Good afternoon, ladies and gentlemen. My name is Jenny, and I will be your conference operator today. At this time, I would like to welcome everyone to The Gap, Inc. Fourth Quarter 2021 Earnings Conference Call. Today's call is being recorded. At this time, all participants are in a listen-only mode. [Operator Instructions]. I would now like to introduce your host, Joe Scheeline, Head of Corporate Finance and Investor Relations. Please go ahead, sir.

Good afternoon, everyone. Welcome to Gap Inc.'s fourth quarter 2021 earnings conference call. Before we begin, I'd like to remind you that the information made available on this webcast and conference 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 the description and reconciliation of any financial measures not consistent with generally accepted accounting principles. Please refer to Page 2 of the slides shown 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 Securities and Exchange Commission on March 16, 2021, 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 3, 2022, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Chief Executive Officer, Sonia Syngal; and Chief Financial Officer, Katrina O'Connell. With that, I'll turn the call over to Sonia.

Good afternoon, everyone, and thank you for joining us. I would like to start by reflecting on where we are in executing our power plan strategy, and then I'll address how we are set up to compete in 2022. Looking back on 2021, I'm proud of the progress we've made on our long-term strategies to drive profitable growth. While navigating another year of volatility, we delivered record sales of $16.7 billion. This is a 21% revenue growth versus last year and up 2% versus 2019, inclusive of shedding an estimated $1.1 billion of unprofitable sales through store closures and divestitures. And we achieved a reported operating margin of 4.9% and adjusted operating margin of 5.5%, while absorbing approximately 2.4 points of estimated unexpected air cost as we navigated the supply chain disruption in the second half. Over the last two years, we have undertaken significant restructuring necessary to become a more nimble and focused company. With that, we've completed over 70% of our North American fleet rationalization with 250 store closures, transitioned our European business through capital-efficient partnerships and divested smaller non-strategic brands. All while we leaned into a digital-first mindset. This has resulted in reductions in fixed costs in both road and store expenses. Importantly, our four brands have healthy core businesses. With Old Navy crossing $9 billion in sales for the year, our revived and relevant Gap North America, delivering 12 percentage comp sales growth versus 2019. Banana Republic's new elevated brand positioning taking hold and that led a demonstrating standout comparable sales growth of 48% versus 2019, well on its way to $2 billion in revenue. Collectively, our brand improved AUR to last year through lower discount rates driven by relevant product and marketing and enabled by the customer health we saw in 2021. I'm particularly pleased with the partnerships we've launched, such as Gap Home with Walmart and EasyGap, Simone Biles and Alicia Keys' Athleta, and NEXT joint venture in Europe. We expect these partnerships to drive brand awareness, attract new customers to our brands, enable asset-light category and market expansion and ultimately grow our revenue. It's also important to note that we have intentionally leaned into demand-generating investments in marketing and technology by redeploying much of the fixed cost reduction. These investments have driven brand health, customer acquisition and revenue growth. Especially in our important $6.4 billion online business, which contributed 39% of sales in 2021 versus 25% in 2019. In 2021, we grew our active customer file to 54 million. And in Q4, our loyalty customers accounted for roughly 80% of our U.S. sales, setting us up to deepen customer relationships and drive long-term value. With customers returning to pre-COVID purchasing behaviors, we are pivoting to a more versatile fashion, offering on-trend product across a range of used occasions while playing to our market leadership in Denim, Active, and Kids and Baby. We saw these trends play out in the rise of Old Navy's classic workhorse staple, the pixie pant and Athleta's best-selling elation type, both now in flare leg shape. At Gap and Banana Republic, we're seeing return to fashion essentials with sales of Gap's modern khaki pant, climbing 33% over 2019 in January alone. And while Banana Republic's women's blazers outperformed expectations, specifically in novelty and high emulsion colors. And as kids return to in-person school and sports, we expect our Kids and Baby business with a market share of 9% to perform well. In the face of a dynamic consumer landscape, our teams continue to drive deeper connections with our customers and the communities we are proud to serve. Throughout, our employees have navigated two years of pandemic-related disruption with ingenuity and an unwavering focus on doing what's right, all while advancing our ESG goals. I look forward to sharing our progress on that front in next month's sustainability report. Today, we are a company positioned for balanced growth through our four purpose-led brands that reach a wide range of customers across all ages, sizes, use occasions and price points from value through to premium. In 2021, we also faced headwinds. The supply chain issues weighing heavily on our performance, especially in the back half. In the face of longer transit times from the West Coast port delays and a sudden and prolonged closure of factories in Vietnam, we experienced eight to 10-week delays in seasonal categories. In order to meet demand, we can utilize significant air freight to deliver as much of holiday product as we could. As a result, sales were muted and profits pressured. We studied the levers we have to more profitably improve on-time delivery in 2022, and I'd like to share a few of those strategies with you: first, we accelerated booking deadlines for a portion of our spring 2022 product and booked summer even earlier. As we saw delays worsen, we accounted for elongated transit times and believe we have built in enough buffer for the current full delays. Second, we are diversifying port exposure. Beginning with our summer assortment, we are moving the vast majority of our products through Eastern and Southern ports, where delays are materially