Katrina O'Connell
Chief Financial Officer at GAP
Thanks, Sonia, and good afternoon, everyone. Building on the momentum from Q1, we delivered very strong second quarter results, with the backdrop of a strong consumer demand for our four purpose-led billion-dollar lifestyle brands remained high. As Sonia discussed, we believe this is the work of our team's tremendous progress on executing our Power Plan 2023 strategy.
Of note are the following. One, our strategy is driving growth consistently. First, Old Navy and Athleta grew 21% and 35%, respectively, in Q2 versus 2019, and combined represented 65% of Company's sales. Both brands delivered standout sales performance led by their brand strength, omnichannel offerings, and relevant product categories. Gap North America is growing, with a 12% two-year comp in the second quarter, demonstrating continued strength in our core North American market. This growth underscores the progress the brand is making in product and operations. We're pleased to have new leadership at Banana Republic, infusing creativity and improving customer experience, resulting in improved sales and operating performance in Q2 as the brand regains relevance.
We're becoming digitally dominant. Our online business grew 65% in Q2 versus 2019. At over $6 billion in sales, our online channel is ranked number two in U.S. apparel e-commerce sales. And then combined with our well-located fleet is a strategic advantage in serving our customers through the omnichannel lens. And we're targeting continued growth for all our brands, adding categories and reaching new addressable markets through extensions like home, plus size, and community and wellness as we strive for sustainable momentum.
Two, we're making the hard decisions to improve the Company's economic model and drive management focus on what matters. Our fleet rationalization is on track and driving significant economic value. Last year, we announced a plan to close 350 Gap and Banana Republic stores in North America and expect that 75% will be completed by the end of this year. These closures, along with lease negotiations and higher online sales, contributed to over 330 basis points of ROD leverage in Q2 versus 2019 and will contribute ongoing value for the remainder of the year. The transition of our European market to a new and more profitable operating model is underway and expected to be completed this year. We're making great progress on our goal of improving the performance and profitability of Gap brand as we partner to amplify through asset-light models and we successfully divested two smaller brands as we focus on our $4 billion purpose-driven lifestyle brands.
And three, we're leveraging the power and scale of our shared platform to enable our growth agenda and help us navigate the near-term volatility in the market. Some relevant examples are as follows. Our technology spend, enabled by our recent cloud migration, has been meaningfully deployed against new digital capabilities, improving site performance and enhancing customer experience across all of our brands. Our new tiered loyalty program rollout, combined with our already strong cross brands credit card program, enabled our 65 million known active customers to shop with rewards across our portfolio, maximizing customer lifetime value. Our scaled and automated DC network supports our online growth, and our improved loyalty shipping promise increased its efficiency and drives down fulfillment costs.
Strategic partnerships within our vendor base are allowing for rapid product innovation across the Company such as the launch of Old Navy's Powersoft active fabric sourced from fabric technology used in Athleta's Powervita collection, which has enabled Old Navy to dominate the value active space and has propelled the Company's total active growth, with sales on target for $4 billion in revenue in fiscal 2021. And our strength and size in Canada will enable Athleta to enter that market in Q3 seamlessly. There are more, but these are just a few examples of how the power of the platform is a competitive advantage to growing all of our brands as we drive this synergy of the portfolio with the scale of the platform.
Given our year-to-date performance and confidence in our strategy, we are raising our outlook for the year despite continuing macro headwinds. We now expect fiscal year 2021 sales to grow about 30% versus fiscal year 2020, and with an operating margin of about 7% on a reported basis and about 7.5% on an adjusted basis. This upwardly revised outlook puts us on an accelerated path toward our 2023 operating margin target of 10% plus. And we expect our fiscal year 2021 reported EPS to be in the range of $1.95 to $2.05, with adjusted EPS in the range of $2.10 to $2.25, a $0.50 increase from last quarter.
COVID variants continue to cause volatility in certain markets, and we're actively working through supply chain constraints, inflation, and wage pressure. We expect these challenges will continue for the remainder of the year, but our teams have been hard at work, leveraging our scale advantages and strong relationships with vendors and carriers to navigate materials and other cost increases and secure necessary ocean and air capacity to navigate supply chain delays.
