GAP Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 24, 2023

There are 12 speakers on the call.

Operator

Afternoon, ladies and gentlemen. My name is Brianna, and I will be your conference operator today. I would like to welcome everyone to the Gap Inc. 2nd Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode.

Operator

For those analysts who wish to participate in the question and answer session after the presentation, you may now press star 1 to enter the Q and A As a reminder, please limit your questions to 1 per participant. Please press the star key followed by the 0 key on your touch tone phone. I would now like to turn your call over and introduce your host, Emily Gaca, Director of Investor Relations.

Speaker 1

Good afternoon, everyone. Welcome to Gap Inc. To Q2 fiscal 2023 earnings conference call. Before we begin, I'd like to remind you that the information made available on this conference call to the operator. Contains forward looking statements that are subject to risks that could cause our actual results to be materially different.

Speaker 1

For information on factors that could cause our actual results to differ materially from any forward looking statements as well as to the reconciliation of any financial measures not consistent with generally accepted accounting principles, please refer to the cautionary statements contained in our latest earnings release. The risk factors described in the company's annual report on Form 10 ks filed with the Securities and Exchange Commission on March 14, 2023, and any subsequent filings with the Securities and Exchange Commission, all of which are available on gapinc.com. These forward looking statements are based on information as of today, August 24, to 2023, and we assume no obligation to publicly update or revise our forward looking statements. Joining me on the call today to our Executive Chair, Bob Martin Chief Executive Officer, Richard Dickson and Chief Financial Officer, Katrina O'Connell. With that, I'll turn the call over to Bob.

Speaker 2

Thank you, Emily, and good afternoon, everyone. Before Katrina shares our 2nd quarter results, I have the pleasure of welcoming our new Chief Executive Officer, Richard Dixon to the call. There's no denying that Richard was destined for this role at this moment. His experience as a transformational brand builder makes him a perfect fit for this freight company. He's uniquely qualified to lead and carry out the transformative work already underway.

Speaker 2

And more importantly, he is the right leader for tomorrow defining the future for GAAP Inc. Appointed to our Board of Directors in November of 2022, He's had a view into how we are changing the way we work and the results we deliver. But what energizes him most Is building a new legacy for our renowned portfolio of brands, one that matters to our customers, employees and shareholders. And before I hand off, I want to say thank you to our entire Gap Inc. Team for their commitment to the success of this company And their tenacity and care for our brands for embracing operational rigor and regaining the product and customer to Obsession with an eye on modernizing the way we work, all of which becomes a strong foundation for what's ahead under Richard's leadership.

Speaker 2

To I have great belief that Richard and this team will define a very bright future for this company. So with that, I want to welcome Richard Dickson, to the new Chief Executive Officer of Gap Inc. Richard?

Speaker 3

Well, good afternoon. This is my 3rd official day to CEO of Gap Inc. So first, let me begin by thanking Bobby, the Board and the entire Gap Inc. Organization for the opportunity to lead to this incredible company. And thank you everyone for joining us today on our Q2 2023 earnings call.

Speaker 3

To the call. Now, many have asked me why Gap Inc. And why now? So let me start by saying that I have admired Gap Inc. And its brands, to Old Navy, Gap, Banana Republic and Athleta.

Speaker 3

For decades as a customer, a brand builder and most recently as a Board member. Those of you who know a bit about my career know that I've always been drawn to companies and brands with storied to legacies and powerful purposes. And in apparel, there's no equal to Gap Inc. To the conference call. When Don and Doris Fisher opened the very first Gap store in San Francisco in 1969, to the conference call.

Speaker 3

Little did they know that they had tapped into the zeitgeist in a way that would democratize and define American style. Suddenly, to Great clothes were accessible, stores were experiential, self expression could be an everyday pursuit open to all. To talk about a game changer, Gap did that. Creating an opportunity from the currents of culture Has been a hallmark of Gap Inc. For more than 5 decades.

Speaker 3

Over the years, our brands made jeans, khakis, to kidswear, suits, yoga pants, you name it, into massive trends through great design, to great marketing and an all out obsession with our customer. Fast forward to today, The apparel and retail landscape has changed dramatically. Evolving at an even quicker pace now, it requires that great brands run at the to the speed of culture to maintain relevance. What has not changed is the customer's desire for fashion that they can make their own. We will take that one step further, making what we do, what we stand for and what we sell relevant.

Speaker 3

To the Q and A As anyone in this industry will tell you, clothing is a rational need, while fashion is an emotional want. To our brands will balance both. Going forward, I'm confident that we have the scale, talent and determination to Spark's huge defining trends again. Think about it. Gap Inc.

Speaker 3

Is the largest specialty apparel company in America, an empowered community of more than 90,000 people who apply their talents to Gap Inc. And our brands, producing about 900,000,000 units a year. Our brands draw 600,000,000 visits to stores and 1,400,000,000 to our sites online each year, making Gap Inc. The number 2 player in U. S.

Speaker 3

Apparel e commerce. To these customers across multiple generations turn to Old Navy, Gap, Banana Republic and Athleta to help them to step out everywhere from schools and studios to offices and date nights. So our brands matter, But it can matter even more. In my previous role in toys and entertainment, we always strive to make consumers fans and to grow those fandoms. And I want to apply that approach to our portfolio of brands.

Speaker 3

Our virtuous cycle Where our products and experiences motivate belief and loyalty that fans then badge and amplify in culture, Growing the fandom, validating and inspiring us to even greater creativity and monetization. It works because everyone wins. Gap Inc. Brands already have incredible fans. Our job now will be to excite and delight them even more, growing their numbers and the value of our brands.