better than on the West Coast. Third, we are beginning to optimize manufacturing, including proximate sourcing to enable flexibility and increase speed. Specifically, we are growing our Mexico and Central America sourcing in 2022. And fourth, we accelerated the adoption of digital product creation capabilities at Old Navy. In doing so, our teams are able to innovate more rapidly with suppliers and significantly reduce product design and development time lines. For our fall 2022 season, Old Navy led the way in creating its assortment with a 75% year-over-year reduction in total development samples and a 40% reduction in total development time versus fall 2021. We will continue to build on this, both at Old Navy and across our brands. While Q1 will have moderate product delays that necessitated air freight as a result of the aforementioned actions, our summer and go-forward deliveries are expected to be more on time and require only modest more normalized air. By the end of the first half, we expect the transitory air costs will have mostly flowed through the P&L. Looking forward, Katrina will share more on our outlook for the year and what we're seeing in the first quarter. As we are keenly watching the dynamics of the macro environment. Let me speak to our strategies for 2022 across our portfolio. Old Navy is expecting tougher first half compares as we look to anniversary the brand's disproportionate benefit from last year's stimulus, and the fact that the consumer has quickly pivoted to fashion, such as dresses and tops, which are underrepresented in Old Navy's women's product mix. Teams have chased into more versatile categories with better balance showing up in Q2. I remain confident in the overall health of Old Navy and in its position as a value brand, offering the Democracy of Style for the whole family at jaw-dropping prices. Gap is building on its momentum fueled by great product and strong pricing authorities. On the base of a healthier core and rightsized fleet, the brand is leaning into its Gap Home, EasyGap and now EasyGap engineered by Balenciaga partnerships to further extend its reach and relevance around the globe. Now that Gap has landed these big partnerships, the year ahead will be about scaling them to drive sales. The brand is commencing the year with new channels for growth adding 125 points of distribution in 2022 through partnerships, licensing and franchise. Banana Republic's new premium positioning now claiming a stake in the accessible luxury space is enabling significantly higher AURs, basket size and price authority. The rebrand is giving us confidence that we can capture resilient premium customers while attracting new ones by entering adjacent categories like BR Baby, which was announced earlier this week. And Athleta is on track to hit $2 billion in sales by 2023, led by its digital dominance, including growth in the wellness space, now 6 months into the launch of AthletaWell. The brand's world-class partnerships and inspiring marketing are helping reach new customers. Take, for example, its announcement of its Simone Biles partnership last summer. Supported by TV, which generated a significant pickup in traffic in stores and online from that investment. This helped drive a five point increase in brand awareness for Athleta in fiscal year '21 Q3 alone. And for the full-year of '21, Athleta grew its customer file in the double-digits, with nearly half of new customers driven by marketing investments. After significant investments in marketing and technology while we restructured, we are focused on extracting maximum value in 2022 from those investments as well as optimizing the core. Specifically, we're looking at three key areas. First, growing our loyalty program and using first-party data to better monetize our customer relationships. We are rigorously focused on increasing the lifetime value of our over 50 million loyalty members, particularly growing our tier members who spend on average more than 2x that of our core level members in Q4. We will do this through greater personalization at scale, enabled by the rich first-party data we acquired from marketing investments we made last year, coupled with the customer insights we've gained from our fully integrated loyalty program. This is particularly important with the changes happening across the media landscape and in customers' media consumption happens. Second, end-to-end supply chain transformation, where we are improving processes to drive efficiency and eliminate waste. This includes digital product creation that trims time from the development cycle and saves on overhead its ample costs, optimize shipping logic that reduces split shipments and implementing automated returns in our distribution centers that get product back to inventory in under an hour. We are working on -- de-risking our supply chain by rebalancing our sourcing to rely less on single countries of origin and building deeper relationships with near-shore vendors. And third, we're building inventory management capabilities in addition to balancing category mix, which we believe will improve our ability to hold on to average unit retail even in the face of potentially higher promotional environment. New digital tools are unlocking inventory allocation accuracy using predictive analytics and data to better forecast and making us more agile and precise about where we place product across our 2,800 company-operated stores and creating assortments by location to meet customer demand, in turn, reducing markdown and helping maintain AUR. From a category mix perspective, we're leaning into higher AUR products, such as Banana Republic's new silk, leather, cashmere and suede style. And at Old Navy, fashion essentials like dresses, pants and woven tops. As I look ahead to an environment where style, price and quality are top of mind for consumers. We're leaning into the power of our portfolio. Versatility and our ability to offer a range from value to premium, particularly as some customers tighten budgets, while others seek out luxury statement pieces is our competitive advantage. The 2022 outlook we provided today represents a continued step forward of our strategy with profitable sales growth and a path to get through Q1 disruption and deliver on our priorities for the year. While we are entering the year focused on executing against our strategy, building on our progress and with a firm grasp on the levers we have to compete, I would be remiss to not acknowledge the fluidity of the