Now, turning the second quarter financials. Net sales for the quarter were up 5% versus 2019, and comp sales increased 12% on a two-year basis. Permanent foreclosures and the divestitures of our Intermix and Janie & Jack businesses impacted sales by approximately 8 points. In our international markets, COVID-related foreclosures persisted for most of the quarter, resulting in an estimated 2 percentage point impact to sales versus 2019. We're pleased to report that while we're still carefully monitoring the COVID situation globally, as of the end of Q2, nearly all of our stores have reopened.
Even though store sales start to rebound, outsized online growth continues. Enabled by investments in our omnichannel capabilities, customers are getting a great experience engaging with our brands regardless of how they choose to shop with us. The online business grew 65% versus 2019 and contributed 33% of total sales in the quarter. As noted in our press release, second quarter reported results include an SG&A charge of $19 million, primarily related to the decision to close our stores business in the U.K. and Ireland, which will ultimately drive improved profitability and remove fixed costs from our structure. For details on sales by brand, please refer to our earnings press release.
In terms of gross margin, second quarter gross margin was 43.3%, reaching a historical high in the quarter and expanding 440 basis points versus 2019. The majority of expansion resulted from ROD leverage from online growth, strategic North American store closures, and the ongoing benefit of renegotiated rents for the remaining fleet. During the quarter, ROD leveraged by 330 basis points versus 2019, a trend that we expect to directionally carry forward in the second half of 2021. In addition, we were able to reduce discounting across all of our brands, resulting in meaningful average unit retail growth versus 2019 and significantly expanded product margins. Despite 130 basis points in higher shipping costs, primarily due to increased online demand, merchandise margins still improved versus 2019 by 110 basis points.
Turning to SG&A. On a reported basis, SG&A of 33.6% deleveraged by 180 basis points compared to fiscal 2019. On an adjusted basis, SG&A was 33.1% of sales, 260 basis points higher than 2019 adjusted SG&A. We are acutely focused on driving down fixed expenses to reinvest in demand generation as we look to grow sales in the long term. In Q2, our work on optimizing store expenses yielded about 150 basis points of benefit, helping to fund high-impact marketing, filling brand health and relevance. Marketing drove 230 basis points of the increase to 2019 as we leaned into further digital marketing, celebrity partnerships, and important growth initiatives like our integrated loyalty program launch.
The success we're seeing evidenced by improved profit margins and new customer acquisition gives us the confidence to lean into this important demand driving strategy in the second half as we expect marketing spend of approximately 6% of sales for the full year. In addition, we experienced approximately 200 basis points in higher bonus accrual costs related to our strong financial outlook and pay-for-performance philosophy.
Regarding operating margin, operating margin for the quarter was 9.7% on a reported basis. Adjusted operating margin of 10.2% increased 190 basis points versus 2019 adjusted operating margin. As the initiatives of our strategy take hold, we're encouraged to see the results through growing sales with improved profitability.
Moving on to taxes and interest, the effective tax rate was 28% for second quarter of fiscal 2021. Second quarter net interest expense was $50 million. Regarding earnings on the quarter, reported earnings per share for Q2 were $0.67, up $0.23 compared to 2019. Adjusted earnings per share were $0.70, an increase of $0.07 to 2019 adjusted EPS.
Turning to inventories, second quarter inventory ended up 2% compared to 2020 and down 2% to 2019. As part of our strategy to mitigate challenges within the supply chain due capacity and COVID impact, we are leveraging our scale advantages to ensure we have appropriate inventory to fuel sales growth during the important holiday season. We currently expect third quarter ending inventory to be up mid-single digits compared to last year.
Regarding the balance sheet and cash flow, we ended the quarter with $2.7 billion in cash, cash equivalents, and short-term investments. During the quarter, we paid the second quarter dividend of $0.12 per share and completed approximately $55 million in share repurchases as part of our plan to repurchase up to $200 million in shares this year to offset dilution. Earlier this month, we announced we will pay a third quarter dividend of $0.12, consistent with our plan to return cash to shareholders through a competitive dividend program. We ended the quarter with 376 million shares outstanding.
