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Gap (NYSE:GPS)
Q3 2020 Earnings Call
Nov 24, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good afternoon, ladies and gentlemen. My name is Karina, and I will be your conference operator today. At this time, I would like to welcome everyone to The Gap Inc. third-quarter 2020 conference call.

[Operator instructions] I would now like to introduce your host, Steve Austenfeld, head of investor relations. Please go ahead, sir.

Steve Austenfeld -- Head of Investor Relations

Great. Thank you very much. Good afternoon, everyone, and welcome to Gap Inc.'s third-quarter 2020 earnings call. Before we begin, we'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, a 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, our quarterly report on Form 10-Q filed with the Securities and Exchange Commission on June 9th, 2020, and any subsequent filings, all of which again are available on gapinc.com. These forward-looking statements are based on information as of November 24th, 2020, and we assume no obligation to publicly update or revise the 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 Katrina.

Thank you.

Katrina O'Connell -- Chief Financial Officer

Thank you, Steve, and thank you, everyone, for joining us today. Before we get started, we hope you and your loved ones are safe and healthy, recognizing we continue to address the COVID pandemic. As we head into the holiday season, we recognize many people are eager to purchase gifts for their family and loved ones. At Gap Inc., we've invested year-to-date over $100 million in health and safety measures to make our stores a safe shopping experience, both for our store employees and our customers.

Additionally, we further invested in online shipping capabilities, as well as, curbside pickup options, enabling our customers to purchase gifts how and when they want for themselves and their family during the upcoming holiday season. We hope everyone remains safe and healthy this holiday. For today's call, I'd like to quickly connect this back to the investor meeting we held last month, unveiling our Power Plan 2023 strategy. Following that, I'll review the company's third-quarter performance followed by our thoughts on the remainder of fiscal year 2020.

Sonia will then share her perspective followed by Q&A. So as mentioned, before I jump into our third-quarter results, I want to acknowledge our investor meeting we hosted last month. In summary, we provided perspective on the power of our brands, specifically our four-billion dollar brands with Old Navy being largest at over $8 billion as of the end of last year. The power of our portfolio, noting the growth synergies that come from each brand being part of our portfolio, and the power of our platform, with just two examples being the digital capabilities and extensive supply chain that all brands benefit from.

Additionally, we shared our economic model with financial assumptions beginning in 2022 that we believe reflect how we'll drive ongoing shareholder value. Specific to the economic model, I noted that we expect 2021 to be a year of profitable growth versus 2020, which has been significantly disrupted due to the COVID pandemic. I would call it a rebound year and we'll share our thoughts on 2021 as part of our fourth-quarter earnings call in early 2021. We also noted that as we emerge from 2021 beginning in 2022, we anticipate the structural changes we're making now and into next year will set up the company to deliver, on a consistent basis, low to mid single-digit sales growth and consistent operating margin expansion, as well as, achieve a 10% or greater operating margin by the end of 2023.

And we anticipate yielding operating cash flow of 10% of sales, an achievement we've accomplished for a number of years. As we execute our Power Plan 2023 strategy, we continue to focus on a number of key initiatives. These include driving growth in our highest-margin brands, Old Navy and Athleta, both of which had double-digit growth in the third quarter and which we expect to be 70% of sales by the end of 2023. Transitioning The Gap brand to a more capital-efficient model through our licensing agreement with IMG, the YEEZY Gap partnership, as well as, a strategic review of our European business to improve profitability.

We also will continue closing unprofitable Gap and Banana Republic stores, which as stated during our investor meeting, will yield $100 million in EBITDA savings on an annualized basis by the end of 2023. Additionally, we target to have 50% of our sales by the end of 2023 being online, building off the 40% of our sales that were online in the third quarter. And beginning in 2021, returning to a normalized level of capital expenditures, focused on investments to further our omni capabilities, including digital and technology capabilities and distribution capacity. So having addressed some of our key elements of our Power Plan 2023 strategy, let me turn to our third-quarter results.

Starting with top line. Total company net sales were flat, which included the impact of the company's decision to close unprofitable stores, consistent with our store rationalization initiative, a key element of our strategy. Importantly, comparable store sales -- where our comparable sales were up 5% in the quarter, reflecting the fundamental health of the business. We're also pleased to see that our strategic focus on driving our online business is paying off as online sales increased 61% in the third quarter.

The 5% increase in comp sales was driven by Old Navy and Athleta, which both delivered strong double-digit comp numbers as customers responded positively to their strong product offerings and relevant marketing messages. As noted during our investor meeting, Old Navy and Athleta, which are cumulatively 63% of company sales as of the end of third quarter, are both our fastest-growing and highest-margin businesses. We anticipate them growing to be 70% of company sales by the end of 2023, as noted during our strategy review, which will meaningfully add to the company's growth rate and margin. Third-quarter gross margin was 40.6%, up 160 basis points compared to last year.

This reflects margin expansion of 360 basis points from rent and occupancy savings as we continue to close unprofitable Gap and Banana Republic stores, partially offset by 200 basis points of deleverage in merchandise margins as higher shipping costs, resulting from very strong online sales growth exceeded higher product margins, reflecting a lower level of promotions in the quarter. Turning to operating expenses. During the quarter, operating expenses increased by 270 basis points versus last year. This included over 175 basis points in higher [Audio gap] with each of our billion-dollar brands being advertised during the extended back-to-school shopping season.