Speaker 3

To the comprehensive transformation effort that Bobby initiated has been an important step in that direction, streamlining operations so that we could focus on growth to driving initiatives. And Katrina will take you through that progress in addition to the quarterly performance in detail. But before she does, I want to acknowledge that restructuring is challenging and that change of this magnitude doesn't come fast. To transformation is difficult. Still, our people at every level of the organization have stepped up, made tough calls and championed the progress we've made so far and we're going to keep going.

Speaker 3

As we continue to focus on strengthening our financial footing, We're now going to build on that progress, accelerating our efforts to drive profitable growth by unlocking the value in our brands. To this time, we'll do it differently with a clear focus on brand revitalization, redefining our brand's meaning to consumers, to focusing on creativity, designing for relevance as a pursuit rather than a goal, building to quality and leveraging our remarkable legacy to shape an exciting new future. That's my passion. It's why I'm here and why I'm here now. And I know that our teams are just as passionate and committed to making it happen.

Speaker 3

In the quarters to come, I'll share specific priorities and plans. What I can tell you today is that I'm intent on reigniting a creative culture at Gap Inc. That is a magnet for the industry's best talent, including the great creative talent we already have. Recommitting each of our brands to a distinctive brand purpose that aligns with customer values and sets them apart Reorienting our brands around both the art and science of design centric thinking, informed by consumer insights and an to absolute obsession with our customer. We engaging in the cultural conversation with hyper relevant products and ideas that inspire constructive dialogues and rethinking how our brands show up in store and online with customer experiences that excite and delight.

Speaker 3

Most of all, mattering to our people, to our investors, our communities and the world. In the coming weeks, I look forward to spending time in every part of the organization. To our headquarters offices, stores, customer support centers, DCs and with partners in key regions of the U. S. And globally, meeting the people behind our brands, the customers who shop us and you, our shareholders, listening, to learning, experiencing it all firsthand in order to get grounded and even more defined about where we're going.

Speaker 3

To the call. I'll wrap up by saying that my start date was deliberate. Just as August 22, 1969 Was the milestone that created this remarkable company. I want August 22, 2023 to mark the start of an exciting new chapter for Gap Inc, one that celebrates our past as we pioneer an extraordinary future. To the call.

Speaker 3

Thank you. And I'll now hand off the call to Katrina.

Speaker 4

Thank you, Richard. It's been a pleasure working with you in your role as a Board member over the to the past 9 months, and I'm thrilled to partner with you in your new role as CEO. Let me start with some reflections on our financial performance before I dive into more detail. To the operator. Notably, we continue to strengthen our balance sheet and improve cash flows, reducing inventory 29% year over year, to the operator for the Q1

Speaker 5

of 2019. Generating over

Speaker 4

$300,000,000 of free cash flow, further paying down our ABL balance and ending the quarter with to cash and equivalents of $1,400,000,000 nearly twice as much as last year. Even in a choppy consumer market, each to our brands maintained or gained share during the quarter, fueled particularly by strength in our women's business through great style and relevant fashion. To the operator. We delivered net sales within our previously communicated guidance range despite a weak apparel environment. We substantially completed the organizational to changes that we previewed earlier this year, which we continue to expect will drive about $300,000,000 in cost savings annually.

Speaker 4

To fully recoup the excess air costs we incurred during the pandemic. That combined with improved unit sell through rates driving AURs to enabled meaningful gross margin expansion despite the inflationary cost headwinds we have faced. And we believe the actions to improve our operations and to shore up the foundation of Gap Inc. Continue to position us well as we enter the second half of fiscal twenty twenty three and beyond. To the call.

Speaker 4

While we're pleased with this progress, we're mindful of the mixed economic and consumer environment in which we are operating. To the operator. With that backdrop, we continue to plan the business prudently and the outlook we're providing today for both the Q3 and fiscal 2023 to the Q2. Does contemplate the headwinds we continue to navigate in the second half of the year, while also taking on new challenges like the resumption of student loan payments. To the operator.

Speaker 4

Let me start now with our Q2 results. Net sales of $3,500,000,000 decreased 8% versus last year, to the operator for the Q2. Thank you, everyone. Thank you. Thank you.

Speaker 4

Thank you. Thank you. Thank you. Thank you. Thank you.

Speaker 4

Thank you. Thank you. Our next question comes from the line of to the operator. Online sales decreased 11% versus last year and represented 33% of total net sales in the quarter. As a reminder, the sale of Gap China completed at the beginning of the Q1 of fiscal 2023 had about to $60,000,000 or 2 point negative impact to net sales growth.

Speaker 4

There was also a 1 point foreign exchange headwind. To the operator. Excluding these factors, total company net sales would have been down about 5%. Comparable sales were down 6% in the quarter. To the operator.

Speaker 4

In spite of the sales declines, we're pleased to report that all 4 of our brands gained or maintained market share during the Q2, with particular strength in women's. To the operator. We know that regardless of market conditions, strong brands, brands that matter, win. So we remain focused on the levers and opportunities in our control to deliver on behalf of our customers, employees and shareholders. Let me now provide some sales color and highlights by brand.

Speaker 4

Starting with Old Navy.

Speaker 5

To the operator. Net sales in the Q2 were

Speaker 4

$1,960,000,000 Both net sales and comparable sales declined 6% versus last year. We're pleased that Old Navy again modestly gained share in the quarter despite increased softness in the active category as well as continued slower demand from the lower income consumer.