macro challenges impacting the speed with which we can unlock value and the portfolio. As always, we remain balanced, taking a comprehensive view of all strategic options that account for and address the evolving macro environment and ultimately deliver the best outcomes for our customers, our employees, and our shareholders. With that, I'll hand it to Katrina. Katrina O'Connell: Thank you, Sonia, and good afternoon, everyone. I'll begin with some highlights from the year, then cover Q4 and fiscal year 2021 annual results before moving on to our 2022 outlook. Fiscal year 2021 net sales reached $16.7 billion and grew 21% versus last year and 2% versus 2019. Comparable sales improved 6% versus last year and 8% on a two-year basis. We achieved these strong sales results while making significant progress towards our North America fleet restructuring, divestitures and international partnerships walking away from approximately $1.1 billion or seven percentage points of unproductive sales since 2019. We generated considerable gross margin expansion through ROD leverage as well as better product margins with average unit retail growth driven by less discounting offsetting higher airfreight costs. Finally, we returned over $400 million to shareholders during the year through our dividend program and share repurchase plan, and we're able to reduce and restructure our long-term debt saving approximately $140 million annually in interest expense beginning in 2022. A note before moving to Q4 and full-year results. Our adjusted fiscal year 2021 results exclude pretax charges of $59 million related to divestitures, $41 million in charges related to the transition of our European business to a partnership model and $325 million in fees associated with the restructuring of our long-term debt. Moving on to Q4 results. Net sales of $4.5 billion were down 3% versus 2019, which included about nine percentage points of impact from divestitures, permanent store closures and our European partnership transition. Two-year comparable sales were up 3%. Two-year comparable sales by brand were as follows: Old Navy, flat; Gap Global, up 3%; Banana Republic, down 2%; and Athleta, up 42%. We continue to be pleased with the strength of the core at Gap with Gap North America two-year comparable sales of plus 12%, the turnaround of Banana Republic and the momentum at Athleta. Old Navy results were disproportionately impacted by supply disruption in the quarter. Moving to gross margin for the quarter. Reported gross margin of 33.7% deleveraged 210 basis points versus 2019 reported gross margin. On an adjusted basis, gross margin deleveraged 260 basis points versus 2019, due to nearly 600 basis points in estimated air costs. Excluding air, gross margin expanded as we realized continued ROD leverage and product margin expansion from higher average unit retail through lower discounting. Reported SG&A of 33.5% leveraged 760 basis points versus 2019. On an adjusted basis, SG&A at 33.3% of sales deleveraged 300 basis points versus 2019 adjusted SG&A due to higher marketing, technology and incentive compensation expense. The reported fourth quarter loss per share was $0.04, with operating margin of 0.2%. On an adjusted basis, operating margin was 0.4% with a loss per share of $0.02. Fourth quarter ending inventory was up 23% versus 2020. About 15 points of the increase was driven by longer in-transit times as port delays and longer air and ocean schedules continued. The remaining increase is driven by higher AUC resulting from air costs that we expect to sell through as we move through the first half and from product mix shift into higher cost items like BR's new elevated product, multipack offerings and the shift out of mass. Units ended down single-digits versus LY in line with the trends seen throughout the year. Moving to full-year 2021 results. For the full-year, earnings per share was $0.67 on a reported basis. Adjusted EPS for fiscal year '21 was $1.44 with sales of $16.7 billion, growing 2% versus 2019. Comparable sales for full-year '21 were up 8% on a two-year basis. Two-year comparable sales by brand are as follows: Old Navy, plus 12%; Gap Global, plus 2%; with North America, plus 12%; BR, down 9%, but up 24% year-over-year and Athleta up 39%. Gross margin was 39.8% for the year and improved 220 basis points versus 2019 adjusted gross margin. ROD accounted for 320 basis points of the improvement. Merchandise margin deleveraged 100 basis points versus 2019 on an adjusted basis with an estimated 240 basis points of higher air freight offsetting higher AUR and lower discounting. Reported SG&A was 35% of sales for the full-year. Adjusted SG&A of $5.7 billion was 34.3%, up 310 basis points versus 2019 adjusted SG&A reflecting investments in growth primarily through marketing and technology as well as higher incentive compensation costs. Operating margin was 4.9% on a reported basis. Adjusted operating margin ended at 5.5%, inclusive of an estimated 240 basis points of incremental air expense due to supply chain constraints. Regarding store counts, we opened 32 Old Navy and 28 Athleta stores in the year net of closures, in line with the expectations as part of our power plan strategy to expand the footprint of our growth brands. The North America store closure plan for Gap and Banana Republic progressed well during the year with our 350 store closure plan now over 70% complete. We ended the year with nearly $900 million in cash and cash equivalents. During the year, we returned over $400 million in cash to shareholders, repurchasing 201 million in shares to offset dilution and through our reinstated dividend program. As we transition to 2022, we are focused on delivering value to shareholders through our economic model presented as part of our 2020 Investor Day. At the time, we noted that navigating the uncertainty of the pandemic was the priority for 2020 and that we had a goal of returning to profitable growth in 2021, which we have achieved. The ongoing long-term economic model, which will take hold in 2022 is centered on delivering total shareholder return through low single-digit sales growth and operating margin leverage yielding low double-digit EPS growth, combined with a competitive dividend. The progress we've made against our strategy, especially our repositioning unprofitable areas of the portfolio and building relevance across all our brands is enabling the economic model to come to fruition in 2022. Moving to our 2022 financial outlook. We expect full-year