As discussed during the company's investor meeting, we believe the challenging marketplace for many other retailers provides our brands an opportunity to gain market share through increased marketing. Additionally, the company continued to invest in health and safety measures in its stores as part of our safe shopping protocols to provide customers a safe and welcome environment in which to purchase items for their family. In the quarter, these expenses amounted to approximately 140 basis points of deleverage. Lastly, SG&A also reflected approximately 120 basis points of deleverage from costs associated with store closures.

Although from an earnings standpoint, these costs were essentially offset in gross margin through lower rent and occupancy costs. These cumulative increases were partially offset by a benefit of approximately 200 basis points in one-time costs in the year-ago quarter, primarily related to the company's previously planned separation of Old Navy. Looking forward to Q4, we intend to continue investing in brand marketing to compete during the important holiday season. We'll continue to invest in and provide a safe shopping environment for our customers as we manage through the pandemic and we expect to reflect more store closure costs, but again, directionally offsetting gross margins.

So from an operating income standpoint, we've meaningfully improved sales performance versus last quarter and improved gross margin versus last year. The company delivered third-quarter operating income of $175 million or 4% of sales. Looking at other lines of the income statement, interest expense was $54 million. The effective tax rate was 21.5%, primarily reflecting changes in the estimated benefit associated with the enactment of the Coronavirus Aid, Relief, and Economic Security or CARES Act and the impact of the company's geographical mix of pre-tax earnings.

The year-to-date effective tax rate was 23.7%. And lastly, earnings per diluted share for the third quarter was $0.25. Turning to the balance sheet. Looking at inventory on a reported basis, we ended the third quarter up 1%.

Recall that in the face of uncertain demand earlier in the year, we implemented a pack-and-hold inventory approach, whereby, select mostly summer product is being held and will be released during next year's selling season. As a result, pack-and-hold inventory will remain in our reported inventory numbers until released to the market in 2021. Excluding pack-and-hold, end of quarter inventory was down about 7%, reflecting our disciplined approach to managing inventory. Looking forward, we anticipate Q4 ending inventory, excluding pack-and-hold, to be down percentage-wise, roughly the same as Q3.

Now let me turn to cash flow. As we shared at our investor meeting, fundamentally, Gap Inc. is a strong cash flow generator with over 10 consecutive years of at least $1 million in operating cash flow. Despite store closures earlier in the year due to the pandemic, Gap Inc.

year-to-date has generated nearly $400 million in operating cash flow or approximately 4% of sales, driven in great part by disciplined working capital management. Specific to capital expenditures, we've invested $288 million year to date. We now expect to spend roughly $375 million in 2020. The current estimate is higher than our last forecast of $300 million as the company's strong cash position has supported high ROIC-based investments in digital, technology, and capacity, particularly in support of our online business.

As noted during our investor meeting, we anticipate, beginning in 2021, increasing our capital expenditure spend to a more traditional level of 4% to 5% of sales to continue supporting -- supporting our growth. The company ended the quarter with a cash balance, including cash equivalents and short-term investments of $2.6 billion. So we are well funded for 2021 and beyond to invest for the long-term health of the business. Lastly, before I turn it over to Sonia, let me share some thoughts on the final quarter of the fiscal year.

Given the high level of uncertainty in the current environment, particularly recognizing the rising COVID-19 cases in the U.S. and around the globe, we're not providing specific fiscal-year 2020 or fourth-quarter earnings outlook. However, recognizing many aren't able to enjoy the usual simple pleasures of traveling to see loved ones or attending a concert or sporting event, we believe people are looking more than ever to buy gifts during the holiday season for family and friends. Our investments in health and safety measures in our stores, as well as, in our online business, coupled with the marketing investments we're making in our brands, give us cautious optimism for the fourth quarter.

We anticipate giving you perspective on 2021 during our next earnings call, but to be helpful, as we look toward Q4, here are some thoughts on the quarter. We see the following dynamics in Q4. Net sales being equal to or slightly higher than last year; gross margin rate being equal to last year, reflecting benefits continuing from store closures, largely offset by higher shipping expenses; and operating expenses being between 33% and 34% of company sales, reflecting the company's continued investment in brand marketing, capitalizing on the opportunity to capture market share, as well as, the continued cost of in-store health and safety measures on behalf of our customers and employees; and importantly, cash flow performance should remain strong. And with that, I will turn the call over to Sonia.

Sonia Syngal -- Chief Executive Officer

Thank you, Katrina, and good afternoon, everyone. I'm happy to talk with you today about our third-quarter results within the context of our newly defined go-forward strategy, our Power Plan 2023. As we shared with you at our investor event in October, we grow purpose-led billion-dollar brands that shape people's way of life. So what does that look like? It's Old Navy paying employees to serve as poll workers to show that every voice and action count.

It's Gap delivering American optimism by encouraging people to stand up for one another in their Stand United TV spot. It's Banana Republic reissuing its iconic Notorious Necklace and raising $0.5 million for the International Center for Research on Women to celebrate and honor the life and legacy of Supreme Court Justice RBG. And it's Athleta putting its brand mission into action with a $2 million pledge to establish the power of She Fund, keeping women and girls connected through the movement. It starts with brands that stand for something, brands with a distinct point of view that connect directly with how consumers are shopping, what they're wearing, and most importantly, how they're feeling, and in today's landscape, this means more than ever.

Since the beginning, we have led the casualization of the American wardrobe where comfort, fit, and quality matter. Whether it was introduced in khakis in the notion of casual Fridays to the New York Stock Exchange in the late 90s or a modern version of these Gap khakis making the headlines during election coverage earlier this month. It's about more than just a pair of pants. It's about relevance.