Speaker 5

To the next question.

Speaker 4

We believe that Old Navy remains well positioned given its value orientation in the marketplace. The Old Navy team has lined up great marketing, product and value to compete in the important back to school season. Turning to Gap brand. Gap brand total sales of $755,000,000 were down 14% versus last year and comparable sales were down 1%. Excluding the negative impacts to sales of 7 points related to the sale of Gap China, to the 2 points due to the shutdown of Yeezy Gap and the estimated one point from foreign exchange, net sales were down 4% versus last year, predominantly driven by store closures in North America.

Speaker 4

Women's was the standout segment in the quarter outpacing the market as the brand's reinvented icons are resonating with consumers. Gap continues to make great strides with exciting collaborations and partnerships as the brand executes against its strategy to reimagine its product icons in new and exciting ways. Earlier this month, Gap brand partnered with Love Shack to Fancy on a limited edition multi category capsule for every generation. The collaboration merches Gap's iconic styles with LoveShoc Fancies vintage inspired florals and feminine silhouettes. This most recent collaboration is a prime example of how Gap's to our strategy of partnering with relevant brands and individuals can create buzz and marketing for the brand, reaching new consumers and garnering more premium pricing.

Speaker 4

To the Banana Republic. 2nd quarter sales of $480,000,000 declined 11% year over year. Comparable sales were down 8%.

Speaker 5

To the Q1. Revenue remains impacted in the short term

Speaker 4

as the brand lapsed an outsized benefit last year, driven by the dramatic shift in customer preferences. To the Q1. Fyara continues to make impressive strides in its evolution to a premium lifestyle brand. Fine fabrics like linen, cashmere and leather showed signs of strength in the quarter to the brand expects to maximize them in the back half of the year. Banana Republic's transformation towards a more evolved lifestyle position Coming to life through an elevated fashion aesthetic and more full price selling.

Speaker 4

As we look to the future, we're excited to see the brand to extend its vision and refined aesthetic to other addressable markets with BR Home, including the launch of premium bedding, rugs, pillows and decor in March and the upcoming debut of a broader home offering this fall. Athleta sales of $341,000,000 to the Q1 of 2019. We are now in the Q1 of 2019. We are now in the Q1 of 2019. We are now in the to the Q1 of Athleta's assortment accelerated throughout the quarter and outperformed total brand sales.

Speaker 4

Athleta's positioning, empowering a community of to women and girls to reach their true potential through the power of She is as relevant and impactful as ever. The work the team has been doing to improve product presentation, customer experience and creative in the short term, optimizing online marketing, site merchandising and resetting store floors in key markets to the team. We're really excited to welcome Chris Blakeslee to the team. As a proven leader in driving growth and innovation in the active apparel and wellness sector, most recently at Alo Yoga, We look forward to the work he and the team will drive to bring the Athleta brand to its full potential over the long term.

Speaker 5

To the operator. Now turning to gross margin in the quarter. Gross margin was

Speaker 4

37.6%, an increase of 310 basis points to the Q1 of 2019 versus last year's reported gross margin. Compared to last year's adjusted rate, gross margin expanded 160 basis points due to merchandise margin expansion of approximately 260 basis points, which was slightly ahead of our expectations, to the call, partially offset by raw deleverage of 100 basis points. Drivers of the margin rate expansion were as follows: to approximately 200 basis points of leverage as we lapped last year's elevated airfreight and drove our normalized air expense down. To approximately 200 basis points of leverage driven primarily from improved promotional activity relative to last year, to approximately 140 basis points of deleverage related to inflationary cost headwinds, which was better than our prior expectations to the operator to the operator to discuss approximately 200 basis points as we realized improved ocean freight rates. And ROD was flat on a nominal basis compared to last year, but deleveraged 100 basis points due to the lower sales volume.

Speaker 4

Now let me turn to SG and A. To the call. Reported SG and A in the Q2 was $1,200,000,000 and included $13,000,000 in restructuring charges related to our headcount actions. To the operator. On an adjusted basis, 2nd quarter SG and A declined 8% and leveraged 10 basis points versus last year, driven mainly by lower advertising expense, payroll and technology investments.

Speaker 4

Reported operating income was $106,000,000 to the operator. Adjusted operating income, which excludes restructuring charges, was $119,000,000 in the 2nd quarter. To the operator. Adjusted operating margin improved 170 basis points from last year to 3.4% in the quarter, driven by the 160 basis to the Q2 of 2019. During the Q2, we recorded a benefit to both tax and net interest as a result of a transfer pricing settlement related to our sourcing activities.

Speaker 4

Reported EPS was $0.32 to the operator. Adjusted EPS, which excludes restructuring charges, was $0.34 Share count ended at 369,000,000 to the Q2. Turning to balance sheet and cash flow, starting with inventory. Ending inventories declined 29% in Q2 versus last year. To the operator.

Speaker 4

This includes a 9 percentage point decline related to in transit as we lap the prior year supply chain challenges And 6 points of decline related to releasing the majority of our pack and hold inventory balance. The remaining 14 point to the Q1 of 2019. As you know, we made significant progress on reducing inventories as we exited fiscal 2022. To the operator. We remain focused in fiscal 2023 on moderating buys and utilizing our responsive levers.