reported EPS to be in the range of $1.95 to $2.15, with adjusted EPS in the range of $1.85 to $2.05. Of note, our reported guidance metrics include a net benefit of approximately $100 million from the planned sale of our U.K. DC now that our European partnership model transition is complete. In addition, we expect approximately $50 million in charges related to our Old Navy Mexico business, where we have successfully reached a partnership agreement and are proceeding through required regulatory approvals. Here are a few other thoughts about 2022 financial expectations. We expect sales growth for the year to be in the low single-digit range. We are planning for gross margins to be relatively flat on a year-over-year basis with a slight decline in merchandise margins to be offset by continued improvement in ROD. Within merchandise margin, we are expecting mid-single-digit commodity price increases to be largely offset by favorability in airfreight. While we spent an estimated $430 million in air freight in fiscal 2021, we plan to spend about 20% to 25% less in 2022. A little more than half of the full-year 2022 air expense is expected to be realized in Q1 as we sell through product we expedited for fourth and first quarter flows. Improvements we've made to our planning cycle, which we expect to fully come to bear in summer should reduce air usage beginning in Q2 and through the back half of the year. We aspire to maintain average unit retails to be roughly in line with 2021 levels. As we manage through the current macroeconomic uncertainty regarding inflation and consumer spending, we are planning to experience some discount rate reversion, but we'll be able to keep AURs about flat with shifts into higher AUR product mix as well as by leveraging efficiencies resulting from our ongoing inventory management transformation work. Over the last two years, we've been transforming the company and making investments in service of our growth strategy. Moving into 2022 and the next phase of the strategy, we plan to leverage SG&A. We are pleased with the spend levels we have set in demand-generating areas, specifically in marketing and our focus on driving the effectiveness of that spend, but we also drive efficiencies within our operations. Operating margin is expected to improve to 6.3% to 6.8% on a reported basis and 6% to 6.5% on an adjusted basis. Q1 ending inventory is expected to be up in the mid-20% range versus last year due to early bookings to offset longer transit times. For the full-year, we anticipate net interest expense of approximately $70 million. As a reminder, we restructured our long-term debt in 2021, bringing down our overall debt balance and realizing significant interest savings. A note on cash. Q1 is usually a quarter where natural seasonality leads to a low point in cash balances for the year. This year, we have a unique dynamic where higher merchandise payments in Q4 related to airfreight and expected earlier payment timing in Q1 related to early bookings to navigate longer transit times have impacted near-term working capital. And in early Q1 2022, we drew $350 million from our ABL to bridge our normal mid-quarter cash costs. We expect material cash inflows in the first half of the year related to full-year '20 tax refunds from the CARES Act legislation. We expect a full-year effective tax rate of about 27%. Regarding store count, we're planning approximately 25 net closures during the year. Our principles related to capital remain intact. Our first priority is to invest in the business to the degree we feel we can drive strong returns on our invested capital. Next, we believe an important part of total shareholder return is paying a competitive dividend that we look to grow annually as we see growth in net income. And last, we plan to return cash to shareholders with share buybacks intended to offset dilution. With these principles in mind, we're planning full-year CapEx investments of approximately $700 million. Investments will be largely slated against supply chain and technology projects focused on driving automation, speed and efficiency within our fulfillment network, along with enhanced digital loyalty and personalization capabilities across the portfolio. In fiscal 2022, we expect to repurchase approximately 200 million of shares to offset dilution. Dividends remain a key component in our strategy to maximize total shareholder return and we were pleased to announce a 25% increase to our Q1 2022 dividend versus Q4 2021. Before I close out the call, I'd like to provide some additional color on the cadence for sales with particular focus in Q1 that's contemplated in our sales guide for 2022. Year-over-year sales growth comparisons will likely be uneven throughout the year with some headwinds as we lap the stimulus benefit with continued supply disruption in the first half, particularly in Q1 and then tailwinds as we lap supply challenges that constrained demand in the second half of fiscal year 2021. We expect total company sales in Q1 to be down mid to high single-digit negative versus 2021 with an estimated five points of the decline coming from lapping last year's strong sales generated by the benefit of stimulus, two points from lapping divestitures, store closures and our EU partnership. And the balance largely related to short-term softness at Old Navy related to category imbalances. As Sonia described, Old Navy is adjusting their category mix beginning in Q2 and beyond to be more balanced between cozy and fashion. Old Navy has built strong responsive capabilities that allow the brand to chase into fashion trends, but the ability to chase has been adversely impacted by supply chain bottlenecks. In closing, the progress we've made this year against our strategy sets us up to deliver our long-term ongoing economic model. We still have a firm conviction in our ability to grow our core brands and achieve a 10% operating margin over time. While this goal is still very much on our minds as we look forward, in light of recent headwinds, it is possible that this time line may extend modestly beyond the original time line. Our primary focus is on the long-term health of the business and delivering value to shareholders through consistent profitable growth year after year. We are clear on our 2022 priorities and are acutely focused on realizing increased operational efficiency and most importantly, driving sustainable, profitable growth. With that, I'll turn the call back over to the operator to begin Q&A.

