis points versus we had prior said 50 basis points of headwind and then the offset there is ROD where we now expect 70 basis points of deleverage, whereas we had said somewhere between zero and 50. So it’s really this inflationary benefit offset by ROD deleverage, but overall, the nominal guide is very similar.

And a promotional level is different than what you expected? Katrina O’Connell : We came in very close in the second quarter to what we expected on promotions. And overall, we’re holding the full year to about 100 basis points of overall leverage coming out of that promotional guide. And for the third quarter, what we said is we expect promotions to be about flat. So we’ll see. Obviously, we came in with inventories down 29%. And markdown inventory well under control. And the teams are excited to have chase capability back after the supply disruption that we experienced for so long. So we’ll aspire to do better. But right now, that’s what’s embedded in the guide.

[Operator Instructions] Your next question comes from Alex Straton with Morgan Stanley.

Katrina, maybe this is just for you. It looks like Old Navy has yet to inflect though we are seeing some other value-oriented businesses, pulling that off, it seems in this quarter. So can you talk to you about what’s going on there? Are you seeing any green shoots outside of women? I feel like we’ve had that maybe for a couple of quarters now? And then how you think about the time line to improvement. Katrina O’Connell : Yes, it’s a great question, Alex. So when I look at what’s been happening at Old Navy, I think what’s been consistent is what we’ve been calling out, which is they do have a low income consumer that remains pressured. And so that dynamic hasn’t necessarily changed. When I look at what happened in Q2, though, lapping last year’s significant clearance of active product, in particular, really weighed on the performance. If you remember last year in Old Navy, we were in the process of really rightsizing the assortment away from cozy-casual. We had a lot of the sizing issues. So lapping that has really weighed on the revenue side of things. As we move into the second half, we are seeing the active business improve modestly. Women’s is getting better and kids is looking better as well. So we’ll see where that all lands us. But yes, we are seeing green shoots at Old Navy. I think all of those categories we aspire to have getting better. Again, the consumer pressure is most acute at Old Navy, and that’s the piece that I think we all remain cautious on is whether it’s the low income consumer starting to get real wage pressure from inflation or whether it’s the new student loan dynamic, we’ll see how that plays out for Old Navy.

Our next question comes from Lorraine Hutchinson with Bank of America.

Katrina, as you think about the mid-single-digit decline in sales guidance for the year, it does imply a nice improvement in fourth quarter, can you just talk about how you’ve been thinking about that improvement? What drives it outside of the 53rd week, of course, and how you’re getting comfortable with that level of improvement from here? Katrina O’Connell : Yes. So Lorraine, you’re correct that the fourth quarter does have some benefit from the 53rd week. But in addition to that, I know we’re all tired of looking back at 2019, but I just sort of look at the run rate in the business from the first half to the back half versus 2019. And the quarters Q3 and Q4 are very similar to what we just sort of went through. So I think there’s a lot of quarterly variation that we have seen over the last couple of years. Fourth quarter when you look back to 2019, looks more similar to history.

Our next question comes from Jonna Kim with TD Cowen.

Just a question on Athleta, sort of how you’re thinking about turning around the brand and getting the brand back from growth over time and just be competitive in the market? Katrina O’Connell : Yes, I’ll take that. And I mean, Richard, of course, I welcome your view as well, but maybe I’ll start, and then you can say a little bit more. As I said in my prepared remarks, we feel really good about Athleta’s positioning in the marketplace. The power sheet positioning is incredibly strong. And we feel like we have a lot of white space in that brand to win. We knew we had some near-term product execution issues, which the team, as I said, has been heads down working on. For fall, there’s not a lot of change to the product that the teams have been able to do, but they’ve been remerchandising the stores and the site and hopefully, if you’re a consumer, you see that it looks much more in line with the brand aesthetic. And then we are excited to welcome a few new players to the team, whether it’s Chris or Julia, who we think will also bring their experience to bear on the brand starting in fourth quarter and then really into next year. So we’re very excited about Athleta’s potential long term, and we know we’re just sort of going to get through the next quarter or two as we make the changes we can to the assortment we have. But Richard, I’ll let you add if there’s something else.