Speaker 4

As a result, we are to our Q3 financial results. We are now planning for year over year inventory to be down generally in line with year to date trends at the end of Q3. Quarter end cash and equivalents were $1,400,000,000 to an increase of 91% from the prior year. Year to date net cash from operating activities was $528,000,000 driven primarily by lower inventory levels. Capital expenditures were $199,000,000 We are pleased to have generated free cash to the Q3 of fiscal year 2019,000,000 year to date.

Speaker 4

As we told you last quarter, we expect to be positioned to pay down the $350,000,000 draw on our to our Investor Relations Asset Backed line of credit this year. During the quarter, we paid down $200,000,000 and intend to pay down the remaining to $150,000,000 balance by the end of the year. We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns. To the Q3, we paid a dividend of $0.15 per share. And on August 16, our Board approved maintaining that $0.15 dividend for the Q3 of fiscal 2023.

Speaker 4

Now turning to our outlook. We are all well aware of the mixed to the Q3. We are pleased with the progress we made in the Q3. To the operator. As a result, we continue to be prudent in our approach to planning in light of what remains an uncertain macro environment and choppy consumer backdrop.

Speaker 4

To the call. We now anticipate fiscal 2023 net sales, inclusive of the 53rd week, to be down generally in the mid single digit range to the Q1 of 2019 compared to $15,600,000,000 in net sales last year and similar to our first half twenty twenty three sales performance.

Speaker 5

To the

Speaker 4

next question. The extra week is estimated to add approximately $150,000,000 to 4th quarter and fiscal 2023 net sales. To the Q3 sales, we're encouraged by trend improvements as we exit Q2 and into August. To the operator. However, we remain mindful of 2 important dynamics for the quarter.

Speaker 4

First, we are lapping tougher sales comparisons from last year. And second, as mentioned, we remain measured in our outlook. With these dynamics in mind, we are estimating 3rd quarter net sales to be down in the low double digit to the $4,040,000,000 in net sales last year. Turning to gross margin. To the full year compared to the 35% adjusted gross margin in fiscal 2022, gross margin to the company's financial results.

Speaker 4

Expansion in fiscal 2023 is expected to be driven by the following factors: an estimated 200 basis points of leverage as we lap last year's elevated airfreight and continue to drive down normalized air expense. At least 100 basis points of margin benefit as a result of our better inventory position and expected improved promotional activity compared to last year. To approximately 10 basis points of inflationary cost deleverage versus last year. As we look to the second half, we expect the inflationary deleverage in the first half to the Q1 of 2019. We'll shift to leverage in the back half as we benefit from both improved commodity costs and ocean freight rates.

Speaker 4

And Rod as a percentage of sales is now planned to deleverage roughly 70 basis points compared to last year. To the Q3. For the Q3, we expect gross margin to be generally in line with last year's adjusted gross margin of 38.7%. To the operator. We anticipate lower inflation and air costs slightly below normalized levels are expected to offset approximately 150 basis points of rod deleverage.

Speaker 4

And we expect that promotional activity will be largely in line with last year. Turning to SG and A, we now to expect fiscal 2023 SG and A of approximately $5,150,000,000 below our prior outlook of $5,200,000,000 to the operator, primarily driven by variable expense flow through on our narrowed fiscal 2023 sales. SG and A in the 3rd quarter is to the operator. We continue to expect capital expenditures of approximately $500,000,000 to $525,000,000 for the year. In closing, we're pleased to drive meaningful margin expansion and strong cash flow generation in the quarter and remain focused on delivering our fiscal 2023 outlook despite what continues to be a choppy consumer environment.

Speaker 4

I'm looking forward to working with Richard and the team as we unlock the value of our important and iconic brands and 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 call for questions. Operator?

Speaker 5

To the operator.

Operator

Thank you. As a reminder, for those analysts who wish to participate in the question and answer session after the presentation, to you. Our first question will come from Matthew Boss with JPMorgan. Your line is open.

Speaker 3

Great. Thanks. So maybe a 2 part question. Richard, could you elaborate on the encouraging signs progress that you see across the organization and maybe just as we think about opportunity for your concepts to take market share over time. And then, Katrina, maybe just any way to elaborate on trends that you saw progress as the Q2 move forward?

Speaker 3

And maybe what you're seeing today in terms of consumer behavior in August and into back to school. Well, first off, thank you, Matthew, for the question. And I'll start with Saying again how excited I am to be here on my 3rd day. What I can tell you in the context of where we are, to the operator. First and foremost is that these brands are incredible assets.

Speaker 3

Gap, Old Navy, Banana Republic, Athleta, These are truly some of the most iconic brands in the fashion industry. We serve such a broad based consumer, Which is such a strength as well, generations and backgrounds. We've got incredible storied legacies, to 54 year old history. We created massive trends. When I look at the strength across the portfolio, to As I mentioned in my opening remarks, it was the number one specialty apparel company in America.

Speaker 3

The Scale that we operate with 600,000,000 store visits, 1,400,000,000 online visits, to the scaled operations we have from our DC network and logistics, our vendor partnerships, which can provide us incredible favorable rates to service our production. We produce over 900,000,000 units annually. The stats and strength The fundamentals of this business are pretty incredible. Clearly, the transformation work that the team has done Has put us on incredibly better financial footing. As Katrina mentioned again $1,400,000,000 in cash on hand in the balance sheet, to $300,000,000 of cash flow, 30 percent less inventory.

Speaker 3

These are metrics that matter and ultimately metrics that are incredibly encouraging in the context to our ability to build upon it and continue it and go forward. As I also mentioned, part 2 to the question in terms of to where are the opportunities? These are brands that truly matter. Now, as I also said, they can matter more. And how to do that, I talk about reigniting the creative culture at Gap.