Thank you. [Operator Instructions]. We will go to our first question from Matthew Boss of JPMorgan.

Great. Thanks and thanks for all the color. Sonia, so how do you see inventory levels positioned at Old Navy today? How best to think about the opportunity across categories as the year progresses? And then, Katrina, with the outlook for '22 guided 6% to 6.5% operating margin, I think what would be really helpful is just any way to split the opportunity that you see remaining between gross margin and SG&A from here?

Hi, Matt, thank you. So the inventory composition at Old Navy is changing dramatically along with customer preferences. They're leaning into the categories like dresses or new silhouettes and pants for back-to-work that are working for them as well as denim with new leg shapes. It's a pretty radical change from last year, which was driven by cozy, and active, and fleece. And so the team is working to chase that trend and rebalance the composition of the inventory. And we're confident that as we progress in the first half, we will see that balance intact. And as you know, the Old Navy has dominance in Kids and Baby with market share as number one in the kids space as well as denim, very high market share, as well as in dresses. So they have the authority, and we're working on shifting the balance. And then the inventory amount, I'll let Katrina perhaps comment on the actual overall levels. But it really is a composition shift as well as an opportunity to chase into a very dynamic consumer preference. Katrina O'Connell: Yes. And Matt, as it relates to the operating margin, are you talking about beyond 2022, how that splits out?

Exactly. I was thinking 6% to 6.5%, where do we go from here and how best to split it between gross and SG&A? Katrina O'Connell: Yes. So as we look forward, I think there's incremental opportunity in the margin expansion that will come from finally being able to shed the last of the air freight. So in 2022, we talked about how we are getting some benefit from having about 20%, 25% less air than the prior year. But really, starting in 2023 and beyond, we should not need that air freight. And so I think that's a meaningful benefit that we should see. And we talked about how airfreight overall has been about 240 basis points of drag on the operating margin. So some of that comes into play this year, but the majority in the out year. So that's a big portion of the opportunity. And then beyond that, I think it's going to be split between margin and SG&A. But when I talk about margin, it's really more about getting after the big cost in margin like returns or split shipments or the places where we actually have costs that flow through cost of sales spread combined with really figuring out new ways of operating. An example of that is this digital product creation. Breakthrough ways of using digital tools to be able to work really differently and finally get a lot of the fixed cost out of the business. So we have lots of opportunities to really be refining the way we operate. And I think beginning this year, you heard us say, we've made a lot of investments. Now it's time to really start getting leverage off of those investments and then begin to really lean into how do we pull out more cost in the business through digital capabilities and new ways of working.

Thanks for all the color. Best of luck. Katrina O'Connell: Thank you.

And we'll move to our next question from Mark Altschwager of Baird.

Hi, good afternoon. Thanks for taking my question. I wanted to dig into the gross margin just a little bit more. Lots of moving pieces there for the year. It sounds like margin overall down slightly, but you'll be seeing some of the incremental air in Q1 in the first half, maybe some promotional reversion, I would think, concentrated in the first half as well. But then you're starting to lap some of the pressures in the back half. So I think I have that right, but just any more color you can provide on the quarterly cadence to get to the flat overall for the year would be very helpful? Thank you. Katrina O'Connell: Yes. Sure, Mark. I mean, it is complicated. And as you noted, there's a lot of puts and takes. I think if I start with the year, simplistically, you're exactly right. We're hoping to keep margin overall flat, really with continued benefit in rent and occupancy. So we continue to get real benefit from the restructuring we've been doing. And then when it comes to merchandise margins, as you say, we're trying to take a prudent outlook for the year that while we saw great average unit retail improvements last year through much lower discounting, there is the possibility that the consumer could revert, and we would need to be more promotional. So we're proactively planning for that. Of course, we're going to do everything we can to hold on to the gains we got. But for the purposes of guidance, we are not assuming that we have to hold on to all of that. And instead, we are using the tools that we have at our disposal, like the inventory management optimization, combined with some of the inventory mix changes that we're making to try and buoy the AUR even if discount were to revert. And then in addition to that, we know that we have commodity increases primarily in the face of cotton prices escalating and yet really matching off against that is some benefit we have from airfreight. So it's complicated, but all of that to say that we do think we can still hold gross margins relatively flat. Now Q1, in particular, and potentially the first half, a little bit of a different story and as you say, tailed to half, where we did still have to use air freight coming into Q1 in order to navigate what was still fairly acute. We do plan to sell through that airfreight mostly in the first quarter. And then as Sonia said, we've used a lot of new levers to really get back to navigating the supply challenges, which we think will remain long, but with other tools that don't necessitate airfreight. So that should make for more normalized margins in Q2. And then a real benefit in the back half as we lap the significant air that we experienced. So hopefully, that's helpful, but I know it's a lot to digest, and we'll keep talking to you guys about it as we learn more.

That is helpful. Thank you. And if I could just follow-up with maybe an SG&A focused question, but curious on your takeaways from the marketing initiatives over holiday and how you're planning overall marketing spend into 2022? Thanks again.