Yes. Thanks, Katrina. As a member of the Board, I had a chance to get to know Chris and help select him for this role. He’s an exceptional talent, broad-based experience across the apparel retail and wholesale industries holding roles across multiple functions. As the recent President of Alo Yoga, he was really able to successfully and quickly grow that brand, nearly doubling its year-over-year growth and with extraordinary expertise in performance apparel. So as Katrina called out, we couldn’t be more enthusiastic about the team that Chris is leading and their recent efforts and we’re really looking forward to the accelerated progress that we intend on making with this brand.

Our next question comes from Bob Drbul with Guggenheim Securities.

Richard, welcome. I guess, Richard, for you, when you look at the -- you talked about Chris, but when you look at the team that you have in place having been on the Board is -- I think you understand their vision. Should we assume there are no further management changes necessary at a very senior level as you look at the portfolio?

Yes. Thanks, Bob, for the question. I’ve been on the board since last year when much of the work began taking root. And I feel I could really hit the ground running. That said, it’s early. I’m focused on listening and learning. We really do have a very strong team. I only see it getting stronger. So in the context of, let’s call it, more tenured and now obviously 3 days in, from what I feel and see in the context of being on the ground, I’m very encouraged. The work that the team has done around the transformation has really toiled the soil, if you will, in the context of my entrance and really feel like the baton being handed is strong. So with that said, we’ll share a lot more in the coming quarters around where we’re headed, how we’re going to get there, and ultimately, much more detail associated with it, but early days, I’m very encouraged.

Great. And Katrina, if I could just sneak a second one in for you. In terms -- you made some progress on the SG&A. I know there’s been some discussion around potential for further cuts. Is there any sort of further idea on additional opportunities as you look at the SG&A line going forward? Katrina O’Connell : Yes. It’s a good question, Bob. I mean, when we look at the work we’ve done, we’ve impacted about $550 million of cost in the business, whether it’s the actions we took early last fall, that have helped offset some of the inflationary pressure this year or whether it’s the overhead actions we just took that we think will generate $300 million cost. So I think you’ve heard both Bobby and Richard say that we’re happy with a lot of this work we’ve done to set the foundation. The remaining SG&A work, I think, is to be seen. A lot of it is on some of the demand-generating investments we’ve made, marketing and technology where I think Richard and I will really partner on assessing whether we think those are adding the value that we think they need to add or whether there are some refinements we can make there. And that’s the next leg of the journey for us to see how we would if we would really moderate those in the next coming quarters. So more to come, but those are the areas, I think, consistent with what we’ve been saying that we would look at.

Our next question comes from Corey Tarlowe with Jefferies.

You mentioned in your prepared remarks about how you’re rethinking about how the brands show up in-stores and online. So just be curious to kind of get your thoughts. And again, having been on the Board since November, your thoughts around kind of the store fleet and how to profitably leverage the store fleet to drive further sales ahead? And then just – Katrina, just wanted to get your thoughts around -- apologies if I missed it on promotions in the second half of this year?