Speaker 3

We have extraordinary talent here. To we are going to not only encourage the great talent to be unlocked in new and innovative ways, but we're also going to become a magnet for the industry's best talent. We are going to work very specifically with intent on creating distinctive brand purposes and ultimately to really driving a consumer proposition that sets us apart from the competition and really leveraging, if you will, the art and science of this business, informed by consumer insights, but ultimately really obsessing over the consumer. There's a lot of work ahead, but I'm incredibly encouraged with 3 days in around what we can offer and where we're going ahead. And obviously, in the days ahead, quarters ahead as well, we'll get more details and look forward to sharing that with you.

Speaker 4

Thanks, Richard. And Matthew, I think on your other part of your question, We saw sequential improvement throughout the quarter in Q2, where in July, we We saw more improvement than we had seen sort of in May June. I think that mirrored a lot of what apparel showed overall. And we've seen that improvement continue into August, which we're encouraged by. Overall, what we're seeing is that the women's business, particularly Japan Old Navy has shown momentum shift and kids and babies were in the important back to school period has also started off fairly well.

Speaker 4

So all of that is encouraging to see. And then as I said in my prepared remarks, we're mindful though of the fact That we've seen the consumer still be pressured, especially at the low income range. And we're watchful of what I think is widely reported as the student loan repayment coming in the end of the quarter, which does primarily impact our Old Navy consumer.

Speaker 3

It's great color. Welcome aboard, Richard. Thank you.

Operator

Our next question comes from Paul Lejuez with Citi. Your line is open.

Speaker 6

Hey, thanks guys. Richard, you've been on the Board, so obviously in touch with what's been going on Operationally, to some extent, so I'm curious what you think might be the lowest hanging fruit as you think about each of the brands. Also curious, big organization, you talked about scale, profitability doesn't quite match The efficiencies you would expect with such scale. So I'm curious what you think are the biggest inefficiencies at the company? Thanks.

Speaker 3

Yes. Thanks, Paul. Look, broadly speaking, it's about really reigniting Gap Inc. Culture to to really empower creativity. In my experience on the Board and certainly on the ground for 3 days running fast, Our teams are incredibly creative and they're all in on this.

Speaker 3

They're differentiating and strengthening our brands, being design centric, to being customer obsessed and ultimately being culturally relevant. These are not necessarily new phrases And their common language, but these are the areas that we need to work upon and reignite, and ultimately really to think about how our brands show up in store, online with consumer experiences that really excite and attract, to drive demand and all of the variables that go into kind of balancing wants and needs that ultimately is kind of where fashion lies. When I think about our brands in the context of opportunity, brands that have the kind of strengths that we do, Brands that matter, can be monetized. We need to make these brands matter more. And ultimately, that is going to be the pursuit.

Speaker 3

When I look at the strengths of the business, it is incredibly encouraging. That being said, we have work to do. To we've started this transformation work under Bobby's leadership and the team has worked tirelessly to make extraordinary progress. But we will continue not only the transformation that we've begun, but we will start to build upon it and really unlock the value of these brands. We can all agree that there is greater value in the portfolio than is showing up in the stock today.

Speaker 3

And with the consistent performance that we expect, we're going to get rewarded for that. And ultimately, that's going to start with really driving demand, exciting our consumers and mattering more. And we'll be back very shortly to share how we're going to reveal all of that and continue moving forward.

Speaker 6

Okay. Thanks. So could you just talk about what changed in your gross margin assumption for the back half of the year, Which pieces moved as a result of what you've seen first half to date and what you're seeing thus far in the Q3? Thanks.

Speaker 4

Yes, absolutely, Paul. So, in Q2, overall, the gross margin in total came in very close to, I I think the words we had used to get you guys close to the margin we just delivered, there was a little bit of a shift between to the inflationary pressure, which was better, came in at about 140 basis points of headwind. We had thought it would be closer to 200. And that was really because we saw rates in the freight area get better through some negotiations we just finished with some of our big suppliers. And where we saw the margin get a little worse was in rod, where we deleveraged more since we came in at the lower end of our sales range in the quarter.

Speaker 4

So that dynamic plays through to the year where again the overall guide on the full year margin is basically intact. Air is still about 200 basis points of benefit, but we now see less impact from inflation, so only 10 basis points versus we had prior said 50 basis points of headwind. And then the offset there is rod where we now expect 70 basis points of deleverage, where as we had said somewhere between $0.50 So it's really this inflationary benefit offset by raw deleverage, but overall the nominal

Speaker 6

And the promotional level is different than what you expected?

Speaker 4

We came in very close in the second quarter to to what we expected on promotions and overall we're holding the full year to about 100 basis points of overall leverage coming out of that promotional guide. And for Q3, what we said is we expect promotions to be about flat. So we'll see. Obviously, we came in with inventories down 29%, to Markdown inventory well under control, and the teams are excited to have Chase capability back after the supply disruption that we experienced for so long. So we'll aspire to do better, but right now that's what's embedded in the guide.

Speaker 6

Thanks, Kumar.

Operator

Ladies and gentlemen, as a reminder, please limit your questions to 1 per participant. Your next question comes from Alex Stratton with Morgan Stanley. Your line is

Speaker 4

open. Perfect. Thanks for taking the question. Welcome, Richard. Katrina, maybe this is best for you.