Yes. I think we're pleased with the investments we've made. In Q4, we saw really good SG&A discipline in many lines. And the marketing investments helped us build sales growth at Q4 over Q3 for three of our four brands. So our share of voice and the investments we're making, we think, are paying off. We don't expect to increase the rate of investment this year. It's really as Katrina said earlier, extracting the maximum value, the marketing effectiveness, right. And one of the big benefits we have is all the rich first-party data we have. We're in direct communication with our customers. We know lots about them. And we're increasingly personalized in our communication with them based on understanding their shopping patterns, their category patterns, their brand preferences. And we think that, that's going to continue to give us advantage coupled with a sustained marketing investment that's more effective. So no growth expected, more effectiveness expected. Katrina O'Connell: Yes. And I think to just put a point on that. We did say that we had historically as a company really underspent in the demand generation of the company, and that has resulted in our brands being sort of lackluster in their relevance and performance. And so we really purposely invested even while we were restructuring the company because we didn't want to lose the opportunity to build the relevance of our brands. To Sonia's point, I think we've done that successfully. And now we really are focused on getting leverage out of those investments we've made as we grow sales. So it's definitely a year of pivoting to leveraging SG&A and getting more optimal in our spend.

Great. Best of luck this year. Katrina O'Connell: Thank you.

And we'll move on to our next question from Adrienne Yih of Barclays.

Yes, thank you very much. Good afternoon. Sonia, I wanted to focus on the inventory optimization processes that are being implemented this year. What exactly -- can you give us some more details? Is it distribution at the edge that we've heard from other retailers? And what is the sort of net benefit that is in the P&L? So how did that in basis points impact the overall merchandise margins? So I'll start there. Thank you very much.

Yes. That's great. Listen, we buy a lot of units to distribute to 2,800 stores. And so what we're doing is applying more and more advanced analytics and AI to optimize our distribution from our DCs to our stores. So we get better, more even sell-through, less markdowns whether that's size optimization or assortment optimization for seasonality or whether it's just replenishing sell-throughs. And so that, we're expecting some nice benefits on that front as well as on fashion forecasting. And so we have a multi-year plan on inventory management transformation and the big wins this year will be around allocation.

Okay. And then, Katrina, just to finish up on the inventory. So units are down low single-digit, at being transit, the inventory is up 8%. So it sounds like inflation is about 10%, but you're talking about AUR flat. So I'm just wondering how -- what's the impact? I mean if that would sort of imply pressure on merchandise margins throughout the year, and I guess that's being offset by leverage? Just trying to understand without price increases that we're hearing from many others, it doesn't sound like you're taking broad scale price -- initial retail price increases. Is that a correct assumption? Thank you. Katrina O'Connell: Yes. So Adrienne, I think when you think about the inventory heading into Q1, what's sitting in that AUC is not just the product cost inflation, which we did say was mid-single-digit. But also the air cost that we said we were carrying in. And that air cost, if you do the math, is about $150 million to $200 million, and that is in the AUC. So that will potentially pressure the gross margin in Q1 not to the -- not quite to the level we saw in Q4, but certainly will have an impact on the first quarter margin as we sell through the air cost. Now since we don't expect that to continue, that's where we should see that margin pressure get alleviated. And then we will get back to what I described for the year, which is benefit in air offsetting commodities and then potentially a reversion on discount being offset by some of these inventory management capabilities that we're using to get better yield.

Okay. Any early color that you want to provide to us, given all those pieces, what the GM rate should be in the first quarter? It sounds like flat for the year, but a lot of pressure in Q1. So how should you -- how do you think we should model kind of all those moving pieces for Q1 in the gross margin line? Katrina O'Connell: I mean there's a lot of different outcomes for gross margin depending on the range of sales. But what I can tell you is if you do the math on the air impact, it's about 400 basis points of air impact in the quarter. And so hopefully, that's helpful. That subsides. And I'll let you guys do the math on what you think the sales outcome is and what would play through on the rest of it.

Okay. Thank you very much and best of luck. Katrina O'Connell: Thank you.

[Operator Instructions]. Your next question comes from the line of Kimberly Greenberger of Morgan Stanley.

Great. Thank you so much. I wanted to ask about just the cost inflation that you're seeing. It sounds like it's primarily product cost inflation, Katrina? I'm wondering, and I understand that the mix between air and ocean got really out of whack because of the Vietnam factory closures and just trying to expedite product in. But if you set aside that mix shift between ocean and air, are you seeing inflation costs in your freight expense in general outside of the mix shift? And are you -- I'm just asking about inflation and your general cost, whether -- if you could help us understand what you're seeing in product costs, freight costs, and wage costs? Thank you. Katrina O'Connell: Sure. Yes. There are so many vectors of inflation that we're all navigating right now, right. So there is this air-ocean mix that we talked about. I think we've talked about that dynamic. We are also seeing product cost increases in the mid-single-digits. I think that's what we said to you, and that's primarily the cotton price escalation that we had seen. And then as you say, there are freight costs that are higher and then wage costs that are higher. All of that is contemplated in the guidance that we just gave. I think we've talked a lot about the use of our various AUR levers to be able to navigate the product cost mix. And then on the freight side of things, look, we're watching it carefully, and certainly, the Russia, Ukraine thing doesn't help things. But so far, we've been able to navigate that relatively well with the long-term contracts we have with our suppliers. And then on the wage side of things, we've been working hard to find ways to overall make the employee value proposition better by working on scheduling and a bunch of other tools that we have to make all that work out as we can, and we're finding efficiencies in other places to pay for that. So not an easy time to navigate, but those have all been on our radar and then contemplated in the outlook we just provided today.

