Katrina O'Connell
Chief Financial Officer at GAP
Thank you, Bobby; and thanks, everyone, for joining us this afternoon. The actions we are taking to significantly reduce excess inventory, improve category and assortment balance, transform and optimize our operating structure and significantly reduce operating expenses, while further fortifying our balance sheet have allowed us to enter fiscal 2023 better positioned.
During the first quarter, we delivered net sales in line with our expectations driven by continued women's category strength at Gap and Old Navy, despite the weaker sales at Athleta; over 600 basis points of adjusted operating margin expansion as we drove down excessive air freight expense and delivered significantly improved promotional activity most notably at Old Navy and leveraged adjusted SG&A; reduced inventory down over 27% year-over-year, which was only up 3% versus the first quarter 2019; and ended the quarter with cash and equivalents, up 38% from last year to nearly $1.2 billion.
While we believe we are making progress to better position our model to deliver for the long-term, we continue to take a prudent approach in planning and managing our business in light of what continues to be an uncertain macro and consumer environment. We remain focused on the levers and opportunities in our control to deliver on behalf of our customers, employees and shareholders.
Let me start now with our first quarter results. First quarter net sales of $3.3 billion decreased 6% versus last year and were consistent with our expectations for first quarter sales to be down mid-single digits. As a reminder, the sale of Gap China at the beginning of the first quarter had a 2-point negative impact to net sales growth and there was also a 1 point foreign exchange headwind.
Excluding Gap China sales of approximately $60 million from Q1 last year, and the foreign exchange headwind, total Company net sales would have been down 3%. Comparable sales were down 3% in the first quarter. Store sales decreased 4% from the prior year. Online sales decreased 9% versus last year and were up 39%, compared to pre-pandemic levels in 2019. Online represented 37% of total sales in the first quarter.
Turning to sales by brand. Starting with Old Navy, sales in the first quarter of $1.8 billion were down 1% from last year, compared to 2019, Old Navy sales were up 2% in the quarter. Although we believe Old Navy continues to experience demand softness from its lower income consumers, we are pleased to deliver first quarter comparable sales down 1%, which was a continued improvement from fiscal 2022, driven by strength in women's and a modest improvement in baby offset by continued softness in active and kids.
Old Navy continued to gain share in the quarter, driven largely by market share gains in women's and the kids and baby category. We continue to believe that Old Navy remains well-positioned given its value positioning in the marketplace.
Gap Brand total sales were $692 million, excluding the 8-point negative impact related to the sale of Gap China, the 3-point negative impact from foreign exchange headwinds, and the 1 point negative impact due to the shutdown of YZY Gap, sales were down 1% versus last year largely driven by store closures in North America. Gap Brand comparable sales were up 1% driven by continued strength in women's, a modest improvement in baby, offset by continued weakness in active and kids. Gap Brand continued to gain market share in women's as its reinvented icons are resonating with consumers.
Banana Republic sales were $432 million in the first quarter with comparable sales down 8% on top of a positive 27% comp last year. While the transformation of BR into an elevated lifestyle brand continues to take hold and resonate, the brand is lapping outsized growth last year driven by the post-COVID shift in consumer preferences, which is impacting year-over-year growth.
Athleta sales of $321 million were down 11% from the prior year, or an increase of 45% compared to 2019 pre-pandemic levels. Comparable sales were down 13%. As we told you last quarter, Athleta has had product acceptance challenges, which we believe are impacting results. While we know it will take at least a few quarters to make meaningful changes to the assortments, the team has been at work to improve product presentation and creative with an emphasis on the performance DNA that Athleta is known for.
Now, to gross margin in the first quarter. Reported gross margin was 37.1%. Adjusted gross margin increased 570 basis points to 37.2%. Merchandise margin on an adjusted basis increased 610 basis points. This was driven by approximately 560 basis points of leverage as we lapped last year's elevated air freight and drove our normalized air expense down; approximately 330 basis points of deleverage, due to inflationary cost headwinds as we are now selling product locked in at last year's peak cotton prices. This was slightly better than the 360-basis point headwind we anticipated as we are beginning to benefit from better ocean freight rates; and the remaining 380 basis points of leverage stemming primarily from improved promotional activity relative to last year, primarily at Old Navy. ROD as a percentage of net sales deleveraged 40 basis points versus last year.
Now, let me turn to SG&A. Reported SG&A in the first quarter was $1.2 billion, including a $47 million gain related to the sale of our 1 Harrison office building offset by $71 million in restructuring charges related to actions to optimize our operating structure, including the reduction of approximately 1,800 corporate and upper field roles. As we discussed last quarter, the actions we are taking to optimize our operating model and structure are expected to result in annualized savings of $300 million, of which half we estimate to benefit SG&A in the second half of fiscal 2023 and the remainder in the first half of fiscal 2024. Adjusted SG&A of $1.2 billion was down 7% from last year. As a percentage of total sales, adjusted SG&A leveraged 60 basis points, driven by lower advertising expense and lower technology investments resulting from our cost saving actions late last year.
Reported operating income was a loss of $10 million. Adjusted operating income, which excludes restructuring charges and the gain on sale was $18 million in the first quarter. Adjusted operating margin improved 620 basis points from last year to 0.5% in the quarter, driven by the 570 basis point improvement in adjusted gross margin and 60 basis points of adjusted SG&A leverage.
Reported EPS was a loss of $0.05. Adjusted EPS, which excludes restructuring charges and the gain on sale, was $0.01. Share count ended at 368 million.