Speaker 4

It looks like Old Navy has yet to unselect, though we are seeing some other value oriented businesses pulling that off it seems in this quarter. So can you talk to me about what's going on there? Are you seeing any green shoots outside of women's? I feel like we've had that maybe for a couple of quarters now. And then how you think about the timeline to improvement?

Speaker 4

Thanks a lot. Yes, it's a great question, Alex. So, When I look at what's been happening at Old Navy, I think what's been consistent is what we've been calling out, which is they do have a low income consumer that remains pressured. And so that dynamic hasn't necessarily changed. When I look at what happened in Q2 though, lapping last year's significant clearance of to the Q1 of 2019.

Speaker 4

Active product in particular really weighed on the performance. If you remember last year in Old Navy, we were in the process of really rightsizing the assortment away from cozy casual. We had a lot of the sizing issues. So lapping that has really weighed on the revenue side of things. As we move into the second half, we are seeing the active business improve modestly, women's is getting better and kids is So we'll see where that all lands us.

Speaker 4

But yes, we are seeing green shoots at Old Navy. I think all of those categories to the next question. We aspire to have Getting Better. Again, the consumer pressure is most acute at Old Navy and that's the piece that I think we all remain cautious on is to the Q and A.

Speaker 5

Whether it's the low income consumer starting to

Speaker 4

get real wage pressure from inflation or whether it's the new student loan dynamic, we'll see how that plays out for Old Navy. Thanks a lot. Good luck. Thanks, Alex.

Operator

Our next question comes from Lorraine Hutchinson with Bank of America. Your line is open.

Speaker 7

Thank you. Good afternoon. Katrina, as you

Speaker 4

think about the mid single digit decline in sales guidance for the year, to the Q4. Can you just talk about how you've been thinking about that improvement? What drives it outside of the 53rd week, course and how you're getting comfortable with that level of improvement from here. Yes. So Lorraine, You're correct that the Q4 does have some benefit from the 53rd week.

Speaker 4

But in addition to that, I know we're all tired of looking back to 2019, but I just sort of look at the run rate in the business from the first half to the back half versus 2019. And the quarters Q3 and Q4 are very similar to what we just sort of went through. So I think there's a lot of quarterly variation that we have seen over the last couple of years. Q4, when you look back to 2019, looks more similar to history.

Speaker 7

Thank you.

Operator

Our next question comes from Donna Kim with TD Cowen. Your line is open.

Speaker 4

Thanks for taking my question. Just a question on Athleta, sort of how you're thinking about to the brand and getting the brand back on growth over time and just be competitive in the market. Thank you so much. Yes, I'll take that. And I mean, Richard, of course, I welcome your view as well.

Speaker 4

But maybe I'll start and then you can say a little bit more. As I said in my prepared remarks, we feel really good about Athleta's positioning in the marketplace. The power of she positioning is incredibly strong and we feel like we have a lot of white space in that brand to win. We knew we had some near term Product execution issues, which the team, as I said, has been heads down working on. For fall, there's not a lot of change to the product that the teams have been able to do, but they've been remerchandising the stores and the site.

Speaker 4

And hopefully, to if you're a consumer, you see that it looks much more in line with the brand aesthetic. And then we are excited to welcome to a few new players to the team, whether it's Chris or Julia, who we think will also bring their experience to bear on the brand starting in Q4 and then really into next year. So we're very excited about Athleta's potential long term and we know we're just sort of going to get through the next Quarter or 2 as we make the changes we can to the assortment we have. But Richard, I'll let you add if there's something else.

Speaker 3

Yes. Thanks, Katrina. Jenna, as to a member of the Board. I had a chance to get to know Chris and to help select him for this role. He's an exceptional talent, to broad based experience across the apparel, retail and wholesale industries, holding roles across multiple functions.

Speaker 3

To as the recent President of Allo Yoga, he was really able to successfully and quickly grow that brand, nearly doubling its year over year growth And with extraordinary expertise in performance apparel. So as Katrina called out, we couldn't be more enthusiastic about to the team that Chris is leading and their recent efforts, and we're really looking forward to the accelerated progress that we intend on making with this brand. To the

Operator

operator. Our next question comes from Bob Drbul with Guggenheim Securities. Your line is open.

Speaker 8

Hi, good afternoon and Richard, welcome. I guess, Richard, for you, when you look at the you talked about Chris, but when you look at the team that you have in place, having been on the Board, I think you understand their vision. Should we assume there are no further management changes necessary at a very senior level as you look at the portfolio?

Speaker 3

Yes. Thanks, Bob, for the question. I've been on the Board since last year when much of the work began taking root. And I feel I could really hit the ground running. That said, it's early.

Speaker 3

I'm focused on listening and learning. We really do have a very strong team. I only see it getting stronger. So in the context of, let's call it, board tenure, and now obviously 3 days in, from what I feel and see in the context of being on the ground, I'm very encouraged. To the work that the team has done around the transformation has really toiled the soil, if you will, in the context of my entrance and really feel like The baton being handed is strong.

Speaker 3

So with that said, we'll share a lot more in the coming quarters around where we're headed, how we're going to get there and ultimately much more detail associated with it. But early days, I'm very encouraged.

Speaker 8

Great. And Katrina, if I could just sneak a second one in for you. In terms you made some progress on the SG and A. I know there's been some discussion around potential for further cuts. Is there any sort of further idea on additional opportunities as you look at the SG and A line going forward?