Thanks, Corey. There’s a lot in my opening remarks, and we can double-click on many of them. But in the context of the areas that I see the most opportunities, it’s specific to really working on this distinctive brand purpose that aligns with our customer values and really sets them apart. As I talk about the brands and their legacies, I really -- these are brands that matter. And when you have brands that matter, they could be monetized. That being said, you have to make these brands matter more that has to have great product, great marketing, great execution, and we really need to understand and be obsessed with our customer. I think that we have elements of it, but where we’re going to really work very, very diligently on is creating meaningful differences in the context of our brands and making these brands matter more. When you look at our stores, they need to reflect, if you will, the right narrative in the context of product statements that we believe are heroic, products that we believe will matter to our consumers, the right balance between basics and fashion and an experience where details really come across to create an experience that consumers will talk about, want to return to and ultimately find, if you will, the value and quality and product experiences that are required today for brands that win. And that’s what you’re going to see us work much more diligently on as transformations go, these things take time. But we will start to test and roll and really learn essentially what works and what doesn’t in a more accelerated way so that we could do more of what works and do less of what doesn’t, lots more to come with lots more examples, and we’ll share those as they evolve. Katrina O’Connell : Yes. It’s great, Richard. And I think, Corey, to answer your second question, we did see successful expansion of gross margin with lower promotional levels in the second quarter. So we saw about 200 basis points of margin expansion coming from lower discounting in the second quarter. Right now, in our outlook, we have basically a flat level of promotional activity in Q3. So as we talked about, we’ll aspire to do better with the lower inventory levels and chase that we have but we remain cautious on the consumer. And so we definitely want to make sure that we’re offering enough value to the consumer heading into the third quarter. So we’ll see where that lands.

Our next question comes from Adrienne Yih with Barclays.

Great. Richard, this is sort of more philosophical question given you’ve only been there 3 days -- a year and then 3 days. So your tenure at Mattel was sort of similar in concept sort of reinvigorate sort of the core brands, restore growth and restore the position sort of as an industry leader. So I guess my question is, oftentimes, when you have a company that’s been struggling, the creative team and all those assets get very safe, right? So they become very risk averse. And I’m just wondering, how do you create a culture of greater risk-taking and innovation such that, that creativity can kind of come to the forefront?

It’s a great question. There are a lot of parallels with my experience at Mattel and Gap Inc.’s business across many levels. And I’m here to architect and orchestrate ultimately to lead. And the parallel construction of where Mattel was and where Gap is, is very familiar. Great assets great talent, a moment where, to some extent, a lot of self-inflicted challenges, some within our control and some ultimately impacting our business and our industry. And ultimately, a phase that we are going to go through, which is really about unlocking the value of our brands through reigniting a creative culture, the balance of fundamental and/or fiscal responsibility and operational rigor. While you are driving a design-centric and creative culture is the art and science of the leadership that you need to have in this business. It is a very familiar language. It’s actually a very familiar model. And ultimately, you’ve got to be able to take swings that are calculated, test, roll, learn and scale and accelerate very, very quickly. That is a muscle that we will begin to exercise and strengthen with the experience that I bring in the context of that type of leadership, I believe that that’s going to add value very, very quickly. This is an organization that is really excited to unlock and reignite, if you will, creativity. And so I feel incredibly fortunate to be inheriting a business that, from a transformational perspective, has come through, if you will, a very heavy lift and is now delivering, if you will, a fertile ground for a design-led culture, creativity that ultimately will show up for consumers and the ability for us to make brands that matter, matter more.

That’s super helpful. Katrina, one quick one -- sorry, did you talk about shrink? When do you take your physicals? I think it’s midyear, but I may be wrong. And is there anything to call out there of note? Katrina O’Connell : Yes. There’s nothing notable to call out from us on shrink. We do full counts once a year in the early part of the year, first quarter. We do partials in the second half of the year. And as of now, our shrink remains below pre-pandemic levels, and there’s really nothing to call out. So shrink is so far for us not anything of note.

Our next question comes from Dana Telsey with Telsey Group.

Welcome, Richard. Just following, Richard, in terms of some of the thoughts to what you’ve done in the past. I’ve read some of the articles about how you put together the thoughts on brand relevance of 4 points. Why do we exist design-led innovation, culturally relevant and execute with excellence. How do you look at those initiatives or those topics in comparison to Gap and your initial thoughts on reinventing and rearchitecting the business model in any way. And then, Katrina, I just wanted to follow up on, as you think about 2024 and planning, how are you thinking about inventories for the back half of the year and into next year?