And since our recent election coverage, we saw a dramatic increase in online traffic and within a day, the number of straight-fit palomino brown khakis we sold online went up 90%. We connected with people. Together, our brands reach all ages, all bodies, all social economic brackets, all moments, and all use occasions and target approximately 80% of the very large addressable apparel market. The majority of our assortment is pointed at the use occasions that are most relevant today.

And when you couple that with the scale we have across key categories, with our nearly $3 billion active business, including fleece and our nearly $4 billion kids and baby business, we are delivering that product consumers want and need, and we deeply know and understand our customers, enabling us to make business decisions with them at the heart of it. Fueling our brands are our powerful omni capabilities. We are ranked No. 2 in U.S.

apparel e-commerce sales. We have sharpened our real estate strategy so that our stores will be where our customers want to shop today and we have increased focus on convenience and experience in uniquely ownable digital and physical spaces. These advantages give us the power to deliver. This is such a unique moment in time.

In a dislocated market, we are investing in growth today to drive share gains for the long-term. While we adjust and build out our strategy, our teams have been leveraging the power of our brands, the power of our portfolio, and the power of our platform for many months now and it's showing up in our performance. Before I dive into third-quarter results, I really want to thank our team and I can't say this enough. I'm proud to see them leading with our competitive strength, embracing our new cultural imperative, co-creating with our customers and each other, and driving for growth.

Recognizing that the effects of COVID-19 are still very much a reality for our business, our customers, and our communities, this has not been easy. Their belief in Gap Inc., our purpose-led brands, the values of this company, and the customers we serve has been unwavering. So let me reflect on Q3 and bring to life the Power Plan 2023 in action. First, the power of our brands.

During the quarter, our billion-dollar brands leveraged their brand power to win in a dislocated market by delivering the right product at the right time, at a time when trust matters most. Each brand led with their values in their fall campaigns. They invested dollars and increased digital marketing to drive traffic, and for the first time in 10 years, all four brands were on TV and it paid off. Let me start with Old Navy, our largest brand, ranked No.

2 apparel brand in the U.S. and now, the No. 5 apparel retailer on a rolling three-month basis according to NPD Group. Old Navy's results were exceptional, driving a 15% sales growth year over year while also delivering margin expansion and market share growth.

They did this by focusing on the democracy of style and service, leveraging promotions strategically, and leaning into brand value. Their omnichannel offerings provided superior convenience to customers by leveraging their large online channel and well-located fleet. Online sales for Old Navy grew 86% in the quarter, maintaining its momentum from Q2 even as stores fully reopened. They delivered strong product performance in relevant and advantaged categories like active and fleece and kids and baby.

According to the NPD Group, Old Navy grew market share faster than any other denim brand in the U.S. in October on a rolling three-month basis, thanks to its Denim America campaign focused on inclusive sizing. Celebrating Old Navy's commitment to equality and inclusivity is, We Are We campaign, delivered a positive year-over-year brand impressions. At Gap brand, sales declined 14% in Q3.

Store sales were lower, reflecting our plan to strategically shed unprofitable sales as part of our fleet rationalization efforts while online sales grew 38% year over year. While we transition Gap brand to a capital-efficient and more profitable business, the team is really focused on maximizing online demand through relevant marketing, product and quality improvements, customer engagement, and stronger execution. Gap's fall marketing campaigns Stand United and Be the Future both generated positive customer response while store traffic beat the industry average throughout the quarter. Moving on to Banana Republic, which represents about 10% of Gap Inc.'s sales.

In Q3, sales declined 34% and while we are nowhere near satisfied with this result, this is an 18-point improvement from Q2. As we noted during our investor meeting, Banana Republic continued to face challenges driven by the shift in customer preference from a more formal work wear to casual in light of work-from-home trend. With this in mind, the brand is working hard to update its product assortment, prioritizing more relevant categories like lounge, sleep, active, fleece, and sweaters with a reduced focus on work wear categories like tailored fitting. And last, we are extremely proud of the results at Athleta, our fastest-growing brand.

In Q3, Athleta delivered 35% sales growth with September reaching the highest sales comp in the history of the brand. This is continued evidence that Athleta is on its path to double, reaching $2 billion in sales by 2023. Once again, they delivered incredible online growth, supported by investments in digital marketing with traffic and net demand, both up approximately 75%. They are focused on key growth categories that will help us reach new customers, which is driving a healthy reg price business and productivity gains.

And their 1 times to 3 times inclusive sizing pilot is delivering a strong early read ahead of a full relaunch in January 2021 and will be a major growth driver for us next year. Next, I want to talk about the power of our portfolio. We acquired over 6 million customers in Q3 and our total customer file now sits at 176 million, up 15% from last year. Our customers also spent 6% more with us on average than last year.

We're fueling enduring relationships through personalization, infusing the voice of the customer at every turn to create products and experiences that they need and want, and this is showing up in our Net Promoter Score, which across all channels is, up 13% from Q3 of last year. Customers continue to come to our brands for masks and we updated styles and introduced innovation across the category, now representing 4% of sales across the company. It is our goal to turn every customer into a loyalist. One of the things I'm most energized about is the strong launch of our multi-tender loyalty program and the enhanced value this program can unlock.