Speaker 4

Yes, it's a good question, Bob. I mean, when we look at the work we've done, we've impacted about $550,000,000 of a cost to the business, whether it's the actions we took early last fall that have helped offset some of the Inflationary pressure this year or whether it's the overhead actions we just took that we think will generate $300,000,000 in costs. So I think you've heard both Bobby and Richard say that we're happy with a lot of this work we've done to set the foundation. The remaining SG and A work I think is to be seen. A lot of it is on some of the demand generating to the segments we've made, marketing and technology, where I think Richard and I will really partner on assessing whether we think those are Adding the value that we think they need to add or whether there are some refinements we can make there.

Speaker 4

And that's the next leg of the journey for us to see how we would if we would to really moderate those in the next coming quarters. So more to come, but those are the areas I think consistent with what we've been saying that we would look at.

Speaker 3

Thank you.

Operator

Our next question comes from Cory Tarlow with Jefferies. Your line is open.

Speaker 9

Great. Thanks for taking my questions and welcome Richard. You mentioned in your prepared remarks about to how you're rethinking about how the brands show up in stores and online. So just be curious to kind of get your thoughts. And again, having been on the Board since November your thoughts around kind of the store fleet and how to profitably leverage to the store fleet to drive further sales ahead.

Speaker 9

And then just Katrina, just wanted to get your thoughts around, apologies if I missed it on promotions in the second half of this year.

Speaker 3

Yes. Thanks, Corey. There's a lot in my opening remarks and we can double click on many of them. But in the context of the areas that I see, the most opportunities that's specific to really working on this distinctive brand purpose that aligns with our customer values and really sets them apart. Yes.

Speaker 3

As I talk about the brands and their legacies, I really these are brands that matter. And when you have brands that matter, they can be monetized. That being said, you have to make these brands matter more. That has to have great product, great marketing, great execution, And we really need to understand and be obsessed with our customer. I think that we have elements of it, but where we're going to really work very, very diligently on is creating meaningful differences in the context of our brands and making these brands matter more.

Speaker 3

When you look at our stores, they need to reflect, if you will, the right narrative in the context of to product statements that we believe are heroic, products that we believe will matter to our consumers, the right balance between basics and fashion And an experience where details really come across to create an experience that consumers will talk about, want to return to and ultimately find, If you will, the value and quality and product experiences that are required today for brands that win. And that's what you're going to see us work much more diligently on. As transformations go, these things take time, But we will start to test and roll and really learn essentially what works and what doesn't in a more accelerated way So that we could do more of what works and do less of what doesn't. Lots more to come with lots more examples and we'll share those as they evolve.

Speaker 4

Yes, it's great Richard. And I think, Corey, to answer your second question, we did see to successful expansion of gross margin with lower promotional levels in the second quarter. So, to the operator. We saw about 200 basis points of margin expansion coming from lower discounting in the second quarter. Right now in our outlook, we have basically to a flat level of promotional activity in Q3.

Speaker 4

So as we talked about, we'll aspire to do better with the lower inventory levels and chase that we have. But we remain cautious on the consumer and so we definitely want to make sure that we're offering enough value to the consumer heading into the Q3. So we'll see where that lands.

Speaker 9

Great. Thank you very much.

Operator

Our next question comes from Adrienne Yih with Barclays. Your line is open.

Speaker 10

Great. Thank you very much. Richard, this is sort of more of a philosophical question, given you're only been there 3 days, So your tenure at Mattel was sort of similar in concept sort of reinvigorate to the core brands, restore growth, and restore the position sort of as an industry leader. So I guess my question is, Oftentimes when you have a company that's been struggling, the creative team and all those assets get very safe, right? So they become very risk averse.

Speaker 10

I'm just wondering how do you create a culture of greater risk taking and innovation such that that creativity can kind of come to the forefront?

Speaker 3

Yes. Adrian, thank you for that question. It's a great question. There are a lot of parallels with my experience to At Mattel and Gap Inc. Business across many levels.

Speaker 3

And I'm here to architect and orchestrate ultimately to lead. And the parallel construction of where Mattel was and where Gap is, is very familiar. To great assets, great talent, a moment where to some extent a lot of self inflicted challenges, Some within our control and some ultimately impacting our business and our industry. And ultimately, to a phase that we are going to go through, which is really about unlocking the value of our brands through reigniting a creative culture. The balance of fundamental and or fiscal responsibility and operational rigor, while you are Driving a design centric and creative culture is the art and science of the leadership that you need to have in this business.

Speaker 3

It is a very familiar language. It's actually a very familiar model. And ultimately, you've got to be able to to take swings that are calculated, test, roll, learn and scale and accelerate very, very quickly. That is a muscle that we will begin to exercise and strengthen with the experience that I bring in the context of to that type of leadership. I believe that that's going to add value very, very quickly.

Speaker 3

This is an organization that is really excited to unlock and reignite, if you will, creativity. And so I feel incredibly Fortunate to be inheriting a business that from a transformational perspective has come through, if you will, a very heavy lift And is now delivering, if you will, a fertile ground for a design led culture, creativity that ultimately will show up for consumers and the ability for us to make brands that matter, matter more.

Speaker 10

Thanks. That's super helpful. Katrina, one quick one. Sorry, did you talk about shrink? When do you take your physicals?

Speaker 10

I think it's mid year, but I may be wrong. And is there anything that to call out there of note? Thank you very much.

Speaker 4

Yes. Thanks, Adrienne. There's nothing notable to call out From us on shrink, we do full counts once a year in the early part of the year Q1. We do do partials in the to the second half of the year and as of now our shrink remains below pre pandemic levels and there's really nothing to call out. So shrink Is so far for us not anything of note.

