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Gap Inc. Facing $650 Million Sales Shortfall

The current state of the supply chain has cost Gap Inc. in a serious way in the third quarter. The specialty apparel retailer saw a slight decline in third-quarter net sales, down 1 percent to $3.94 billion, missing Refinitiv estimates of $4.44 billion. But the parent of the Gap, Old Navy, Athleta and Banana Republic brands incurred a net loss of $152 million, or 40 cents per share, as the company estimated that it lost $300 million in quarterly sales due to inventory constraints.

Gap Inc. significantly cut its full-year guidance for both anticipated sales growth and diluted earnings per share, leading the stock to fall more than 20 percent in after-hours trading Tuesday.

In a Nutshell: With approximately 30 percent of product manufactured in Vietnam, where factory closures extended from August to October, Gap Inc. has chosen to fly in approximately 35 percent of its holiday product.

While the retailer spent $100 million in air freight in the quarter, it also invested about $350 million more in the current period to further expedite holiday deliveries, Katrina O’Connell, executive vice president and chief financial officer forGap Inc., said in an earnings call.

O’Connell said the retailer has routed “a modest portion” of its inventory to East Coast ports to bypass the congestion in both the Los Angeles and Long Beach hubs.

Third-quarter ending inventory was down 1 percent year-over-year to $2.72 billion and flat versus 2019. Average on-hand inventory was down 7 percent, while in-transit merchandise was up 16 percent versus last year.

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“Despite strong sell-through trends, we lost volume as a result of limited supply,” O’Connell said. “While our brands all experienced delays in styles and sizes that limited their ability to fully meet strong demand, Old Navy was disproportionately impacted.”

Old Navy, which is the banner brand for Gap Inc. with 54 percent of company sales, saw a 6 percent sales dip to $2.1 billion in the quarter.

Across all brands, Gap Inc. anticipates fourth-quarter ending inventory to be up high-single digits versus last year, although this outlook may still change.

Gap now expects full-year revenue to be up approximately 20 percent, a significant decline from the prior outlook of an expected 30 percent increase. Projections for reported earnings per share are now expected to be in the range of 45 cents to 60 cents, down from the expected $1.90 to $2.05 per share. Adjusted full-year earnings have been lowered to a range of $1.25 to $1.40 per share, from a prior range of $2.10 to $2.25 a share.

O’Connell also noted that the downgraded full-year outlook accounts for roughly $550 million to $650 million of lost sales from supply chain constraints and the combined $450 million in air freight costs.

Despite the surging costs throughout the chain, Gap Inc. reported its highest third-quarter gross margin in more than 10 years at 42.1 percent, up 150 basis points from 2020’s 40.6 percent and up 310 basis points from 2019’s 39 percent. The margin improvement is largely due to rent and occupancy savings resulting from higher online sales, the company’s recent store closures plus a reduced reliance on discounting.

For 2022, O’Connell marked three areas Gap Inc. aims to improve to flexibly navigate the current conditions.

“Our teams have added expected longer port delay times into product booking deadlines, which we believe will enable us to ship goods largely by ocean, for on time deliveries,” O’Connell said. “In addition, Old Navy has now accelerated its use of digital product creation for the majority of its fall orders with vendors. This has added speed to the pipeline and is the breakthrough in efficiency for the brand. Also, to increase geographic different diversification and flexibility, we expect to leverage more multinational vendors.”

Additionally, Gap Inc. will begin to deploy AI from its recent acquisition of store operations and execution platform CB4 to better drive in-stock inventory in stores.

The specialty apparel retailer ended the third quarter with $1.1 billion in cash, cash equivalents, and short-term investments. Year-to-date free cash flow was $196 million, while fiscal capital expenditures were $486 million.

Syngal called out the company’s partnership with Yeezy as driving strong results. “Our newest Yeezy Gap icon, the Perfect Hoodie, delivered the most sales by an item in a single day in history,” she said. “With over 70 percent of the Yeezy Gap customers shopping with us for the first time, this partnership is unlocking the power of a new audience for Gap, Gen Z plus Gen X men from diverse backgrounds.”

O’Connell also noted that partnerships, included the deals with Yeezy and with Walmart, sparked positive “momentum” for the Gap brand.

Net Sales: Net sales at Gap Inc. declined 1 percent to $3.94 billion from $3.99 billion the year prior, and also 1 percent on a two-year basis from $3.99 billion.

Old Navy had the poorest performance of the Gap Inc. slate of brands with a 6 percent sales dip to $2.1 billion in the quarter, from $2.24 billion in the year-ago period.

Gap jumped 5 percent to approximately $1.0 billion in the quarter, ahead of last year’s $993 million. Banana Republic had a bounce back quarter, growing 24 percent to $479 million from the $386 million taken in the 2020 period.

Athleta, the fastest-growing Gap Inc. label, boosted sales 10 percent to $320 million from $292 million.

Net Earnings: Net losses for the specialty apparel retailer mounted at $152 million for the third quarter on a diluted earnings per share loss of 40 cents, a downturn from the $95 million made in the year-ago period on 25 cents per share.

CEO’s Take: Sonia Syngal, CEO of Gap Inc., remained optimistic, referring to the current air freight costs as “transitory” and saying the retailer will reveal more about the pricing adjustments to counteract the costs at the end of the year.

“We do think that even with the lumpiness of the quarter, we are on track to our Power Plan first year,” Syngal said. “Through the price gains we’ve seen across all four of our brands as exemplified by the Q3 margins, we think that can continue through a combination of the investments we’ve made in marketing, the strong product acceptance we’re seeing, as well as enabling capabilities such as personalized pricing and inventory management optimization. These key levers can continue the charge over the coming years and price gains across the company. We’re really pleased with the level of discounting we’ve been able to stymie, and we expect that, in order to drive health and brands sequentially, that will continue.”

Additional reporting by Jessica Binns.