Since the rollout on September 22nd, just two months in, we have enrolled 3.5 million new members to a double-digit conversion in stores and online enrollment. We're excited to build on this as we move into 2021 and fully leverage all customer touch points to market the program. We now have more than 50% of our sales coming from loyalists, meaning they have a credit card with us or they're part of our loyalty program. This is more than double where we were able to deliver with card alone and is an important enabler to our personalization imperative.

Lastly, I'd like to talk about the power of our platform. As we shared in October, the strength of our platform, including our omni capabilities and scaled operations, enables us to serve our customers the way they're shopping today, whether it's online, safely in stores, via partnerships or combination of all three. Our agile network also allows us to be nimble as customers' shopping preferences change. In Q3, we saw strong performance online even with stores reopened with 51% growth versus last year comprising about 40% of total sales in the quarter.

And to fuel the online growth and drive site conversion, we developed new functionality this quarter to make it easier for customers to shop, including quick add-to-bag features, redesigned navigation on our mobile experience, and improved usability of product reviews. And our profit's coming to life across our site better than ever with elevated product photography that is more emotional and more aspirational. Our partnership with PayPal and Afterpay went live this quarter, with strong conversion in mobile and attractive new customer acquisition with demographic skewing toward millennial and Gen Z. Across both, we expect to deliver approximately 2% lift in revenue per visitor, compared to customers using other payment methods.

I really want to celebrate the work of the digital team. I've seen a massive collaboration and acceleration of both talent and innovation as they work to deploy functionality and creative cut through, big and small, to make the site more engaging for our customers. One of the biggest value drivers of our Power Plan 2023 is our real estate restructuring strategy, largely pointed at closing select stores across Gap and Banana Republic. Our strategy is rooted in moving away from traditional malls and focusing on more advantageous locations to better meet customer needs.

As Katrina mentioned, the work is on track and delivering substantial savings and we'll continue to do so in the future. That being said, we believe there are profitable opportunities to open stores in both Old Navy and Athleta. In fact, Athleta opened eight new stores in Q3, including their 200th store. Our stores remain a very important part of the shopping journey for our loyalists.

We're making investments to deliver standout moments across our omni experiences, whether in store, on mobile or through one of our new capabilities like curbside pickup or virtual styling. In Q3 alone, overall net sales volume across BOPIS and curbside increased over 50%, proving that our customers are voting for convenience and safety this spring. And on November 19th, just in time for holiday shopping, we've launched convenience hubs across the entire fleet of Old Navy and Athleta stores. These stations will streamline the in-store process and create a single destination to expedite BOPIS orders, curbside pickups and return, reducing customer pain points and congestion at the cash register.

This is one way we're leveraging our lean and advantaged operations to make customer-facing improvements that will also help improve operating costs across the fleet. Before we turn to Q&A, I'd like to comment on Q4. As we look at the remainder of the year, we're encouraged that according to NRF, the National Retail Federation, retail sales have largely recovered from the pandemic heading into the holiday season, which points to the resiliency of the consumer. In some ways, this doesn't surprise us as people aren't spending money on things like travel or sporting events or concerts.

So with more disposable income available, heading into the holidays, research suggests people will be more likely to buy products across our brands, showing their love for family and friends, at a time when gifting means more than ever. At the same time, consumers still face uncertainty with rising COVID cases, high unemployment, and uncertainty around any incremental stimulus, an ambiguous operating environment that poses some risk to store operations. To hedge against these challenges, we are doubling down on initiatives that nurture deeper relationships and trust with our customers. We're seeing strength in key indicators such as a 15% increase in stores' Net Promoter Score versus last year, especially as customers appreciate the safety measures we have committed to.

Ensuring they can shop without worries in our stores, and as you've heard, our online business is growing faster than it ever was, enabling our customers to purchase our products regardless of the pandemic. And to support the unprecedented channel shift to online, we have scaled and deepened relationships with existing parcel carriers and have added new shipping partners. We've ramped up automation and staffing in our distribution centers or as we like to call them, our customer experience centers and pulled forward demand to reduce pressure on fulfillment. Recognizing the increasing online shopping we've seen year to date, we have invested in having the right capabilities to address the possible surge in online demand.

Big picture, I'm proud of the company's ability to improve sales performance during the unique pandemic-related challenges. It's a once-in-a-generation opportunity right now. With the holidays upon us, we feel confident in our preparedness and the trust we've built with our customers through strong execution and safe shopping practices. We believe in the power of our brands and that products, experiences, and capabilities we deliver to our customers will enable us to grow sales profitably and generate meaningful cash flow to invest in the long-term growth, all consistent with our Power Plan 2023 strategy.

Before I wrap up, I want to share the exciting news that we have two new leaders joining our Gap Inc. senior leadership team. Asheesh Saksena will join our team this January as our chief growth officer, a newly created position that will focus on executing against our strategic agenda, as well as, leading growth initiatives for the future. Asheesh joins us most recently from Best Buy, where he served as President of Best Buy Health, and prior to that, chief strategic growth officer.

He's also led strategy and growth organizations at Cox Communications, Time Warner Cable, and a partner at Accenture. Asheesh is an agent of change with 30 years of experience as a growth igniter. Once on board, I look forward to his assessment of value creation opportunities to ensure consistent growth for the company. And Sandra Stangl will step into the role of president and CEO of Banana Republic, as the brand continues to redefine affordable luxury.