Turning to balance sheet and cash flow. Starting with inventory, ending inventories declined 27% in the first quarter versus last year. This includes a 17 percentage point benefit related to in-transit as we lapped the prior year's supply chain challenges and 4 percentage points of decline related to pack-and-hold inventory. The remaining decline is primarily driven by a decrease in fashion and seasonal basics inventory. As you know, we made significant progress rightsizing inventories as we exited fiscal 2022. We remain focused in fiscal 2023 on moderating buys, leaning further into our responsive levers, and continuing to integrate the inventory that was placed in pack-and-hold in fiscal 2022 into future assortments. As a result, we are planning for inventory to be down significantly more than sales as compared to fiscal 2022.
Quarter-end cash and equivalents were nearly $1.2 billion, an increase of 38% from the prior year. Net cash from operating activities was $15 million in the quarter driven primarily by improved inventory levels and leaner buys. Capital expenditures were $117 million. Consistent with typical first quarter seasonality, free cash flow was an outflow in the quarter of approximately $102 million.
We remain confident that cash flow trends will continue to normalize throughout fiscal 2023. As we told you last quarter, we expect to be positioned to pay down the $350 million draw on our asset-backed line of credit this year. In fact, last week we paid down $100 million and intend to pay down the remaining $250 million balance throughout the remainder of the year.
We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns. During the quarter, we paid a dividend of $0.15 per share and on May 9th our Board approved maintaining that $0.15 dividend for the second quarter fiscal 2023.
Now turning to our outlook. We continue to take a prudent approach to planning in light of the continued uncertain consumer and macro environment. Starting with Q2, let me first provide an overview of factors impacting year-over-year sales comparisons in the second quarter. Gap China represented approximately $60 million in sales last year in Q2, and is expected to be an approximate 1 to 2 percentage point headwind to Gap Inc. for the quarter.
We are assuming an estimated 1 point foreign exchange headwind in the second quarter. We are estimating total net sales in the second quarter to be down mid-to-high single-digits year-over-year reflecting a range of outcomes based on what continues to be an uncertain macro and consumer environment.
We expect gross margin improvement in the second quarter versus last year. Compared to the 36% adjusted gross margin in the second quarter last year, we anticipate an estimated 200 basis points of leverage as we lap last year's elevated air freight and continue to drive lower normalized air expense; an estimated 200 basis points of deleverage due to inflationary cost headwinds, primarily cotton cost headwinds similar to Q1.
We expect these inflationary headwinds to moderate and become a tailwind in the back half of the year as we benefit from lower commodity prices, as well as improved ocean freight rates. This 200 basis point inflationary headwind is expected to be fully offset by improved promotional activity as a result of improved inventory positions relative to last year; and ROD is expected to delever by approximately 50 basis points compared to last year.
We are planning for adjusted SG&A of approximately $1.3 billion in the second quarter largely reflecting the continued benefit of last year's savings actions offset by higher incentive compensation. As discussed previously, we expect to begin to benefit in the back half of the year from the $300 million in annualized savings related to the actions we are taking to optimize our operating model and structure that we began implementing last month.
Now, turning to full-year 2023. As a reminder on the factors impacting year-over-year comparisons, Gap China represented approximately $300 million in net sales last year, representing an approximately 2-point headwind to Gap Inc in fiscal 2023. Fiscal 2023 will have a 53rd week, estimated to add approximately $150 million to net sales or approximately 1 point of growth. As we look to the remainder of fiscal 2023, we continue to believe net sales could be down in the low-to-mid single-digit range for the year.
Turning to gross margin. Compared to the 35% adjusted gross margin in fiscal 2022, adjusted gross margin in fiscal 2023 is expected to be driven by, an estimated 200 basis points of air freight leverage as we lap last year's elevated air freight and continue to drive down normalized air expense, approximately 50 basis points of deleverage versus last year stemming from inflationary cost headwinds. This is an improvement from our prior expectations of a 100 basis point headwind as we are experiencing an improvement in ocean freight rates earlier than previously planned.
We anticipate approximately 250 basis points of inflationary deleverage in the first half of the year, shifting to a tailwind of approximately 150 basis points of leverage in the back-half as we benefit from improved commodity costs and ocean freight rates. We continue to expect more than 100 basis points of margin benefit in fiscal 2023 as a result of our better inventory position and expected improved promotional activity compared to last year, and ROD as a percentage of sales is planned to be roughly flat to down approximately 50 basis points compared to last year.
We continue to target fiscal 2023 adjusted SG&A to be down low-to-mid single-digits from the prior year, or approximately $5.2 billion. As we communicated last quarter, the higher incentive compensation and wage inflation planned for fiscal 2023 is expected to be fully offset by approximately $250 million of cost savings implemented in fiscal 2022.
In addition, as discussed earlier, we expect to realize roughly half of the $300 million in annualized savings related to the optimization of our operating structure, including the elimination of approximately 1,800 corporate and upper field roles.
We now expect capital expenditures in the range of $500 million to $525 million, down from our prior range of $500 million to $550 million, largely reflecting lower capital project investments, as well as fewer store openings than previously planned.
We now plan to open a net 25 to 30 Old Navy and Athleta stores in total, roughly one-third Old Navy stores and two-thirds Athleta stores. We continue to plan to close a net total of 50 to 55 Gap and Banana Republic stores in North America, of which approximately more than half are Gap stores and the remaining Banana Republic stores.
We are entering fiscal 2023 better positioned as a result of the actions we are taking to change the trajectory of our business not only in the near-term, but even more importantly setting the Company up for the long-term. We are confident in the actions we are taking and believe we are taking the right steps to position Gap Inc. back on its path towards sustainable, profitable growth and delivering value for our shareholders over the long-term.
With that, we'll open up the line for questions. Operator?