Speaker 10

Okay. Thank you very much and best of luck and welcome.

Speaker 3

Thank you.

Operator

Our next question comes from Dana Telsey with Telsey Group. Your line is open.

Speaker 7

Hi, good afternoon, everyone, and welcome, Richard. Just following Richard in terms of some of the thoughts what you've done in the past, I've read some of the articles about how you put together the thoughts on brand relevance of 4 points, why do we exist, design led innovation, to the culture relevant and execute with excellence. How do you look at those initiatives or those topics in comparison to GAAP and your initial thoughts on reinventing and re architecting the business model in any way. And then Katrina just wanted to follow-up on as you think about 2020 forum planning, how you're thinking about inventories for the back half of the year and into next year. Thank you.

Speaker 3

Thank you. Dana, thank you for the study of to my background and playbook at Mattel. My experience in turning brands around and accelerating performance, It goes beyond the development of a playbook, but really rallying teams to deliver on a plan, ensuring operational rigor and enabling a culture to to Execute with Excellence. In the context of that methodology, when you look at to Gap Brands. These are beloved brands.

Speaker 3

They have a real connection with consumers and we need to reignite that connection. To I'm passionate about motivating teams to uncover what made a brand or a company iconic and special in the first place and then working together to reinvigorate them to new relevance. So the familiarities in the context of the work And legacy brands, revitalization methodologies are familiar and similar. That being said, the playbook that we will reveal that will be the strength and the consideration set to reignite The Gap portfolio will be one that we collectively work on as a team as I listen, learn, spend time with our to stores, our headquarters, DCs, partners and really start to understand ultimately what will be the Gap playbook that will deliver ultimately to our consumers, our people and our shareholders. And we'll be back shortly to be able to share all of that.

Speaker 4

And then Dana on inventory, we do expect that Q3 ending inventory will be very similar to the first half trends. And overall, more to come as we head into next year, but we expect to be running more and more on leaner inventory with receipts left open so that we can be more responsive to consumer demand closer in. And a lot of the transformational activity that we're working on is, not only just reinstating the responsive levers that we've had, to working closer with our vendor base to make sure that we have the right materials, the right logic with our vendors to be closer to the consumer. So all of that helps us have leaner inventories and be more dynamic. So more to come on what those levels are going forward.

Speaker 7

Thank you.

Operator

Our last question comes from the line of Brooke Roach with Goldman Sachs. Your line is open. To

Speaker 11

Good afternoon and thank you for taking our question and welcome Richard. I wanted to follow-up on Old Navy. Can you elaborate on the competitive backdrop that you're seeing in the business today, particularly as Old Navy competes for that value oriented to customer who has options both online and with other discounters. And are you seeing any benefits from a trade down customer in your stores?

Speaker 4

Yes, Brooke. I mean, what we're seeing is that some of the brands that are really winning with our consumer are to T. J. Maxx, Amazon, Cheyenne, we're definitely seeing those businesses gaining share And those compete with our customer, we're also seeing strong brands like Nike and Lulu and Adidas win, Which tells us that great brands win in any economic environment. Old Navy has the Benefit of being the number 2 brand behind Nike.

Speaker 4

And so it is a big player in the branded space as well as being Taylor. So I'm thrilled to have Richard on board with his experience in creating relevant brands and that brand already has such a strong positioning. I think We have a lot to do there to keep winning in that space. So, more to come there, but we're glad with their positioning for sure.

Speaker 11

To the operator. The

Speaker 4

trade down benefit, we're not currently seeing any trade down benefit. That said, we're certainly positioned to add value to any consumer as we move forward since our goal is to have great fashion and a great value. So, But we're not seeing that yet.

Speaker 11

Thanks, Katrina. If I could just follow-up on one other topic. We've heard a number of companies this week address to credit and card portfolios amidst some of the macro concerns that we're seeing in the environment broadly. Can you to provide a brief update on how you're planning your credit business and what might be planned in your outlook for the rest

Speaker 7

of the year? Thank you.

Speaker 4

Yes, it's a good question, Brooke, and certainly we're watching that too. So, any trends in credit card income That we see from industry reports or see within our own business are currently reflected in the outlook we provided today. We do see same as the industry reports loss rates increasing from the recent lows in 2021 2022. However, ours are not back to pre pandemic levels yet. And we're working with our credit card provider to adjust our underwriting strategies to make sure we're mitigating risk of higher delinquencies, while still providing our customers with flexibility.

Speaker 4

So, we're actively monitoring the consumer environment. We're watching the impact to credit And all of the trends on the credit card customer, again, are in the outlook we just provided.

Speaker 11

To the operator. Great. Best of luck

Speaker 5

and thanks again.

Speaker 4

Thanks, Brook.

Operator

Thank you. We've reached the end of the question and answer session. And I'll now turn the call over to Richard Dickson for closing remarks.

Speaker 3

To Thank you. I'd like to thank all of you for your time, your interest and your questions. And I just want to reiterate my belief in Gap Inc, to our people, our brands and how truly thrilled I am to be the CEO of this extraordinary company. I also just want to thank the people of Gap Inc. For this incredibly warm welcome and to thank Bobby in particular for his tireless leadership over the past year and for igniting transformative work that I really am eager to pick up and run with.

Speaker 3

And all of you who joined the call today. I look forward to meeting all of you in the coming weeks months and thank you all for joining. To

Speaker 5

the operator.

Operator

Thank you. That does conclude our conference call. You may now disconnect.

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Earnings Conference Call
GAP Q2 2024
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