Katrina O'Connell
Chief Financial Officer at GAP
Thank you, Bobby and thanks, everyone, for joining us this afternoon. Let me start with our third quarter results. Third quarter net sales of $4.04 billion increased 2% versus last year or 3% on a constant currency basis, driven by an improvement in trend relative to the first half of the year and in part due to the timing of franchise sales.
Sales in the third quarter were 1% above pre-pandemic levels in 2019. Comparable sales were up 1% on top of negative 1% comp last year and a significant sequential improvement from the negative 10% comp last quarter, primarily as our assortment rebalancing efforts at Old Navy and Gap are starting to take hold and resonating with our customers as well as the benefit of an early holiday promotional event at Old Navy in October.
Store sales increased 1% from the prior year. Year-to-date, we have closed a net total of 29 Gap and Banana Republic stores in North America and now anticipate closing approximately 30 additional stores this year, bringing us to close to 90% of our goal of closing 350 stores in North America by the end of fiscal 2023.
As we look to the remainder of fiscal 2022, we remain on track to open a net 30 Athleta stores and now expect to open a net 10 Old Navy stores this year. Online sales increased 5% versus last year and represented 39% of total sales in the quarter. Compared to pre-pandemic levels in 2019, online sales increased 55%.
Turning to sales by brand. Starting with Old Navy, sales in the third quarter of $2.1 billion were up 2% versus last year and increased 10% relative to pre-pandemic levels in 2019. Old Navy comparable sales were down 1%, representing a sequential improvement from the negative 15% comp last quarter, driven by improvements in category mix and a more balanced assortment that now includes more of the product that our customers have been looking for, as preferences have shifted from cozy casual to work occasion this year.
However, we do believe that Old Navy did benefit from a slight pull-forward of sales from the fourth quarter into October, as a result of its efforts to get out earlier than typical with its first holiday promotional event.
Gap brand global sales of $1.04 billion were flat versus last year, with global comparable sales up 4%, driven by improved category mix and a more balanced assortment, including more occasion-based and fast and driven categories, as well as comp growth in Asia as a result of lapping the outsized negative impact of COVID-related restrictions last year. North America comparable sales were flat, a sequential improvement from negative 10% last quarter.
Banana Republic sales grew 8% from last year to $517 million, with comparable sales up 10% as the brand continued to capitalize on the shift in consumer preference and the relaunch and elevated positioning of the brand last year.
Athleta sales grew 6% to $340 million or an increase of 57% compared to 2019 prepandemic levels. Comparable sales improved sequentially to a flat comp in the third quarter compared to negative 8% comp last quarter and negative 7% in the first quarter.
As we look to sales in the fourth quarter, we continue to take a prudent approach, given the uncertain macro and consumer environment as well as the competitive promotional environment. Also, as stated earlier, third quarter net sales benefited in part by the timing of franchise sales as well as the October holiday event at Old Navy.
In addition, Gap brands will be up against an approximate 1 point headwind as we anniversaried Yeezy Gap sales last year that will not be in the base this year. As a result of these factors and the continued uncertain environment, we anticipate that total company sales in the fourth quarter could be down mid-single digits year-over-year.
Now to gross margin. Gross margin in the third quarter was 37.4%, deleveraging 470 basis points versus last year, inclusive of 130 basis points of deleverage related to a $53 million Yeezy Gap impairment charge. On an adjusted basis, gross margin was 38.7%, deleveraging 320 basis points versus last year as we continue to experience higher levels of markdowns in order to better position our inventory. Excluding the impairment related to Yeezy Gap, merch margin deleveraged 370 basis points as a result of higher discounting due to the previously communicated assortment imbalances as well as more aggressive focus on better positioning and clearing excess inventory as we exit fiscal 2022.
Air freight contributed approximately 200 basis points of leverage as spend levels normalized during the quarter and we lapped the $70 million of incremental air freight expense last year. Equally offsetting this was approximately 200 basis points of deleverage due to inflationary and commodity cost-related headwinds.
Turning to ROD. We continue to benefit from our fleet restructuring efforts through lower ROD costs, which were relatively in line with last year on a nominal basis. Excluding a Yeezy Gap impairment charge, ROD as a percentage of sales leveraged approximately 50 basis points. As we look to gross margin in the fourth quarter, we will lap last year's $245 million of incremental air freight, which is expected to add approximately 540 basis points to gross margin versus last year. We continue to anticipate an approximate 200 basis point inflationary and commodity cost headwinds and that ROD will likely be about flat as a percentage of sales versus last year.
As we communicated last quarter, while we are taking actions to rightsize inventory in an increasingly promotional environment, we continue to expect significant variability in discount rate. As a reminder, gross margin in the second and third quarters were impacted by approximately 370 basis points of deleverage stemming from higher discounting.
Turning to SG&A. Reported SG&A was $1.3 billion or 32.8% of sales, leveraging 540 basis points from the prior year and includes an $83 million net benefit from the sale of our U.K. DC now that our European partnership model transition is complete. In addition, we recorded an immaterial amount of severance related to the overhead reductions taken in the third quarter. Adjusted SG&A, excluding the U.K. DC benefit, decreased 5% versus last year to $1.4 billion. As a percentage of sales, adjusted SG&A leveraged 280 basis points from the prior year's adjusted rate, primarily as a result of higher sales volumes, lower bonus accrual and lower marketing expense compared to last year.