With more than 25 years of experience, Sandra is a strong creative leader known for delivering design vision, brand expansion, and outstanding financial results. Sandra has held numerous leadership positions, including president of Pottery Barn, where she was part of the team that envisioned and launched Pottery Barn Kids and Pottery Barn Teen, as well as, president of Restoration Hardware. And most recently, she cofounded and was chief merchant of MINE, a disruptive pure-play home business. She'll join Banana Republic in December.

I'm pleased to have Asheesh and Sandra join the team, both strong industry veterans and visionary leaders known for driving growth through creativity. As we steer Gap Inc. and our purpose-driven billion-dollar brands into the future, this gives me even greater confidence in our ability to deliver against our Power Plan 2023. With that, why don't we open it up for Q&A?

Questions & Answers:


Operator

[Operator instructions] We'll go ahead and take our first question from Kimberly Greenberger with Morgan Stanley. Please go ahead, ma'am.

Kimberly Greenberger -- Morgan Stanley -- Analyst

OK. Great. Thank you so much. Uh, very nice results tonight.

I wanted to ask specifically about Old Navy. The really impressive 15% bounce-back in revenue here would seem to suggest that Old Navy delivered some margin expansion as well here in the third quarter. I'm just wondering if you can laser in on Old Navy's margin performance in particular. And I know after potentially two challenging third quarters in a row, the Old Navy business was sort of off of the levels that had delivered back in 2017 margins.

I'm wondering if you made progress toward recovering back to 2017 and what are the sort of key drivers for Old Navy margin expansion or, let's say, returning back to those 2017 margins in the future? Thanks so much.

Katrina O'Connell -- Chief Financial Officer

Sonia, I don't know if you want to start with sort of the sales performance and I'm happy to wrap up with margin questions --

Sonia Syngal -- Chief Executive Officer

Oh, listen, Old Navy had a standout quarter and we're really pleased with the results. Strong response to product offering. We saw a great increase in digital and traditional marketing, with more to come, with high return on that investment. Strong active business, the kids and baby achieved the No.

1 brand in that segment and in terms of sustainability, it speaks to the brand positive. And we have referenced in our Q4 sales outlook that we expect to be equal or slightly higher than LY, so we're confident about their business and their momentum and the product margin expansion that we saw this quarter. And I think that the yield management that they drove, in combination with their strong product, is something that they'll continue to focus on.

Katrina O'Connell -- Chief Financial Officer

Yeah. I mean, Kimberly, what I would add is the team has done really a tremendous job between the lean inventories that we had when we sort of cut the inventories heading into the pandemic and then chasing back into the categories that really have resonated, active, fleece, knits, kids and baby, etc. They've done a tremendous job managing the inventory and then the promotions on those inventories. So you're right, the team did see expanded gross margins [Audio gap] levels.

We'll see [Audio gap] with the way that team is executing on all fronts.

Operator

We'll then take our next question from Ike Boruchow with Wells Fargo. Please go ahead.

Ike Boruchow -- Wells Fargo Securities -- Analyst

Hey, good afternoon, everyone. Two questions. Katrina, just one quick one. I'm sorry if I missed it.

Did you pick up the merchandise margin versus occupancy dynamic in the third quarter? And then just -- and then on the SG&A, I guess at a higher level, can you kind of talk to the accelerated investments you guys are making that we saw in the third quarter and that you're talking about for the fourth quarter? Is this a sign that your expectations on growth going forward are higher? Just, you know, it's an interesting dynamic that we're not really seeing from the other -- from a lot of other retailers out there. So I'm just kind of curious how you're thinking about pulling forward that investment and what that really means to your ultimate trajectory to get the margins back to 10% over the next couple of years.

Katrina O'Connell -- Chief Financial Officer

Yes. Thanks, Ike. So on the margin question, you're right. So our third-quarter margin was up 160 basis points.

What I have said is that rent and occupancy was 360 basis points of expansion and that was partially offset by 200 basis points of deleverage in merchandise margins, which was the result of higher shipping, which largely offset the lower level of promotion, so higher product margins. So that was the margin dynamic. I'm glad you brought up the SG&A. It's really an important point because we see this time as a very unique time for us to really drive market share gains ahead of other competition in this dislocated time.

We still remain committed to what we said less than a month ago or a month ago, which is, we're going to continue to invest in demand generation expenses and we're going to reengineer the fixed cost structure of the company. And that's going to be everything from the store closures to the evaluation of some of our international markets for partnerships to some [Audio gap] important for us achieving the 10% and beyond operating margin in 2023. But in 2020, with this COVID environment and really a lot of the weaker players seeing significant amount of disruption, we see this as an important time to be investing in our brands for demand generation and that's the quality of the consumers we're going to gain now will pay dividends in the future. So it is a strategic shift that we have chosen to make.

Sonia Syngal -- Chief Executive Officer

You know, I'll just add on to that, it is quite intentional. Thanks for putting it out, Ike. And as we said at Investor Day, apparel, $200 billion in market size at a unique moment to consolidate share with, whether it's the share donors or it's the weaker players and using both the power of our brands and the scale advantage we have, we are playing to win in this unique time. And we are very committed to the [Audio gap] 2023 last month, with the growth in profitable sales and that growth plan delivered on quarter over quarter.

Ike Boruchow -- Wells Fargo Securities -- Analyst

Thank you.

Operator

And we'll go ahead and move on to our next question from Matthew Boss with JP Morgan.

Matthew Boss -- J.P. Morgan -- Analyst

Great. Thanks. Maybe to follow up on SG&A. Is there a way to maybe help quantify the 3Q buckets if we think about store closure costs, COVID costs, and marketing expense? And just maybe those same buckets, what's embedded in your fourth-quarter forecast? And just larger picture, as we think about the timeline, when is it best for us to think about the inflection to operating margin expansion as you outlined at the Analyst Day?