Thank you for the study of my background and playbook at Mattel. My experience in turning brands around accelerating performance, it goes beyond the development of a playbook, but really rallying teams to deliver on a plan, ensuring operational rigor and enabling a culture to execute with excellence. And the context of that methodology, when you look at Gap brands, these are beloved brands. They have a real connection with consumers, and we need to reignite that connection. I’m passionate about motivating teams to uncover what made a brand or a company iconic and special in the first place and then working together to reinvigorate them to new relevance. So the familiarities in the context of the work and legacy brands revitalization methodologies are familiar and similar. That being said, the playbook that we will reveal that will be the strength and the consideration set to reignite the Gap portfolio will be one that we’ve collectively work on as a team as I listen, learn, spend time with our stores, our headquarters, DC, partners and really start to understand ultimately what will be the Gap playbook that will deliver ultimately to our consumers, our people and our shareholders, and we’ll be back shortly to be able to share all of that. Katrina O’Connell : And then, Dana, on inventory, we do expect that third quarter ending inventory will be very similar to the first half trends. And overall, more to come as we head into next year, but we expect to be running more and more on leaner inventory with receipts left opened so that we can be more responsive to consumer demand closer in. And a lot of the transformational activity that we’re working on is not only just reinstating the responsive levers that we’ve had, but working closer with our vendor base to make sure that we have the right materials, the right logic with our vendors to be closer to the consumer. So all of that helps us have leaner inventories and be more dynamic. So more to come on what those levels are going forward.

Our last question comes from the line of Brooke Roach with Goldman Sachs.

I wanted to follow up on Old Navy. Can you elaborate on the competitive backdrop that you’re seeing in the business today, particularly as Old Navy competes for that value-oriented customer who has options, both online and with other discounters. And are you seeing any benefits from a trade-down customer in your stores? Katrina O’Connell : Yes, Brooke, I mean what we’re seeing is that some of the brands that are really winning with our consumer are T.J. Maxx, Amazon, Shein, we’re definitely seeing those businesses gaining share. And those compete with our customer. We’re also seeing strong brands like Nike and Lulu and Adidas win, which tells us that great brands win in any economic environment. Old Navy has the benefit of being the #2 brand behind Nike. And so it is a big player in the branded space as well as being a retailer. So I’m thrilled to have Richard on Board with his experience in creating relevant brands. And that brand already has such a strong positioning. I think we have a lot to do there to keep winning in that space. So more to come there, but we’re glad with their positioning for sure. Trade-down benefit, we’re not currently seeing any trade-down benefit. That said, we’re certainly positioned to add value to any consumer as we move forward since our goal is to have great fashion at a great value. So -- but we’re not seeing that yet.

If I could just follow up on one other topic. We’ve heard a number of companies this week address credit and card portfolios amidst some of the macro concerns that we’re seeing in the environment broadly. Can you provide a brief update on how you’re planning your credit business and what might be planned in your outlook for the rest of the year? Katrina O’Connell : Yes, it’s a good question, Brook. And certainly, we’re watching that, too. So any trends in credit card income that we see from industry reports or see within our own business are currently reflected in the outlook we provided today. We do see same as the industry reports loss rates increasing from the recent lows in ‘21 and ‘22. However, ours are not back to pre-pandemic levels yet. And we’re working with our credit card provider to adjust our underwriting strategies to make sure we’re mitigating risk of higher delinquencies, while still providing our customers with flexibility. So we’re actively monitoring the consumer environment. We’re watching the impact to credit and all of the trends on the credit card customer, again, are in the outlook we just provided.

Thank you. We’ve reached the end of the question-and-answer session. And I’ll now turn the call over to Richard Dickson for closing remarks.

Thank you. I’d like to thank all of you for your time, your interest and your questions. And I just want to reiterate my belief in Gap Inc., our people, our brands and how truly thrilled I am to be the CEO of this extraordinary company. I also just want to thank the people of Gap Inc. for this incredibly warm welcome and to thank Bobby in particular, for his tireless leadership over the past year and for igniting transformative work that I really am eager to pick up and run with. And all of you who joined the call today, I look forward to meeting all of you in the coming weeks and months, and thank you all for joining.

Thank you. That does conclude our conference call. You may now disconnect.