Thank you.

I'll just add, I think to Katrina's point, while we are seeing those mid-single-digit product cost increases, and we are trying to go full AUR. We do see some areas where we have opportunity to increase select ticket prices in categories such as Athleta stretching into premium or the elasticity we're seeing in Gap or Banana Republic's new premium positioning. And so that helps to select areas. That being said, we're not planning on it at a holistic level, but we do have those levers in addition to the yield management levers around inventory transformation that we spoke of. So we'll use all the levers at our disposal to continue to manage the margins to the outlook that Katrina provided.

Thank you, Sonia.

And we'll go next to Lorraine Hutchinson of Bank of America.

Thanks, good afternoon. Katrina, you've made a lot of progress on the ROD leverage with the fleet transformation. As you think through the past year long-term targets, is the bulk of that behind us and the rest of the gross margin opportunity on the merch margin line? Or are there further gains to be had from here? Katrina O'Connell: Yes. No, thank you, Lorraine. It's a great question. As I think about the bridge that we gave at the Investor Day and where the value creation would come from, we are really definitely getting the value we expected to from the ROD line, both through the store closures in North America as well as the Europe partnership. We'll see if there's more opportunity there in some of our other international markets as we assess. But for the most part, I think that value is largely done. The second piece that we had talked about was being able to invest in demand generation to grow our average unit retails and to let that gross margin expansion help offset the digital shift that we expected in the business. And again, I think that's largely played out as we expected. In fact, we've probably made more progress on the gross margin side than we expected through average unit retails offsetting digital. And really, before the supply chain pressures, that was largely offsetting, if not adding value. And then the last leg was very much this operating efficiency. At the time, I think we thought it was just SG&A leverage. Now we see it more as really digitizing operations and going after these big value creation levers. And honestly, what we hadn't contemplated was the significant disruption and macroeconomic changes. So all to say, the ROD leverage is probably mostly behind us. But with sales growth, we should continue to leverage that line modestly, but the material benefits behind us, most likely.

Yes. And what I will add is I think we have a renewed emphasis and focus on SG&A with the leverage that we're expecting this coming year, the focus on fixed cost coming out of the business, stronger transformation and core operations like inventory management, like returns, like splits, et cetera. We are really leading into that. And we saw good progress and discipline in Q4 that benefited us, and we expect to lean -- continue to lean into that as a very important lever in dynamic times in 2022.

Thank you.

And we'll move to our next question from Paul Lejuez of Citi.

Hey, thanks guys. You gave the sales guidance for the year overall. I'm curious if you could talk about which brands you expect to grow in '22? I assume Athleta, but curious if you are looking for growth at the other brands. And then second, can you just talk about the competitive landscape at Old Navy? Any signs of increased promotion amongst the competitive set there? Thanks.

Yes, listen, it's a great question. I was hoping someone would ask them these questions. Because as I said in my speech, Paul, this is a year of balanced growth. We're expecting all four of our brands to contribute to the sales growth as well as to the profit of the company. And that's been years coming, and we're expecting. And really, that's the value of the portfolio. So I think different brands will have different proportionality. We're expecting big growth from Athleta, continuing with their trend, et cetera. But all of our brands will be contributing to top line growth. And your second question, I'm sorry, was around competitive pressures in margins for Old Navy. Is that what your question was?

Yes, just curious what you're seeing on the competitive landscape front for any signs of increasing promotions amongst the competitive set.

Yes, I mean we are expecting it to be a more promotional environment than last year, right? Last year was a big stimulus. I think a very happy consumer, particularly in the first half. So as we lap that, and as the consumers are becoming more price conscious, a lot of pressures with inflation, I think the retailers will benefit to drive conversion. And we are seeing some of that in our own business as well. That being said, I think it is manageable, and we will continue to see different levers to compensate for that. And the value space is really important to hold on to the value equation and compete there. And in times like this of inflation, a brand like Old Navy can compete very well because the overall apparel contribution to value typically grows. So we're expecting the value proposition of fast essentials at jaw-dropping prices for the family to continue. And we're expecting that we'll see trade-down customers that will benefit Old Navy as well for this year. So we'll see how it all plays out, but it should be a good environment and particularly our Kids and Baby business, where we have almost 10% market share across our brands quite resilient in this kind of environment.

Do you plan to take a leadership role in going after market share, maybe investing in price a little bit to do that?

Any market share is really, really important, and our investments have been in the area of marketing to drive brand health and conversion as well as in technology to have more profitable sales flow-through. So we're happy with those areas. And we think our prices are very competitive. We benchmark all of our brands against their competitive sets. And I feel good about where our price is positioned.

Thank you, good luck.

Thank you.

And we'll go to our next question from Brooke Roach of Goldman Sachs.