Katrina O'Connell -- Chief Financial Officer

Yeah. So, hi, Matt. In my speech, I tried to break out the basis points of deleverage associated with each one, so I'm happy to go through that. But we said that of the 270 basis points of operating increase -- operating expense increase, 175 basis points was attributable to higher marketing and then 140 basis points is attributable to the safe shopping.

And then we have this dynamic in SG&A also where any cost that it -- that we have to incur to close the stores that were strategically closing, that falls into SG&A and that was 120 basis points of deleverage. So that's hopefully helpful to you guys. That 120 basis points of deleverage is basically offset in gross margin, though, through a one-time savings in rent and occupancy. So that's the one unique dynamic there.

As we think about Q4, we were trying to be helpful in our guidance around how we're thinking about operating expenses. We said we expect them to be 33% to 34% of company sales. When you look at our as-reported last year, you'll see this is a meaningful improvement to last year. That's mostly because we had an almost $500 million expense last year attributable to some store impairments and separation costs.

When you isolate for that, we expect that some marketing and the store closure -- or excuse me, the store safety costs will be about the same impact as what you saw in Q3. And so hopefully, that's helpful for you as you look at your model. You know, longer-term, let's see what happens. We've got a vaccine coming and we don't know how long the COVID pandemic will last.

But hopefully, what's helpful is that we've tried to let you guys know we think it will be a profitable sales growth year next year and we'll provide more details on exactly how we see that play out when we get to our fourth-quarter earnings call.

Sonia Syngal -- Chief Executive Officer

And to build on what Katrina said, two of the three line items are because of the environment we're in, right? Whether it's the store safety cost or the cleanup of the real estate that's been a long time coming, and the marketing investment is to play to win and play aggressively to consolidate share and we'll continue to learn. We have a lot of rigor around the return on that -- of those invested dollars with marketing effectiveness mechanisms and so we feel very good about that. But two of the three are not long-term costs that we expect to incur and so we'll be out of that at some point and linked to the vaccine, etc.

Matthew Boss -- J.P. Morgan -- Analyst

That's helpful. Thanks.

Operator

We'll go ahead and move to Mark Altschwager with Baird. Please go ahead.

Mark Altschwager -- Baird -- Analyst

Hi, good afternoon. Thanks for taking my question. With respect to the fourth quarter, I was hoping you could talk about the planned shipping headwinds there, maybe relative to what you saw in the third quarter. And then what are the controllable drivers you have to offset some of these pressures? You know and along those lines, maybe hoping you could talk about the trends in split shipments and how that trended in the fall relative to what you experienced in the spring.

Thanks.

Katrina O'Connell -- Chief Financial Officer

Yeah. I mean the good news is that, as we expected, shipping while still a headwind in Q3 was meaningfully improved from Q2. And that was based on what you just said, Mark, which is that dynamic of being able to buy our inventories more strategically back into the online channel and reduce mostly that shift from store dynamic and so we did see a meaningful improvement there. Now as we look to Q4, our guidance does sort of reflect a multitude of possible outcomes but largely similar to maybe increasing pressure on shipping and a little bit of air freight associated with, either airing in product where we chase products for the pandemic or the port issues we've been having.

The levers we have, whether it's the merchandise margins that you saw deliver higher product margins in Q3 and let's see how Q4 plays out, but we could see similar execution, that would be great. We would see merchandise margins offset some of that. But I would say, some of the shipping is a shift that we're seeing and we'll see a lot of that benefit offset in ROD with a lot of the store closures. And then longer-term, working through some algorithmic way to start to reduce splits, as you say, and those are going to be some of the longer-term capital investments.

But I also think we have said before, our supply chain is advantaged and so I don't know, Sonia, if you want to talk about that.

Sonia Syngal -- Chief Executive Officer

Yeah. Listen, I think we have the most automated DCs to our sector and that gives us an advantage versus the competition versus more labor-intense environment. And in terms of shipping, we have focused quite a bit on, whether it's order logic improvements, whether it's reducing split shipments, all the drivers that are controllable, as you say, whether it's multipacks in the value space with the Old Navy. We have many, many levers that we are deploying.

And you're noticing, hopefully, execution for us is at a very heightened premium and we're expecting and know that the teams will continue to deliver on innovation in the technology space, as well as, in terms of end-to-end unit economics that will help us reduce these costs in the coming months and quarters.

Mark Altschwager -- Baird -- Analyst

That's great. Thanks and best of luck.

Operator

And we'll go ahead and take our next caller, Lorraine Hutchinson from Bank of America. Please go ahead.

Lorraine Hutchinson -- Bank of America Merrill Lynch -- Analyst

Thanks. Good afternoon. I just wanted to follow up on the gross margin point. It seems as though some of the store closure ROD benefits will continue in 4Q and into the first half of next year.

As we think of the first half of '21 and look at it versus 2019, do you think you'll be able to post higher gross margins on a year-over-year basis?

Katrina O'Connell -- Chief Financial Officer

Well, Lorraine, I think it'll be good for us to have that discussion on the fourth-quarter call when we guide more specifically to 2021. But it's fair to say that the ROD benefit, as we discussed in our investor meeting just a month ago, is a significant benefit to gross margin, as well as, operating margin in the long-term. But we can talk more specifically about 2021 and the dynamic when we guide later or actually early in 2021.