Finally, before we turn to our 2021 outlook, a brief update on the progress of our North America real estate plan and the transition of our European operating model. Year to date, we've closed 24 Gap and Banana Republic stores as part of our 350 store closure plan for North America. As a reminder, we expect to be about 75% complete on that plan by the end of 2021, with 189 North America stores closed in 2020 and 75 stores expected to close this year.
Old Navy and Athleta opened 25 and 13 stores respectively year-to-date on a path toward 30 to 40 openings at Old Navy and 20 to 30 openings at Athleta. Regarding the partner-to-amplify strategy we're deploying in our European market, we've announced that we are in discussions to move to the partnership model in France and Italy, and that while we will still maintain an online presence, we will be closing our store locations in the U.K. and Ireland. Year-to-date, we've closed 26 stores, with the remaining 58 stores expected to close by the end of September. In the short term, we're not projecting a benefit in the back half of 2021 due to employee and lease-related costs as we wind down the stores business. But these strategic changes are expected to drive earnings accretion on an annual basis. For some helpful context, in fiscal 2019, the European market generated $539 million in net sales. About half of these sales were generated by the U.K. and Ireland stores at a slight operating loss.
Now, I'd like to provide an update on our full-year financial outlook. We'll be providing both the reported and adjusted outlook for the year. Earnings per share are now expected to be in the range of $1.90 to $2.05 on a reported basis, which includes non-recurring charges related to divestitures and the impact of changes to our European operating model, totaling approximately $0.20. Excluding these charges, we expect adjusted EPS to be in the range of $2.10 to $2.25, a $0.50 increase to our prior guidance. We now expect sales growth of about 30% versus 2020. This incorporates the loss of sales due to store closures in the U.K. and Ireland.
Reported operating margin is expected to be about 7%. Our adjusted operating margin is expected to be about 7.5%, an increase of 150 basis points versus prior guidance, and puts us well on the path to the 10%-plus goal laid out in our Power Plan 2023. As we develop this outlook, we considered a number of scenarios, carefully balancing the benefits related to our brand strength, new product offerings, and loyalty program against the near-term expense from inflation and supply chain pressures, including sizable investments in airfreight to partially mitigate longer lead times and shipping delays so that our inventories will be well-positioned to compete during back to school and holiday.
Regarding capital expenditures, we continue to expect to spend approximately $800 million for the full year. Our strong cash generation is enabling investments in our sustainable growth strategy. With a sharp focus on ROIC, we're targeting high return investments in digital, loyalty, and supply chain capacity in addition to store growth at Old Navy and Athleta.
As I look forward, I'm energized by the following. First is that our strategic approach to growth is working. As Sonia articulated, we're driving growth in existing categories, and we're targeting new addressable shares rooted in customer trends with initiatives like BODEQUALITY at Old Navy and Athleta Canada launching in Q3. And our study of the homebody economy and wellness trends may open the door to other new and exciting growth categories and services in 2022 and beyond.
Next is our acute focus on customer lifetime value. With the formal launch of our integrated loyalty program in July, we're significantly increasing our ability to attract, interact with customers in a more personalized and meaningful way. The program has already grown to over 40 million members. And based on the early results from the program's soft launch last fall, we expect to see increased purchase frequency and higher average order size from loyalty numbers. In addition to driving better transaction economics within a brand, the program encourages consumers to become multi-brand loyalists through our universal rewards program. Loyalty is just one way that we've doubled down on building deep relationships with our customers that result in stickiness and deliver value.
Finally, our commitment to transforming the fixed costs in the business into demands generating dollars for investments or even expansion is showing results. Our fleet rationalization is deeply underway, our smaller brands have been divested, and our Partner to Amplify strategy for international operations is in flight. We've also begun to pivot our technology investments toward the digitization of the enterprise. From our inventory management transformation and shipping optimization work, to productivity improvements in stores using technology and proven automation practices from our DCs, we are now developing a roadmap for leveraging the use of data and AI to unlock trapped costs, increase speed, and aid in decision making, proactively unlocking investment dollars to drive long-term growth.
With that, I'll now turn the call over to the operator for questions.