Good morning and thank you so much for taking our questions. Sonia, I'd be curious to hear what you're seeing across the consumer landscape today, how is demand trending across each consumer income cohort across your portfolio of brands? And I think you mentioned potential benefits of trade down in the Old Navy banner in a prior question. Are you already seeing the benefits of that trade down today? Or is that something that you're anticipating to happen over the course of the next few quarters?

So I'll start with the premium sector. We're seeing a lot of resiliency in the premium space in Athleta, in Banana Republic or both, I think, achieving strong price realization and customer opportunity there. Income levels are high and from an aprotic are growing in terms of the percentage of their customers and higher income brackets. So that is good. I think Gap working through their comp growth, they're seeing really strong average unit retail growth, so attracting, I think, a balance of customers value through premium. And Old Navy there's many shoppers in the value space, they do making over $75,000 a year. So they spent quite a range of customers because of their Kids and Baby business. I mean what I would say is we think there's opportunity to win across all those segments. It's really about having the right assortment and the right brand management and that forward focus. So certainly, the headwind of anniversarying the stimulus is a factor, as Katrina said, in the first half. And so we do think the consumer typically in the lowest income bracket is part of inflationary prices. So we'll be watching that carefully, and we do expect some headwind in that space in the short-term.

Thank you. And then for Katrina, in the prepared remarks, you talked about several initiatives in the organization to increase the speed and agility of merchandise planning and sourcing. And that's one of the big opportunities for margin as you go forward. Can you talk to the time line of this process and maybe the quantitative impact that, that aspect of the plan has in the long-term plan? Thank you. Katrina O'Connell: Sure. I think that the main value creation that we see happening this year is very much in those inventory management capabilities that Sonia spoke to primarily the allocation data science that we're putting in. Also with the purchase of CB4, the first deployment that we have is leveraging the math that they have to better inform our stores on where they're performing in product versus other stores and giving them more data on how to better sell the product they have. So I would say that's the first leg. And then in addition, the value creation this year in our guide is coming from the operating leverage coming from sales growth in the SG&A line. So those are those. The future really is getting after the data science that gets to what Sonia talked about, the returns optimization, the split shipments and many of those other levers that are big cost items. I would say, Brooke, those are -- we're going to lay those foundations this year. We're going to work as fast as we can to get value this year if we can. But most likely, those will be big value creators for 2023 and beyond. So that's how I would think about it.

Yes, I would just say, look, the logistics lead times will be long for this year. That is just the fact of the industry. And so the way we're looking to compensate for it is by driving digital product creation as we mentioned, which is taking weeks out of the product development cycle as well as moving into more proximate manufacturing. And so we're expanding our manufacturing in Latin America and Mexico this year. And so that will start to balance some of those longer lead times. And create some speed as we build some responsive capabilities back into our supply chain this year as well.

And our last question will come from the line of Ike Boruchow with Wells Fargo.

Hey, thanks everyone. So I guess two questions, maybe Katrina, first. On the margins, so the airfreight math you're laying out kind of suggests you another 200 basis points beginning back next year. So that kind of would get you to 8% to 8.5% margin. Are you still comfortable with the 10% margin goal for next year? Or given all the cost pressures in the business, has that become too much of a stretch at this point? And then just a second follow-up for, I guess, both of you. Athleta, another quarter of 40% to your comp, really strong growth. I guess anything you could tell us about the margins in the business, the EBITDA generation of the business? And I guess my point is the market is clearly not giving you full value for that asset right now when you look at your market cap. Are these conversations that you guys have internally when you think about trying to extract value for your shareholders? Thanks. Katrina O'Connell: Ike, so yes, so I know I said in my prepared remarks, there's no reason why we don't still have the 10% operating margin fully in our sites. As you say, we achieved the operating margin we achieved in 2021 even with 240 basis points of headwinds from air. We think we can get to 6% or 6.5% this year with significant disruption still in the business. And while we're not pleased with the speed with which we're getting there, given the new macro headwinds, we are navigating them as best we can while still pushing forward on the plan, which we think makes sense. We still have the 10% operating margin in our goals. As I said, it might be modestly delayed from 2023, a little bit maybe more into 2024. If the current macro environment stays as challenging, given that the new headwinds are just material that we're navigating. But it doesn't mean we have given up on that goal. We actually still fundamentally believe and will challenge ourselves to get there, if not in 2023, then definitely by 2024. Maybe, Sonia, do you want to speak to Athleta?

Yes, I think that we've been pleased with Athleta's growth, right and has seen the growth within the portfolio. And we believe in our strategy. We believe we're doing the right work to grow our operating margins and to enable Athleta's growth. They have healthy margins. And they're also enabled by the power of the company, whether it was launch into Canada, the leverage of the e-comm site, the first-party customer data, et cetera. So we're happy with our strategy. We're focused on executing it and growing all of our brands. That being said, Katrina and my job is always in parallel to be looking at options around value creation and your point is well taken and well understood. And we'll -- as we do always, continue to look at options.

Thank you.

And thank you. That ends today's question-and-answer session, and that does conclude The Gap Inc. earnings call. You may now disconnect.