As Bobby discussed, we've begun to take actions to rightsize our cost structure and improve profitability, focusing acutely on areas where we may have invested without commensurate returns in recent years as it relates to overhead, marketing and technology. We've already acted on approximately $250 million in annualized savings stemming from the reduction of approximately 500 existing and open corporate roles in the quarter, the renegotiation of advertising agency contracts and the reduction of technology operating costs and rationalization of digital investments.
These actions will not have a material impact on SG&A as we look to the fourth quarter as a result of timing and severance offsets, in addition to headwinds in the quarter related to higher seasonal labor costs relative to last year. However, these actions will provide a significant offset to the higher incentive compensation and wage inflation headwinds we anticipate in fiscal 2023.
Reported operating income increased 22% to $186 million or 4.6% as a percentage of sales. Adjusted operating income decreased 8% from the prior year to $156 million. Adjusted operating margin of 3.9% was 40 basis points lower than last year's adjusted rate, reflecting the elevated promotional activity and higher inflationary costs, offset by the air freight leverage and the SG&A leverage relative to last year.
Moving to interest and taxes. We recognized $18 million in net interest expense, a $25 million savings versus last year due to the refinancing of our long-term debt last fall. During the quarter, we recorded an income tax benefit of $114 million on pretax income of $168 million, which resulted in a negative effective tax rate of 68%. This income tax benefit was related to the cumulative impact of a change in the estimated annual tax rate as a result of quarterly earnings variability. This year-to-date tax benefit is expected to reverse and result in at least $200 million of tax expense in the fourth quarter, offsetting the tax benefit on a fiscal year basis.
Reported EPS was $0.77. Adjusted EPS, which excludes an approximate $0.18 net benefit related to the U.K. DC sale and a $0.12 negative impact due to the Yeezy Gap impairment charge was $0.71. Adjusted EPS includes $0.33 related to the tax benefit in the quarter. Share count ended at 365 million.
Turning to balance sheet and cash flow, starting with inventory. We are making initial progress on our plan to rightsize inventories and move to levels below last year by the end of the fiscal year. Our more aggressive markdowns combined with moderated holiday receipts drove a sequential improvement in the inventory growth during the quarter. Total ending inventory was up 12% versus last year, a sequential improvement from 37% inventory growth in the second quarter. The 12% year-over-year growth in the third quarter includes a 13 percentage point benefit related to in-transit as we lapped last year's supply chain challenges. 9 percentage points of growth related to pack and hold, and close to two-thirds of the remaining increase is attributable to elevated levels of slow-turning basics and the remainder seasonal products.
Compared to prepandemic levels in the third quarter of 2019, ending inventory was up 12%. While an improvement in trend versus the first half as we expected, we are entering the fourth quarter with overall elevated inventory levels and some carryover of fall product despite the increased markdown activity in the third quarter. Although we did take action earlier this year to reduce holiday receipts, we continue to anticipate a competitive promotional environment, given the increased inventory levels industry-wide and plan to continue to take aggressive action to clear inventory in order to enter fiscal 2023 better positioned.
As we look to fiscal 2023, we continue to moderate buys and expect to begin to lean into our responsive levers this spring, which will provide further flexibility to better align inventory levels with demand trends next year. In addition, we are releasing some of last year's holiday pack and hold inventory, and we'll continue to integrate our pack and hold inventory into future assortments. As you know, while pack and hold is the use of cash in the short term, we are able to optimize our margin in the near term and benefit working capital next year as we buy lower receipts and sell through the pack and hold inventory.
Quarter-end cash and equivalents were $679 million. Net cash from operating activities was an inflow of $95 million in the quarter, driven by a moderation in working capital usage as a result of our progress on improving inventory levels and composition coupled with our receipt cuts and leaner buys. As we stated last quarter, we anticipated beginning to see more normalized cash flow in the back half of the year and we are seeing that play out.
We continue to focus on fortifying our balance sheet and cash positions. As discussed last quarter, we've cut or deferred some capital spending and reduced the number of Old Navy stores slated for back half of the year and continue to expect capex of approximately $650 million for 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 November 8, our Board approved a $0.15 dividend for the fourth quarter of fiscal 2022.
We repurchased 1.2 million shares early in the quarter. As discussed last quarter, we have completed our goal of offsetting dilution in fiscal 2022 and do not anticipate repurchasing additional shares this year. We continue to have $476 million available under our current share repurchase program authorization.
Before closing, we understand that there has been increased focus on freight- and commodity-related tailwinds in fiscal 2023 across the industry as we've all begun to see favorability in rates. As a reminder, we have experienced a more modest freight headwind throughout fiscal 2022 as compared to many other retailers as a result of our long-term ocean contracts, which were locked in at favorable rates. These negotiated rates remain below current ocean container rates.
As a result, as ocean container rates come down, this will not represent a significant tailwind to our margin as it may for other retailers as we look to fiscal 2023. In addition, as it relates to cotton and commodity costs, we have already made purchases through the first half of fiscal 2023, and therefore, will not begin to benefit from advantaged pricing until we enter the back half of next year.
In closing, while we continue to navigate an uncertain consumer environment and promotionally competitive environment, we are confident in the actions we're taking and believe we are taking the right steps to position Gap Inc. back on its path towards sustainable, profitable growth and delivering value to our shareholders over the long term.
With that, we'll open the line for questions. Operator?