Sonia Syngal -- Chief Executive Officer

So just to build on that, we're more than pleased with the progress we're making on the real estate strategy and execution and the compromises and the fairness of deals we've landed with now the vast majority of our landlords. And I think it'll be nice to close that out and really focus on what that's going to then positively impact on the P&L. I'm excited to see that complete.

Lorraine Hutchinson -- Bank of America Merrill Lynch -- Analyst

Thank you.

Operator

And we'll go ahead and take our next question from Paul Lejuez with Citi. Please go ahead.

Paul Lejuez -- Citi -- Analyst

Hey, thanks, guys. Just one clarification, one question. First, you mentioned 120 basis points, I think, of store closing costs that deleveraged, that was offset by launch of the rent line. I just want to make sure I understand, the 120 that you mentioned on the store closing side, is that one-time in nature? Is that going to continue? And I guess, same question on the rent line.

Wouldn't that be something that is ongoing -- an ongoing benefit that would help gross margin? So that was just a clarification and question. I'm just curious about the new customers that you're seeing in the Athleta brand. What's customer profile of the new customer relative to your existing customer base? Anything you could share on spend. Thanks.

Katrina O'Connell -- Chief Financial Officer

Yeah, Paul. So the store closure costs that we're referencing and maybe we're not being clear. I think maybe we're not, but those are attributable to the buyout. So if you remember, when we were at our investor meeting, we did indicate that there was about $210 million of buyout costs that we would incur as we try and get out of some of the high-profile stores.

It's going to be lumpy depending on when those negotiations land. So the 120 basis points that's attributable to the costs that we use -- the dollars that we use to pay out some of those buyout costs with a select number of stores. And then as we do those buyout costs, we're able to settle some rent expense and that comes through the one-time benefit to ROD. Now so it's a unique dynamic.

It doesn't repeat other than maybe in Q4, we have more buyouts as we chunk away at that $210 million and get that behind us. But it's kind of, that piece is going to be lumpy depending on negotiations. And then you're correct, going forward, there is an ongoing rent benefit that's more associated with the monthly rents we would have been paying in those stores. So it's a little complicated, but that's what we're referencing.

Sonia Syngal -- Chief Executive Officer

So, listen, we're very lucky and fortunate to have such a cash-generating business that we are able to get some of these problems behind us that are lumpy and hard to bottom out. But you know, we can take the one-time measures that we are taking that are showing up and get them done, and continue to think about our cash to fuel organic growth and accelerate our growth going forward.

Katrina O'Connell -- Chief Financial Officer

And then Paul, I think you had a customer question, but I'm not remembering it. Do you mind repeating it?

Paul Lejuez -- Citi -- Analyst

The Athleta customer, new customers that you've seen in the brand, how the profile is different from the existing customer base spending levels?

Katrina O'Connell -- Chief Financial Officer

Do you want to take that, Sonia, the Athleta customers, sort of how the new customers are different than the existing?

Sonia Syngal -- Chief Executive Officer

Yeah. Look, what I would say is masks, they have a great way for many new customers to be introduced to the Athleta brand. Also it's a relevant category in the active space, which has become even more relevant during COVID and advantage because of the online channel being greater than 50% of sales. The relationship with the customer has been a real builder with masks and the team has innovated and introduced now their fourth mask that has greater and greater sustainability, beauty, and technical capabilities that customers are really talking to.

And so then they get [Inaudible] and they get into the masks into some of the core loyalty products such as the bottoms business. So we've been quite pleased and then the recent ads that they did has had 60 million views. So the impression that that brand is making right now in this unique moment in time is quite high.

Paul Lejuez -- Citi -- Analyst

Thanks, guys. Good luck.

Operator

We'll go ahead and take our next question from Kate Fitzsimons with RBC Capital Markets. Please go ahead.

Kate Fitzsimons -- RBC Capital Markets -- Analyst

Hi, thanks very much for taking my questions. I think just one follow-up to Paul's question. I guess when you noted resonance on some of the marketing at Athleta, I am curious just how you are viewing customer acquisition costs at that brand over time. And just relative to the superior profitability, it does see to the other brands, do you expect ongoing investments in that item? I think, to move the needle on brand awareness with perhaps offsets on the merch margin front? That would be helpful, just some of the puts and takes there.

And then next, I guess just on the supply chain, with inventories down 7% ex packaway, can you just remind us about some of the supply chain capability perhaps by brand or category that you think, in particular, can help you support the top line at Old Navy and Athleta? Thank you.

Katrina O'Connell -- Chief Financial Officer

So in terms of the first question in Athleta, as we shared in our Investor Day, Athleta is our fastest-growing and most profitable brand. So all of the marketing investments that we're making are contemplated in that statement and in our three-year view. So while we are leaning into aggressive growth of brand awareness to these mechanisms, we're also really pleased with the profitability of the brand and expect that as it grows as a greater share of the portfolio, to impact the overall financial health of the company in a very good way. Now your second question was around the advantage supply chain.

And what I would say here is, look, we have just moved very, very quickly to add speed and agility because the one thing that we do know is that it's very hard to predict what the environment will look like and we will be best served with that agility. So our scale advantage has given us the ability to chase in a product that's working really well very quickly, shed weeks and even months out of our supply chain lead times, bringing hundreds of millions of units in faster ways. You know, as we shared at Investor Day, we are -- I think we've got over 100, maybe 150 now, planes that are direct shipping into our DCs so that we can chase the product that it's selling. So lots of mechanisms in our supply chain across the portfolio to enable really driving sales growth and capitalizing on this once-in-a-generation opportunity for us.

