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How Gap benefited off the pandemic to improve the brands business models

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Gap reported its fourth quarter earnings, with net sales down 5% due to store closures amid the pandemic and a 49% increase in online sales. Katrina O'Connell, Gap CFO, joins Yahoo Finance to break down the details and provide outlook for the company in the year ahead.

Video Transcript

[MUSIC PLAYING]

BRIAN SOZZI: Gap stock is on the rides today after a better than expected quarter of profits for the retailer. The company forecast a return to sales and profit growth this year. Said the first quarter has started well. and. A new apparel line with Kanye West is on track to arrive in stores and online soon.

Joining us for a Yahoo Finance exclusive is Gap CFO Katrina O'Connell. Katrina, good to see you this morning here. One of the headlines among many here is that Gap is forecasting a return to sales growth this year, a return to profitability. How has the year started for you guys? Because so far, we're hearing a lot of retailers come out of the gate pretty strong.

KATRINA O'CONNELL: Yeah, no, I really appreciate being here today, Brian. And I would say, first of all, we're quite pleased with how we closed out the year. Our fourth quarter, despite the resurgence in the pandemic, ended up with flat comp sales. We were able to win through the power of our brands, particularly our Old Navy brand, which ran a seven comp in the quarter and ended the year as the number two apparel brand in the US, and our Athleta brand, which grew sales 29% in the quarter and past a billion dollars and grew 16%, despite the pandemic on the year. Really pleased with the way our brands competed.

And we were digitally dominant. We grew to over $6 billion in revenue in our online channel, with almost 46% of our sales coming from online. So fourth quarter ended quite well. We were able to do that with expanding margins and exceed expectations as it relates to EPS. So all in all, a great quarter for us.

As we look forward to this year, the start to the quarter, quarter to date is actually showing some good signs. We're seeing momentum, even as it relates to Q4. And so that's really nice to see.

BRIAN SOZZI: Talk to us a little bit about the Kanye West line. There haven't been a lot of details. But I know a lot of folks are really looking forward to seeing that. Is it still hitting? Is that line still hitting in the first half of this year? And is that line a financial needle mover this year for Gap?

KATRINA O'CONNELL: Yeah, when I think about Gap brand, one of the things we've said is that we are looking to build relevance with the brand. And our strategy is to partner to amplify the strength of that brand.

And so the Kanye West deal is a good example of a partnership that we believe will be important in boosting the relevance of the brand. And it's already really resonating with people. We get asked, probably most commonly, when that is going to hit. We are still on track for delivering that product to our online business probably at the end of the first half of this year-- I mean, excuse me, the first half of this year.

JULIE HYMAN: Katrina, it's Julie here. I want to ask you about inventory and markdowns. I know you all saw inventory up 14% as of the end of last year. And Gap is known for markdowns, right? I cop to being a longtime Gap customer and someone who's become accustomed to those markdowns. How does that cadence look this year? Because as a customer, it looks less like a cadence and more just like what always exists.

KATRINA O'CONNELL: Yeah, Julie, I'm glad you asked the question. So first of all, when you look at the quality of our sales in fourth quarter, we have said that we were able to reduce the amount of promotions we drove in fourth quarter. And so actually, our product margins were up, driven by higher average unit retails as a result of lower promotions and lower markdown sales. So we are making good progress on reducing the level of promotions in our business.

When I think about the end of period inventory, we did say that markdown inventory was below last year. And so we feel quite good about the quality of the inventory at the end of the year. We also said that, based on the quality of the assortments, we believe that we will drive higher margins in the front half of the year.

All that said, the increase in inventory year over year is actually driven by timing of inventory, two factors there. We have inventory that we packed and held from last year at the end of the pandemic. It's high quality inventory that we kept in our distribution centers to reintroduce this year as a way of holding that inventory to be more profitable.

And then in addition to that, I'm sure you've heard a lot about the fact that the ports are a little backed up based on having slower processing speeds. And so we are seeing a little bit of our inventory in transit come up. But all said, we feel, actually, quite good about the assortments in the front half of the year. And we believe those will drive higher margins and lower markdowns.

MYLES UDLAND: Katrina, it's Myles here. I want to ask a little bit about store closings. You guys closed a couple more stores than your target last year. And how you're thinking about the footprint not only as part of that transformation plan that you've been on, but also any learnings you've had through the pandemic on what customers have kind of indicated they responded to and how you're thinking about rationalizing that footprint.