Kate Fitzsimons -- RBC Capital Markets -- Analyst

Great. Thanks so much.

Operator

Thank you. We'll go ahead and take our next question from Susan Anderson with B. Riley FBR. Please go ahead.

Alec Legg -- B. Riley FBR -- Analyst

Hi, good afternoon. Alec Legg on for Susan. Thanks for taking our question. So were you -- are you able to provide the store productivity by brand or just overall Gap Corporation and how that has trended throughout the quarter and maybe in the fourth quarter? And then has conversion rates in-store increased with just customers shopping more for purpose? And then also is the YEEZY collection is still on track to launch this spring?

Sonia Syngal -- Chief Executive Officer

So I think Katrina can go through by brand, but I will start with this. We're pleased with the conversion improvements in stores, we have seen that. And I think fueled by the 15-point improvement in our Net Promoter Score that we spoke about. The store environment is something that the customer is really pleased with between the focus on safety, the focus on the heightened experience, leader units that give a more elevated merchandising environment, and the service emphasis that we place.

So you know, pleased with the in-store experience and what that's doing. And then your question on YEEZY Gap, you know, I think, yeah, we're looking forward to our first half launch next year. And what I will say is the creative that I've seen and whether it's the product or the e-comm site that is getting prepared is very exciting and very innovative. Some of the most creative work we've seen and so pleased with what's ahead and we are on track for our launch as announced.

Katrina O'Connell -- Chief Financial Officer

And then as far as store sales are concerned, so net sales were flat with a 61% increase in online and our store sales down 20%. Now several percentage points of that store sales decline was driven by closures as we said, and so the remaining sort of is the average of the productivity in Q3. And similar to the dynamics we've articulated in the past, given the results that you see at Old Navy and Athleta, I think it's fair to assume that those stores have recovered more quickly. Especially since they are largely off-mall and strip locations, as well as, the fact that they're seeing a disproportionately high performance of our online business.

But then Gap is sort of more in line and then Banana more disadvantaged based on the product categories that they've been having a tougher time with as they look to reposition their assortment. So I would say that's what I would tell you as far as thinking about productivity in Q3 and then we'll see in Q4. But as you've heard, we've been investing substantially in store safety measures to make sure people feel comfortable. And we're also prepared with capacity and shipping capabilities, as well as, store-related capabilities to service the customers for however they want to shop, since we know that this will continue to be a unique environment for shoppers.

Alec Legg -- B. Riley FBR -- Analyst

Thanks. And if you don't mind, just to follow up on shipping. Have the carriers provided a cutoff date just to essentially guarantee delivery by Christmas? Or is that something that's still being worked out on?

Sonia Syngal -- Chief Executive Officer

So listen, we are in deep relationship and partnership with our carriers and they're being very agile with us. So as demand comes in over the next -- these 11 days of the Black Friday through Cyber Tuesday now. I guess, very, very important time frame for us than December shopping. So we're seeing a lockstep with our carriers where added capacity is needed in order to service our customers.

Alec Legg -- B. Riley FBR -- Analyst

Thank you.

Operator

And we'll go ahead and take our final question from Alexandra Walvis with Goldman Sachs. Please go ahead.

Alexandra Walvis -- Goldman Sachs -- Analyst

Good afternoon. Thanks so much for taking my question here. I wanted to just ask a follow-up on the fourth-quarter guide. Can you help us out with anything that's giving you confidence in achieving the sales level and you're seeing at quarter-to-date.

How within that, you are thinking about the timing of the holiday season this year is difficult to predict, but perhaps, different from prior years. And then whether you're factoring anything on store capacity you can take and some delivery bottlenecks, which you commented on it a little bit so far, but I'd love you to pull that together which would be very helpful.

Sonia Syngal -- Chief Executive Officer

So I think I caught it all. Let me try. So listen, we think the consumer is in a really good place. We think that the forecast for consumer spending is up.

We think that apparel is a great category when customers can't travel or spend on sporting or events, those kinds of things. And we believe that our -- our voice share growth, as well as, our relevance makes us an ideal destination for Q4 selling. You know and as we learned and shared with you in our last quarter, you cannot predict when exactly the customer will make their decisions for holiday shopping. Back-to-school was much later than it had been in previous years because of the pandemic situation, we expect dynamics to be what they are and we will be ready.

Our whole focus is we will be ready and ready to service the customer whenever she's ready to shop. With 176 million customers, they're all going to choose different times to shop, whether it's the early shoppers or the ones that love Black Friday or the ones that shop on December 24th, and I think we'll be ready for all of them.

Duration: 60 minutes

Call participants:

Steve Austenfeld -- Head of Investor Relations

Katrina O'Connell -- Chief Financial Officer

Sonia Syngal -- Chief Executive Officer

Kimberly Greenberger -- Morgan Stanley -- Analyst

Ike Boruchow -- Wells Fargo Securities -- Analyst

Matthew Boss -- J.P. Morgan -- Analyst

Mark Altschwager -- Baird -- Analyst

Lorraine Hutchinson -- Bank of America Merrill Lynch -- Analyst

Paul Lejuez -- Citi -- Analyst

Kate Fitzsimons -- RBC Capital Markets -- Analyst

Alec Legg -- B. Riley FBR -- Analyst

Alexandra Walvis -- Goldman Sachs -- Analyst

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