KATRINA O'CONNELL: Yeah, so we've put out a target by the end of 2023 to have closed 350 Gap and Banana Republic North America stores. We're quite pleased that this year alone we closed 228 of those stores. And we'll close another 75 this year, so that we'll have closed about 75% of our targeted closures by the end of 2021.

You saw that in fourth quarter, the store closures combined with our online sales allowed us to expand our ROD, rent and occupancy, by over 400 basis points, which drove a significant amount of profitability in the quarter. So it's a very important lever that we have to driving profitability for the company.

That said, we still believe that a well-located profitable fleet is important. We've seen consumers come into our online channel but then transact between our online channel and our stores through many of the capabilities that we offer, buy online, pick up in store, ship from store, curbside pickup. So we believe that having both a well-located profitable fleet and our digitally dominant capabilities are important to consumers, especially in this new normal.

BRIAN SOZZI: Katrina, you mentioned on the call last night that you're undertaking a strategic review of your European business. That's 2% of sales, a little over 120 stores. Why are you doing that?

KATRINA O'CONNELL: Yeah. I mean, I think what you'll see from this management team is we want to grow sales profitably. And so we are looking at all of the models that we have in place and ensuring that we can still represent our brands in the jurisdictions that we would like to still drive revenue.

So Europe in particular is a good market for our Gap brand. The consumer loves the product. But we're not overly pleased with the business model we have there. It's not the most profitable for us. And so we are looking to see if there's another way to partner our European business to be able to still drive sales in the important Europe market but do it in a more profitable way. And so I would say overall, our approach to the business is very much about driving profitable sales growth.

BRIAN SOZZI: One of the decisions, among many, that the new management team at Gap-- and certainly you're included in that-- is to keep all these brands together. It wasn't too long ago where the company was looking at potentially divesting some assets here or just splitting up the company. Do you still think that was the right choice?

KATRINA O'CONNELL: Absolutely. I think what we learned in going through this split is that there's a power to the portfolio. And there's a power to our platform. The portfolio gives us an ability to scale our 183 million customers across our portfolio of brands. And the platform allows us to have a significant amount of scale as it relates to our supply chain, our technology footprint, our digital capabilities, et cetera.

And so what we've learned is actually, the consumer likes all of our brands. And there's a significant amount of synergy that occurs using our leverage on our platform and our portfolio.

BRIAN SOZZI: And what about Banana Republic? If there was any disappointment in the quarter, the sales there were under pressure again. How could that brand turn around if we're all wearing these casual clothes?

KATRINA O'CONNELL: Yeah, I mean, Banana's been disproportionately impacted this year by the shift away from traditional workwear as we all sort of Zoom from home. And so the team has been heads-down on relooking at the assortment.

And then we hired a new president and CEO of Banana Republic, Sandra Stangl. She joined us in December. And she's very much focused on repositioning the brand for what we believe the new normal will be.

We're excited that we've already launched several new product lines in Banana that are doing quite well. BR Standard, which is actually the new sort of upscale active line, is doing quite well. And True Hues, which is a lingerie line that it has been launched, is also quite good.

And so we'll see how the year progresses. But we definitely think that the new leadership and the new focus on casualizing what the new work will look like will help Banana Republic come back.

BRIAN SOZZI: If I had my math right, you just passed your one year mark as CFO of Gap. Certainly, you helped turn around the Old Navy business when you were there. How hard has it been to change the culture at Gap?

KATRINA O'CONNELL: It's been a year like no other, as I'm sure you can imagine. I took my seat on March 13, which happened to be the day that we all sort of went home and never came back. But I would say that while this has been truly a crazy year from a personal and pandemic standpoint, it's actually been an amazing opportunity for both me and Sonya to come in and honestly use the crisis as an opportunity to really change the culture fairly immediately and also change the business model as much as we possibly could.

Sometimes, I think crisis is an opportunity. And we were able to see that really play out this year. We were able to come in and restructure like I don't think we would have been able to and drive a culture of winning. We went from the first month or six weeks of shutting down stores and procuring liquidity to deciding that really, this was our opportunity to accelerate our agenda for restructuring the company and then setting ourselves up for profitable sales growth going forward.

BRIAN SOZZI: Well, I'll say I am looking forward to picking up some Yeezy pants very soon. We'll leave it there. Gap CFO, Katrina O'Connell, stay safe. We'll talk to you soon.

KATRINA O'CONNELL: You too, Brian. Thank you so much for the opportunity today.